The Law of Unintended and Unanticipated Consequences

Our Government does not handle dissent or opposition very well.  The Bush Administration has refined this to a science.  But the Congressional hearings on the Paulson bailout package hammer home the point, and should raise a red flag as high and as poignantly as the flag the Marines hoisted at Iwo Jima.

We are facing the gravest economic crisis in generations.  Warren Buffett’s description of this as an “Economic Pearl Harbor” probably understates this by multiples.  In magnitude it is probably more like the tsunami that destroyed the Pacific a few years ago; maybe something far worse.  And yet, facing a cataclysm, our legislature has hastily arranged a party for two.  We have heard from Hank Paulson and Ben Bernanke, the crafters and proponents of the bailout ackage.  Their message, boldly stated, is do this or else.  They state they have considered alternatives.  In their opinion, this is the best alternative.  Unfortunately, no one else has been asked to testify, opine and answer questions about this plan or other alternatives.  The media really does not help.  They parade on people who are part of the marketing team; often people with a vested interest in the outcome.

Quick passage of this package may feel good.  But the rush to judgment and the unwillingness to consider alternatives means that the analysis has probably been relatively simple, relatively linear.  It means they have probably missed a lot or ignored a lot.  That carries big risks.

First of all, the plan focuses on saving financial institutions by taking assets off of their balance sheets.  How long will it take to get the program up and running?  More importantly, how long will it take before these institutions start lending again?  As I read the plan, it will be a while.  This economy needs financial intermediaries to extend credit for growth to occur.  While we wait, what happens to the economy, to employment, to consumption?  In addition, even if banks can start lending again, it is not clear that borrowers will want the money.  Japan experienced this problem.

How about other risks?  We are printing money.  What does this mean for our currency?  For inflation?  The Government’s financial condition is deteriorating at a staggering rate.  This could pose significant risk to growth trajectories for a generation.  Further, the current financial crisis is not the only major problem that we are facing.  The cost of this bailout may limit our ability to address other problems.  As is well known, the Social Security/Medicare/Medicaid System is in trouble.  Now, there is talk that the FDIC is in a $400 billion bind.  The PBGC, guarantor of many pension plans, is deeply in debt.  As became apparent last year when a bridge collapsed in Minnesota, we have under-invested in plant and equipment for a generation.  At the time, Senator Dodd estimated the rebuilding cost to be $1 trillion to $2 trillion.  Can we afford this?  The longer we delay, the higher the cost. 

In many ways, this country has been under-investing in technology.  Energy is a great example.  Often, Government is a necessary participant.  Without investment, we become less competitive, less productive.  In general, the private sector needs capital to grow and thrive.  The Government’s demand for money may crowd out the private sector.  At the very least, it will make the cost of money more expensive for years to come.  This has negative effects on growth, income, prices, deficits.  Private savings become more vulnerable.  The real value of assets will rise far more slowly.

In essence, by focusing our resources on the financial crisis, we are focusing our resources on all of these problems, and probably many others.  Unfortunately we are not focusing our attention.  We ought to consider this now.  If not, the Law of Unanticipated Consequences will surely apply. Unfortunately, so will the Law of Unintended Consequences.  Let us hope, that it does not bring Murphy’ Law into play.

The Buck Stops Anywhere But Here

When I was young, I was taught that people were expected to assume responsibility for their actions.  The idea was encapsulated in a quote that appeared on President Truman’s desk.  Remarkable in its succinctness, the quote read “The Buck Stops Here”.  Unfortunately, as the years have passed, that simple concept seems to have been turned upside down.  In this hour of national crisis, it has become “de rigueur” to point fingers at eveyone else.  From the President down, someone else is always to blame.  And maybe that is why we find ourselves mired in quicksand.  Nowadays, the “Buck Stops Anywhere But Here.”

In the spirit of the moment, I have decided to hand out some awards to people who bear some responsibility for this economic and political morass.  I would like to call them the Truman Awards, but they already exist and I do not want to enter a legal minefield.  So I think I will be simple and call a rose a rose.  I give you the “Pass the Buck” Awards.  Hopefully, when I get through handing out these well earned awards, we can stop blaming each other and focus on getting this country back on a sound economic footing.  It will not be easy; it will not be fast; it will probably be painful (even more than has already been felt); and it will require contributions from everyone.   Anyway, here goes.

Pass the Buck Award 1.  The American People.  Yes you; and you; and you; etc.  Oh, and me.  Why?  Simple.  This crisis is, in part, political in nature.  The American people are responsible in the end for our political representatives and processes.  And, although it may not have felt that way before, they have let us down for a very long time.  We have tolerated mediocre electoral choices to be presented to us and, in most instances, we have chosen a relatively mediocre (maybe that is too polite) group of representatives who have become ensconced in our nations’ political establishment.

Pass the Buck Award 2.  The American Taxpayer.  Will the recipients of Award 1, please come back to the stage to accept their second Award.  This has been one of the most contentious areas in this year’s nominations.  The middle class says they pay too much tax, and the wealthy don’t pay enough.  Congress tends to come out and vocally support this view, although who knows what they really think or do.  The wealthier amongst us (and that can be a relative term), obviously think the opposite.  And to be fair, each position has its merits.  For instance, although there is a lot of anger at Wall Street, they did actually pay a lot of taxes: at the local, state and national level.  Maybe the percentage was not enough, but New York State just woke up and found that 20 percent of its’ revenue is seriously impaired.  Washington will feel these effects too.

