Sunday, September 28, 2008

The Bailout Explained by the CBO

Peter Orszag, Ph. D., Director of the CBO

The Director of the Congressional Budget Office (CBO), economist Peter Orszag, publishes a blog with detailed information about the issues shaping current legislation. In his role as the leader of the non-partisan research office of the U.S. Congress, Dr. Orszag is the ultimate insider--a primary source of impartial information to which Members of Congress often turn when seeking deeper insight.

Of course Dr. Orszag has posted a number of comments over the past few weeks on the current liquidity crisis. For example, the article posted 26-Sept-08, entitled Net Budget Cost of Treasury Proposal, begins:

A Wall Street Journal blog posting mischaracterizes CBO’s testimony earlier this week on the net budget impact of the Treasury proposal to buy troubled assets. The Wall Street Journal blog states that the plan “likely won’t have any effect on the 2009 budget deficit.” That is incorrect.
Orszag goes on to discuss how the plan would impact the 2009 budget deficit with the kind of specificity and understanding typically lacking in media coverage.

In his remarks of 25-Sept-08, Troubled Asset Relief Act and Insolvencies, Director Orszag focuses attention on the distinction between competing goals: increasing liquidity for the financial system as a whole and avoiding insolvency at particular financial institutions.
A company holding an overvalued asset would have to write down the value of that asset not only if it actually sold that asset to the government at a price beneath its current book value, but also if other companies sold comparable assets to the government at a price beneath that book value. This is the essence of mark-to-market accounting.

...Even if this process revealed more financial institutions to be insolvent, the result would not necessarily worsen the financial crisis. As I stated in my testimony yesterday before the House Budget Committee, the current crisis is fundamentally one of collapsing confidence in the financial markets and “providing more transparency about the lack of solvency at specific institutions may be necessary to restore trust in the financial system.”

...Financial markets face two distinct, but related, problems. One problem is that the markets for some types of assets and transactions have essentially stopped functioning. To address that problem, the government could conceivably intervene as a “market maker,” by offering to purchase assets through a competitive process and thereby provide a price signal to other market participants. That type of intervention, if designed carefully to keep the government from overpaying, might not involve any significant subsidy from the government to financial institutions. The second problem involves the potential insolvency of specific financial institutions. Restoring solvency to insolvent institutions requires additional capital injections, and one possible source of such capital is the federal government. Although the problems of illiquidity and insolvency are interrelated, they are at least conceptually distinct. Indeed, some policy proposals appear to be aimed primarily at the illiquidity of particular asset markets, and others appear to be aimed primarily at the potential insolvency of specific financial institutions. The Treasury proposal appears to be motivated primarily by concerns about illiquid markets. The more the government overpays for assets purchased under that act, however, the more the proposed program would instead provide a subsidy to specific financial institutions, in a manner that seems unlikely to be an efficient approach to addressing concerns about insolvency.

We expect to learn more about how well policymakers have actually performed when the revised proposal is published, which is expected to happen later today. It is difficult for this consultant to remember an economic episode that played out more dramatically or with greater consequences.

Update: Review of the Emergency Economic Stabilization Act of 2008, signed 3-Oct-08.

The Senate passed a modified version of the bill, now called HR1424, the night of 1-October-08. A letter of summary and analysis of that version was prepared by Director Orszag for Sen. Dodd. That bill is expected to be put up for a vote by the House 3-October-08. If passed without amendment, it will go to the President, who will then have 10 days to sign it into law.

A collection of our posts about the US Economy is maintained here. See also The Case Against the Paulson Plan and Can the Banking System Hold Water?

A permanent link to the CBO Director's Blog has been added to Reference Websites.

See Key Provisions of the Bailout Plan as summarized by Reuters 28-Sept-08. For the complete text of the 28-Sept-08 version of HR 3997 The Emergency Economic Stabilization Act of 2008, click here.

