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Sunday, November 23, 2008

Wall Street's Ethical / Competitive DNA

If the recent past is any prologue, the news over the coming months will be remarkably easy to predict. A new economic statistic will be released, the world markets will drop another five percent, and executives of yet another uncompetitive, debt-laden behemoth selling expensive credit-dependent products will suddenly fly to Washington (private jet, of course -- no point in mingling with the commoners in commercial steerage until you HAVE to…) hat in hand to explain why more taxpayer dollars should backstop their business.

As GM, Ford and Chrysler executives prepared to participate in the ritual two weeks ago, I wrote a commentary (#1) that examined the economic mismatch between the size of the "Three" and current market demand and contrasted their ability to make material changes in their business and products with the needs of the current situation. It wasn't (and still isn't) a pretty picture.

Now, on November 23, 2008 it appears to be Citibank's turn at the rite of failure. However, the sheer number of bank and brokerage failures experienced in the past year warrants a broader review. Focusing on any one institution -- even one as big as Citibank -- seems guaranteed to miss the root issue. A recent article (#2) published at www.portfolio.com by writer Michael Lewis entitled The End prompted me to read his older book Liar's Poker published in 1989. His recent piece was a follow-up to the book in which he attempted to analyze what, if anything was learned by the financial industry since he wrote the book. The answer is NOTHING. Going back to read his book makes it pretty clear what the root issue is.

Liar's Poker as a Standalone Work

The book was originally published in 1989 as a memoir of sorts of his experience working for three years for Solomon Brothers. It wasn't a tale of a failure and the disillusionment stemming from it. Quite the opposite. Lewis was quite successful financially in his three years at the firm. That is precisely why he left. He realized the wealth financial firms were producing for their traders and executives had nothing to do with the value they were providing to customers (and in MANY cases came directly at the expense of their customers) and therefore were unsustainable. A few points about the book itself are worth mentioning before tying it back to the larger point here.

Liar's Poker is very well written and contains several chapters which do a tremendous job explaining the mechanics of the derivative securities that have melted down the world's financial systems. The technical content of the book is so well done and apropos for the current situation twenty years later that other than a few date references and the name Solomon Brothers itself, the book reads like it was written in 2008. Reading it will give anyone watching the current market a disturbing sense of déjà vu.

The book is uniquely valuable because of two aspects of Lewis' experience in working for Solomon Brothers. First, because of his art history undergraduate background, he wasn't exactly expecting or even wanting a career in high stakes finance. As a result, when a chance meeting with the wife of a Solomon executive at a dinner with the Queen of England (you'll have to read the book for the full story…) turns into a position at the firm, Lewis immediately enters the dragon's lair with the perspective of an unlikely outsider -- he didn't even have an MBA. Probably because of his sense of the improbability of landing the job in the first place, he continued doing free-lance writing for other publications which probably kept him in the habit of noting details of his experience at Solomon in real time. As a result, the book is far more vivid than it would be if it had been written entirely in retrospective after quitting the firm.

His perspective in working at Solomon was also unique because as a trainee, he was pulled into the corporate headquarters like all of the other new-hires of the class of 1985 for six months of seminars on corporate practices, etc. before beginning real work. However, he was assigned to the London office, so he was in the unique position of learning virtually all of the key players in the firm's growing mortgage bond trading operation while getting to watch them from a distance -- with an outsider's perspective.

Back to the Future

If Liar's Poker was going to be republished now, Lewis might just as well use Back to the Future as the title. Reading the book now is like traveling back in time to the point where many of our current problems first began. However, the unique nature of Lewis' circumstances for landing his gig at Solomon Brothers in the first place and his insider-yet-outsider perspective while working there are why the book is particularly useful to read now. The book became a bestseller in 1989 and even now, the promotional "blurbs" for the book often cite how funny or entertaining the book is to read. My take on the tone might be colored by 20 years of hindsight reading it now but the book doesn't read like Lewis was aiming at "funny" or "entertaining."

Two elements of the book can be recounted here to explain the strange mis-read of the book's original audience. The first involves the story at the beginning of the book that explains the Liar's Poker game Lewis chose to set the tone for the book. Liar's Poker is a numbers game that was popular with traders at the time (and who knows, maybe still now) which uses digits of the serial numbers of US currency as "cards" in the hand being played. Everyone playing takes out a dollar bill and stakes a position or "hand" based upon the quantities of digits in the serial number of their bill. In Liar's Poker, hands are ranked by either the same number of higher digits (three 5s beats three 4s) or more of a lower digit (four 4s beats three 5s). The game circles around all of the players until all of the players challenge the same player's "bid" then everyone shows their hands.

