Detailed Abstractions

Well.  It’s official.  Not only do we have an economic crisis, but now we have an economic debate crisis…. apparently that is.

Why is it so important?

Easy… because without being able to spend more money than we can realize in revenue through taxation, we’re all going to die.  Just look around, this theoretically historically unprecedented permanently damaging possibility is sure to end the Republic as we know it:

President who tells us our senior citizens and military members will not get paid….

Bernake warns of catostrophy…

For others, our national security is at stake…. in fact, Al Qaeda itself might attack just because of this!

& on and on….

 With all of that looming, it’s not wonder someone has to be at fault….

There are alternative answers to defaulting itself, for instance let’s get rid of the ceiling altogether.  Or maybe, since a five dollar treasury bond and a five dollar bill are virtually the equivalent, why not give out more IOUs in a different form thereby removing the need for the ceiling in the first place?

But those ideas are centrist, so largely ignored and with a problem this large… someone has to be to blame.

So who is at fault?

Maybe the Tea Party’s fault?  Or maybe, like much of everything else, it’s Bush’s fault?  How about Governor Norquist?!?!

Or maybe there is no maybe.  Ask the brilliant policy minds over at The Rolling Stones, and they’ll tell you, that without question it’s the GOP’s fault.

For the logic minded, one might contend that the President, who refused to pass this perfect budget a year ago when his party controlled both legislative houses shares some blame.

But what do I know…. according to some Barack supporters, his only problem is being too much like the Big Gipper, the famous “let’s raise taxes” President…

The issue is, when you push predictions of doom and gloom for some scenario, blame has to be affixed quickly and preferably without relation to actual facts as that just muddies the waters.  Nope, the goal for almost every writer, seems to be scare tactics followed by blame.

There are a couple who have offered advice.  HBR for one had an interesting post about needing a moderator, perhaps Adam Smith.  It’s not an unpleasant thought and certainly a brilliant economic mind serving as moderator cannot help, but what most struck me about their advice is the same thing that struck me about most of those pieces blaming this or that: it misses who is truly responsible.

For when HBR states the Debt Ceiling Debate needs a moderator, I have to stop and say, they already do: the American public.  Certainly one could make the argument that the current moderators are abdicating their responsibilities and I might agree, but as much as one can delegate tasks, authority and responsibility cannot be delegated.

So sure, the public collectively can give moderator powers to Adam Smith or someone similar but alive, however the responsibility for the consequences of that process will still be the American people.

So…. is there a debate crisis?

Maybe not… as while many of us individually and seemingly ever single writer might view this whole process as out of control; seeing the whole thing as a demonstration in nothing more than the problems with this country, these are just mere opinions.

In all honesty, I’m sympathetic to that view.  However, the market place of ideas is free.  & If you analyze politics like one does the market, with the idea being the result cannot be wrong as the market is not wrong…

Then I think based upon the current political result I would submit a large enough percentage of voters have already cast their vote to continue the political infighting, applaud Pyrrhic victories, and any number of other actions which are designed to benefit their collective and not the average individual.

As proof of this reality, see incumbency rates, or polls which say cut things, but say no to all questions about what to cut, the current press articles being created because people are buying them, and more.  But even without those facts, the logic is simple: the current debate has to be ok with society at large because a free people is watching it happen and doing nothing, in a concerted effort, to substantially change anything.

So by virtue of its mere existence, it is the correct debate needed at this time.

& if it’s not?

Well, as Lincoln stated <paraphrased here>  ”As a nation of free men, we will live forever, or die by suicide.”

Well currently, the question is moot as the US government does own 61% of GM stock.  So they are the controlling shareholder, but it seems once again, pundits, journalists, and the rest are acting as if it’s a good thing only because it’s not as bad is it could be.

Via the Economist (here subtitled: An apology is due to Barack Obama: his takeover of GM could have gone horribly wrong, but it has not):

AMERICANS expect much from their president, but they do not think he should run car companies. Fortunately, Barack Obama agrees. This week the American government moved closer to getting rid of its stake in General Motors (GM) when the recently ex-bankrupt firm filed to offer its shares once more to the public…

Which sounds nice in theory, but in reality, the US Treasury through pressure by the Obama administration spent $50 billion dollars to own 61% of the shares.  With roughly 500 million shares available, this means the US government current owns 305 million shares.  At the current stock price today of .375 dollars, their 50 billion dollar investment is worth roughly 115 million dollars.

So even if a theoretical IPO that generates excitement were to happen, in order for the government to recoup $50 billion dollars the stock price will have to increase to $163 dollars a share or by more than 400 times it’s current price.

