Posted by Marc Hodak on December 30, 2008 under Invisible trade-offs, Scandal | 
A Reuters reporter created a story that began like this:
Cynthia Goldrick’s daughter is in and out of the hospital for brain surgery, her mother has Stage 4 lung cancer and her father has moved into a home for the elderly.
So when the Goldrick family’s adjustable rate mortgage reset while husband Patrick was off work for a job-related injury, it eliminated the thin margin between their income and the mortgage payment and put them on the road to foreclosure.
While these circumstances may seem extreme — a perfect storm of bad luck — the basic economics of a hike in mortgage rates and a bank’s inability or unwillingness to modify terms have been shared by many Americans over the past year.
Let me see if I got this story right. A family runs into horrible luck with their health. The adjustable rate on their mortgage adjusts. Lots of people saw their adjustable mortgages adjust up. I think what this story is aiming to do is link the hike in the family’s mortgage to their foreclosure, and claim that this is symptomatic of a nationwide problem with mortgages. But this is a strange tale.
First of all, this family is faced with losing their home because of a string of factors, mostly health related, with the mortgage adjustment being just one of them. But a story has to have a villain, and they don’t want to blame God. Second, very few people are defaulting because they are suffering anything like bad luck visited on this family. It trivializes their plight to equate this family to the deadbeats who got mortgages they couldn’t afford, often under false pretenses, and the stupid lenders who indulged them.
Likewise, it doesn’t make sense to demonize the banks that gave this family money. Either the family deserved the loan at the time (in 2005), or they didn’t. Either way, the bank gave them the money. Now that this family is unable to pay back the loan, yeah the family risks having to downgrade to a cheaper home, but the bank is also faced with a disappointment that threatens its well-being. It’s hard for me to see how the banks are the bad guys in this story–which is clearly how they are portrayed–for the sin of trying to minimize their losses.
The end of this story includes a note that investors, finally seeing light at the end of the tunnel, are starting to come back into the mortgage market:
But that won’t help the Goldricks, who like many other families are in danger of losing their house and not likely to benefit from the $700 billion that Congress has allocated to Wall Street for bailing out financial institutions.
“I am absolutely bitter,” said Patrick Goldrick, who sees the scandal surrounding investment advisor Bernard Madoff as further evidence of Wall Street wrongdoing. “I am bitter toward Congress and bitter toward the big banks and the creepy billionaires who get away with stealing pensions.”
Bitter toward the big banks? Here is a family that had four major things go horribly wrong (plus the work-related injury, which was presumably temporary and covered by insurance). Of those four things, the only one that they consciously signed up for was the adjustable mortgage. They presumably didn’t want a fixed-rate loan–they wanted a step up from a cheaper rate to a more expensive one. The story doesn’t suggest that their choice about this was uninformed.
In fact, it’s possible that this family did, in fact, take on a loan they couldn’t afford long-term in order to help their sick daughter in the short term. I wouldn’t blame them for such a decision. I would probably make the same choice if it were one of my kids who desperately needed help. But I don’t think I would be bitter at the investors or the banks that gave me the money. The fact that Mr. Goldrick was indicates that he buys into the press’s distortion that the investors or their agents are the bad guys in this story.
I often warn my students that the job of the press is not to provide information–it’s to create stories. Stories sell papers. Facts are simply the building blocks of stories. Some facts are helpful to a particular story, some are not, and much of what makes a story good are the facts that are selected versus not. In this story, the helpful facts are the ones that create sympathy for a family that is hurting, enabling their situation to be crafted into a twisted version of an archetypal morality tale of good versus evil, David vs. Goliath, etc. The unhelpful facts are the ones that create ambiguities among the characters, each with their peculiar interests and incentives, exercising choices that are difficult to characterize along an ethical scale. Unhelpful facts create that noisy sense of life that you and I experience, without the forced overlay of comedy, tragedy, or drama.
Posted by Marc Hodak on December 29, 2008 under Irrationality |
Our security theater put on a great act for me and my wife this weekend as we traveled back from Missouri.
When we reached the security station, my wife had to take our cat from her travel case, and carry her through the metal detector. Beep. The inspector asked my wife to step aside to try to figure out what set it off. She asked if she was carrying any metal (“No. Maybe my necklace has some metal.”) The inspector (a female) wanded my wife, found some metal near her chest and waist, where the cat (and the necklace) happened to be, and asked her to put the cat down. She patted my wife down cursorily, but found nothing. She looked at the cat. “Does she have any tags on her?”