The game of Liar's Poker was the perfect metaphor for Lewis' experience because as Lewis writes, part of the game depends upon a basic understanding of the math behind the probabilities behind the possible combinations of digits appearing in the serial numbers (somewhat akin to card counting in blackjack). Of course, that's the part of the game anyone can master after playing enough times. The rest of the game relies on each player's ability to bluff, each player's ability to read the bluffs of the other players, and each player's willingness to take risk.

(Uh oh…)

The book starts out with a story of how one day, during one of his management-by-walking-around walks through the bond trading floor, Solomon Brothers Chairman John Gutfreund suddenly challenged John Meriwether, one of the firm's top bond traders, to a single round of Liar's Poker. In front of the entire floor of traders. For one million dollars.

Lewis' narrative reads like the screenplay to For A Few Dollars More where Manco attempts to intimidate Mortimer into leaving town by shooting his hat off his head then incrementally further down the street as Mortimer chases it. Only in the Solomon scene, Meriwether manages to avoid the game by counter betting his chairmen TEN million dollars. The chairman calmly eyes his lead bond trader for a period, demures and walks away, normal trading resumes, and Lewis dives into the rest of his tale.

That episode makes a critical point for the book and for current readers trying to make sense of events on Wall Street today. What types of people have a mentalities that seek out such risks involving such huge stakes and games of brinksmanship? The types that work on Wall Street, it turns out. The types that are supposed to be managing OUR money. The types working in an environment that has concentrated so much wealth in their hands that sums of money constituting a fortune to the rest of us are mere pittances to be waged in pointless games.

After that introduction, Lewis goes back to explain the unlikely chain of events that led him to get hired at Solomon then spends a few chapters describing the training program at Solomon and the manner in which trainees vied for permanent positions in the various divisions of the firm. The first surprise Lewis describes is the behavior of the new hires in the training program. Wall Street started booming in the 1982 timeframe and stories of new hires quickly making large amounts of money in the bond trading operations of firms supporting junk bonds and the leveraged buyouts they made possible started intensifying competition for Wall Street jobs. One would think recent MBAs graduates selected to work at one of the big dogs on Wall Street would arrive grateful, eager to learn and more eager to make a good impression with their new employer.

One would be wrong.

The stories Lewis conveys of his "class of 1985" -- all 127 of them -- read more like the behavior of a class of 8th graders on a day with a substitute teacher. The training classes were structured to have key executives from the ranks up to the board of the firm come in and pontificate on various aspects of the firm, its strategies and unique codes of conduct for working deals, etc. The new hires were supposed to sit attentively and ask pertinent questions of the honored guests. Instead, the class immediately stratified into "suck-ups" who sat at the front of the class, frat boys who sat in the back tormenting the weak in the herd and a group of floaters in the middle who simply tried to make heads or tails of the jungle around them. Here's how Lewis described it (page 41):


--------------------------------------
That the back row was more like a postgame shower than a repository for the future leadership of Wall Street's most profitable investment bank troubled and puzzled the more thoughtful executives who appeared before the training class. As much time and effort had gone into recruiting the back row as the front, and the class, in theory, should have been uniformly attentive and well behaved, like an army. The curious feature of the breakdown in discipline was that it was random, uncorrelated with anything outside itself and, therefore, uncontrollable. Although most of the graduates from Harvard Business School sat in the front, a few sat in the back. And right beside them were graduates from Yale, Stanford and Penn. The back had its share of expensively educated people. It had at least its fair share of brains. So why were these people behaving like this?

And why Solomon let it happen, I still don’t understand. The firm's management created the training program, filled it to the brim, then walked away. In the ensuing anarchy the bad drove out the good, the big drove out the small, and the brawn drove out the brains. There was a single trait common to the denizens of the back row, though I doubt it ever occurred to anyone: They sensed they needed to shed whatever refinements of personality and intellect they brought with them to Solomon Brothers. This wasn't a conscious act, more of a reflex. They were the victims of the myth, particularly strong at Solomon Brothers, that a trader is a savage and a great trader a great savage.
--------------------------------------


Fast Forward to the Present

Lewis actually wound up speaking to later classes of new hires before he left in 1988. The classes got bigger each year and the trainee behavior he described became worse each year as the bond trading bubble attracted more and more graduates with winner-take-all attitudes and a false sense of entitlement from having survived graduate school and "winning" a coveted spot on Wall Street.

