Survival Of The Unfittest?

"Greed is good," is the phrase that most comes to mind when thinking of the infamous villain Gordon Gekko in the movie Wall Street. I am not naive or crass enough to believe that greed is good, however Gekko did say another phrase that is much more relevant in today's world. He spoke about survival of the unfittest, and in recent history our nation's breakout of bailouts is creating a culture that is bringing to life Gekko's nightmare. Or at least that is the way an article within the Economist describes the culture, and not just in the US.

But the dramatic changes in the pecking order mask a lack of more profound change in the system of finance itself. Lehman aside, no big firms have been allowed to fail (as they would have done, unaided). Thanks to state aid, the law for big firms today is what Gordon Gekko, the red-blooded villain of the film “Wall Street”, dubbed “survival of the unfittest".

Don't jump to conclusions too quickly. The article is not a total advocation of complete free markets within the banking industry. The article makes some great points on why some government regulation is necessary, but warns of the dangers of setting a precedent of state guarantees.

Removing the explicit side of the state’s commitment is relatively simple. Some guarantees are still plainly needed now, but a firm deadline of, say, five years for the final expiry of the governments’ various crisis-induced pledges should be set globally. With the world economy in better shape, this looks more realistic than it did six months ago. But even then the implicit assumption will linger that banks will always be bailed out. This is the core problem. There are two possible responses to it: regulate banks to try to make them safer, and attempt to limit the implicit guarantee. Both approaches are now needed.

No one should pretend that banking is an industry where pure natural selection takes place. But as guarantees, both explicit and implicit, are withdrawn, the hope is that self-discipline will be imposed on banks, not just swathes of new regulation. There are signs that riskier banks are already paying more to finance themselves. This differentiation must be promoted, so the weak and reckless are gradually forced to shrink and live within their means—and not off taxpayers’ largesse.

I really like the article because it talks about some of the consequences of providing an 'implicit state guarantee' to the banks. The described guarantee is a fancy way of saying that we are starting down the slippery slope. I have blogged about the unforeseen consequences that can arise out of government deities deciding who lives and who dies, and this article illustrates some that are being to take shape. A good read from a good source of information.

Banks and Balance

Not sure I agree with everything in this article in Forbes, but there are some good points made. I think when it comes to banks it is a little trickier because people don’t act rationally when banks start failing. Banks are only required by law to maintain but a portion of the cash on hand that is managed within their institution. When people start pulling money out en masse banks don’t have the ability to get all the people their money. That reason alone makes it a little trickier to say that banks should be allowed to fail. However, I love how he illustrates the slippery slope of the 'too big to fail' mentality that I have blogged about numerous times.

For the institutions supposedly lucky enough to be tapped by our federal minders as too big to fail, the much remarked upon "optimistic" scenario is one in which their cost of capital will drop for them being protected by Washington. This ensures that the many financial institutions not important enough to fit under the Fed's umbrella will be weakened for having to lend in an environment distorted by larger institutions profiting from their tight relationship with Uncle Sam.

I also like how he spoke about profit and loss being the real regulators. Legislation is flawed and people will always find the most profitable approach given new guidelines, and undoubtedly new problems will arise from new legislation. What remains unchanged though is the desire to make a profit and avoid a loss.

For banking institutions more broadly, the Obama plan involves raising their capital requirements while putting rules in place to make sure they're got more exposure to the loans they securitize and sell. What's forgotten here is that without investor capital there are no banks, so while it may be comforting to think that the federal government can rearrange the path to banking profits, if investors don't agree, they can surely take their money elsewhere.

Along those lines, the beauty of finance is that it is fungible. If the stringent capital requirements make it difficult for stateside banks to operate profitably, the dollars that fill their coffers will move offshore along with myriad financial jobs. Almost to a man politicians worship at the altar of "job creation," but if the new capital requirements prove problematic, the creation of financial jobs will occur in London, Frankfurt and Tokyo--not on Wall Street. "Systemic risk" will simply find a new address.

A truly free market economy does not and will never exist, so to state simply that total free market policy will be a cure all is a little unreasonable. However, I feel that when the choice is the free market or government legislation and intervention I believe we should always err on the side of the free market. People look to blame the free market and capitalism for the mess we are in today, but the free market was only free within the boundaries that were set by legislation. Lobbying and legislation have contributed as much as, if not more than, greed has to fueling the build up and eventual downturn we are facing today. I guess like most things in life it is about balance. What is the lesser of two evils? Letting banks fail unconditionally or going down the dangerous road of the too big to fail mantra?