“No,” my wife replied. “It’s an indoor cat.”
She asked my wife if she could inspect the cat, and my wife assured her that our little beast, frightened as it was in this foreign environment, would probably not take kindly to getting handled by anyone else.
“What are you looking for?” she asked the inspector.
At this point, unsure what to do, and clearly unwilling to take a chance on the shaking cat, the inspector called a supervisor.
The supervisor was one of those imperious types who quickly figured out what needed to be done. Folding his arms on his chest, he ordered, “Pat down the cat.”
My wife looked at him incredulously. “Are you sure you want to do that?”
He didn’t offer any instruction to the poor inspector as to how she was supposed to frisk the cat without any harm to herself. Of course, he offered no explanation to my wife what, exactly, he was looking for. (Aha, what is this! A zipper!!! We unzip this and find…a smaller cat in a fur coat!!! Hiding…box cutters!)
Needless to say, the frisking didn’t yield any proscribed items. The cat, in fact, had nothing but her fur. But you knew that. So did the inspector who, fortunately, got away without a scratch or bite. So, very likely, did the supervisor.
I wish I had brought my camcorder with me, but I think filming security is not allowed, which probably deprives us untold hours of YouTube entertainment that might otherwise provide some return on this insanity.
Posted by Marc Hodak on December 19, 2008 under Executive compensation |
Jamie Dimon of JP Morgan Chase has joined the growing list of highly visible banking CEOs giving up their bonus for 2008. JP Morgan has outperformed its sector by over ten percentage points, arguably preserving about $16 billion in market value that, on a comparable percentage basis, was lost by its peers. Most observers, inside and outside of the company, would give Dimon a good deal of credit for that performance, at least $10 million, which is about what I would estimate he has surrendered.
Dimon doesn’t play the heads-I-win-tails-you-lose compensation game. He was among the lowest paid Wall Street CEOs when times were good for JPM. Given his firm’s relative performance this year, he deserves to be among the highest paid for 2008, but that’s not happening, either. I would think the shareholders would not begrudge him an extra $10 million if that’s what it took to keep him from even the least bit of indifference to bottom line results or his employment at their firm. What would Citi pay to get Dimon back? If they thought they could get him for an extra $10 million, how many milliseconds would it take for them to throw the cash at him? This is, in fact, a case of shareholders exploiting their CEO, based on his work ethic, and his demonstrated willingness to go all out for the firm regardless of his personal opportunity cost.
Alas, the shareholders are not in control, right now; the mob is. The mob controls things partly because the government forced JPM to accept a $25 billion investment that they didn’t need. (The New York Times version is that “Dimon, agreed to take a $25 billion capital injection courtesy of the United States government,” but the New York Times has long since proved that it can’t distinguish courtesy from coercion.) This investment gave the press and the politicians a license to opine on what they think executives should be making. In other words, Barney Frank, Henry Waxman, et. al used taxpayer money to buy a $25 billion ticket to a heckling session.
The cynical among us will say, “so, what’s $10 million to a guy like that?” True enough. But I have yet to see a single congressman who contributed to this debacle giving up anything, not a dime, even as they call everyone else on the carpet.
Posted by Marc Hodak on December 18, 2008 under Executive compensation |
Credit Suisse is going to use its toxic debt to pay executive bonuses. This is brilliant on a couple of levels.
First, it has a “let the chef eat his own cooking” appeal. True, very few of the managing directors eligible for this program were directly involved in creating these putrid instruments, but to the extent that this is a harbinger of a policy that threatens to use the most mis-priced assets as a basis for bonuses in the future, there will develop at least some peer pressure not to create such things again. Frankly, a lot of the problem in investment banks has been the willingness of one group of managers to laugh away boneheaded behavior on the part of their peers, instead of saying, “Hey, are you sure that lead structure will float?” Uncaring behavior happens where bonuses were based largely on the short-term profits of one’s own division.
The other clever thing about this plan is that it transfers these assets into something called a “Partner Asset Facility” at the current value. From here, any mark-to-market changes in these assets will be exactly offset by changes in their liability to the managers. In other words, this vehicle effectively removes from their balance sheet the very assets that were gumming it up.
The bank won’t begin making payments from this facility for five years, and who knows what those payments will look like, so the retention value of this plan is a bit dubious, like awarding you managers gobs of underwater options. But for those who believe that these illiquid assets are way undervalued, this could be exciting to the risk-takers in the firm who could possibly end up laughing all the way to and from the bank.
