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Friday, May 20, 2011

On Term Limits & Representation: The Anti-Federalist View

In the New York convention for ratifying the U.S. Constitution, Melancton Smith favored having the state legislatures rotating their U.S. Senators rather than keeping the same men in the Senate for life. "It is a circumstance strongly in favor of rotation, that it will have a tendency to diffuse a more general spirit of emulation, and to bring forward into office the genius and abilities of the continent. If the office is to be perpetually confined to a few, other men of equal talents and virtue, but not possessed of so extensive an influence, may be discouraged from aspiring to it" (Storing, p. 348).  This argument could easily be applied to the people electing U.S. Senators.


The complete essay is at Essays on Two Federal Empires.

A Health-Insurance Mandate Consistent with Federalism

On June 7, 2011, according to the Huffington Post, “three judges on the 11th Circuit Court of Appeals panel questioned whether upholding the landmark law could open the door to Congress adopting other sweeping economic mandates.” Chief Judge Joel Dubina, who had been appointed by President George H.W. Bush, "struck early by asking the government's attorney 'if we uphold the individual mandate in this case, are there any limits on Congressional power?' Circuit Judges Frank Hull and Stanley Marcus, who were both appointed by President Bill Clinton, echoed his concerns later in the hearing.”


The complete essay is at Essays on Two Federal Empires.

Tuesday, May 17, 2011

Federalism & Business: States in India Deregulating for Economic Growth

The gross domestic product in India for the year ended March 31, 2011 was estimated to have grown at a robust 8.6%. Gordon Chang at Forbes argues that besides Delhi’s own fiscal and monetary stimuli, competition between the states of India for business has been a formidable factor. Federalism, it turns out, can be good for business—yet at what cost? Chang omits this element, writing only that “As the states try to outdo each other, India’s investment climate improves.”

Chang cites Abheek Bhattacharya, who points to Tamil Nadu for its protection of property rights and Gujarat for its minimal regulations. Both states have been growing at double-digit rates. However, if the lack of regulations means that the economic growth has been at the expense of the environment and health of the citizenry, perhaps the weakness of the federal government is not such a boon to India. Federalism proffers the potential of a check and balance between the federal government and the state governments such that a “race to the bottom” element among the latter can be checked by a baseline of regulations issued by the federal government. To be sure, the latter is not without its own risks.

Whereas a race to the bottom risks the destruction of the country for short-term economic development, federal regulations risk a consolidation of power at the center. Federalism functions optimally if it is in balance. Chang undercuts such balance in suggesting that the “intense rivalry could even end up moving New Delhi in the right direction.” While such change would risk consolidation at the expense of federalism, Chang again cites Bhattacharya.

Although Bhattacharya had said on the John Batchelor Show that the states are essentially laboratories for nation-wide change, he had not meant that New Delhi would take over; rather, the more “laggard” states would simply realize that they need to “catch up” to the other states by loosening restrictions on growth. While evincing a “race to the bottom” in some respects, such convergence would not risk consolidation, as would New Delhi being moved “in the right direction.” Indeed, were the other states to join Tamil Nadu and Gujarat, any federal involvement should be antipodal to the deregulation at the state level to check any downsides. However, such a check and balance could risk eventual consolidation under the guise of protecting the environment and the Indian citizens.

In short, dangers exist in both runaway state and federal power. Just as economic growth and minimizing externalities needs to be balanced, so too must federalism for it to operate optimally as a system of public governance proffering governmental checks and balances. In a general sense, any system characterized by a maximizing variable that can break through the systemic constraints is doomed to implode. Accordingly, attention should be directed, at least in part, to the system itself so it may continue to be viable.


Sources:

Gordon Chang, “India’s Accidental Economic Formula,” Forbes, May 15, 2011.

Abheek Bhattacharya, “India Looks to the States,” The Wall Street Journal.

Monday, May 16, 2011

The E.U.'s Membership in the U.N.'s General Assembly: An Oxymoron or Reality Catching Up?