Now consider those words were written in 1989 to describe the process used to select and indoctrinate MBAs hired between 1985 and 1988. Over twenty years ago. I'm sure the process and types of players Lewis described at Solomon were not unique to that firm. The class of 1985 is now present in middle or senior management across Wall Street and many in Lewis' class in particular quickly rose to unique positions of power throughout the bond and mortgage backed securities business due to the unique role Solomon played in growing those markets.

Now fast-forward to the present and consider the situation people like the "class of 1985" have produced in the financial markets and the larger economy. Everything Lewis described in his book -- the arrogance, the outsized compensation, the indiscriminate risk-taking, the double dealing of traders for their own interest and against the fiduciary interests of their customers -- has been institutionalized throughout nearly every large financial firm in the industry. By sheer demographics, firms like Citi are managed almost entirely by executives who grew up in the swing-for-the-fences heyday of Wall Street and profited from the game and have no ethical or strategic DNA that would aid them in operating effectively in any other competitive climate.

This is the ethical and competitive DNA of the people now begging the US Treasury and the Federal Reserve for bailout money. The correct answer seems pretty obvious.

No.

Hell no.


===================================

#1) http://watchingtheherd.blogspot.com/2008/11/automotive-hail-mary.html

#2) http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom

Tuesday, November 11, 2008

An Automotive Hail Mary

On November 7, General Motors and Ford announced stunning losses for the third quarter of 2008 totaling $7.18 billion. News of tightening in the consumer credit markets for the past several months didn't make the sales dip much of a surprise. The more worrisome news from both makers was the staggering amount of cash burned during the quarter -- roughly $14.6 billion between the two. (#1) The quarterly results triggered renewed discussions about the merits of a bailout of the American auto makers by the Federal Government and (hence) American taxpayers.

If Americans needed any reminder of how expensive and potentially futile such bailouts might prove to be, they got it -- the very next business day. On November 10, AIG requested and received a $25 billion dollar nightcap on top of a $37.8 billion dollar refresher granted October 8 on top of a $85 billion dollar initial bailout granted September 16. After nearly $150 billion granted, there is zero concrete proof the money granted to AIG will change the final outcome. That should give pause for elected officials and Treasury officials considering solutions for the auto industry.

A review of the economic footprint of the auto industry is sobering and makes it obvious that a lengthy or permanent decline in sales will produce great economic problems in the larger economy. However, a review of the operations of the firms involved also makes it clear they face issues with management inertia and other intangibles that make it doubtful any road to recovery exists for these firms in their current form and size.


First, Some Statistics

Because every major auto manufacturer operates and sells in nearly every market, trying to correlate sales per company per country with production per company per country and costs can prove confusing. However, it's still useful to summarize some key statistics.

Auto Production by Country for 2007 (see #2):
Japan = 11.59 million
United States = 10.78 million
China = 8.82 million
Germany = 6.21 million
South Korea = 4.09 million
France = 3.02 million
Others = 27.39 million
TOTAL = 71.9 million

Auto Production by Manufacturer for 2007 (see #2):
Toyota = 9.50 million
GM = 9.35 million (13.2% of world total)
Volkswagen = 6.35 million
Ford = 6.25 million (8.69% of world total)
Honda = 3.91 million
PSA (Peugot) = 3.46 million
Nissan = 3.43 million
Chrysler = 2.54 million (3.53% of world total -- ***)
Others = 27.11 million
TOTAL = 71.9 million

*** four makers ahead of Chrysler omitted here for brevity

Total US sales for October 2008 across all makes plummeted 32 percent to 838,156 vehicles (#3). Sales across all of the major makers plummeted in October of 2008. players have been falling in August and September compared to 2007 results for the same months. For GM, August sales dropped 15.6 percent, September sales dropped 20.7 percent, and October dropped 45 percent.

Some other possibly interesting statistics from the "Auto Alliance", a PR media consortium sponsored by virtually all worldwide automakers doing business in the United States (#4):

* Autos account for $690 billion of U.S. retail sales, or about 20% of US retail sales
* Auto sales produce roughly $10 billion in local / state sales tax revenues
* Auto-related production accounts for roughly 4% of United States GDP, or about $554 billion
* total "auto related" jobs are 13 million (10% of non-farm employment)

Per news stories on 2007 UAW contract settlements, employment in the US and Canada for parts and assembly work amounts to 70,000 for GM, 55,000 for Ford and 45,000 for Chrysler.


