Alan Greenspan, former chairman of the U.S. Federal Reserve Bank
“Well written and an interesting perspective.” Clan Rossi --- “Your article is too good about Japanese business pushing nuclear power.” Consulting Group --- “Thank you for the article. It was quite useful for me to wrap up things quickly and effectively.” Taylor Johnson, Credit Union Lobby Management --- “Great information! I love your blog! You always post interesting things!” Jonathan N.
Saturday, March 16, 2013
After the financial crisis in September 2008 in the U.S., the former chairman of the Federal Reserve, Alan Greenspan, admitted to a Congressional committee that his free-market notion that a market will automatically self-correct itself had a major flaw. He had come to this realization because the financial market for mortgage-backed bonds had failed to correct in terms of price for the dramatic increase in risk. Instead, that market, and that of overnight commercial paper, had seized up rather than simply adjust price to the decreased demand. Fear had paralyzed what had hitherto been thought to be a self-correcting market. The failures of Bear Stearns and Lehman Brothers introduced us to the concept of systemic risk, wherein the failure of a bank (or company) causes a market to collapse. Such a bank is thus too big to fail. If actualized, such risk interferes with even the basic operation of a market, not to mention its self-correcting feature. One question is whether banks that are too big to fail should merely be more adequately regulated or broken up, as the U.S. Supreme Court broke up Standard Oil in 1911.
In March 2013, Alan Greenspan said in a TV interview that banks like JPMorgan that are too big to fail should be allowed to fail. “[What] we ought to do is to allow banks to fail, go through the standard Chapter 11 type of process of liquidation, and allow the markets to adjust accordingly,” said the 87-year-old Greenspan. “That has worked for a very long time.” Had he forgotten his own Congressional testimony in which he had admitted that markets may not “adjust accordingly” to irrational exuberance and systemic risk? Decades of the central banker’s experience had not prepared him for the “financial cliff” that the financial system nearly went over in the fall of 2008. Apparently for Greenspan at least, old habits (of thinking) die hard.
Greenspan said that the Dodd-Frank Act of 2010, which was oriented to saving the banks from their own risky excesses and providing such banks with an orderly liquidation process should they declare bankruptcy, had been a failure. He said the “too big to fail” problem was getting worse, not better. Banks such as JPMorgan had been “gaming” the new regulations, attracted by the high profits gained from risky trades outlawed by the Volcker Rule. That FDIC deposits were used at JPMorgan to make the trades suggests that the taxpayers have been underwriting the continued high risk, at least in part. In other words, free-market capitalism does not completely account for the risk that banks willfully assume even though it can cause the financial sector to suddenly seize up as a big bank goes under.
Greenspan’s answer to the failure of Dodd-Frank involves a return to his faith in the free market, as if the freezing of commercial paper had not occurred in September 2008 after Lehman failed. A year after that crisis, the former central banker had urged the break up of the big banks too big to fail. “If they’re too big to fail, they’re too big,” Bloomberg News reports Greenspan said in October of 2009. “In 1911 we broke up Standard Oil -- so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.” One might add that the sheer existence of a bank with over $1 trillion in assets is too big for not only the financial markets, but also the republic as well. Even after the banks’ culpability had been made transparent in the financial crisis, Wall Street still had considerable lobbying pull over Congress—enough to get lawmakers to scrap Sen. Dick Durbin’s amendment that would have allowed judges merely to adjust mortgages that are in foreclosure. The allure of large contributions is simply too overpowering to a candidate or elected official for such concentrations of private wealth to be compatible with representative democracy. One or the other must inevitably give way. Relying on chapter 11 bankruptcy and market re-adjustment does not even begin to touch such ramifications.