On May 3, 2011, the United Nations’ General Assembly passed Resolution 65/276 by a vote of 120 to 0 (with two abstentions—countries subject to E.U. sanction). The resolution makes the European Union a non-voting member of the General Assembly. As such, the E.U. can “be inscribed on the list of speakers among representatives of major groups and be invited to participate in the Assembly’s general debate, in accordance with the order of precedence and the level of representation.” The E.U. is also “able to present oral proposals and amendments, which, however, would be put to a vote only at the request of [a voting member].” Hence, the E.U. membership is without the right to vote, co-sponsor resolutions or decisions, and put forward candidates. In other words, the E.U. has been granted a sort of “quasi” status commensurate with the world’s notion of the E.U. as a “regional organization”—whatever that means.  I contend that this misunderstanding of what the E.U. is has led to the resolution giving the union a quasi-status in the General Assembly even as another such union, the U.S., enjoys not only voting membership in the General Assembly, but also a veto on the Security Council. In short, the world is confused on the E.U. and the resolution bespeaks this condition.


The complete essay is at Essays on Two Federal Empires.

The Electoral College Electing the U.S. President: A Check on Excess Democracy at the Empire Level

As a delegate in the U.S. constitutional convention, Governeur Morris stated on July 19, 1787 that the proposed National Executive (i.e. the U.S. President) should be “a firm guardian of the people and of the public interest.” (1)  Given this role, Morris maintained that it “cannot be possible that a man shall have sufficiently distinguished himself to merit this high trust without having his character proclaimed by fame throughout the Empire.” (2)   In other words, presiding requires a requisite credibility or stature that may be difficult to find in a territory on the scale of an empire.

The E.U. has obviated this problem by having presidencies of particular E.U. governmental bodies the a state government serving in the E.U. Presidency, a figure-head “office” based on a six-month rotation. The U.S., on the other hand, put all of their eggs in one basket in terms of having one president with substantial power in being commander in chief and having a legislative veto as well as a “bully pulpit.” Considerable emphasis is thus placed on the office’s selection process.

In the constitutional convention, Morris believed that the people at large “would be as likely as any that could be devised to produce [a President] of distinguished Character.” (3) Morris was assuming that at least one candidate can be found whose character has been proclaimed by fame throughout the Empire. Differing from Morris, Gerry argued on July 19 in the convention that the “people are uninformed, and would be misled by a few designing men. He urged the expediency of an appointment of the Executive by Electors to be chosen by the State Executives.” (4)  In other words, suitable candidates could exist, but the people would not be sufficiently aware of their characters to discern the wheat from the chaff.

Electors selected by the governors and presidents of the States would be of lesser number and thus able to come to know the candidates and thus avoid electing a lemon. However, Williamson, also on July 19, “had no great confidence in the Electors to be chosen for the special purpose. . . . They would be liable to undue influence.” (5) Even so, the convention voted that the President would be appointed by electors to be chosen by the State legislatures.

Williamson turned out to be right; the political parties have had tight influence on the States’ electors. The electors would also prove to be excessively subject to the influence of the  citizens who vote for them, rather than being a check on the passions and ignorance of the wider public.  In other words, the selection process has come to enervate an intended check on the democracy of the moment (e.g., the flavor of the month).  Presidential elections have become virtual popularity contests.  The matter of finding someone with sufficient maturity and credibility to preside over the common good has been lost.  Accordingly, the presidents have been highly partisan—even going against their campaign promises for political expediency. My point is that we can look beyond the individual presidents and find that the selection process itself is perhaps biased against producing good governance.

It seems to me that a better alternative would be to have the governors of the States meet together to select the U.S. President. The governors are apt to know the candidates (or can meet them), and could assess them from the standpoint of presiding and executing law. Lest this alternative be thought to slight representative democracy, it could be pointed out that governors are popularly elected and thus accountable to the people.

In actuality, the alternative is both rooted in democracy and capable of providing a check on some of its drawbacks (e.g., popularity contests). Perhaps having the governors select the office would prompt voters to take their governor races more seriously. Additionally, this alternative might provide a needed check on the encroachment of the Federal Government onto the domains of the States (i.e., beyond the enumerated powers in the US Constitution), since the State governments lost their involvement in the U.S. Government in 1913 when U.S. Senators were no longer appointed by the State governments.