But of course when it’s not your money you lost, but taxpayers money, I guess that changes the calculus….

The Economist continues:

…Many people thought this bail-out (and a smaller one involving Chrysler, an even sicker firm) unwise. Governments have historically been lousy stewards of industry. Lovers of free markets (including The Economist) feared that Mr Obama might use GM as a political tool: perhaps favouring the unions who donate to Democrats or forcing the firm to build smaller, greener cars than consumers want to buy….

& here’s where it gets more confusing.  After stating the obvious concerns one would normally have when any business starts making decisions based upon politics instead of what’s best for the company (& also what they are legally bound to do, their fiduciary responsibility), they tell us those fears are wrong:

…Mr Obama has been tough from the start. GM had to promise to slim down dramatically—cutting jobs, shuttering factories and shedding brands—to win its lifeline. The firm was forced to declare bankruptcy. Shareholders were wiped out. Top managers were swept aside….

While simultaneously explaining to us how they did in fact make tons of political decisions:

Unions did win some special favours: when Chrysler was divided among its creditors, for example, a union health fund did far better than secured bondholders whose claims should have been senior….

DA posted about how the Obama administration used their leverage and power to bend the law to help the Unions over other creditors who should’ve legally be first in line for any monies (here).

But of course, that wasn’t the only political meddling in GM (the Economist):

Congress has put pressure on GM to build new models in America rather than Asia, and to keep open dealerships in certain electoral districts. But by and large Mr Obama has not used his stakes in GM and Chrysler for political ends….

Then why does the Economist think it’s a good idea?

[President Obama] his goal has been to restore both firms to health and then get out as quickly as possible. GM is now profitable again and Chrysler, managed by Fiat, is making progress. Taxpayers might even turn a profit when GM is sold….

& there we have it.  So long as there wasn’t a huge amount of political intervention and there’s a possibility that the government might recoup all their money…. Thing are good for The Economist.

Of course “good” is being defined by potential future results.  The truth is, the US government buying up private businesses creates far more implications that whether the stock prices rise enough to recoup the money they were given.

Enter Harvard Law School on Corporate Governance and Financial Regulation.  Instead of asserting some win based upon theoretical future value, they asked the more important question (here):

In our paper When the Government Is the Controlling Shareholder, recently made publicly available on SSRN, we analyze the ways in which existing corporate law structures of accountability change when the government is the controlling shareholder, and the extent to which federal “public law” structures substitute for displaced state “private law” norms.

& the implications are vast.  In their full research paper (here), they ask a much more serious and long term question.  Which is, what rights do other shareholders have when the government owns a controlling interest and is forcing companies to make decisions that will not benefit shareholders in the long term?

Normally, shareholders have legal rights at the state level where officers of any company are held legally liable to their fiduciary responsibility:

In the handling of money and when one acts as a corporate or individual trustee, there is a fiduciary responsibility owed to the principal party. It is defined as a relationship imposed by law where someone has voluntarily agreed to act in the capacity of a “caretaker” of another’s rights, assets and/or well being. The fiduciary owes an obligation to carry out the responsibilities with the utmost degree of “good faith, honesty, integrity, loyalty and undivided service of the beneficiaries interest.” The good faith has been interpreted to impose an obligation to act reasonably in order to avoid negligent handling of the beneficiary’s interests as well the duty not to favor ANYONE ELSE’S INTEREST (INCLUDING THE TRUSTEES OWN INTEREST) over that of the beneficiary. Further, if the agent should find him/herself in a position of conflicting interests, the agent must disclose the dual agency (acting for two parties at the same time) or risk being accused of constructive fraud in regards to both or either principals….

What this is for, is so shareholders can be protected.  If a company you own shares in decides to willfully make decisions which are counter to this responsibility, shareholders can sue for compensatory damages.

But what if the main decision maker is the federal government?  Even though the Economist seems to be ok with this, though recent history shows this is an incredibly naive position to take (from the full report):

Even though government investment started less than three years ago, there are already troubling anecdotes….

For instance, after the government purchased 71% of AIG and AIG gave 165 million dollars in bonuses which were contractually guaranteed, the “owners” responded with threats.  Senators and Congressmembers bemoaned this.  Told us it was unethical for AIG to follow their contractual obligations because the government owns them.  Even President Obama:

….urged Congress to draft legislation that sends “a strong signal to the executives who run these firms that such compensation will not be tolerated.”

As if Senators, Congressmen, and the President have any idea what pay should be in the first place… (DA post here), but they went further (from the full report):

Barney Frank, chairman of the House Financial Services Committee pushed the idea of suing AIG….