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Saturday, September 27, 2008

The Case against the Paulson Plan

Professor Robert Shimer, University of Chicago

In a letter to Greg Mankiw, Professor of Economics at Harvard, Professor Robert Shimer of the University of Chicago shines a bright light on the $700 billion financial system bailout proposed by Henry Paulson. His prescription, that financial institutions be forced to raise capital in the market to increase their liquidity, would put the onus on the institutions themselves, and not the taxpayers, to solve their crisis. Participation would need to be coerced because no individual institution has the incentive to do so acting alone, fearing that such a unilateral move would signal desperation.

Greg Mankiw's Blog: The Case against the Paulson Plan

The letter makes clear that the Paulson plan may be neither necessary nor sufficient to solve the liquidity crisis.

A collection of our posts about the US Economy can be found here. See, for example, Review of the Economic Stabilization Act of 2008 (3-Oct-08)

See also Can the Banking System Hold Water?

To learn more about our work in consulting, read about our Practice or check out our Case Studies

Friday, September 26, 2008

The US Economy and the Bailout

See these posts from our blog, A Management Consultant @ Large, for our perspective on the Political Economy and the issues confronting economic policy makers in the U.S.

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Tuesday, September 23, 2008

Can The Banking System Hold Water?

John Kuhlman (left), economist, teacher and humanitarian

Struggling to understand the depth and breadth of the liquidity crisis enveloping us, I thought back to a quote projected onto a giant screen behind Professor John Kuhlman in the 900-seat auditorium at the University of Missouri many years ago.

The society which scorns excellence in plumbing because plumbing is a humble activity, and tolerates shoddiness in philosophy because philosophy is an exalted activity, will have neither good plumbing nor good philosophy. Neither its pipes nor its theories will hold water. - John William Gardner
Henry Paulson, U.S. Treasury Secretary, has put forth an emergency plan by which taxpayers would buy up some $700 billion of "troubled" mortgage-related credit instruments in order to inject liquidity into the financial system.
  • Would it solve the problem?
  • What would we be buying?
  • From whom?
  • Why us?
  • Why now?
It is easiest to answer the questions in reverse order. Most immediately, the Treasury Secretary needed to coordinate an international effort to avert a liquidity crisis. It is not just that the money market funds were losing value; they were at risk of default. Nervous investors were redeeming money market funds for cash at such a rapid rate that some funds were on the verge of stopping or postponing payments, unable to sell assets fast enough to keep pace. Fearing a disastrous run on the entire financial system, Paulson's team reached for the most powerful defensive weapon in the arsenal, promising to put the full faith and credit of the U.S. Government behind those instruments. Only U.S. taxpayers could float that kind of cash, and it would take an Act of Congress to get them to do it.

Both presidential candidates, currently Members of that Congress, have rightly asked what they are expected to buy and under what terms. After all, $700 billion is the kind of money usually reserved for major programs like tax cuts, health care system overhauls, global wars, or all three combined. As it happens, the most troubling financial instruments at issue, credit default swaps (CDS), are mind-numbingly complex instruments by which investment bankers, mortgage lenders, and others have been able to transform risky portfolios of assets into profitable streams of cash, at least in the short run.
In an article last week in Investors Business Daily, Ken Hoover states that "the worldwide CDS market has been estimated at $58 trillion at the end of 2007, a hundredfold increase from seven years ago." According to Wikipedia:
A credit default swap is a contract between two counterparties, whereby the "buyer" or "fixed rate payer" pays periodic payments to the "seller" or "floating rate payer" in exchange for the right to a payoff if there is a default or "credit event" in respect of a third party or "reference entity"...A credit default swap resembles an insurance policy, as it can be used by a debt holder to insure against a default under the debt instrument. However, because there is no requirement to actually hold any asset or suffer a loss, a credit default swap can also be used for speculative purposes and is not generally considered insurance for regulatory purposes.

"In the long run," however, as economist John Maynard Keynes famously quipped, "we are all dead." Issuers of credit default swaps, like AIG, make money as long as the instruments they insure are safe. Holders of CDSs, like banks, are insured so long as the insurer stays solvent. However, when the underlying portfolios of insured assets began to fail, as did mortgage-backed securities, CDSs became unprofitable and more visible to investors. So many CDSs were becoming so unprofitable that the values of their issuers and some of their holders began to fall in spectacular fashion. Had AIG been allowed to fail, it might have taken hundreds of banks with it.