The Demand Side of the Equation

One concern about a potential bankruptcy of GM is that it is such a large consumer of parts from domestic companies that if it goes bankrupt, those firms will not be able to survive on the remaining demand for parts. Concern over this second-order effect of a GM failure is valid but requires some analysis. For this concern to be strictly true, this second-order affect assumes a GM bankruptcy means:

1) 9.35 million new vehicles stop getting built -- IMMEDIATELY
2) demand for spare parts of existing GM vehicles vanishes - IMMEDIATELY

If point #1 became true in a literal sense, it would mean worldwide demand for cars and trucks would immediately drop by 9.35 million. Auto demand has already dropped precipitously so another drop of 9.35 million in demand certainly isn't out of the question. However, the current climate isn't a reflection that the world market doesn't want ANY of the 9.35 million vehicles, just that SOME of those cars aren’t desired (for price or fuel economy) or that SOME potential buyers can't get credit to buy them. Because of the residual demand for SOME cars, a bankruptcy filing by GM isn't likely to completely shutter the company but is instead more likely to result in additional production cuts of 20-40 percent. That's a huge hit to overall economic activity but far different than a 100% reduction.

If scenario #1 does come to pass, one also has to doubt the likelihood of scenario #2. If demand for new cars drops by 9.35 million, existing owners will be doing without a new car by driving existing cars longer. That will INCREASE demand for spare parts for the existing fleet on the road which is likely 35 percent GM made.

A more subtle point about scenario #2 should also be made. If demand for spare parts for existing GM vehicles also vanishes in a short period of time, the only viable explanation would be that the cars aren't being driven at all, which means consumers will have found ways to reduce miles driven. If that's the case, that's not an argument for trying to prop up what's left of the current domestic auto industry at its current scale. Any effort to do so will simply subsidize designs and manufacturing skills for products that consumers have left behind and no longer want.

For a firm like GM, the analysis has to focus on where demand drops are likely to occur first: profitable gas guzzlers that remain affordable to those less dependent on credit -- OR -- low margin, entry-level fuel efficient vehicles demanded by less affluent customers more in need of credit? The reality is that either answer may not help any automaker who is only profitable making gas guzzlers. More will be discussed of this dilemma under the Supply Side heading below.

In reality, scenario #2 -- a complete evaporation of demand for GM parts -- is highly unlikely. Due to credit restrictions and the need for people to keep older cars longer, demand for spare parts for 10 years of GM products will continue nearly unabated for some time, giving parts manufacturers some recovery time.


The Supply Side of the Equation

Take a look at these figures culled from GM's 3Q2008 report (#5):


3Q2007 3Q2008 change
North American Production 1,020,000 915,000 -10.3 percent
Worldwide Production 2,156,000 2,039,000 -5.4 percent

North American Deliveries 1,206,000 978,000 -18.9 percent
Worldwide Deliveries 2,388,000 2,115,000 -11.4 percent

North American Utilization 84.5% 78.8%



The production versus delivery numbers above point out that GM has succeeded in cutting the growth in excess inventory (deliveries over production is dropping) but a drop from 186,000 sales from inventory in 3Q2007 to 63,000 sales from inventory in 3Q2008 still means they are producing far more cars than dictated by demand. Though worldwide utilization figures weren't provided, the North American number alone is scary enough --- a 78.8 percent utilization rate means GM's yearly total North American capacity is 4.64 million vehicles but if the 3Q2008 trend continues, current demand will only be 3.91 million vehicles for an excess of 730,000 vehicles. It's likely things will get worse before they get better if they get better at all which means GM is operating with nearly 33% excess capacity just for North America. Worldwide excess capacity may be even greater (and more damaging).


Management Strategy and Inertia

For such a capital intensive business, excess capacity implies problems far beyond imbalances between final assembly capacity and demand. In the case of GM, continuing to operate Saturn, Chevrolet, Buick, Pontiac, Cadillac, GMC, Saab and Hummer means it is continuing to dilute any focus on meaningful product redesign and quality for its suppliers and its own final assembly plants. If the company was firing on all cylinders, maybe they could make a case for "focusing their efforts across the board." When the firm is burning $6.9 billion in cash per quarter, it really needs to review every dime of capital spending.

So what projects have been absorbing GM's R&D dollars for the past few years as it lost BILLIONS of dollars and headed into this perfect storm?

* a special edition 2009 Corvette with a 650 hp V8 engine and a $103,000 price tag
* a January 2009 roll-out of a relaunched Camaro with a 300 hp V6 or 422 hp V8

Does anyone have any theories on lessons from building a new generation 650 hp V8 that can be applied to creating a $15,000 entry level car? Does anyone have any idea how much it costs to tool a plant to make an engine for only 5000 units? Does anyone want to venture how many teenagers are going to be able to afford a 300 hp Camaro or the insurance on a 300 hp Camaro when their parents are unemployed?