Too Big To Fail

I read this article in Forbes about a week ago but am just getting around to posting it. Thomas Cooley writes about the inherent dangers in accepting the 'too big to fail' rationale. The article addresses some of the same issues I have been exploring here at BadskiBlog but obviously with a lot more data.

First, the very notion of "too big to fail" is dangerous. It suggests that there is an insurance policy that says, no matter how risky your behavior, we will make sure you stay in business. It encourages banks to get bigger (or more interconnected), and it subsidizes risky behavior.

Second, it leaves ambiguous the important issue of who gets protected in the event of insolvency--the equity holders, creditors, subordinated debt holders, etc. It seems fair to say that the solutions that have developed on the fly have done severe damage to the notion that there is a well-ordered capital structure that means something.

The most crucial element of the government and free market dynamic is trust. Bailouts and the government deciding who is saved and who perishes is a slippery slope that completely undermines that confidence and trust.

Is Anyone Else Nervous?

Am I the only person getting a little nervous about the dynamic between American government and American business? Rick Wagoner has been asked to step down by a presidential task force. Read one of the many articles here.

There are a few things that disturb me about what is going on. First and foremost, any time the government decides to try their hand at making business decisions I get queasy. This however is not any business decision, it is a request from the government of our nation for the CEO of a publicly traded company to step down. Talk about blurring the lines. Isn't that the shareholders' job?

Not when the government uses taxpayer dollars to keep the company afloat you say. My point exactly! This is the embodiment of the slippery slope argument from my previous posts on government bailouts. The companies who sought government intervention should have been careful of what they wished for because they are definitely getting government intervention.  

Amidst all the actions that rub me the wrong way are a few that are just leaving me utterly confused. Try and stay with me on this one. A company that was deemed too big to fail was being kept afloat by taxpayer dollars. The creditors and unions, seeing that the company was not going to left by the wayside, refused to make any meaningful concessions. The administration who ran a heavy pro-labor campaign is now firing the CEO and refusing additional bailout funds for the company that we originally deemed too big to fail. Upon being fired Wagoner, who was making a whopping $1 salary, became entitled to a roughly $20 million retirement package. What is going on here? Does anyone stand for anything or are we just knee-jerking each and every week. I am all about being pragmatic in our approach to government problems but this just seems indecisive to me, not to mention it shouldn't be a government problem! 

Furthermore, I don't buy the too big to fail argument. I know the stats surrounding the big 3 and the amount of jobs both directly and indirectly they provide. However, I don't believe that if one of them went out of business it would be the end of the US as we know it. People need cars and that market share would shift to another car manufacturer. This is where it gets politically sticky, because the companies who are doing it best happen to be foreign manufacturers. Constituents don't like that. Consumers don't mind, but constituents do (we are all both). Ironically, most of these 'foreign' makers have plants right here in the USA. 

I have no doubt that there are consequences to these companies going out of business. The period of adjustment would be difficult to say the least and a lot of workers would be displaced. But does that justify our government using the tax dollars of everyone to string along a broken company that will likely not last in the long run anyways? Which is the greater evil? I guess no one can really be sure until everything plays out. I just think that the government is always so concerned with being fair and taking care of those in need, but what about those who need to fail? Who is not to say that five new American auto makers would rise to fill the void left by a fallen GM? Creative destruction anyone? Only time and tax dollars will tell!

More Stimulus Updates

I read this article in the Economist today and it is very interesting. I was talking to a friend at hockey last night about the new proposed stimulus by Tim Geithner and we hit some of these points. However, I think that this article does a great job of taking this complex proposition and explaining it in layman's terms. 

Upon first glance, I actually thought that the proposal was much more interesting and in a sense appropriate than all the actions thus far. I must say that my knowledge of the plan is somewhat limited, but I liked that the government was almost incentivizing private investors to stimulate the economy instead of spending mindlessly and egregiously on what they deemed was stimulus ($1.7M for pig odor research in Iowa?). There are large potential gains to be had and the acknowledgement that the government is not the end all be all answer to fixing our economic crisis was refreshing to say the least.

With all that said, the parts of the article I found most interesting were the critical questions it raised. Firstly the article brings up the paradox that in a time when most most private firms are shoring up their balance sheets and paying down debt, it seems ironic that getting them to take on massive debt and leverage would be the answer to our crisis. Actions are being taken, through co-investment, cheap loans, and guaranteed debt but who is willing to put themselves out there like that in our trying times. 

