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Sunday, July 30, 2006

Losing Elections / Faux Conservatism

Originally posted: April 23, 2006 -- 7:13pm
Fool Boards link: http://boards.fool.com/Message.asp?mid=24009139

A recipe for combining optimism, ignorance and cynicism into a winning strategy for elections and a losing strategy for governing.


In another thread,


I made a comment that Democrats have failed miserably in three key areas with American voters:

1) explaining that the "starve the beast" strategy of Republicans doesn't work
2) explaining that cutting taxes CANNOT be the solution to every problem
3) explaining that voting people who claim to ABHOR government INTO government makes no sense

goofyinMD posed the following questions in response:

Why do you think it was so easy to make the majority of Americans think government was screwing them.

Or let me put it another way.

It was fairly easy for the Republicans to sell the idea that big government, fueled by high taxes was the problem. Why was it such an easy sell?

I've been mulling over this for quite a while, actually. Here's my best guess.


Republicans succeeded in selling a flawed ideology of government to American voters due to two key factors:

* monumentally poor communication about basic economics and policy by Democrats
* faux conservatism on the part of the American people.

I say "faux" because words like "misguided" or "deluded" or "tragically uninformed" would come across as too harsh.

In a nutshell, this "faux conservatism" resulted from a few key factors:

1) macroeconomic shocks between 1973 and 1981
2) ignorance of basic fiscal / economic theory
3) American optimism / wishful thinking

Macroeconomic Shocks from 1973 to 1981

Macroeconomic shocks that affected the US produced recessions and recoveries whose causes and fixes were not understood by the American public. My amateur economist summary of the basic chain of events is:

* spending on the Vietnam War institutionalized deficit spending and bad fiscal policy
* the Arab oil embargo in 73-74 spiked oil prices and started feeding inflation
* inflation expectations were baked into labor contracts in already inefficient industries
* bad fiscal / monetary policies in 76-80 timeframe fueled higher inflation

By 1980, the embarrassment from the Iranian hostage situation and the stalled economy led voters to try Reagan for a change. At this point, die-hard Republicans believe Reagan took the reigns and single handedly snapped the country back to the golden path via huge tax cuts and cuts of government programs and spending.

Well, at least half of that is true.

Reagan DID cut taxes. However, drastic increases in military spending (which in hindsight, we probably didn't need because Russia was already destined to rot from within) actually increased government spending and drastically increased yearly deficits. In the end, Reagan's policies TRIPLED our total national debt from $930 billion in 1980 to $3.233 TRILLION in 1990. (#1)

I believe the two most important factors that drove the eventual recovery from 1983 on were:

* monetary policy changes that spiked interest rates from 80 through 81 (#2)
* skyrocketing oil prices due to the Iran / Iraq war (#3)

The prime rate got as low as 11 % by July 25, 1980 but shot up to 21.5% by December 1980 and remained above 15% through 1981. At the same time, oil prices spiked due to the Iran / Iraq war. Unemployment ranged from 7.2 to 8.2 percent under Carter but went from 8.2 to a high of 11.4 percent in January 1983 under Reagan. By the time of Reagan's "morning in America" re-election campaign in November 1984, unemployment had only come down to 6.9 percent. (#4)

In short, macroeconomic factors having nothing to do with Reagan and the Republican Party induced one of the worst recessions the United States had ever experienced, which drastically cut inflation. (#5) The recovery was magnified by a dramatic, coincident drop in oil prices which had nothing to do with Republican policies, tax cuts or fiscal management. Instead, the drop was due to a breakdown of pricing collusion within the OPEC cartel as members desperate for revenue in the face of drastically reduced demand flooded the market with oil at prices below the official OPEC cartel "list price."

Ignorance of Basic Fiscal / Economic Theory

To me, a true lower-case-c conservative would never live beyond their means, would minimize personal debt, would habitually save for a rainy day, and would expect their government to do the same. That certainly doesn't describe the average American at this point. The average American has over $7500 in high-interest revolving credit card debt, is borrowing against the equity in their home to buy plasma TVs and giant SUVs, has maybe $15 to $20k in retirement savings, and has virtually no cash savings. I'm guessing the average American is no more than 2 or 3 months from losing their house if they lose their job.

If Americans cannot understand the long term impact of deficit spending in their own household, it's no surprise that they continue voting incumbent politicians back into office for more drunken sailor spending.