Rumors also abound of what has NOT been absorbing R&D dollars at GM:

* development of the Cruze sedan slated to replace the Malibu may be on hold (#6)
* redesign of full size trucks and SUVs was deferred as of June 2008

It's not clear if the truck and SUV redesigns were normal restyling or actual attempts at improving efficiency.

The return of $60/barrel oil may only last 3-4 years if economic recovery resurrects worldwide demand or if peak oil theories about supplies hold true. That's not enough time for a complete revamping of product design teams, engine and power train designs and assembly plants to eliminate the gross inefficiencies that GM, Ford and Chrysler have in their current product lines. Typical product development cycles for a significantly new vehicle might be 4-5 years. The current product plans at GM are telling --- and damning -- of its management team. The "car guys" running GM may know cars but they really don't know the car business. They have demonstrated zero insight into where the world markets are headed nor have they demonstrated any understanding of their competitive position. They have laid absolutely ZERO groundwork for new products which can be profitable with gas at $3.00 to $4.00 per gallon.


Considering the Intangibles

If GM and the other American automakers were only facing a credit crunch, overcapacity problems and outdated / obsolete product designs, those problems would be more than enough. The American firms also face key intangible, but equally daunting, problems.

For nearly twenty years, consumer research and quality studies have been published confirming American automakers closed the quality gap with Japanese brands and are producing equally high-quality vehicles. Those reports may be true and won't be argued here. What is worth mentioning is that consumers who bought the junk produced by GM, Ford and Chrysler in the 70s and 80s have very long memories. It's safe to assume that those who resolved to never buy American again will stick to that resolution until they have a worse experience with an "import" than they remember having with an American car.

It's also safe to assume that most buyers are aware that a large portion of units from Toyota, Honda, Nissan, BMW, etc. are made in America and have significant American parts content. Buyers are also likely aware "American" car companies have numerous parts and assembly plants in Canada and Mexico so "buying American" is a slogan, not a reality for any make or model.

The Opportunity Cost of an Automotive Bailout

Estimates of the cost of a bailout of the auto industry have ranged from $25 to $50 billion dollars. Little has been said about whether an attempt would be made to spread those dollars across GM, Ford and Chrysler or if those with a vote have already decided Chrysler isn't worth saving. What hasn't been discussed much yet is the opportunity cost of any bailout attempt.

The opportunity cost of a economic choice is the value of the next best alternative that wasn't chosen. If you have a choice between working overtime for six hours on Saturday for $50.00/hour or playing a round of golf for free and you choose the golf, that round of golf wasn't "free". In economic terms, the opportunity cost of that round of golf was $300 because choosing to play required you to surrender the opportunity to earn $300 in the same time doing something else.

The cost of an automotive bailout is extremely difficult to determine because not only are the alternatives to a bailout difficult to formulate but because it isn't at all clear if a bailout can actually produce its intended effect. The chance of success isn't clear because no one has attempted to clearly state the goal. Is the goal to

1) return the current industry at its current size to profitability with current products?
2) return the current industry at its current size to profitability with new "cars of the future"?
3) provide a smoother path to a downsized industry trying to profit from current products?
4) provide a smoother path to a downsized industry trying to profit from new "cars of the future"

The likelihood of continued tight consumer credit makes any plan aimed at sustaining an industry producing current volumes of cars seem unlikely, making scenarios #1 and #2 highly unlikely. The long term pressure on petroleum supplies and resulting higher prices means cars that perform like today's average cars have little future, making scenarios #1 and #3 unlikely to succeed.

The key variable left is the "car of the future" wildcard.

Any solution considered for the auto industry has to contribute in a concrete way to enabling technologies for more efficient transportation to be developed -- whether that comes in the form of ultra-efficient personal transportation or renewed investment in public transportation.

Go back and read the section on management strategy and inertia then carefully consider one question:

Have General Motors, Ford or Chrysler demonstrated ANY knack for identifying, developing and operationalizing technologies that amount to quantum improvements in vehicles?

The United States and the world at large desperately need two things right now --- a huge economic stimulus to slow down the reduction of jobs and a quantum leap in highly efficient, profitable transportation technology. Solving only one of the two just defers a larger economic contraction by possibly 5-8 years. The bet we make on technology right now HAS to be correct. So are GM, Ford and Chrysler really the receivers we want to send downfield for this Hail Mary pass?