In short, the move would strength democracy as well as federalism. This is merely one alternative; doubtless other good ones exist as well.  My main point is that such alternatives should be dug up and debated using the American media and our representatives as conduits. We ignore the bias in the selection process at our own peril. Slighting the problem is itself indicative of the danger in the current process.

Click to add a question or comment (or view them) on the Electoral College.

1. James Madison, Notes in the Federal Convention of 1787. New York: Norton, 1987, p. 324.
2. Ibid.
3. Ibid., p. 327.
4. Ibid.
5. Ibid., pp. 328-29.

The Financial Crisis of 2008: On the Role of Negligence Breaching Fiduciary Obligation

Roger Lowenstein laments that “New York Times columnist Joe Nocera lamented that ‘Wall Street bigwigs whose firms took unconscionable risks … aren't even on Justice's radar screen.’ A news story in the Times about a mortgage executive who was convicted of criminal fraud observed, ‘The Justice Dept. has yet to bring charges against an executive who ran a major Wall Street firm leading up to the disaster.’ In the same dispassionate tone, National Public Radio's All Things Considered chimed in, ‘Some of the most publicly reviled figures in the mortgage mess won't face any public accounting.’ New York magazine saw fit to print the estimable opinion of Bernie Madoff, who observed that the dearth of criminal convictions is ‘unbelievable.’ Rolling Stone, which has been beating this drum the longest and with the heaviest hand, reductively asked, ‘Why isn't Wall Street in jail?’”

Lowenstein interprets these sentiments as implying “that the financial crisis was caused by fraud; that people who take big risks should be subject to a criminal investigation; that executives of large financial firms should be criminal suspects after a crash; that public revulsion indicates likely culpability; that it is inconceivable (to Madoff, anyway) that people could lose so much money absent a conspiracy; and that Wall Street bears collective guilt for which a large part of it should be incarcerated.”

Lowenstein argues that “(t)hese assumptions do violence to our system of justice and hinder our understanding of the crisis. The claim that it was ‘caused by financial fraud’ is debatable, but the weight of the evidence is strongly against it. The financial crisis was accompanied by fraud, on the part of mortgage applicants as well as banks. It was caused, more nearly, by a speculative bubble in mortgages, in which bankers, applicants, investors, and regulators were all blind to risk. More broadly, the crash was the result of a tendency in our financial culture, especially after a period of buoyancy, to push leverage and risk-taking to the extreme.”

Lowenstein also ticks off a loose monetary policy (i.e., extremely low interest rates), unaccountability at Fannie Mae and Freddie Mac, weak financial regulation, and an overconfidence in “risk management” methods in arguing that we should not be reductionist in ascribing the crisis to fraud alone or even primarily.  

Analysis:

Lowenstein is undoubtedly on firm ground in labeling the crisis a “multi-causal” affair. In a general sense, the positive feedback loop wherein everyone benefitted from a rising housing market turned to a negative feedback loop once that market decided to take a hard landing. However, even though he makes a good point that criminal fraud was probably not pervasive on Wall Street, he downplays the litigation that is still possible in going after senior managers at Wall Street banks for negligently breaching their fiduciary obligations to stockholders—the negligence being in the sheer recklessness (which I suspect is a function of individual personalities).

For example, Richard Fuld essentially ignored his risk committee at Lehman Brothers as he added leverage up to forty times value in order to continue buying CDO’s and commercial real estate by the bucketful—his ultimate objective most likely being to bring the bank up to the big league (e.g., with banks such as Goldman Sachs). Would not such recklessness based on egotism constitute fiduciary negligence? It is as though Fuld were under the illusion that the stockholders’ wealth in the bank was his own because of how much of the stock he himself held.