In short, Dodd-Frank can be viewed as a piece of legislation that did not go far enough. This is perhaps no coincidence, given the power of the banks in Congress. Furthermore, as the $6.2 billion trading loss at JPMorgan demonstrates, bankers are able to evade and obstruct whatever incremental strengthening of financial regulation that lawmakers and regulators are able to enact over the objections of the bankers. The Volcker Rule, which bars the risky proprietary trading of banks, is no match for the wizzes on Wall Street. Systemic risk demands public policy beyond some additional regulation, or even a return to New Deal regulation. Going back to the Glass-Steagall Act of 1933, which had separated investment from commercial banking, would be insufficient, as banks had been gaming that law for decades before it was repealed in 1998 by Bill Clinton and Sen. Phil Gramm. Systemic risk and risks to democracy warrant public policy that changes the economic map, rather than merely giving the existing players some additional instructions or letting them fail and hoping the market will not collapse as a result. Addressing systemic risk warrants a systemic rather than an incremental or laissez-faire approach. I suspect that in addition to the obvious vested powerful interests, an aversion to substantive change and an associated preference for incrementalism account societally for much of the aversion to breaking up the big banks, as they had become ensconced in the system as part of the status quo.
Caroline Fairchild, “Greenspan Says Too Big To Fail Problem ‘Is Getting Worse, Not Better’,” The Huffington Post, March 15, 2013.
Thursday, March 14, 2013
With fiscal policy hamstrung by public debt in both the E.U. and U.S., monetary policy was a major beneficiary in the wake of the financial crisis of 2008 and the ensuing debt crisis that stammered on at least until 2013 in Europe. Lest it be concluded that central bank policy had reached an unassailable hegemony, the expanded role actually made its delimitations transparent, at least in financial circles.
Speaking to Charlie Rose on March 11, 2013, Jeremy Grantham of a Wall Street firm argued that the Fed’s extremely low interest-rate policy would be unlikely to spark an increase in employment. In fact, the low interest rate is a transfer of wealth from the poor to the rich. Fiscal policy, such as the CCC of the New Deal in the 1930s, is a much better tool to achieve full employment.
Meanwhile, Jens Weidmann, the president of the Bundesbank, argued that monetary policy in the E.U. “can only buy time at best..” He went on to say he was “a bit concerned about some of the expectations around the power and potential of monetary policy.” The ECB should get back to monetary policy in a stricter sense, rather than trying to spark economic growth and employment through low interest rates and buying state government bonds.
Behind the hypertrophy of interest-rate policy as salvific economically was the paralysis of fiscal policy determination in both unions. Divided government at the federal level stymied fiscal policy in the U.S. after President Obama’s “stimulus” package in 2010. In the E.U., the vetoes retained by the state governments at the federal level put pressure on state governments strapped fiscally to take on themselves additional fiscal expenditure by issuing even more debt. In short, much of the allure of monetary policy was actually structural flaws in the political systems.
Katy Barnato, “Central Banks Alone Can’t Fix Europe: Weidmann,” CNBC, March 12, 2013.
Tuesday, March 12, 2013
In the debate on whether to end the Bush Tax Cuts, the nominal (or statue) tax rates were salient. Much less was said of the effective rates, which are calculated by dividing the actual tax paid by total income (individuals) or net income (corporations). According to the New York Times in 2011, although “the top corporate tax rate in the United States is 35 percent, one of the highest in the world, companies have been increasingly using a maze of shelters, tax credits and subsidies to pay far less.” The name of the game in all too many corporate tax departments is to minimize the tax due as much as possible. No countervailing notion of “corporate citizenship” or even “fair share” exists in that world of single-minded minimization. Put another way, responsibility does not compute in the operative business calculus. Lest it be concluded that that calculus itself is the reason for the tax avoidance (which is legal, unlike tax evasion), the financial power of business to essentially bring government “in house” ought to be recognized as part of the larger problem of plutocracy.
In 2010, General Electric (G.E.) reported global profits of $14.2 billion, $5.1 billion of which came from operations in the United States. Rather than owing any federal income tax, however, the company claimed a tax benefit of $3.2 billion. Behind the “fierce lobbying for tax breaks and innovative accounting that enables [the company] to concentrate its profits offshore,” the company’s tax department was led at the time by a former U.S. Treasury official, John Samuels. Moreover, the Times reports that the department included “formal officials not just from the Treasury, but also from the I.R.S. and virtually all the tax-writing committees in Congress.” G.E. had essentially brought the tax-writing and enforcement skill of the U.S. Government “in house.” As paid employees of G.E., the formerly government expertise was then put under the aims of the private company, which are not necessarily in line with the public weal.