The average American also lacks an understanding of two of the most important concepts within economics

1) public and private goods and externalities
2) moral hazards

A famous essay entitled "The Tragedy of the Commons" (#6) illustrated the problem of private use of public goods using the metaphor of a common pasture shared by multiple herdsmen. Each herdsman can add another animal to his flock, have it graze on the shared pasture, net ALL of the proceeds of selling the animal, but pay only part of the cost to the pasture by overgrazing it by adding the extra animal. If only one herdsman makes that decision, he benefits. However, if ALL of them reach the same conclusion, ALL suffer because the pasture becomes overgrazed and cannot sustain any of the animals.

The overuse of the shared public resource is termed an "externality." When economic policies allow private individuals or businesses to enjoy 100% of the gains from using a resource for which they pay less than 100% of the cost, society as a whole can suffer. This is the root issue involved in policy debates about energy, pollution, natural resources on public lands, etc.

These concepts sail completely over the head of most Americans. It is easy to argue for reduced government regulation making an individual business more efficient when only considering the costs actually incurred by that business. However, without understanding the concept of "externalities" and understanding exactly how a company is producing savings, dangerous social consequences can often occur.

Economists define a moral hazard as a situation in which an individual is protected (or THINKS they are protected) from the full cost of a potential problem (a natural disaster, a car wreck, etc.) and consequently behaves in a way more likely to actually incur the problem. In economic terms, by reducing the marginal cost of the disaster to the individual, they do less to avoid it, thus INCREASING the actual cost to society.

The concept of a moral hazard is involved in a huge variety of public policy debates ranging from consumer product safety, FDA regulations, health insurance, flood insurance, social security, and bailouts of banks, Savings & Loans, and big businesses, etc. When government actually promises to be the safety cushion of last resort (or simply fails to clearly state it does NOT intend to fill that role), the existence of that safety net actually encourages many to take larger risks than they would without that backstop. When more and more risks are being taken at the same time expecting to draw on the same resources to bail them out when something bad happens, REALLY BAD THINGS HAPPEN.

American Optimism / Wishful Thinking

The American economy did pretty well from 1986 through about April 2000 when the NASDAQ and Dow peaked during the Internet bubble. We had a relatively minor recession from late 1988 through 1990 that probably cost GHWB a second term. However, the economy rebounded primarily due to a reduction in concern about Cold War expenses with the collapse of the Soviet Union and Berlin Wall and a divided Congress that kept spending in check. Things continued to improve during Clinton's first term due to more divided government deadlock and resulting spending restraint. By 1996, the economy had been rolling for five years and was then further stimulated by two factors for the next four years. The Telecommunications Act of 1996 created an artificially large demand for high-dollar optical and telecom gear for new CLECs. Technology spending then skyrocketed as businesses overestimated the benefits of Internet technology and pent money on Y2K software issues. The Fed then added fuel to the fire by easing interest rates in anticipation of a Y2K economic burb that never happened.

Americans saw a landscape where 25 year old engineers were making $80,000. Where people who knew NOTHING about investing were seeing their portfolios grow 10-20 percent annually. The vast majority naturally reached only one logical conclusion from surveying this scene:

I am a rugged, individualistic, self-sufficient financial genius. And I did it all myself.

Who cares about Social Security? I'm going to retire at age 40 on my dot com pre-IPO shares. Who cares about pension funding? I'm going to be independently wealthy. Who cares about employment stability? Every time I change jobs, the next dot.com is raising my salary by $15k. Who cares that I had to take out a zero-principle ARM on my $700,000 McMansion? Real estate prices are going up 10 percent annually as overpaid dot.com workers drive up sale prices so I'll make money on the deal.

As someone once famously said, things that CAN go wrong usually don't, then people draw the wrong conclusions. This mindset is a quintessential example of that phenomena.

Another witticism also comes to mind... "Things really ARE different this time, just not for the reasons you think." People thought the economy was doing well because Internet technology cured the business cycle and we all became highly productive geniuses. In fact, the economy was being over-stimulated by flawed telecom deregulation policies and easy monetary policy that was overcompensating for an upcoming Y2K disaster that didn't materialize.

Americans have historically been an optimistic lot and much of that optimism has been historically justified due to our unique combination of political climate, natural resources and splendid geographic isolation from the rest of the world. However, that optimism has delayed recognition of the impacts of a global market for labor and the potential downside of the tremendous concentration of economic power in fewer but ever larger multi-national corporations. China's President spent just about as much time talking with Bill Gates of Microsoft and John Chambers of Cisco as he did talking to Bush during his recent visit. What does that say about the balance of power between government and industry within the United States?

So What Is Finally Waking Americans Up to Reality?