* the same companies that brought us the Corvair?
* the same companies that brought us exploding "side saddle" gas tank in trucks?
* the same companies that brought us exploding Pintos?
* the same companies that brought us the X-cars?
* the same companies that brought us the Fiero Flambe?
* the same companies that brought us unstable Explorers with tread-separation prone tires?
* the same companies that resisted adding air bags for 20 years as too expensive?

The answer to the Hail Mary question really answers the job protection question. If consumers have little faith that the existing incarnations of GM, Ford and Chrysler have any chance of inventing the next generation vehicles we need, their sales will continue to collapse, making it pointless to continue paying people to make vehicles no one wants to buy or no one can afford. The design talent and manufacturing expertise needed for the car of the future may very well be trapped somewhere inside those firms but it seems clear the current management of these firms has no demonstrated ability to lead the charge.

Even if the companies manage to sustain current sales levels, they still have far too much current capacity -- GM needs to cut capacity by nearly 33 percent per the analysis earlier. More large job cuts ARE coming and GM can choose between cheaper Canadian and Mexican plants to meet North American demand. For the jobs remaining, it is VERY likely the companies will use bankruptcy to break collective bargaining agreements and shed pension obligations to reduce wage rates far below current averages.

Different people will come out on different sides of the auto bailout issue but there is one thing probably no one disagrees about. The cost of getting this decision wrong is unimaginably high.

================================

#1) http://www.reuters.com/article/asiaDealsNews/idUSTRE4A52V020081107

#2) http://en.wikipedia.org/wiki/Automotive_industry

#3) http://www.autoalliance.org/index.cfm?objectid=abbreviated

#4) http://ap.google.com/article/ALeqM5gsz39lpYrNG7OiKs3FJt6jhV6NEwD947OQ1G0

#5) http://media.corporate-ir.net/media_files/misc/Q3_2008_Highlights.pdf

#6) http://www.businessweek.com/lifestyle/content/oct2008/bw20081023_883385.htm

Sunday, November 02, 2008

A Great System Theory of History

During an interview about his work, historian David McCullough outlined one technique for writing history termed "the great man theory" which uses an underlying assumption of greatness and/or destiny as a theme to keep the action moving. Any time actual events or decisions don't add up or aren't known or don't make sense, the historian can just fill in the plot and chalk it up to the "destiny" of the lead character moving steadily forward towards their inevitable greatness. It makes it much easier to tidy up a book or screenplay but it really reflects lazy work on the part of the historian and encourages sloppy thinking on the part of the reader or viewer.

In the 2008 race for President, we've seen media handlers and sometimes the candidates themselves use the "great man" approach to justify their election. Since elections are a key tool we use in making our history, the idea that voters can ignore what happens in their local, state and federal governments for years at a time then try to find a "great man" to pull the country out of a ditch after years of inattention is dangerous to say the least.


The Great System Theory

The Constitution begins with the words

We the People of the United States, in order to form a more perfect union.

The framers were famously meticulous thinkers and writers. It is no accident the very first sentence of our principle governing document not only focuses on We as a pluralistic society but explicitly acknowledges the purpose of their work was not to lay down the ultimate FINAL set of rules but instead to establish an orderly, stable process for continually refining our society. Note that nowhere in the Constitution does it state

Look, we won this time, here's the way it's gonna be for the next two hundred and thirty two years. If you don't like it, screw you. The Ohio Territory is thattaway.

America has the best system of government. Period. However, every system has its limits, beyond which it either grinds to a halt or outgrows its support systems and implodes. It's not difficult to argue our history over the past forty years has proven that case in spades.


From One Extreme...

After building our way out of a Depression by building the roads, bridges and electric grid needed for a modern industrial nation, America entered the 1960s with the wealth resulting from a decade long head start over the rest of the world in manufacturing prowess and one of the best educated work forces courtesy of the G.I. Bill. We also entered the 1960s with the confidence of a country that won a major world war and was succeeding at keeping our major foe at bay around the world.

In the 1960s, our confidence in our military abilities led to involvement in a minor proxy war in Vietnam which inexorably pulled us in deeper and deeper for months and years and eventually cost tens of thousands of lives over a decade. At the same time, recognition of long standing problems with race, injustice and poverty led to improved civil rights laws and government programs aimed at reducing poverty and providing improved healthcare for the elderly.

Unfortunately, few understood the actuarial costs of those new government programs. Even fewer understood some of the negative incentives some of those programs would create to actually counteract any supposed benefits. And absolutely no one felt any need to true up the numbers and actually PAY for such a great society and a (ahem...) great war. As a result, a decade of bad social, military and fiscal policy in the 1960s set the stage for a decade of stagnation and industrial decline in the 1970s.