And so U.S. taxpayers are being told to cover the failed bets of financial institutions or suffer the consequences of an insolvent financial system that brings down speculators, investors and savers alike.
The details of the plan are still being worked out and the price tag may change as well. As initially proposed the Government would buy mortgage-backed securities. Now Congress wants to include mortgages themselves.

The timing of the crisis does not bode well for devising a comprehensive solution, nor is it clear that Paulson has asked for one. The Federal Reserve and Treasury have already taken steps to provide liquidity to financial markets, extending federal loans to banks and equity to AIG, as well as supporting the transition of the two solvent investment banks, Morgan Stanley and Goldman Sacks, to more regulated bank holding company status with access to federal lending.

When Paulson asks for federal government help in cleaning up the balance sheets of private corporations, however, he raises profound issues about the role of government and the responsibility of private corporations to accept the consequences of the risk they freely take on. Demanding immediate and absolute authority to spend $700 billion to clean up private debt smacks of brinksmanship. A prudent Congress will take only the emergency measures required and leave the comprehensive solutions for its succeeding Congress in January.

Any comprehensive solution will require far greater measures of oversight, accountability and respect for federal debt than has been in evidence as of late. In a democratic republic such measures should be subject to careful deliberation and open debate.

There will be plenty of time in the coming weeks and years for the accountants and politicians to count the dead and bury the wounded. For thirty years politicians have found it useful to paint civil servants with the broad brush of "fraud, waste, and abuse" while promoting the virtues of Wall Street's "Masters of the Universe." Regulation and regulators, disparaged as unnecessary and incompetent, were ushered out of the financial markets with the passage of the Financial Services Modernization Act of 1999.

Had we paid more heed to John Gardner and John Kuhlman, would our financial plumbing flow more freely today?

Professor Kuhlman himself, now 85 and retired from a distinguished academic career, continues his career of service, teaching English to immigrants.

A collection of posts on the US Economy can be found here. See also Review of the Economic Stabilization Act of 2008 (3-Oct-2008)

See How AIG Fell Apart by Adam Davidson, in Slate.

See also Nearly Deaf Professor Teaches English Literacy, One Student at a Time, by Samuel G. Freedman, New York Times, May 21, 2008.

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Monday, September 22, 2008

Blog vs. Flog: Promoting Professional Services

A review of SCOTUSBLOG

Providers of professional services, including lawyers, consultants, accountants and doctors, face a uniquely awkward sales challenge. Discouraged or prevented by law or practice from conspicuously flogging their services, most market their services through bone-dry websites. A few have begun to realize the potential of blogging to help them make more personal, but unobtrusive, contact with prospective clients. Among those leading the way is Akin Gump Strauss Hauer & Feld, a US law firm with 700 professionals and 12 offices.

Their traditional website at, with a reported Google PageRank of 6, draws an estimated 5100 visitors per month. That site lists their service areas and offices, provides white papers, supports recruiting, and highlights company news.

However, the firm also publishes one of the better professional services blogs,, which itself has a Google PageRank of 6, and draws about 19,000 visitors monthly, according to “SCOTUS” means “Supreme Court of the United States” and the blog is an authoritative source of information of interest to anyone following that court. Divided into sections called “commentary and opinion”, “new filings”, “orders and opinions”, “multimedia” and “term tracker”, the blog leaves little doubt that this firm knows the Supreme Court and practices before it frequently. The featured commentators are pictured in the right-hand margin, with accompanying links for emailing them. The tone of their posts is authoritative but not stodgy, sometimes speculative, always interesting. For example, in the post “Wild Opinion Speculation” from June 23, 2008 one of the authors surmises that Justice Scalia will be writing an important upcoming opinion:

It does look exceptionally likely that Justice Scalia is writing the principal opinion for the Court in Heller – the D.C. guns case. That is the only opinion remaining from the sitting and he is the only member of the Court not to have written a majority opinion from the sitting. There is no indication that he lost a majority from March. His only dissent from the sitting is for two Justices in Indiana v. Edwards. So, that’s a good sign for advocates of a strong individual rights conception of the Second Amendment and a bad sign for D.C.