The truth of the matter, however, is that none of us have paid enough taxes for a long time.  Over time, the books of this country have been presented in a way that masks the true extent of the financial mess that awaits us.  In part, that is why the current crisis is so bad.  However, be aware that this is Act One.  Unless we do something comprehensive, and do it now, the Second and Third Acts will make the current crisis look mild.  And this burden rests on all of our shoulders.

Pass the Buck Award 3.  The President and the Executive Branch.  We have created an Executive Office where it is more important to protect the President from the consequences of his decisions, or those of the people around him, than it is to insist they stand behind their actions.  Well, President Truman is turning over in his grave and would never tolerate such behavior.  Few if any of our great statesman would either.  In this day and age, we bandy about the word “Patriotism” more as a sword than a badge of honor. Unfortunately, in many ways, we have forgotten what it means.  Real patriotism means being willing to take a side, state a view, admit you are wrong and take responsibility.  And that is the type of leader this country needs, crisis or not.

Pass the Buck Award 4. Congress and State Legislatures.  Okay, I don’t really need to say much here.  These guys are really pros.  They have done so much to cause so many problems.  Yet, they refuse to accept any recognition.  Nevertheless, they do point fingers so often I am surprised they can still lift them.

Pass the Buck Award 5.  Chairman Greenspan.  I can’t help myself here.  Under his leadership, the Federal Reserve sowed the seeds of the current crisis.  Free money created bubble after bubble.  Economic distortions became the norm.   Expectations became detached from reality.  Inflation, at least for most Americans, became oppressive.  (Although it is not discussed, I will go so far as saying that inflation was a major, if not the major, cause of the sub-prime crisis). Leverage exploded.  Risk management was relegated to the minor leagues.  In the end, well, you see the damage.  Perhaps this goes a bit far, but remember that “Sir Alan” willingly assumed the mantle of an oracle.  Every economic policy or act needed his imprimatur.

Pass the Buck Award 6.  Wall Street, the Banks, the Rating Agencies, the Mortgage Lenders and the Housing Agencies.  Yes.  They too bear their share of responsibility.  Lots can be said here, but too much has been said everywhere.  However, lets note that there was encouragement from many other sectors.  “Home Ownership” was the “American Dream”.  That is a major reason why all of these institutions exist.  Combine the Dream with a political agenda, an aversion for oversight and meddling, lots of money to be made by everyone (including the politicians), and you have the recipe for a disaster.

By the way, as people may now be learning, there are other financial risks that have been swept under the rug.  Do you have exposure to equities?  Important safety tip, equities can go down; and they can go down further.   How about our pension system?  It also has a lot of exposure to equities.

Pass the Buck Award 7.  The Homeowner.  I know everyone in trouble thinks they have been conned.  I am sure some were.  Our political leaders certainly want to reinforce this point of view.  However, at the end of the day, there is only one John Hancock on each mortgage, and I don’t know of many people who were forced to ink their name with a gun to their head.  Everyone dreamed of owning a home.  Money was cheap.  Down payments (a risk cushion) became a distant memory.  Prices only went one way.  Buy now.  There was no downside.  Except there was.

Unfortunately, everything went wrong at the same time.  Rates went up (on resets and new loans).  So home prices started to drop.   The exit door slammed shut.  On the other side, living costs exploded.  Oil for heating the home and gasoline for travel exploded in price; so too did the cost of food and other necessities such as education and health care.  Families were squeezed from both sides.  And many people could not afford the double whammy.  It was a lethal combination and the rest is history.

Now that the awards are out of the way, and blame has been adequately meted out to everyone involved, can we please stop pointing fingers and start to address the problems we are confronted with.

Our political system has stopped working.  Perhaps the system is outdated.  Our politicians want power, but they do not want accountability.   We are unwilling to take them to task.  But our future really depends on sending talented people to Washington who are there for the long term health of this nation, not the long term health of their own careers.

The financial system has been shredded and is on life support.  This economy can not grow fast, or fast enough, without a strong financial sector.  Improving balance sheets is not enough.  A lot more capital is an imperative.  While the financial sector has been in cardiac arrest for a while, Main Street recently was admitted to the ER too.  Business is grinding to a halt.  Jobs are at risk.  Income, savings and consumption are falling.  Wealth and capital has been decimated.  The economic landscape needs more than cosmetic help.  However, decisions need to be carefully thought out for the long term and band-aids are not enough.

Many now stand with their hands out, begging for assistance.  And assistance is necessary.  However, it should not be too much to ask those who receive assistance to return the help in kind, if and when they are able.  Financial firms need better regulation, more transparency and more oversight.  They should welcome a guiding hand, not resist it.  They should also understand they are being treated in an extraordinary manner and should return the favor.  Where possible, protecting jobs is important.  And standing up as a taxpayer should not be too much to ask either.  The same can be said for distressed homeowners who receive assistance.

The balance sheet of this country is also in tatters.  At every political level, we are in trouble.  Liabilities are exploding.  The pension and benefit programs are insolvent.  Public sector demands will crowd out the private sector.  Again it is a problem that will not easily go away.  The longer we wait, the more intractable the problem becomes.

It is a difficult time.   No one needs to be told or reminded.  As a country we have to make difficult and painful decisions.  In periods of crisis, great leaders have stood up and asked us as a nation to come together, share the pain and overcome great challenges.  This is one of those rare moments.  Let’s stop blaming each other.  Let’s all assume responsibility.  And let’s rise to the occasion as the great nation we are.