I'd like to think Americans are waking up due to the costs we are incurring due to our misguided "war on terror" and the spectacular lack of tangible results. However, if most Americans grasped even 25% of the magnitude of the avoidable strategic mistakes the Bush Administration made, I would guess there would be a million people surrounding the White House daily demanding Bush's resignation. That clearly isn't happening so I'm guessing the awakening is due to traditional pocketbook factors.

In my day job, I am involved with a project that my firm has contracted out to a major consulting firm who has assembled a team of about 30 people for the project. Of that group of 30 people, I would estimate about 80 percent of them are foreign nationals here on guest worker visas. These are extremely bright people who almost to a person are as skilled as American citizens that could have done the work. The only difference? I don't know exactly what they are being paid by the consulting company but I am guessing it is at most only 60 percent of what we are effectively paying the consulting company on a per-hour basis.

American workers are seeing this happen ALL THE TIME and are starting to realize it isn't just $70,000 per year factory jobs at GM at risk, it's $70,000 to $100,000 jobs in programming, project management and all the other "new economy" jobs the Internet boom was supposed to produce.

American workers are watching healthcare costs skyrocket and healthcare coverage shrink every year to the point where many workers probably care more about health insurance coverage in retirement than an actual pension. By the time they retire, monthly health care premiums might be $1000 to $1500 (if they're not there already).

Americans are looking at natural disasters like Katrina and seeing how a big economic hit can literally stop a local or regional community in its tracks. At a time when they are most vulnerable, many Americans are also seeing big businesses use its power to weasel out of contributing its fair share. As a poster on the Fool noted last week, even Trent Lott, a poster child of the anti-trial-lawyer perspective, suddenly wants to sue State Farm Insurance after rumors came to light that State Farm destroyed evidence that would have confirmed policy-holders were owed settlements for damage done by winds, not by water. It's amazing how quickly you learn government DOES have a role in maintaining a stable, equitable society after losing your house and losing your job and losing every physical possession you have.



#1) Total US Debt From 1910 to 2004: http://www.answers.com/topic/u-s-public-debt
#2) Prime Interest Rate History: http://mortgage-x.com/general/indexes/prime.asp
#3) Oil prices History: http://www.wtrg.com/oil_graphs/oilprice1947.gif
#4) US Unemployment Statistics: http://www.dlt.state.ri.us/lmi/laus/us/usunadj.htm
#5) US Inflation Graph 1976 to 2006: http://www.clevelandfed.org/research/inflation/US-Inflation/
#6) Tragedy of the Commons: http://dieoff.org/page95.htm

Sunday, July 23, 2006

Time to Lead The Leaders

News stories earlier in July were hinting that John Kerry intends to run for President in 2008. The idea of John Kerry joining Hillary Clinton and even Tom Daschle as Presidential candidates for 2008 points out a major failure of the Democratic Party that mirrors the Republican failure in 2000 and signals bigger trouble for the country.

In a nutshell, we voters are cementing a pattern of making two catastrophic mistakes in the political arena:

1) choosing candidates and policy proposals based on name recognition and branding like they were choosing between a Tahoe, Yukon and Escalade when in fact those are superficial differences masking something underneath that is completely unsuited for our current problems

2) assuming the parties have actually FOUND candidates with the best new ideas for solving problems when in fact the parties have focused on selecting candidates most effective at re-using old strategies that have won elections but have failed to solve problems


After the debacle of a Bush / Clinton / Bush change of power, the last thing America needs is a Clinton / Bush / Clinton succession. Surely, in a country of 290 million people with problems as vexing as ours, there are factors more important than name recognition when choosing candidates for President.

I've mentioned before that George W. Bush did not wrap up the Republican nomination in 2000 because Republicans agreed he was the sharpest knife in the drawer. Bush wrapped up the nomination early because of early successes in 1999 collecting contributions from conservative evangelicals and obvious name recognition within the party. A big win on Super Tuesday for Bush dried up virtually all contributions to other Republican candidates, allowing Bush to seal up the nomination in less than two months after the Iowa caucuses, leaving Republicans primary voters in the rest of the states with literally no alternatives -- all of the other candidates ceded the race.

Okay, true conservative Republicans, how did THAT strategy work out for you?

The Democrats could very well do the same thing in 2008 with Hillary Clinton. I might agree with 60-70 percent of her policies. She's also an excellent communicator probably 80 to 90 percent of the time. However, she has demonstrated at least a couple of times that she can have an INCREDIBLE political tin ear either in terms of policy or matching language to her audience. You only have to think back to Kerry's 2004 sound byte of "I voted for the war before I voted against it" to see how the current political climate can convert one verbal misstep into quicksand. Any candidate might make such a gaff but choosing a candidate with a history of just such a problem will spell disaster.