Credit Suisse will also be instituting a claw back mechanism. We did think of that one.
Posted by Marc Hodak on December 16, 2008 under Scandal |
He thought the cause of the financial crisis was “simple. Greed on both sides—greed of investors and the greed of the bankers.” I thought it was more complicated. Greed on Wall Street was a given—almost an obligation. The problem was the system of incentives that channeled the greed.
This comes from Lewis’s wonderful article in Portfolio this month.
There’s something primal about our collective affinity for morality plays. Sex scandals can always be blamed on lust or envy. The most interesting murders can often be attributed to pride or wrath. Financial scandals are invariably rooted in greed. Morality tales share their religious roots in a mythical world view that attempts to provide a consistent explanation for every crazy thing that we can neither understand or control. We learned communal prayer and dance as a way of making the rains come, as if we could lash God to our desires by simple utterances and movements.
When the world seems to be falling apart as it is now, we revert to those superstitions, to the archetypes they spawned, and to the cleansing purges of whatever evil we can collectively identify. We instinctively look for the leadership that will save us from the dark forces arrayed against us. Many people seek that leadership from government. (Others of us see that as the dark force.)
It takes a certain geeky distance from reality, some might say a dissociation, to appreciate the chaotic nature of what we’re dealing with when it comes to emergent phenomena, like global economies. It takes a studied deference to uncertainty and the huge realm of ignorance best characterized as “the things we don’t know we don’t know.” It takes a powerful discipline to focus on the negative, hidden, secondary consequences of potential “cures” when the primary beneficiaries of those cures are screaming at you to save them.
One would have to look to Far Eastern cultures to find a suitable mythology for for the unseen benefits of minimal intervention. We simply don’t have that in the West. In the West, we have a relentless search for villains.
Posted by Marc Hodak on December 14, 2008 under Unintended consequences |
Here are five reasons I believe a bailout will accelerate the decline of the American auto makers:
Congress will run the auto companies: Everyone will report to a car czar. Who do you think the car czar will report to? Anyone following the travails of the Big 3 know that their problem was not a deficit of politicized decision making. It’s almost inconceivable how bad it will get with Barney Frank moving from back seat driver to one of several hands on the steering wheel.
Why would I buy a car from a loser: Even if Congress keeps its paws off of car maker operations, most car buyers will note that only the American auto manufacturers are on the dole. They will figure that Toyota, Honda, Kia, etc. must be better car companies since they haven’t been whining, threatening, or cajoling for handouts. Why would someone buy a car from a bad company? The government stamp of “welfare queens” on GM, Chrysler, and the UAW can’t help their image.
I gave at the office: It is well-documented that as government taxes and spending increase for certain welfare programs, private giving to those programs drops. Every time people look at a GM, they will think, “They already have my money.” Some might succumb to the sunk cost fallacy, but I think it’s more likely that people will question why they should send voluntary dollars after their mandatory payments.
Management pisses me off: Many people were turned off by the spectacle of CEOs flying in their private jets to petition Congress. They were then turned off by the cynical pandering of those executives driving to Washington in non-production hybrid vehicles. Wagoner, Nardelli, and Mullaly are not the most sympathetic characters. The Big 3 would have probably invested huge ad dollars in not putting their faces all over the media for two solid months. But they apparently would not have spent $15 billion to avoid it.
The UAW pisses me off: Gettelfinger is only marginally more sympathetic, but his union has spent a lot of their goodwill in this campaign, too. Sure, many people still think of the union as “for the worker,” but a lot of data has poured forth highlighting the gold-plated lunch-boxes these workers carry. The average Joe, worried about keeping his job so that he can support his parents on Medicare, has heard the UAW arguing to keep much higher salaries and benefits for their laid off workers, who by the way are entitled to superior medical care. Even union members, most of whom don’t belong to the cushy UAW, poll against the bailout.
HT: Commenter on Coyote’s blog
Posted by Marc Hodak on December 12, 2008 under Politics |
Richard Wagoner, the CEO of General Motors, played politics with his company and lost. For the last couple of months he has been going around telling the American public that if GM went into bankruptcy, no one would buy its cars. That’s tantamount to telling the public “If GM goes into bankruptcy, you shouldn’t buy our cars.”
One of the key roles of any CEO is chief sales officer. The CEO is supposed to believe in his company’s products 100 percent. If he doesn’t who else should? Even if it’s plausible that under certain conditions one’s products might not be as desirable, it’s not a CEO’s role to point that out. That’s the job of the competition and the critics. The CEO is supposed to be a cheerleader. When the home team is down 30-7, a cheerleader doesn’t turn to the fans and say, “If we don’t score on this next drive, we might as well all go home.”