As another example, even Alan Greenberg over at Bear Stearns may have been negligent in not alerting the board as Jim Cayne, the CEO at the time, became “more aloof and full of himself” even as two of the bank’s hedge funds were going down in July 2007 (Greenberg, p. 145). Incredibly, Cayne was playing in a card-game tournament in Nashville for over a week as the executive committee labored daily over whether to liquidate the two hedge funds at the bank that were losing money from their mortgage-related securities and the ensuing redemption calls from nervous investors. Virtually everyone in the senior management of Bear Stearns should have informed the board of Cayne's conduct (i.e., his priorities, which evinced immaturity befitting the man's pot-smoking at the tournaments and even at work). If the directors would have failed to act (e.g., being too cozy with Cayne), the board too should be held by stockholders as woefully negligent.

Furthermore, being on the risk committee, Greenberg may have been negligent in deferring to Warren Spector on the risk issuing from the fixed-income area (e.g., mortgage-backed securities). Claiming that Spector was “imperious” in that area is no excuse for Greenberg failing to exercise diligence given the amount of business the bank was doing in CDOs. Greenberg recounts that “multiple variables contributed to an extremely complex dynamic, yielding consequences that I hadn’t previously encountered” (Greenberg, p. 156). However, he admits to have told Warren a few years earlier to unload CDO’s within 90 days because of the risk involved. Greenberg simply gave up in pushing back from the financial pressure of the large profits being made. Accordingly, he gave up on due diligence on the risk committee and should be held accountable by Stearns stockholders. 

Incidentally, I admire Greenberg for his straightforward recounting of the events leading up to the collapse of his bank, even though I do not buy his account of his role on the risk committee. Perhaps the lesson is that even an ethically solid and competent person is fallable, and may even inadvertantly fall into a negligent pattern of complacency in the midst of momentary profit. The depth of the causes leading to the financial crisis may be evinced, moreover, in that a person such as Greenberg became unintentionally complicit. As Greenberg himself observes, Jamie Diamond at Morgan had urged his bank out of the mortgage-related securities business altogether as far back as 2006 as the housing market was peaking. From this vantage-point, Greenberg himself must surely know in hindsight that he had fellen short.

Whereas Lowenstein claims that one of the causes of the crisis was that risk management methods were followed, I contend that they were relegated or ignored even by the risk averse because the standards stood in the way of large profits. To be sure, Greenberg and others on risk committees relied on the AAA ratings from Moody’s and S & P (though Greenberg had been sufficiently worried to urge quick sales of the bonds). Even so, it should have been prime facie evident that a mortgage-based bond is not a Treasury bond. Furthermore, the rating agencies’ managements should not be held blameless, as they did the bidding of Bear Stearns and Lehman in exchange for lucrative fees;  there was undoubtedly fraud or at least negligence in this conflict of interest.  

Whereas fraud may have been limited largely to salesmen at mortgage brokerage firms and the rating agencies, breaches in fiduciary obligation were, I suspect, running rampant on Wall Street. In other words, money being easy and regulation being light (or non-existent in the case of the CDOs) did not give the banks’ managements a pass on their fiduciary obligation to exercise a duty of care over stockholder’s equity in the banks. Whereas cheap leverage and lack of oversight are context, recklessness with others’ wealth may constitute the principal cause—the lack of concern for risk being part of it.

Generally speaking, boards allowed senior managements—as evinced in the persons of Dick Fuld and Jim Cayne—far too much rope with which to hang themselves. It is astounding to me that people like Fuld and Cayne were able to get anywhere near the authority of a CEO. Their glaring immaturity and incompetence may point to a systemic problem in corporate governance going far beyond what even institutional stockholders realize. It would seem that the boards of Lehman and Stearns were either asleep or in somebody’s pocket (which involves at the very lease a stark conflict of interest). Although holding the managers accountable for their recklessness leading up to the financial crisis of 2008 would be a step in the right direction, stockholder interest warrants systemic reforms to corporate governance itself such that “upper” managements are given much shorter leashes (and stature).  


Sources:

Roger Lowenstein, “Why No Wall St. Bigwig Has Been Prosecuted,” MSNBC.com, May 16, 2011.

Alan Greenberg, The Rise and Fall of Bear Stearns (NY: Simon and Schuster, 2010).

Sunday, May 15, 2011

Strategic Thinking Beyond the Business Plan: Business Is Human After All

“When smart people came up with ideas for well-conceived business opportunities, we said go for it. As always, organizational charts, management consultants, and business plans played virtually no role in any of this. My own strategic thinking I did mostly while showering or shaving.”