A post with that kind of immediacy must surely be designed to attract the attention of the media, who will have no trouble finding experts at the firm to interview.

The blog directs readers back to white papers on and also links to a new sister site,, a reference site that "features pages maintained by many regular SCOTUSblog contributors, top law students, and leading experts in various legal fields."

What does this effort bring to the firm? The blog is a quick, interesting read that attracts both a general audience and potential clients, collaborators, recruits and reporters. It has a kind of personality and newsiness that keeps people coming back frequently for a few minutes at a time. It personalizes the experience of meeting the firm in a completely non-threatening way.

For potential clients, it is the written equivalent of speed-dating, except the prospect never has to tell the blog “No”.

To learn more about our work in consulting, read about our Practice or check out our Case Studies

Sunday, September 14, 2008

McDonald's Strategy: Meat, Potatoes and Coffee

"50th Anniversary McDonald's"
in River North, Chicago, IL


In a story appearing in today's Chicago Tribune, McDonald's CEO Jim Skinner reports that his biggest pet peeve is when a worker fills a cup of coffee directly from the drip dispenser instead of waiting for the pot to be filled.

"You don't get the best cup of coffee that way," he said.
Having myself worked at a McDonald's restaurant in the St. Louis area when Skinner was getting his start with the organization as a manager trainee in Carpentersville, Illinois in 1971, I had to chuckle. Like Skinner, most of my managers had come out of the U.S. military and they had taught me to "shortstop" the coffee machine when a customer was waiting for a cup. They had also taught me an elaborate set of operating procedures, as specific and detailed as any I have seen since, e.g.:

  • Get the milkshakes first because they will hold their temperature the longest and may need to thaw a bit before they are served. Then get soft drinks. Then milk and coffee.
  • You can pour two cups of cola simultaneously if you tilt the cups to the side; Diet Coke foams more than regular.
  • Throw away the burgers in the bin if they have been there more than thirty minutes; the fries don't last even half that long. Count and record the wrappers from the discarded food after the shift.
McDonald's has variously been characterized as a marketing company, a franchising company and property management company. It is certainly all of those things. However, under CEO Jim Skinner, McDonald's is once again, more than anything, a company focused on operations.

Skinner rose through the ranks of US restaurant operations until 1992, when he was tapped to lead restaurant development in the company's emerging markets of Central Europe, Middle East, Africa and India. At various times in subsequent years he had executive responsibility for every other part of the world and nearly every corporate function.

When Skinner ascended to the CEO position in 2004, McDonald's was preparing to celebrate its 50th anniversary. Planning had been underway to update the iconic "Rock and Roll McDonald's" in Chicago's River North entertainment district and prominent Chicago architects, including Helmut Jahn, Martin Wolf, and Dan Coffey were asked to submit designs.
Foreshadowing its "back-to-basics" approach, and to the apparent chagrin of at least one architectural critic, Skinner's team instead decided to build the "really big" McDonald's depicted above.

His first priority was to renew focus on customer service, cleanliness and food quality at the more than 30,000 locations. Setting aside the restaurant diversification program begun in the late 1990's by Jack Greenberg, he sold McDonald's interests in Boston Market, Chipotle Mexican Grill, and Fazoli's Italian restaurants. At the same time, the products, menu and the store formats were updated, broadening the chain's appeal to more sophisticated consumers. Better salads and chicken sandwiches were introduced. Chicken nuggets and, most especially coffee, were upgraded. If critics of style have not always been impressed, investors have been delighted. The stock that traded in the mid-$20 range when Skinner took charge now sells for $64; same-store sales have risen consistently.