Since they have majority ownership:

[Barney Frank] “I still believe that we have a right legally to recover this, because we can assert our ownership rights and say, yes, you may have a contractual right to a bonus but your rotten performance means you should forfeit it”…

Additionally:

…”senior Treasury officials have been meeting several times a week all spring to review, one by one, the payments to the company’s executives. But the time-consuming discussions have never been resolved whether any of the executives should get paid.”  Now, even routine bonuses are pre-cleared with Kenneth Feinberg, the “compensation czar.”

& what of the bank bailouts?

…bailout recipients faced mounting pressure from the President and Congress to increase lending.  President Obama said he would “hold banks ‘fully accountable’ for the assistance they recieved and that they ‘will have to clearly demonstrate how taxpayer dollars result in more lending for the American taxpayer’”…

What about foreclosures, from people who can’t pay their mortgages?

Rep. Barney Frank “acknowledged that struggling homeowners [weren't] getting help as fast as many in Congress had hoped”, and urged bank executives to put in place a foreclosure moratorium until the government could implement mitigation programs.

These same people who also went after GM & Chrysler for closing too many dealerships.  And then there’s Citigroup, Bank of America, etc, etc, etc. (DA post here).

But this is Harvard, so they talk about ways other countries have handled this.  For instance, the UK started another government agency.  Theoretically it’s independent of politics, with a sole goal to find businesses which need to be saved and to save them.

Which of course is an entire other conversation…. why anyone believes the government can make the bad decision of buying a failing private company and solve the conflict of interest by simply building another government agency is…. well, it’s stupid.

It would be like having an entire corrupt police force arguing that the solution to the corruption is to merely hire more cops.

& therein lies the true problem.  When the press, politicians, and us normal voters, refuse to look into the future to see the true implications of such actions, we end up with answers like “since our [government's] original plan didn’t work, it must only be because we didn’t go far enough.”

I would submit to those willing to critically contemplate, that the decision itself was wrong & all these implications were obvious, known, and serve as further proof that politics and business don’t mix.

More importantly however, they fail in their analysis on a fundamental level.  True critical thinking can never rely on results as proof of anything.  Because it’s always possible to make a bad decision, and have positive results in spite of it.  It’s also completely possible that you make the most perfect decision ever, but it still fails.

So no – the question isn’t really whether the government made a good investment, whether taxpayers will actually recoup the $50 billion spent, or whether GM ultimately succeeds in the long run.

The question should be- should we have done it regardless of the answer to any of those questions?

& I would proffer the answer is easy: no.  The long range implications of such dangerous behavior isn’t worth saving one single car company.

Of course, that’s just my two synapses firing…. they could always be misfiring

Bank of America announced today it’s plans to repay the $45 billion dollars in tarp money to get out from under the restrictions of the government (AFP):

…The bank based in North Carolina said it would repurchase the preferred shares issued to the US Treasury as part of TARP, but would not immediately buy back the warrants, or options to buy additional shares.

“This is good news that the bank can get out of the TARP and can stop having to answer to public and government criticism,” said Jon Ogg at 24/7 Wall Street….

The policies BoA is trying to escape from includes restrictions on the top 25 individuals in the company including the CEO.  I and many others wrote about what a disastrous policy from the new administration this truly was (here):

…Even without bothering with the fact that the government is not in any position to understand what kind of compensation any single employee should have, this is still a radical and arbitrary move that if continued can work to destabilize the economy.

…this decision is an anathema to a free society breaking not only the contract rights of ordinary citizens, but also violating all individuals by pushing a blatant ex  post facto punishment…

Just two days earlier, I also wrote about BoA’s issues with getting a new CEO hired under all the government restrictions (here).  Indeed, at least four potential candidates have simply stated they don’t want the job.

Now, if these policies were actually designed to do this, incentivize those companies with TARP money to pay it back as quickly as possible, bravo!

Taking the language from the administration I doubt it, but it’s always good news when a major business under intense governmental scrutiny shows the quickest to its financial health is to remove the additional scrutiny.

This also  parallels with a recent NBER Paper on the global economic recession (abstract here, full paper purchase price $5).  In the full paper they try to prove the thesis that the main problem with the global economy is that investment money from developed countries should be flowing into developing countries, but instead developing countries such as India and China have investment income flowing into developed countries like the US & Britain.

& This seems pretty intuitive.  In general, investment money will flow to inefficient markets, industries, and companies in an immature market.  The reason is easy – it’s more and faster bang for the buck.  However, in a mature economy like the US and as we move forward in time, there are less and less efficiencies to be gained through anything other than new technologies.