So why has Wagoner gone around telling customers that if GM went into bankruptcy, they might as well buy a Toyota? Because that was his brinkmanship strategy to shake taxpayer dollars out of Congress. He was trying to scare them with an apocalyptic story that went, “if we go bankrupt, no one will buy our cars, which will lead to…economic depression!” What’s bad for GM is bad for America.
It’s important to note that Wagoner was making this cheer apart from his board. The board has responsibly maintained throughout that all options are on the table. They must know that their leader could have embraced the argument that a reorganized, stronger GM is exactly the kind of company car buyers could have confidence in.
But that was not the tack taken by Wagoner. Wagoner chose instead to put all their marbles on a bailout. He pitted GM against the taxpayer in a bold grab at the public treasure. What has that done for GM’s reputation with the 60 percent of the public that was against the bailout? He lost by playing his hand arrogantly and incompetently. Worse yet, he lost playing against the sensibilities of a board that must have known that if he lost, GM would be closer to liquidation than if he had not taken this tack. I don’t know why Wagoner played it the way he did. Maybe he knew his job would not survive bankruptcy, and so he personally had nothing to lose by aiming GM toward the cliff with his foot on the accelerator.
At this point, the board’s credibility is at stake. They need someone who can deftly drive GM through bankruptcy, packaged as best as possible, able to salvage whatever one can for bondholders, workers, and suppliers. They need someone who can reclaim from the customers the trust that Wagoner deliberately undermined.
Update: It appears that Bush is ready to throw the Big 3 losers a lifeline, and that the union seeing Bush standing on the deck with a lifeline in his hands emboldened them to balk at a Senate deal that would have forced them to be competitive. In other words, the Bush administration, which has never owed anything to the unions, is ready to cave in to them again, just as he did with the steel companies early in his administration, almost certainly with the same, dismal political and economic outcome. Or he’s dumb enough to believe the “sky is falling” rhetoric of his CEO buddies. Either way, I find myself counting down the days that Mr. Bush settles back into a nice Dallas retirement.
Posted by Marc Hodak on December 9, 2008 under Executive compensation |
It’s difficult for me to criticize Jonathan Macey given that I generally agree with his prescriptions. However, his diagnosis doesn’t make sense to me, at least the part with which I happen to have a personal familiarity.
In a recent WSJ editorial, Macey says:
The average pay for chief executives of large public companies in the United States is now well over $10 million a year. Top corporate executives in the United States get about three times more than their counterparts in Japan and more than twice as much as their counterparts in Western Europe… I argue that executive compensation is too high in the U.S. because the process by which executive compensation is determined has been corrupted by acquiescent, pandering and otherwise “captured” boards of directors.
It has become fashionable to argue that CEO pay is “too high,” and most critics blame it on “board capture.” Unfortunately, the “board capture” theory, for all its intuitive appeal, happens to run counter to facts and logic.
Consider Macey’s use of the term “has been corrupted.” That implies a period when boards were less corrupted, more pure. When did the corruption happen? Presumably in the 1990s, when CEO pay made its greatest gains. Unfortunately, nearly every corporate critic would say, and I’m sure Macey would agree, that the ’90s saw boards steadily and significantly gain power at the expense of the CEO, not the other way around. That’s not to say that boards don’t still get captured by their CEOs–it certainly happens. I’ve seen it. But as a trend to explain a general increase in CEO pay, this is a non-starter.
Then there’s Macey’s evidence of high pay–the fact that Japanese executives make a third as much as their American counterparts. This runs counter to his claim that weak boards are the problem. When was the last time a Japanese CEO got fired for poor performance? American CEOs have long experienced forced turnover at rates that Japanese companies would find inconceivable. I haven’t worked with Japanese boards nearly as much as American ones, but my sense is that few boards in the world are as independent and challenging as the typical American board, and few boards as collegial and unlikely to upset the apple cart as a Japanese one.
The fact is that CEO pay has gone up exactly as the relative power of the board has increased. While I haven’t heard a decent rejoinder to that inverse relationship, there is a plausible theory as to why increased board power may lead to increased CEO pay. The thinking is that as boards become more demanding and less forgiving, the CEO’s job becomes tougher and riskier–good reasons to command higher pay. Also, in this more competitive and demanding environment, boards increasingly recognize that they get what they pay for, and know that a little extra talent can mean billions of dollars in incremental returns. In that context, the last few million doesn’t really cost that much.