Put another way, U.S. companies of such financial wherewithal as to have annual profits of billions and billions of dollars can appropriate and harness governmental machinery at the expense of the republics and the General Government. The issue is not simply too much tax avoidance, which shirks any sense of responsibility or fairness; rather, the problem is whether such large and powerful private enterprises are compatible with a democratic form of government. Lest this question be interjected into public discourse, vested powerful interests keep us preoccupied with secondary issues, such as nominal individual tax rates, off-shore factories, and NAFTA. That the mainstream media in the U.S. consists of large companies that are owned by even larger conglomerates (e.g., NBC was owned by G.E. before being bought by Comcast) only makes it easier for corporate America to control the public discourse through interlocking directorates. Meanwhile, companies like G.E. and Exxon continue to gain wealth and power.
The question may be whether the American people writ large would object to the threat—or even come to view the mammoth companies as threats to the American republics—were the extent of corporate power over the governments transparent. The mantra of many Americans in the 1950s, for example, could be said to be, “What is good for GM is good for America.” Put another way, economic growth is in everyone’s interest. But is prosperity so wide-open? That corporations increase their stock prices by shedding jobs suggests that what is good for the Dow is not necessarily in the public interest. Abstractly speaking, the good of a part is not necessarily the good of the whole. In political economy, the salience of the parts can be rather subtle, or even subterranean, while the public good can suffer for want of committed defenders. The result is that the parts come to dominate the whole and even define it in their own terms or image.
David Kocieniewski, “G.E.’s Strategies Let It Avoid Taxes Altogether,” The New York Times, March 24, 2011.
Bonnie Kavoussi, “General Electric Avoids Taxes By Keeping $108 Billion Overseas,” The Huffington Post, March 11, 2013.
Monday, March 11, 2013
In spite of essentially flat sales in the U.S. in February 2013 from the same month in 2012, McDonald’s CEO, Don Thompson, said he was confident that the people at the company had sufficient experience to “grow the business for the long term.” Even assuming that a business can be grown as if it were a geranium plant, the claim can be critiqued both in regard to the underlying assumption regarding “growth” and that of long-term viability.
Tackling first the question of a company’s long-term viability, changes in the business environment are important, if not vital to survival. The fast-food industry from 1970 to 2010 is a case in point. As restaurant chains like McDonalds gained substantial economies of scale with the proliferation of restaurants, the increasing popularity of healthy meals subtly undercut the prospects for continued growth.
From "Americana" to "Enjoy Getting Fat": A change in the business environment in the last quarter of the twentieth century in the U.S. that impacted McDonalds at its core. source: McDonalds.com
The management at McDonalds did relatively well in introducing healthy alternatives to its menu by 2010. The strategy also included blending the restaurant with a coffee shop experience. New drinks, such as smoothies, mochas and lattes, and wireless internet service were added. As a result of having adjusted to the changes in the business environment, McDonald’s U.S. sales rose 11.1% in February 2012 from February 2011, and 2.7% in that month from the year before. By 2013, Burger King was renovating its restaurant and adding "coffee shop" drinks. I suspect that being first or second in introducing those products makes less difference than is typically assumed in the business world. Even so, the flat McDonald's sales figure in February 2013 was a bit of a surprise. Although the problem could have been the newly introduced fish product, I suspect that the market may have been questioning McDonald’s expansion into the coffee shop business.
McDonalds was admittedly poised to give Starbucks a "run for its money" concerning its inflated drink prices. That coffee chain was essentially charging a premium price for non-premium products, given the manner of production. Even though McDonalds could undercut Starbucks on price and thus potentially gain market share, it was not clear that being in a McDonalds could feel like being in a coffee shop. Adding to the discordance was the management’s decision to continue to stress the “dollar menu” for the “budget conscious” customer. Put somewhat delicately, the business strategy assumed that two very different market segments would co-exist in the same room. Even just within the “budget conscious” area, incompatibilities exist, such as between university students and the long-term unemployed who are on government aid. The market segment that goes to Starbucks and skips the mocha in order to get a cheaper drink is not necessarily the segment that hangs out in McDonalds until the government check arrives. McDonald's management was essentially blurring the company's identity by seeking continued sales growth by trying to combine a restaurant with a coffee shop.