If both parties want to really improve the country, they need to focus FIRST on formulating a platform, not picking a person. In other words, DO YOUR JOB AS A PARTY. Clearly and succinctly identify opportunities and threats facing the country, cull together the best ideas from your party that you feel address those issues, then find a candidate who not only embodies them but can communicate them to the American people.

Of course, I have zero confidence either party will do this for the same reason I have zero confidence we can rely on large corporations to always do what's best for the national interest. Political parties and corporations are one and the same. They provide an identity and a legal mechanism for a group of individuals to act as one but the collection itself has no "soul" or "conscience." Even if formed of well-meaning individuals, the entity as a whole will evolve to a mode where the only behaviors it is GUARANTEED to exhibit involve its own self-preservation or what it THINKS (incorrectly, many times) is for its own self-preservation.

We are at that point in America with the Democratic and Republican parties.

The two most viable solutions to the problem involve inducing several rounds of "electoral shock therapy" to both parties and abandoning the idea of waiting for the parties to identify potential solutions and selling them to us.

Electoral Shock Therapy

What's "electoral shock therapy". Exactly what you think. Voting out EVERY SINGLE incumbent, regardless of party. This serves three functions:

1) getting rid of all of the Republicans who supported this President's idiotic military, social, economic and scientific policies
2) getting rid of the ineffectual Democrats who in six years have not been able to communicate any concise, cogent argument to the American people for stopping the more extreme excesses of the Bush administration
3) tilting the balance of power away from the extremes of both current parties

Surely, there are good incumbents who are doing their best to help the country and deserve a chance to return to office, right? Probably. That's why I'm not in favor of mandatory term limits. However, all of our representatives need to get the unmistakable message that a) we are watching EVERYTHING they do, b) we are not happy with the current state of the country and c) business as usual is NOT going to cut it -- we cannot keep kicking these problems to future generations of citizens and taxpayers. The parties are so frozen in time it will probably take three successive election cycles (preferably 2008, 2010 and 2012) to get the message across.

(Gloria Borger had an op-ed piece in a recent US News and World Report saying much the same thing but I've had this idea drafted and rolling around in my head for a while… Really. SMILE)

Leading Our Leaders

We cannot allow the rats in the maze of government to set their own agenda and sell it to us every two years and expect the country to improve. We've tried that and it only produces bigger, fatter rats who know the maze inside and out and enjoy a 98% re-election rate. Americans are going to have to set the agenda directly and use the voting booth to lead our leaders to OUR agenda. The most important part of creating an agenda is for Americans to clearly define the principles we want to see used throughout government. At a minimum, that set of principles should include:

We expect sound accounting for proposed government legislation. -- Lawmakers and the public are entitled to accurate representations of the cost of any proposed legislation. Instead, we have legislation drafted by lobbyists set to gain from the legislation and budget estimates where crucial information was withheld from both parties by the Administration prior to voting (the S&L bail-out costs were distorted in 1987 and 1988 until after the 1988 elections, the 2003 Medicare plan costs were withheld from Congress until weeks after a early morning arm-twisting vote).

We expect sound accounting for actual government dollars spent. -- Spending on disaster relief, wartime operations, or day to day government operations must be transparent and well audited. "Secret" intelligence and military programs MUST be under the financial supervision of Congress -- period. We lost track of EIGHT BILLION DOLLARS IN CASH in Iraq. Poof! Gone. I'm sure it's helping establish free-enterprise zones for small business outside the Green Zone. Sure.

We expect all baseline spending to be paid for in current tax year dollars. -- In short, BALANCE THE BUDGET. In a country as large and wealthy as the United States, any government program or expense worthy of spending the people's money on should be worthy of having current citizens pay for it. Running chronic structural budget deficits has artificially reduced the perceived cost of government, causing "consumers" (us) to want more.

We expect all emergency spending to be paid within 5 years. -- In a country as large as the United States, the aggregate cost of most local disasters can be predicted to some extent (e.g. roughly 10 high-damage tornados, 3 forest fires, 2 bad hurricanes) for dollars to be part of baseline (balanced) budgeting. For events outside that, spending to react to those events should be paid for via dedicated tax legislation that only expires when the response ends. When your refrigerator fails in your home, it's not a good idea to refinance your house and take out a 30-year mortgage to pay for a $1200 refrigerator. The financing should never last longer than the value of the asset being financed. Yet that's exactly what the United States does every year with deficit spending.