—Alan C. Greenberg, former Chairman and CEO of Bear Stearns

Similarly, when I write an essay, I inevitably pass on first constructing a formal outline and go instead off of what I have worked out in ratiocinating while exercising, in transit, or showering. Freeing the mind up to search for and try out connections between ideas, and working a theory over and over—like kneeding dough or forming a clay pot on a wheel—are inconsistent with too much structure.

The human mind needs its own space to solve abstract or applied problems needing considerable thought. Subjecting the processes of theory-construction and problem-solving (“critical thinking”) to too much structure is simply not in line with the nature of the mind itself. Human reasoning, it turns out, is not a linear process that necessarily fits within the confines of a business plan or consulting diagnostic tool. Particularly if creativity and innovation are to be encouraged, mechanistic structure must succumb to organic process.

For example, I did a consulting project as part of an organizational design senior seminar that I took in college. The professor had developed a structured organizational audit—a diagnostic tool geared to detecting discrepancies between an organization chart and actual communication. As he had developed the instrument, we were naturally to rely on it in making our recommendations to the clients. I used the tool on a computer retail store and proffered recommendations from it. Because the business was family-owned and operated, I could see that the communications were in part a function of the family dynamics, which the professor’s organizational audit failed to pick up. So I asked some additional questions and made some supplemental recommendations, which the business owner/manager found quite useful—unlike those that came from the audit.

Even though the professor graded me lower for adding the recommendations, the client went so far as to call him to urge that an A be given to me for the project. From what the client told me later, the professor was perhaps too attached to his “organizational audit” tool (which he used in his own consulting practice). My orientation as a novice consultant was neither to my grade nor to the tool; rather, I wanted to help the owner/manager by proffering him insight that he could use to solve his problem. Although I cannot be sure at this point, I might have come up with my final recommendation to him on the way to a class, during a run, or even while shaving.

So I can totally understand Alan Greenberg’s aversion to organization charts, business plans and “professional” consultants. A true consultant comes from a perspective of expertise that clients do not have. For example, a consultant could be an academic or a nearly-retired practioner. In either case, the advice should be viewed as supplemental to the client’s focal situs “on the ground”—that is, consulting advice is something for a client to digest and possibly integrate with his or her larger considerations outside the range of the consultant.

Being geared to helping a client, a consultant should be able to let go of his or her “black bag” if the tools therein fall short in diagnosing the organizational dysfunction, or “illness.” I suspect that one's “gut” can come into play, effectively transcending the mechanistic tools, only if the consultant cares, because only then is he or she intrinsically oriented to the client’s situation rather than the consultant’s own bag of tricks as ends in themselves. In the end, consulting is interpersonal—helping others who are suffering from a problem. Such problems typically involving human beings, it should be no surprise if a consultant should approach them from more than one level.

Therefore, both strategic and consulting thinking ought to be accommodated in the sense of giving them some organic free range. Treating business plans, organizational charts, and diagnostic tools as ends in themselves, as if they were rational beings (i.e., Kant's kingdom of ends), is ultimately self-defeating, if not suffocating. Just as managing can sometimes be informed by simply wandering around, so too the strategic mind needs some room to roam.  

Click to add a question or comment on formal tools and insight in strategy and consulting.

Source:

Alan C. Greenberg, The Rise and Fall of Bear Stearns (NY: Simon & Schuster, 2010)

On Leveraging the U.S. Debt-Ceiling and How the Market Mechanism Handles Trust: Dangerous and Flawed

In May 9 2011, Speaker Boehner insisted “on trillions of dollars in spending cuts, and no tax increases, as the price for rounding up enough votes to allow more borrowing and prevent the country from defaulting on its debt,” according to the Huffington Post. The Ohio Republican had “said failure to increase the borrowing limit [in the summer of 2011] would trigger a financial disaster for the United States and the world.” On May 12th in Congressional testimony, Ben Bernanke, chairman of the Federal Reserve Bank, cautioned against using raising the debt ceiling as leverage for getting a particular partisan policy-prescription on federal spending enacted into law. Richmond Fed President Jeffrey Lacker had told Reuters, “I do share the chairman’s concern that going up to the edge and playing chicken on the debt ceiling is not a wise strategy.”