In general terms, a company’s senior management (or board) should not get so caught up in important changes in the business environment that the resulting strategic change involves trying to be something the company is not. In the case of McDonalds, a fast-food restaurant is not a coffee shop. Blending the social distance between the two would at the very least be a formidable task. Had McDonald's management concentrated simply on adding new healthy fast-food (i.e., restaurant) products, sales would be shored up without risking a corporate identity crisis. But merely shoring up sales is insufficient where a lack of growth means death. Internal pressure to venture into another line of business simply because it is “in” fits, unfortunately, with the mantra of business that to stop growing is to die.
Is it necessarily such a bad thing that sales in February 2013 were flat from the month a year before? Can it be assumed that a large global business such as McDonalds can continue to have increased sales from year to year ad infinitum? Furthermore, might the equilibrium of steady sales provide a large company with more stability? In nature, an ecosystem that is not in equilibrium may be in trouble, particularly if a species is maximizing itself. Reformulating the menu to have healthy items may result in only a few years of double-digit increases, which in turn would be within a longer-term equilibrium rather than in ever-increasing sales. Put another way, the senior management of McDonalds may have used a “shot gun” approach to reacting too broadly to important changes in the business environment. To keep up with societal shifts while not losing touch with the business’s identity is the sort of balance that a corporate management should attempt to reach and sustain in formulating strategy over the long-term.
Candice Choi, “McDonald’s Sales Drop Despite New Fish McBites,” The Huffington Post, March 8, 2013.
Sunday, March 10, 2013
As reported by Reuters in March 2013, “The newest stress tests for U.S. banks produced scores that are at odds with other measures of lenders' safety, in another sign that some institutions may be too big for regulators to understand and executives to manage. For example, Citigroup Inc, which has been bailed out multiple times by the U.S. government, showed up on the score sheets posted by the Federal Reserve . . . as being clearly safer than JPMorgan Chase & Co. That conclusion is at odds with the views of investors, bond analysts and credit-rating agencies, as well as when measured by a yardstick regulators themselves want to use in the future.” Kathleen Shanley, a bond analyst at GimmeCredit, a research service for institutional investors, said "I wouldn't say that Citi is safer than JPMorgan, for a variety of reasons, including its track record.” Citigroup has lower credit ratings than JPMorgan, and prices for credit default swaps suggest that the market views JPMorgan as safer.
The matter was not simply whether the Federal Reserve had an accurate methodology for assessing the likely wherewithal of major banks to withstand financial stress. The more fundamental question is that which was put by Fred Cannon, director of U.S. research at Keefe, Bruyette & Woods. “At the end of the day, there is a legitimate question about the ability of regulators to fully evaluate $2 trillion institutions because of the complexity and exposures they have.” Given the systemic risk inherent in those institutions, the ability of regulators to know their underlying conditions translates into too much systemic risk. Put another way, flying blind is dangerous. The human race may have amassed such gigantic financial institutions that even the fall of one of those large trees could bring down the entire forest.
From a managerial standpoint, a $2 trillion financial institution is of such complexity that the CEO and even the senior management must take the word of subordinates that their complex products will not misfire to an extent that would bring down the firm. Rubbing against the declining economies of scale that go with a very large size is the arduous task of managing complexity on a large scale.
For example, the senior management of AIG was not aware of the extent of the company’s potential payouts on subprime-mortgage-based securities, and thus of the systemic risk of so many claims all at once on the insurance policies. A small unit at AIG constructed and sold the profitable “swaps” without any viable restraint or check on the unit by the upper management. The complexity of the swap instruments, combined with the human proclivity to dismiss low-probability catastrophic outcomes makes it virtually impossible for a senior executive to know what damage is being done at the department level.
Whereas economies of scale—the added synergy or efficiency from increased size—can be quantified, “unmanageable” is not a concept that is so easily put in monetary terms, especially by the managers themselves! In other words, business management itself (and the managers themselves) may be of such a nature (and disposition) that the benefits of organizational “growth” are apt to be overstated while the fuzzy costs are conveniently discounted or even ignored outright. It is rare indeed, if not unheard of, to read of an executive of a large multinational corporation admitting that the complexity at ground level is beyond his or her cognitive grasp. As a result, the systemic risk of gigantic financial institutions that sport an array of highly complex securities may be much higher than anyone realizes.
David Henry, “Stress Test Results Raise Questions Over Federal Reserve’s Ability to Assess Big Banks,” Reuters, March 8, 2013.