Of course, there's no way to create a "rule" that automatically makes elected officials in our government obey these principles. That's why we have the voting booth. That's also why Americans need to pay more attention to what the government does (even the boring minutia). If you need some insight into what the current complacency could produce, John Steinbeck wrote a pretty famous book on the topic.

Sunday, July 16, 2006

A Manhattan Project for Language Skills?

Newt Gingrich appeared with Joe Biden on the July 16 edition of Meet the Press and, at one point, made a comment that the United States only has EIGHT (count 'em, EIGHT) CIA officers on the Korean peninsula who speak Korean.

As I recall, we have a similar language skills deficit in Arabic, Chinese and Farsi.

A quick Google search for "CIA language skills chinese arabic korean" yields the following job posting on the Careers section of the CIA homepage:


Foreign Language Instructors

Work Schedule: Full Time
Salary: $49,397 - $70,558
Location: Washington, DC metropolitan area

Foreign Language Skills Are Essential to CIA's Mission

The Central Intelligence Agency is hiring qualified and experienced Language Instructors of Arabic, Chinese/Mandarin, Dari/Pashtu, French, German, Greek, Indonesian, Japanese, Persian (Farsi), Russian, Serbo-Croatian, Thai, and Turkish to work in the Washington, DC metropolitan area.

Hmmmm. "Essential to CIA's Mission." This has been a problem since before September 11, 2001 and the government HAS made efforts to hire additional foreign language resources. I would think for a skill shortage so critical to our nation's security, upping the ante a bit on pay for these positions might enlarge the size of the talent pool. I'm not sure you can rent a parking spot in the DC/Virginia area to live in your car for $49,397 a year. Why not offer $200,000 a year? $300,000? Ten or twenty of the right people focused on reviewing the right communications could save the United States TENS OF BILLIONS of dollars, not to mention TENS OF THOUSANDS of lives.

We need to treat language skills like the Manhattan Project of the 21st century. An increase in the number of people trained in the language, literature, culture and history (if not "social myths") of our opponents is one of the cheapest but most likely methods of reducing the occurrence of another major world war. This training is valuable under any circumstance because if military action is eventually required, we need those lanaguage skills anyway. Providing stablity requires boots on the ground and boots on the ground require communication with the locals. You cannot adequatly communicate your goals and objectives at the street level with a 1:100 ratio of translators to troops. That's one of many lessons we should be learning from Iraq.

Saturday, July 15, 2006

I'm Having Trouble Naming This One

I'm having trouble coming up with a title for this one. I thought of:

The Neo-Conservative Theory of Creative Destruction, or
The World: America's Geopolitical Guinea Pig, or
Roget's Entry for Meltdown = 2006

The world has some serious, serious problems.

On June 25, militant members of Hamas, a terrorist organization which won control of the Palestinian government in democratic elections in January 2006, kidnapped an Israeli soldier on June 25 as a bargaining chip as part of some larger, unknown, bizarre strategy.

By Friday, June 30, Israel had bombed selected targets in Gaza City and rounded up not only suspected Hamas militants but actual Hamas political players in the Palestinian government.

On July 4, North Korea conducts several ballistic missile tests, publicly confirming their continued desire to at least gain attention if not demonstrate actual aggressive capability and publicly reiterates on July 15 its intent to continue missile testing.

On July 11, terrorist conduct several bombing attacks on trains in Mumbai (Bombay), the largest city in India, the largest democracy in the world and Indian officials have traced participants in the attacks to elements associated with the Pakistani government, a United States ally.

A previous attempted bombing of the Indian parliament in December 2001 has already been traced to elements (the same elements?) associated with the Pakistani government, a United States ally.

Both Pakistan and India posses actual, tested nuclear weapons.

On July 12, militant members of the ruling Hezbollah party of the democratically elected government in Lebanon crossed a boundary into Israel and kidnapped two Israeli soldiers, reflecting a nearly identical strategy as the Hamas attack.

Israel responds to the Hezbollah kidnapping with targeted attacks on the Beirut airport, other key public infrastructure and several towns housing Hezbollah supporters, killing dozens of women and children used as protective cover by the Hezbollah terrorists.

On July 14, Hezbollah attacks an Israeli warship with a rocket that Israel subsequently identifies as an Iranian-made C802 radar-guided rocket but Iran denies any link to the weapon or the attack.

The majority of representatives in the newly elected Iraqi parliament are Shia Muslims who are religiously, culturally and politically aligned with the Shia rulers of Iran.

Shia members of the democratically elected government of Iraq have publicly spoken in support of both the Hamas and Hezbollah attacks and subsequent counter-counter attacks against Israel.