…To the Other

After a decade-long hangover from the 1960s, America went from one extreme (guns AND butter) to another (guns AND deregulation). Like the 1960s experiment, the 1980s experiment looked promising at first. We came out of a deep recession that was imposed to kill inflation created not only by deficit spending in the 1970s but by spiking oil prices. By 1982, the recession combined with a convenient worldwide collapse in oil prices dropped inflation to manageable levels. Savings and loan institutions were deregulated, the stock market soared, leveraged buyouts using junk bonds to raise cash produced ever larger corporate conglomerates and it was sold as morning in America again.

However, warning signs did pop up. The deregulation of S&Ls threw those S&Ls into unfamiliar lending markets while falling energy prices led to falling real estate prices in many areas where S&Ls attempted to begin competing. The cascade of failed S&Ls cost American taxpayers over $124 billion dollars. By 1988, civil lawsuits and criminal charges were pursued against junk bond king Michael Milken for insider trading and racketeering and took his employer, Drexel Burnham Lambert, down with him.

Despite the warnings, the surprise ending of the Soviet Union with a whimper instead of a bang buoyed optimism and politicians' faith in lean, mean, minimally regulated financial markets and industries and the economy was off to the races for the rest of the 1990s. While vastly entertaining for all involved, the decade still managed to provide some danger signs. In 1997, distorted credit markets in Asia had produced a bubble in asset prices in those economies which eventually collapsed, producing a massive unwinding of debt, massive contractions in lending and collapsing currencies which brought those economies to a standstill. In 1998, a collapse in the Russian ruble caught a pair of Nobel Prize winning economists and their firm, Long Term Capital Management, by surprise and triggered an emergency bailout by the New York Federal Reserve Bank and others that cost $4.6 billion.

Despite the second round of warnings, the guns AND deregulation strategy remained in place past 2001 where it was used to sustain an otherwise struggling consumer economy hung over from dot com accounting frauds and spooked by a horrific terrorist attack. For another five years, until 2006, the American economy resembled a spaceship in a Douglas Adams novel, hanging there suspended in the air, much in the way that bricks don't. Now the brick is definitely headed to the floor and America's big toe.


A Return to the Middle

If you believe the worst about what you hear about Republican strategies for solving our problems, they involve even more de-regulation and even lower taxes to improve economic efficiency and increase incentives for individuals to make their fortunes. Of course, that approach will produce even more catastrophic bubbles and frauds while bankrupting the government on the revenue side.

If you believe the worst about what you hear about Democratic strategies, they involve everyone having a job, everyone having free healthcare and lazy teachers earning $100,000 to teach students who graduate unable to work at a McDonalds' without photos of the menu items on the cash register. Of course, that approach will bankrupt the country on the cost side, kill productivity and raise a generation of idiots.

A quick glance over the past forty years of history would seem to make it obvious that the best solutions to the economic and social problems we face lie back in the middle rather than on either extreme. We've already tried extremes which discount individual responsibility and we've more recently tried extremes which discount corporate responsibility. If you're reading this and still haven't decided how to vote on November 4, 2008, nothing I could write will convince you one way or the other. However, I would make the following points:

If you have any opinion whatsover either way THEN VOTE. The most damaging outcome of an election in a country fighting two wars and staving off a major economic meltdown would be for politicians to see the normal, pathetic 51 and 55 percent turnouts in prior Presidential elections. The more voters politicians have to address, the more likely they will have to avoid wedge issues and address core concerns.

The government isn't the enemy, the government is US. As such, the government is as dumb or smart as We The People are willing to become. If you want a smarter, more efficient government, educate yourself about the basics of finance, money and banking, the checks and balances built into our system and a bit of world history. It's amazing how many bad ideas keep returning because no one remembers them from the last time. It's also amazing how politicians can convince voters that taxing less and spending more can balance a budget.

Regardless of who wins, watch them closely and watch your pockets even closer. If politicians want to be trusted, they have to earn it by operating above board at all times and designing government programs with transparent accounting. At this point, none of them have earned that trust.

It's time to stop trying to find great men or women to govern us. We have a great system of government in America. It's time to use it. Properly.