In the end, I agree with Macey’s prescriptions for a more vigorous market for corporate control.
Hedge funds and activist investors like Carl Icahn are the solution, not the problem. The market for corporate control should be deregulated and the SEC’s restrictions on all sorts of equity trading should be lifted at once.
Note that Mr. Icahn doesn’t operate in Japan or in Europe. Icahn counterparts, in fact, are rather hard to find anywhere outside the U.S. And yet we have higher CEO pay. Could it be that the critics have the theory about what is driving high pay exactly backwards?
Posted by Marc Hodak on December 8, 2008 under Practical definitions |
“They made this company the success that it is.”
That is Leah Fried, spokesperson for the United Electric Workers, talking about the bankrupted-into-liquidation Republic Windows and Doors. Fried goes on to describe the effects of this success on her workers:
And on the eve of Christmas, they shouldn’t simply be thrown out on the street. And if the federal government can’t intervene to protect these workers, then I think we’re failing in our main obligation.”
The workers, who are protesting the liquidation of their company with less than 60 day’s notice, may or may not have a legal basis for their grievance–that remains for the courts to sort out. What caught my attention was the way Fried subtly transformed their personal legal struggle into a universal morality tale: “we’re failing in our main obligation.”
“We” Tonto? I, for one, would be happy to let the courts sort out what is and isn’t my obligation on this one. It’s likely from her tone that Ms. Fried really wants us to assume this obligation as a moral one regardless of what the courts decide. More to the point, she wants our obligation to her workers to be our “main” one.
You may have your own ideas of what you consider your “main” obligations, but a collectivist will reflexively assume away your preferences in favor for what she thinks your “main” obligations ought to be. If Ms. Fried did not intend that meaning with her words, it’s only because she is so sloppy with the language. The lazy MSM lets her get away with such sloppiness because it’s easier to write that way, and it’s very likely that the author and editor who got gratuitous Cs in math, unable to grasp relevant distinctions and logic, instinctively buy into all the conflations implied by “we” and “our.”
Of course, when one begins to actually think about this situation in terms of distinct individuals, “you,” “me,” “those guys over there,” “these people over here,” it’s difficult to avoid the contribution of the union to this particular mess. These workers who have been unceremoniously tossed on their butts are so screwed precisely because they have worked for above-market wages for so long. They know they are not going to be able to force another firm into paying them so much. They won’t come close to acknowledging that those above-market wages to which they felt entitled were the same costs that helped push the company into bankruptcy.
Their union doesn’t believe that, of course, because they don’t believe in this thing called ‘markets.’ They behaved as if the company’s revenue were a given, and its distribution were a zero-sum game between their workers and capitalists. The idea that the capitalists are suddenly out of both their returns and their investment, without so much as 60 day’s notice, is left out of the narrative of indignant workers with a sense of entitlement.
So, I hope that the company does what it must under our laws. But please, Ms. Fried, don’t pretend that your workers, who continued to suck off the teat of a sickly cow when it was no longer healthy enough to produce enough nourishment for its own existence, are entitled to some “obligation” from the rest of “us.”
Posted by Marc Hodak on December 5, 2008 under Irrationality |
In what passes as “economics” writing, a CNN writer discusses the current thinking about a government bailout of its citizens:
One leading economist, Economy.com founder Mark Zandi — who was an unpaid adviser to the campaign of Republican presidential candidate John McCain — boosted his estimate for needed stimulus to $600 billion from $400 billion in just nine days late last month.
The fact that this is reported with a straight face actually accounts for a lot of what ails this country economically. It means that the writer of this story in our mainstream media actually believes what she is writing, and that many readers actually think Zandi’s estimate is based on something other than augury or tasseography.
Folks, there is not enough ‘science’ in economic science to say that our $13 trillion economy in the shape it’s in now needs a $0.4 trillion or $0.6 trillion stimulus. We’re lucky to get the order of magnitude right, sometimes even the sign. In fact, an economist could argue that the right amount of stimulus is $0.0 trillion, and many do. Taking seriously a number between $400 and $600 billion is first order hogwash. The fact that the credulous reporter was wowed by Zandi’s number growing that large in just nine days is second order hogwash. Could I amaze you, lady, if I grew my estimate from $100 million to $900 billion in nine hours! I would do that for you, because I’m that kind of guy.
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