In short, we are at a crisis point in the world where virtually every move the United States has initiated, regardless of the intent or motivations of those doing the planning, has failed to improve our security and has had the unintended result of strengthening Iran, which at this point truly is the biggest challenge to world peace. Unless, of course, you consider the United States for making so many strategic errors that have aided their mischief.

A theme I have seen raised subliminally, if not directly, by remaining supporters of the current "war on terror" is that prior strategies for eliminating terrorism in the 1990s not only failed to work but encouraged terrorists by showing we were "weak" and unwilling to muster a true response. When confronted with the cost in lives and treasure of our current war in Iraq, WOT supporters often counter with arguments that boil down to the following: "Well, we had to do SOMETHING. The status quo wasn't fixing anything. We have to start stirring the pot to come up with SOME other strategies."

Another theme in policies of ultra-conservative thinkers is that many management concepts from business can be used effectively in government to do more for less or do the same for far less. Well, one of the concepts often discussed in business management is that of "creative destruction" which expresses the idea that long-term economic results can be improved via "radical innovation" by "entrepreneurs" who develop new products and technologies at the expense of current, entrenched industries / players.

Given that definition, it doesn't take much imagination to see that concept lurking behind the United States' policies for the past 6 years. Current strategies aren't working to solve a long term problem, so let's get some "entrepreneurs" (Paul Wolfowitz, Douglas Feith, Condoleeza Rice, Dick Cheney, Donald Rumsfeld) with ideas for "radical innovation" (a "transformed high-tech military", toppling a dictator to produce an instant democracy and US ally) to hasten the demise of entrenched players (Iraq, Iran, Syria) who are our enemies to foster long term growth of "democracy."

The problem with this approach is that we're not talking about a better mousetrap, a new semiconductor manufacturing technology or a "new and improved" Tide detergent. This theory is being tested on the world stage in an arena that affects the LIVES of millions of people. In effect, United States policies have been devised with the idea of using THE ENTIRE WORLD as our geopolitical guinea pig.

The result? An complete geopolitical meltdown. An increase in world terrorism, a prolonged US military commitment in Iraq that's further inflaming anti-American sentiment and a growing ring of military conflict around our deployment in a region upon which we depend for oil with oil above $78 per barrel and headed higher. Democracy may be on the march but many of its majority-winning players are active agents of terrorism, active supporters of terrorism or aligned with others completely at odds with our long term goals for peace, safety and stability.

But hey, not all is lost. Our leader, President Bush, the most physically fit American President ever, managed to get in TWO bike rides through scenic St. Petersburg, Russia while taking in a few meetings with the G8 members. I certainly hope he can maintain his exercise regimen. I want him to live a looooooong time after he leaves office so he has some chance of comprehending his role in worsening nearly every problem we face.

Wednesday, July 12, 2006

The WSJ: Still Wrong on Options

The July 12, 2006 Wall Street Journal contained a follow-up column by Holman Jenkins discussing reader feedback to his column from June 21, 2006 which downplayed the legal, financial and moral issues associated with the "backdating" of stock options granted to CEOs.

The original column and the follow-up column rejecting the criticism from WSJ readers about the first column both focused on one key point. Per Jenkins' rationalization, the option grant price is only one variable of many that dictate the value of an options package (the others being the vesting period, expiration date, number of options granted, and "exit" rules governing vesting in the case of the CEO leaving). Options themselves are then only one part of the larger compensation package (no kidding, larger…) paid to the executive.

He concludes his piece with the following statement:

None of this is to prejudge, in any given corporate case, whether backdating was designed into the compensation as a matter of policy or done so on the sly when the board thought it had signed off on something else. You'd want to note, however, that the systemic way many companies adopted a lowest price from the prior period does not betoken an obvious attempt to cover their tracks as if they believed at the time they were doing something improper.

Hmmmm. …as if they believed at the time they were doing something improper.

Once again, the timing of Jenkins' piece couldn't POSSIBLY better demonstrate the gap between the Journal's editorial board and reality. The top story on page 1 of the July 12, 2006 Wall Street Journal was:

SYCAMORE EMPLOYEES discussed how they could manipulate the dates of stock-option grants to make them more lucrative while keeping their actions hidden from the firm's auditors, according to an internal memo attached to a recent lawsuit. Separately, Monster Worldwide said it may need to restate results due to past options practices.

