Country Club!

The latest attempts at economic stimulus by policymakers seem to create an exclusive "country club," a few firms who are big and cozy. Bigness apparently is the best proxy for competence and so admittance to the club is solely based on "assets under management." One creative idea is to allow these country club members to buy securities in conjunction with the government. The government will effectively subsidize the purchase of the "toxic securities" by these great firms who have "stepped up" to save the economy. Some of these firms may purchase securities owned by themselves at a price higher than what they are worth. These purchases are partly "assisted" by the government using taxpayer resources. This is perhaps the first time that a company may be allowed to purchase its own assets (that are under water) at a price higher than what they are worth. As history and common sense are being rewritten everyday, this may yet be the most creative policy of them all.

Threatening to return the sacked gold (TARP)

A few institutions are "threatening" to return the TARP money to the government so that they have the freedom to operate again. The executives of these great companies feel too constrained by constraints on compensation and other aspects. That sounds fair, but one has to ask why they took the TARP money in the first place. If they were not at the brink of failure, was TARP sort of extra pocket money? Did they take it thinking it was free? The threats, however, have been that they will return it next month, next few months, etc. If it is extra pocket money, why don't they return it right away (not next few months) and immediately gain the "freedom to operate?" TARP resources came to these institutions through multiple channels - some directly from the Government and some through other companies (because some of these great institutions were counter parties to other TARP recipients and demanded to be paid in full). So, TARP return threats should include ALL TARP money (not just parts of it) and rather than threatening to return it next month, it may be better to do it immediately. If this cannot be done, such threats are just grandstanding.

Misinterpreting the obvious

2000 years ago, a geocentric view of the inverse was well accepted. It was obvious - look up in the sky, and one can find the stars and the sun go round and round the earth. The less obvious reality of the universe was understood much later. Human mind is prone to misinterpreting the obvious and we have done so over and over. We seem to to be doing it again in the grand plans proposed by the planning authorities and regulators.

(a) We (at least some of us) accept, without question, that the mega banks should exist for us to break out of the current financial doldrums. Is this really true? What evidence do we have to prove this is the case? What evidence do we have that the economy revolves around this behemoths run by incompetent, ignorant and fraudulent people?

(b) We (at least some of us) accept, without question, that the current banking system that includes nearly 10,000 banks need to exist for the functioning of the economy. What evidence do we have for this to be true?

(c) We (at least some of us) accept, without question, that the current crisis will end when "the credit problem" is solved. The credit problem is defined as the inability of the incompetent banks to lend because of the assets (that is worth very little) that was accumulated by the banks over the last decade that led them to insolvency. If this is true, why stop at the mega banks, give small businesses money too and they will lend as much as the hearts of the officials desire and the problem will be immediately solved.

(d) We (at least some of us) accept, without question, that there are a few special companies (less than 10), who can be given loans at low rates and protection on the downside (using taxpayer's money) and they will save the world. We can do it too given the same terms. What evidence do we have that the large companies (that so far have shown themselves to be incompetent) are any better than any single individual in doing this?

Large incompetent and fraudulent companies that got us to the current state are now given money and the ability to print money (low interest, downside protection) using taxpayer's money, assuming that because the world circled around these behemoths, that is always the truth. The latest "rescue plan" is yet another attempt at segregating companies and people, using status quo notions. As the manager of one of the largest bond funds remarked immediately afterward the plan was announced, "we stand ready to participate and bring the economy back." Such altruism to save the world cannot be questioned, but please do not insult our intelligence. Most of us can do it too if given low interest loans and downside protection using somebody else's money.

Insurance Quantum Mechanics

A few people in the bailed out institutions, apparently, are the only ones who can understand the complex instruments such as the Credit Default Swaps (CDS) and Mortgage Backed Securities (MBS). These special people, some commanding over $1 Mil/month, are so smart that they are the only ones who can understand the theory and practice of this complex finance. They are, however, unable to explain it because the mere mortals (the rest of us), do not have enough brain cells to even understand parts of it.  Nobel prizes must be reserved for these few for the next several years as they seem to have invented something the rest of the world can't understand. Before that, I wonder if we could run a few experiments:

(a) Take a few of these highly complex instruments and provide the information to the mere mortals - academics, finance professionals etc. - and see if they are even able to comprehend it. The future Nobel laureates in the venerable insurance company can also have some fun with it as they can observe the "unintelligent humans," toil with the complex instruments and finally admitting that they can't understand it.

(b) Use a few first year business school students in the experiment as a control - again, just for the amusement of the experts at the insurance company.

If we find some level of comprehension by ordinary humans, one may want to ask whether it is the incompetence and ignorance of the experts who evaluate the instruments, that make them look complex and unintelligible.