Untying the Knot in Afghanistan and Pakistan

The PBS show Frontline recently aired a segment entitled The War Briefing that should be required viewing (see #1 for video) or reading (see #2 for transcript) for all Americans. The show is a companion to a prior segment entitled Return of the Taliban which is also worth watching (#3) or reading (#4). The War Briefing provides commentary from numerous reporters including Michael Gordon, Dexter Filkins, Steven Coll and Mary Ann Weaver who have covered the war in Afghanistan since 2001 to the present. It does a great job summarizing the complicated, convoluted and often outright contradictory alliances that produced the sanctuaries exploited by Al Qaeda and continue to thwart the defeat of the Taliban.

If boiled down to the simplest terms possible, the program makes the following points:

1) The Pashtun areas of Pakistan have been unconquerable for hundreds of years due to both the terrain and the tribal history.

2) Inhabitants of the tribal areas no more recognize the arbitrary border drawn by the British between Afghanistan and Pakistan than they do the very countries themselves.

3) The US invasion of Afghanistan in 2001 may have toppled the Taliban government in Kabul but it could not destroy the Taliban because they retreated to the Pashtun tribal areas of Pakistan and US forces could not follow and destroy them without destabilizing our .ally. Pakistan.

4) The American invasion of Iraq refocused the vast majority of American resources and intelligence on Iraq and left the hunt for Bin Laden and the rest of Al Qaeda to Pakistan.

5) Pakistan received billions in American aid to .fight Al Qaeda. but Pakistan's security service (the ISS) not-so-secretly supported (and still supports) the Taliban because the Pashtun members of the Taliban are thought to be allied with Pakistan against India, Pakistan's bitter enemy.

6) The Pakistani government (not just the departed General Musharraf) despises the current Afghan government under Hamid Karzai because of his perceived ties to pro-Indian policies and players so Pakistan is likely to continue giving lip service to the American "war on terror" while taking our money and actively supporting the very Taliban forces that are killing Americans in Afghanistan.

Probably the most worrisome point raised in the entire show is that Pakistan's support for the Islamic extremist Taliban as a check against perceived pro-Indian forces in its neighbor Afghanistan is likely to come back and bite Pakistan HARD. The same Islamic extremists it thinks are serving Pakistan's purposes in Afghanistan are now plotting to overthrow the Pakistani government. To date, Pakistan has maintained some semblance of a secular, somewhat democratic government by military leaders staging coups when the fundamentalist influences became too strong. Now, it may be too late.

As Steven Coll states, "They have gradually come down from the hills into settled territory in Pakistan. They control territory not just in a military sense. They also are administering territory and right now, they are in control of this territory and they are not about to hand it over to Pakistan."

As reporter Dexter Filkins put it, "The war is coming home to the Pakistani government. For years, they've had this relationship with the fighters and the Taliban in the tribal areas. They thought they could control them. It turns out they can't. They're out of control. Frankenstein has gotten off the table."

Finally, author Mary Ann Weaver states, "This is now a full fledged insurgency. You have individual Pashtun Pakistani tribal leaders rising up and revolting against the central government. Pakistan is in danger of becoming a failed state with fifty-plus nuclear weapons."

The enemy of my enemy is not necessarily my friend.

I wonder how many times America will have to learn this lesson the hard way. We launched a needless war in Iraq to remove a WMD threat that didn't exist from a tyrant who at least kept fundamentalist threats in check. In doing so, we failed to appreciate the difficulty of securing a lasting solution to the original problem, spent thousands of lives and billions of dollars on that needless battle and provided aid to an ally which was providing aid to forces killing Americans and planning to topple the ally providing the aid. A strategic "three-fer" failure --- wrong on a primary goal (Iraq), wrong by directly impairing our effort on a legitimate primary goal (stabilizing Afghanistan), and wrong by aiding Pakistan which used has materially hampered our effort in Afghanistan while jeopardizing its own stability and increasing the danger of loose nukes --- ACTUAL nukes, not fantasy nukes.

The strategic thinking in the United States has been so abysmal for the last eight years that this geopolitical blunder is just one of three cataclysmic holes dug over the past eight years. Untangling the knot of bad strategy in Afghanistan and Pakistan alone will require previously unheard of levels of insight, courage, and resources. Untangling that knot while trying to stage an exit from Iraq and trying to prevent an economic collapse will be a feat worthy of a spot on Mount Rushmore.

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#1) http://www.pbs.org/wgbh/pages/frontline/warbriefing/view/

#2) http://www.pbs.org/wgbh/pages/frontline/warbriefing/etc/tapes.html (transcript will eventually be available here)

#3) http://www.pbs.org/wgbh/pages/frontline/taliban/view/

#4) http://www.pbs.org/wgbh/pages/frontline/taliban/etc/script.html