I also really like the point that taking advantage of these government stimulus tactics is too politically dangerous for any firm that is seeking the potential profits that are being predicted. After the AIG bonus skewering, who wants to risk all the government intervention into how they do business? I am in no way saying that AIG bonuses were justified. However I think it is a complete joke that the very same Government holier than thou pukes who enabled AIG to take the bonuses are up front and center screaming taxpayer blasphemy. Not to mention many of these bureaucrats accepted campaign contributions from the likes of AIG (and probably worse) while these companies were receiving government bailout funds. It's strange that I haven't heard of too many politicians trying to pass laws taxing campaign contributions at 90% that were a result of bailout funds.

Maybe I am being to simplistic, or maybe I am just playing the I told you so game, but I have warned of the numerous slippery slope scenarios that unfold when the government decides who "needs" to be bailed out. I am interested to see how this new plan plays out and would love to hear another point of view on the topic so post away in the comments section if you so desire.

Stimulus or stimuless?

I came across an interesting article this morning. http://money.cnn.com/galleries/2009/news/0901/gallery.money_summit/index.html
The article answers some of the questions that many of us have regarding the stimulus that congress and our president are pushing to pass. Some of the answers are very interesting, but take them for what they are worth. We are wading into uncharted territory and the truth is that no one knows what will work and what will not. Politicians and economists alike can make educated guesses on what will or will not work based on past experiences but as Dr. Ian Malcom illustrated in his beautiful Jurassic Park crash course of chaos theory no two experiences are ever truly the same.

Those who know me know where I sit on this issue. My stance is that the whole stimulus is bogus. When the government is involved the name of the game is incentives. What is the incentive to pass a stimulus? If you are really crass you could say that government officials are throwing our tax dollars around like candy at a parade to any corporation or special interest group that has sufficient lobbyist influence. Is this happening? I think the character revelations of our recent crop of politicians confirm that this is most definitely happening. Is it the largest incentive to pass the stimulus? The optimist in me says probably not. I think it is way less JFK conspiracy theory than that. I call it the chicken little syndrome. From a political standpoint, when something is going wrong or poorly it is much better to have done something than to have done nothing, even when history and common sense reveal that it only added to the mess. I think this is clearly evident by the way the politicians are pushing action. Hence the term chicken little..."the sky is falling the sky is falling". All we have heard throughout the passing of the first stimulus and the multiple bailouts is that we need to act quickly, something must be done now, the consequences of failure will be dire, etc. etc. But what has happened. Nothing. The economy still sucks and we have bolstered our ever growing national debt in the process. One could argue that we don't know where we would be had action not been taken. OK point taken. But this assumes that implementation of our government policy worked and I would ask when has the government truly been effective at implementing any decision of this scale throughout history. Is that a cricket I hear?

I think the first few questions and responses in the article are also interesting about savings and spending and how much direct impact the stimulus would really have. Now I was actually opposed to the stimulus the first time around even when I knew I was going to get a $1200 check. A lot of it was based on arguments that those stimuli in the past have yielded luke warm results at best, but most was due to the fact that it is a huge assumption of debt that is a temporary band aid. I am a free markets guy that thinks that eventually rates and home values or what have you eventually reach a point where those with cash or access to it can't resist sitting on the sidelines any longer. This assumes they have jobs. Which is why the new buzzword or catchphrase is job creation. But look at the package and a lot of the spending has nothing to do with creating jobs or getting money into the hands of consumers. The money that does likely will not make its way into the system so to speak for a matter of years in some cases. Are we willing to take on the, by some estimates, trillion dollar debt to carry out this stimulus? I am not. I think the luke warm taxpayer disbursement would be a better play especially since it would amount to $9,000 (I know if I instantly pocketed 9k that not all of it would be saved and I am probably more financially disciplined than most. Imagine all the new Iphones out there.).

None of this discussion even addresses the biggest problem I have with bailouts and stimulus.....the principle of the whole thing. Who is the government to decide who deserves to get a piece of the action? If you analyze this scenario it is a very slippery slope. Those who have read the greatest book of all time Atlas Shrugged can find themselves about to vomit at the prospect of this stimulus. An example would be, we NEED to bail out the banks because they are essential to working markets, but now the auto's are in trouble and they are essential to jobs in America. Well lets say that chicken farmer's are hurting as well. Well they NEED assistance as well. Are they as essential as the previous two? Lets say we decide not to help them out. Why? They NEEDED it just as much as the last two. You get the point. In an effort to cut this post off before it becomes a novel I am going to get back to work. But I would love to hear some counter arguments and views on this. Control what you can control and get your own finances in order because you never know what your elected officials might be planning with your money!