Getting Real

Fed's manically active monetary policy of printing money and showering it down on the economy, will do damage to the economy in two distinct ways. First, it will slow down the necessary adjustments in the real economy such as unwinding of unsustainable leverage, bankruptcy of badly run companies and reallocation of capital from low return to high return activities and second it will create an impression of asset price stability in nominal terms while the real value erodes at a faster rate due to inflation. This is a double whammy. The real solution to the problem is still aiding the necessary adjustments to occur, slowly but surely. Leverage has to decline, savings have to increase a bit and bad and incompetent companies have to go away. A passive monetary policy is still the best way to achieve this outcome. The worst policy in the current environment is the one made by those who "closely" studied the depression and the Japanese bubble and overreacts to the problem at hand through a unsustainable and uncalled for monetary shock.

Dumb Executive Walking

As "retention bonuses" soar in the nation's bailout institutions, the primary argument heard for doling out taxpayer money to executives in these companies is that in the absence of such largesse, they will simply walk away from their jobs, leaving the company and the country in dire straits. These people are, indeed, rare talent. After all, as a group, they have caused and presided over the largest shareholder wealth destruction in human history. Taxpayer's should indeed be worried what happens to the world if they walk away from their jobs. These jobs are something they do for the benefit of the world, out of the kindness of their brave hearts hidden behind pinstripe suits and wingtips. As one of the leaders of a failed investment bank remarked, "to keep my best people, I need to provide them incentives." I wondered if he considered even higher bonuses in these times of great stress and tribulations for these executives as they "agree to stay" for the benefit of humanity. He continued, "my best people will simply walk, if they are not provided these bonuses." He, however, stopped short of describing where they will "walk to," whether they will walk to the Atlantic ocean or the New Jersey Turnpike.

But wait, the largest beneficiary of the bailout has more to worry about than the dumb executives walking. In this venerable insurance company, the problem is that the "books are too complicated to understand without the help of those who concocted them." Since these "complicated instruments" actually caused much of the problems for the company, does "understanding" them now really help? Should we try to give the assignment to a few fresh business school graduates, just to see if they can untie the knots? Or is it code for "the counter parties to these instruments would like their money back in secrecy?. Since a large amount of the first installment of the bailout went to buying back securities at "par" from those institutions who "could not do any wrong," perhaps because some have produced great government leaders in recent times and some in close proximity to great countries, who have called for the US "to show leadership" to solve all the world's problems.

In the words of a great man, who runs one of the largest automotive companies in the world, "these are the times companies need the best management. Changing management, bailout or not, is not a good option." Taxpayers may want to start a charity fund to supplement the bonuses to keep these great leaders of our time working (and not walking). Taxpayers should, indeed, be worried about where they will walk to, in the absence of bonuses. The potential application of such unlimited skills and talent could be problematic for industries that actually increase shareholder value and produce something tangible than snake oil and transaction fees.

Innovation and education rebates : The best stimulation for the economy

Policy makers should consider instituting innovation and education rebates for stimulating the stalled economy. Innovation, fundamentally, is the only attribute that increases productivity and thus has broad impact on the economy. The tactical focus has been on jobs. Although this is important, what is equally important is that we create the right type of jobs for the future. Pouring money into incompetent and inefficient companies "to save jobs," is the wrong policy. Policy makers should direct such resources to those who innovate - creating sustainable jobs for the future. Related to this is education and skills upgrade for everybody so as to equip the workforce to move away from status quo and into the future. The implementation of this can be simple - those who innovate and create new products and services establishing new and sustainable jobs get an innovation rebate. Those who educate themselves and put in the effort to upgrade skills, get an education rebate. These twin rebates will put the incentives in the right place. Everything else - saving failing companies, helping bad decision-makers, pet projects, blind infrastructure spending  - etc. take us away from the objective of moving the economy to a more efficient and productive state, enhancing quality of life.

Shell games

The other day I was wondering if the government pumped in large amounts of money to a large insurance company (let's call it A) and the company used the money to "negate" existing contracts with another institution (let's call it G), by "buying back" securities at par, is that proper use of the money? Is this what is termed as "the avoidance of systemic risk?" In this case, G after having entered into bad transactions, simply walk away with tax payer's money as if they never entered into those transactions. If this is the case, large number of the US tax payers would like to pretend that we did not buy stocks in 2007 in our 401Ks. We can set up a company (let's call it B), that can get money from the government and B will then "buy back" all the stocks bought by US taxpayers at the original price (at par). If A used the money in this fashion, both A and G will have to return the money as this was never the intent (or was it?)