Meanwhile, GOP U.S. Senators and House Representatives had been hearing from constituents warning them not to raise the debt ceiling.  “Enough is enough!” such citizens were saying. This pressure was geared to getting the U.S. Government to live closer to its means rather than resorting to its power to increase the debt it can issue without limit. Even so, U.S. Senate Majority Leader Harry Reid said on May 10th that tax increases may be needed, along with spending cuts, to help rein in the deficit. Moreover, he warned against ultimatums. “We shouldn’t be drawing lines in the sand,” he said according to The Wall Street Journal. This was not stopping Sen. Bob Corker, who was urging an automatic spending cap of 20.6% of GNP (when the fiscal 2011 figure was estimated at 24.3%) as a condition of passing an increase in the federal debt limit.

Given the existence of contending policy prescriptions, using default for leverage on one side is faulty. Aside from the implicit presumption that one side of the debate has a monopoly on truth, playing with fire where the viability of the financial system itself could hang in the balance does not evince much statesmanship and it could imperil the operation of the market mechanism itself.

Trust is vital in the very nature of a market. If trust is up for grabs, the increased volatility can freeze the market mechanism itself. Rather than simply increasing a price to account for the added risk, a market mechanism can simply close down even if trust is questioned. The reason is that the mechanism reflects human nature itself. Trust does not behave along a continuum as does risk/reward. Rather, people trust someone or something only to a point at which an implicit “all or none” mental calculation or feeling occurs. Beyond that point, the picture itself is fundamentally different. A shift in risk/return does not come into play because fear is choking off any action. In other words, human beings in fear or lack of trust freeze up rather than slow down. The market mechanism’s interval of risk/return tradeoffs reflecting in adjusting price is inconsistent with this feature of human nature as manifested even in a market mechanism. There is thus a fundamental flaw in the mechanism where it diverges from how human nature reacts to fear as lack of trust.

According to Alan Greenberg, former Chair and CEO of Bear Stearns, “Without reciprocal trust between the parties to any securities transaction, the money stops. Doubt fills the vacuum, and credit and liquidity are the chief casualties. Bad news . . . has an alarming capacity to become contagious and self-perpetuating. No problem is an isolated problem” (Greenberg, p. 3). Money simply stopping trumps price adjusting to reflect the increased risk from less trust because trust in human terms does not function as intervals of degrees. Accordingly, market theory itself, specifically in its risk/return tradeoff running the gambit, contains a flaw with respect to increased levels of volatility due to “trust issues.”

In using the debt ceiling as a bargaining chip for political leverage, the Republican lawmakers in the U.S. Government were risking the flaw being triggered. In other words, those politicians were implicitly assuming that the market would simply adjust to the added risk rather than shut down. Besides the problem in the lack of statesmanship—a political problem—the market mechanism itself contains a fundamental flaw in need of being addressed. Specifically, higher risk that kicks in even just close to the lack-of-trust-threshold can freeze the mechanism itself due to how human nature handles trust as a more of an “all or none” than “matter of degrees” phenomenon even as we wrongly suppose the market handles trust along an interval of prices. Unfortunately, we love the beauty of the latter even after having realized in September of 2008 that it does not hold.


Sources:

Alan C. Greenberg, The Rise and Fall of Bear Stearns (NY: Simon & Schuster, 2010).

Janet Hock and Carol E. Lee, “Democrats Oppose Spending Cap Plan,” The Wall Street Journal, May 11, 2011, p. A4.



Nationalism in Europe: Forestalling Ever Closer Union

Ask a European if the E.U. government could ever consolidate power from the state governments and you would probably get a "nope (or nein, or non), we identity with our respective countries." The problem is, such attachments can change. Indeed, they have changed. Europeans alive after fifty years of "ever closer union" would do well to look back at the U.S. after its first fifty (or one hundred) years to get a sense of how the E.U., too, could change. 


The complete essay is at Essays on Two Federal Empires.