One of his more innovative predecessors, Charlie Bell, had participated in the assault on Starbucks as early as 1993 when the McCafe format was introduced in his native Australia. While that format, a pub-like version of a coffee shop with offerings similar to Starbucks, has been test-marketed in the U.S., it has not been widely adopted. Instead, a series of coffee drinks were perfected and suppliers worked with McDonald's to develop machines that could mass-produce them.

A strategist might have moved more dramatically; an innovator might have hired craftsmen to experiment with drinks as restaurants were rolled out. Skinner, the operations master, perfected the drinks, the equipment, the operating procedures and the marketing message before he unleashed the roll out.

See also Brand, Menu and Store Design and Chain Restaurant Development.

To learn more about our work in consulting you may read some of our Case Studies.

You may contact JP Farrell & Associates here.

Tuesday, September 9, 2008

Remembering Michael Hammer: Father of Reengineering

The late Dr. Michael Hammer

The man at the front of the Reengineering movement passed away suddenly last week.

It is difficult to overstate the impact that he has had on the way the modern corporation operates or the way businesspeople think about their responsibilities. His central premise, that organizations should reconsider not only their business processes but also their fundamental architectures, resonated with leaders who found themselves trying to manage organizations that had evolved from 19th century models or, worse, had been cobbled together by merger and acquisition.

In a new world of more abundant capital, deregulated markets, freer trade and, most especially, inexpensive computing and communication, economies of scale and scope were being redefined. Hammer saw that yesterday's competitive yardsticks were no longer meaningful and that businesses needed to start managing themselves relative to their new potential, not just against their historical performance.

Many consultants have defined new terms, and "reengineering" may not have been either the most provocative nor the most descriptive of the kind of change he envisioned. However, those of us who had the privilege of working on some of the projects that he spawned recognize that his vision went well beyond that of the typical slogan-monger. Rather, his genius was that he could understand the problems in a general way while describing them with sufficient specificity to be credible. His prescriptions for change, neither simplistic nor simple, were accompanied by logical method, complete with milestones, metrics and other controls.

I am grateful for his life and work.

The following tribute was posted by Anand Raman, one of his publishers, The Harvard Business Review.
read more | digg story

See also the obituary from the New York Times, published Sept. 5, 2008. It is the source of the photo in this article.

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Friday, September 5, 2008

Featured in the Media

A Management Consultant @ Large

The posts of
A Management Consultant @ Large have been featured on major online media.
On the Chicago Sun-Times site:
On Nielsen Business Media:

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Kellogg: Digital ROI Surpasses That of TV

CHICAGO ( -- The digital divide is narrowing for Kellogg Co., which today said its return on online investment for the Special K brand has surpassed that of broadcast TV over the past 18 months.

read more | digg story

Articles and Citations for JP Farrell

James P. Farrell, management consultant and economist

A Management Consultant @ Large has become the primary publisher of commentary and analysis of James P. Farrell. Many of our articles have been featured on major online media, including Reuters and the Chicago Sun-Times.

Mr. Farrell's work has been published in the mainstream media and in the intellectual capital of firms that employed him as well. Recent articles include:

  • Mastering Innovation Management: Collaborating for Speed and Profit is an AT Kearney white paper, written by Mr. Farrell, that expands on a discussion by a forum of experts he organized on the topic
  • Keeping Track of Promotion Progress: How Marketing Will Become the Greatest Advocate of RFID, co-authored with Ralf Saykiewicz, appeared in Consumer Goods Technology
  • Smart Freight Navigates the Trading Net is a TSC white paper that discusses breakthroughs in technologies and methods for improving supply chain visibility and control.
Mr. Farrell has previously been published in Food Logistics and Transport Topics. As an economist for the U.S. Transportation he authored studies on trucking deregulation and transit policy. One of those papers was referenced in the Preamble to the Motor Carrier Act of 1980, which deregulated the U.S. trucking industry.

He has been cited as an authority on the consumer products, retail and restaurant industries and consulted on issues related to supply chain management and electronic commerce by international, national and local print media in the U.S., the U.K., Mexico and Hong Kong. The Economist featured Mr. Farrell's comments in a feature article on McDonald's Corporation, Big Mac's Makeover.

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A Management Consultant @ Large