What everyone on the planet seems to understand except Holman Jenkins and the WSJ editorial board is that option grants are supposed to be a purely FORWARD looking compensation scheme aimed at aligning employee behavior with the long-term financial interests of the firm's shareholders. Altering terms of an option grant (ANY portion -- the grant price, the number of options, the vesting period, the expiration date) does not produce FORWARD looking incentives to the employee. Altering terms of a grant after the fact changes the compensation into BONUS compensation that normally rewards employees for PAST performance or hard work in challenging circumstances, etc.

Properly designed bonus and option compensation schemes for employees of large firms are CRUCIAL in establishing the proper balance between short term survival / tactical strategy and the long term health and growth of the company. Too much bonus compensation can encourage management to promote short term profits at the expense of long term product development, capital investment, etc. and destroy a company's future. Poorly structured options with too short a vesting period can produce the same behavior. Compensation plans with nothing but lucrative long term options but poor short term bonuses and mid-term options will inevitably produce lackluster performance or a mass exodus of the best talent.

In virtually every case that's come to light about companies which backdated options, the terms of the options package did not appear to be on some performance incentive "fence" reflecting a company making a judgment call about the trade-off between short-term and long-term performance of the company. Most involved CEOs already well compensated (over compensated?) who were granted additional "sweetheart deal" options timed around periods where the stock price jumped significantly. If the board wants to reward the executive for suddenly educating Main Street on the true intrinsic value of the company's stock, then FINE, pay them a bonus. However, don't claim the incentive was put out for the executive on some prior date, the executive met the challenge and delivered, and file accounting and tax statements furthering the fiction. Shareholders need to know whether the management team can consistently set meaningful goals and achieve them and monitoring "options" compensation is an important part of that process.

The boards of these firms are systematically distorting the information used to judge the performance of their executives and attempting to make the cost of the lavish compensation packages easier to swallow for shareholders by claiming the compensation wouldn't have been paid if the company had not been so incredibly successful. See? No downside cost to the company.

The problem is that anyone could become a billionaire trading stocks in some bizarre Land That Time Forgot by being able to select stocks based upon today's information using yesterday's prices. That's not the management problem executives are hired to solve. They are supposed to set the proper direction for the company and execute on that plan with no time-traveling "mulligan" to reset the starting point of their journey.

Backdating options is a complete, ethical and moral fraud. Unsurprisingly, though, I'm sure we'll find it's perfectly legal. What's even less of a surprise is that the Wall Street Journal is 100% in favor of the practice.

Monday, July 03, 2006

The WSJ: Wrong, Wrong, Wrong

The Wall Street Journal has published an amazing series of editorials in the past few weeks that simply defy logic and reason. The ideas presented are even more amazing given related coverage by the paper's own news staff that shed light on the dangers of the very ideas promoted by the editorial staff. I can't think of a more schizophrenic organization or publication on the planet.

Backdated Options are a Good Thing

Newspapers across the country have been covering literally dozens of cases of major corporations granting millions in back-dated options to CEOs and senior management. The Wall Street Journal's own news staff published a story on March 18, 2006 entitled "The Perfect Payday" that broke the story. The report analyzed the odds of hundreds of grants to CEOs all occurring on EXACTLY the date of a low-point of a company's stock and found the odds well over 300 billion to one.


Of course, prior to the disclosure of the practice, you can be assured that every one of the CEOs benefiting from the practice argued that their largesse was due solely to their genius and leadership as a manager and that they EARNED every penny granted to them and if they HADN'T done such a wonderful job, they rightly would not have gained a cent. Just the free market doing what it does best.

Uh huh.

Undaunted by reality and the facts unearthed by his own newspaper, Holman Jenkins, a weekly columnist for the WSJ, wrote a piece on June 21, 2006 stating that back-dated options are NOT a bad thing. His terminology was "an innocuous and even sensible practice." Jenkins argued back-dated options simply reflect the desire of boards to better control total compensation by controlling both the number and the price of the options. Of course, this is pure rubbish. Not a single one of these publicly traded companies stated that as a goal in their annual reports or SEC filings for periods where the options were granted.

Jenkins' view also flies in the face of any understanding of the structure and purpose of an option taught to first year business school students. Options are intended to improve the alignment of interests between management and shareholders by offering an opportunity for upside compensation when management drives the firm's stock price higher. Of course, options are not a perfect motivation vehicle since they instill no "down-side" discipline to encourage preservation of capital which is ALSO a primary goal of shareholders.

For those of you rugged individualistic investors planning for your own retirement in a world devoid of pension plans, that would put the WSJ squarely in the corner of…

…already overcompensated executives bent on further rigging the game in their favor with money that is rightfully owed to you, the individual stockholder, trying to save for your own retirement.