In an immature market it’s the opposite case.  Industries and companies are new.  Small amounts of investment money can return great efficiency gains and therefore monetary gains.

Some people try to blame us citizens, consumerism, and capitalism in general for this failure, but that’s actually the opposite of the truth as well.  The reason Chinese citizens save so much more of their disposable income than do US citizens isn’t because they are more frugal, but have less real options to invest domestically even though major efficiency gains are theoretically possible.

As the abstract states:

…The inability of emerging economies to absorb savings through domestic investment and consumption due to inadequate national financial markets and difficulties in enforcing financial contracts; the currency controls motivated by immediate national objectives; and the inability of the US economy to adjust to the perverse incentives caused by huge money inflows leading to a breakdown of checks and balances at various financial institutions. The financial crisis in the US was but the first acute symptom that had to be treated. A sustainable recovery will only occur when the natural flow of capital from developed to developing nations is restored….

This doesn’t mean the US doesn’t have fault – so long as we continue to allow the government to write blank checks of any amount without respect to the deficit and ignoring huge unfunded liabilities such as MediCare – we seem to be on a sure path to a back slide.  I’m not really into prediction making as it’s obviously fraught with so many problems, but I’ll never understand how the solution to cheap money and an over investment of housing, is to keep money cheap and incentivize home buying (here).

Either way, it’s good news for BoA, with investors showing their interest with heavy after hours trading (here).

As should’ve been expected and according to all recent news, having a Treasury Department position of paymaster isn’t working out so well for the free market.

Earlier this year, against all basic free market principles the Obama Administration through the Treasury Department started setting up compensation boards (CNN):

WASHINGTON (CNN) — An amendment in the $787 billion economic stimulus package passed by Congress Friday would severely restrict bonuses and other forms of compensation for top executives at companies receiving federal bailout money….

Due to all the negative publicity surrounding the government’s handing over billions of dollars in tax payer dollars to corporations which deserved to fell, Senator Dodd explains:

…”The decisions of certain Wall Street executives to enrich themselves at the expense of taxpayers have seriously undermined public confidence in efforts to stabilize the economy. American taxpayers deserve better,” Dodd said….

Now it might just be me, but I’m not sure Wall Street executives are allowed to vote on appropriations bills and then force the treasury to distribute the funds as they see fit.  It seems Mr. Dodd is blaming Wall Street for the government’s failure to handle the crisis correctly.

With all logic aside though, they went forward.  Not only did they seek to limit overall compensation of the highest paid, but asked for refunds from bonuses already given – one provision in the bill:

…The secretary of the Treasury must review past compensation paid to the top 25 employees of TARP recipients and seek reimbursements “if those payments were contrary to the public interest or inconsistent with the purposes of the [stimulus package] or the TARP,” according to Dodd’s statement….

& People everywhere rejoiced…. I mean complained.  In what was an obviously anti-capitalist move sure to do more damage than any political good it might bring about, people everywhere spoke up (examples here, here, & here), including NBER (abstract here – paper costs $5):

…Important facts about compensation are that: the compensation distribution is highly skewed; each year, a sizeable fraction of chief executives lose money; the use of equity grants has increased; the income accruing to CEOs from the sale of stock has increased; regardless of the measure we adopt, compensation responds strongly to innovations in shareholder wealth; measured as dollar changes in compensation, incentives have strengthened over time, measured as percentage changes in wealth, they have not changed in any appreciable way….

Even little ole me could see this as a negative and wrote about this here just a month or so ago (here):

…Even without bothering with the fact that the government is not in any position to understand what kind of compensation any single employee should have, this is still a radical and arbitrary move that if continued can work to destabilize the economy.

…this decision is an anathema to a free society breaking not only the contract rights of ordinary citizens, but also violating all individuals by pushing a blatant ex  post facto punishment….

& now we have exactly what was shown through economic analysis and basic logic to be true (@Bloomberg):

Nov. 23 (Bloomberg) — Bank of America Corp.’s board may extend its search for a permanent new chief executive officer into 2010 if directors can’t settle on a candidate in the next three days, according to people familiar with the matter….

…At least four external candidates, including Citigroup Inc. director Michael O’Neill, rebuffed approaches….

…That’s narrowing the field and giving the board “an incredibly tough job,” said Michael Holland, who oversees more than $4 billion as chairman of Holland & Co. in New York. “For people who have choices, it’s hard to figure out why someone would take this job.”…

Is it now time to stop calling obvious results  (Un)?intended Consequences…