Still feeling good about retiring early at 50? How about retiring at 65 with ANYTHING?

New York Times Bad, Wall Street Journal Good

After the New York Times published the story concerning US Government monitoring of international financial transactions through SWIFT, the Wall Street Journal devoted their entire editorial column to an explanation as to why the New York Time's reporting on the program was harmful to national security and the war on terror while the Wall Street Journal's coverage of the same story on the same day was not.


The most illogical thought in the entire WSJ commentary is in this single paragraph:

Some argue that the Journal should have still declined to run the antiterror story. However, at no point did Treasury officials tell us not to publish the information. And while Journal editors knew the Times was about to publish the story, Treasury officials did not tell our editors they had urged the Times not to publish. What Journal editors did know is that they had senior government officials providing news they didn't mind seeing in print. If this was a "leak," it was entirely authorized.

Basically, the WSJ believes the NYT was obligated to think about the larger impact of publishing information potentially damaging to the war on terror and that the NYT should have spiked the story when the government asked them not to publish it. At the same time, the WSJ basically states it was "authorized" to publish any information spoon-fed to it by the government in an attempt to dampen the splash a NYT scoop would make for the story. Even if the information was handed to the WSJ and other papers, if the WSJ thought it was so damaging, why run it? Do you believe every time the government tries to hide something, they are protecting us and every time they try to provide information, they're trying to inform us?

The WSJ's willingness to publish any story spoon-fed to it by the government is exactly the same type of lazy stenography by the press that got us into the Iraq war with virtually no serious questioning of tactics or need. Why didn't the WSJ criticize the NYT in 2002 when Judith Miller, despite working for the "liberal" NYT, published reports filled with unquestioned "facts" directly from White House and Pentagon intelligence briefings that had nothing resembling factual intelligence. We could have used some healthy skepticism about government policies, information and spin back two or three hundred billion dollars ago and 2500 lives ago.

Presidential Powers and the USSC Ruling on Gitmo

The Supreme Court issued a ruling in the case Hamden vs. Rumsfeld involving the detention of a man believed to be Osama bin Laden's bodyguard at Camp X-Ray in Guantanamo Bay, Cuba.


In a nutshell, the Supreme Court ruled

ONE - The suspect cannot be tried by a military tribunal as desired by the Bush Administration because a tribunal must operate under rules of the Uniform Code of Military Justice (UCMJ) and the Administration has not clarified the standing of the suspect as a prisoner of war.

TWO - A lower court's rejection of the claim that a tribunal would violate terms of the Geneva Convention was wrong and was "not persuasive."

THREE - The argument that the Geneva Conventions cannot be applied when fighting an enemy who is not a signatory to the Conventions is invalid because Common Article 3 of the Conventions states an obligation of signatories to a minimum standard preventing the passing of sentences without prior judgment of persons placed hors de combat via detention.

The ruling did NOT state that all prisoners in Guantanamo and America's other secret gulags must be immediately freed. It did NOT state that we have no right to detain suspects captured via legitimate military efforts in combat zones until the cessation of combat. It simply reaffirms all such detainees have a minimum set of basic human rights we must honor, that we cannot operate judicial mechanisms outside the bounds of current military and civil law and that the President cannot operate said mechanisms outside the purview of the Legislature and the Courts.

Pretty revolutionary stuff, huh?

On the July 3, 2006 editorial page, the Wall Street Journal completed its "through the looking glass" editorial hat trick courtesy of the "After Hamden" piece. The very first paragraph begins with

American's political elites certainly have come a long way since September 11.

Wow, in the very first sentence, the editorial board manages to reframe a Republican dominated Supreme Court decision as the doings of "political elites" (read "liberals") and to confound a basic issue about human rights, due process and checks and balances with security in a post September 11 world.

The coup de grace of the Journal editorial comes in the following comment towards the end:

But there's a reason the Founders gave Presidents the bulk of the Constitutional power to wage war, leaving to Congress mainly the power to declare war and then finance it. The executive branch can act with speed and decisiveness that a committee of 535 simply cannot. Presidents can also be held directly accountable by voters in a way that a diffuse Congress (and especially the Supreme Court) cannot.

How are the people to hold a President accountable at the polls in a climate where the President systematically blocks the ability of any other branch of government to monitor his conduct? How can Congress be expected to "declare" war when the President has declared a new state of permanent semi-war justifying any level of military decision making without the prior consent of Congress? How can Congress effectively control the purse strings of the military when the President systematically hides the existence and cost of critical, costly programs from oversight by Congress?