Obama at the Augean Stables

Maureen Dowd, The New York Times


We missed Maureen Dowd's columns throughout her December hiatus. She returned this week with fresh themes for a new administration: the novelty of "hot nerds" in the Cabinet and the looming internal conflict between fiscal stimulus and deficit control. Most intriguingly, she compares Obama's challenge of managing the Clintons to the Fifth Labor of Hercules, cleaning the Augean Stables.

Dowd writes as sparingly as a poet, asking the reader to complete her inferences. Wikipedia tells us this about the Augean stables:

The fifth of the Twelve Labors set to Hercules was to clean the Augean stables in a single day. The reasoning behind this being set as a labor was twofold: firstly, all the previous labors exalted Hercules in the eyes of the people and this one would surely degrade him; secondly, as the livestock were a divine gift to Augeas they were immune from disease and thus the amount of dirt and filth amassed in the uncleaned stables made the task surely impossible. However, Hercules succeeded by rerouting the rivers Alpheus and Peneus to wash out the filth.

One is left to wonder how far she meant to carry the analogy.

Dowd, who wrote an entire column in mock Latin this past October, makes frequent references to mythology and classical literature. In her book, Bushworld: Enter at Your Own Risk, she cast George W. Bush in the role of Oedipus, in psychological battle with his father as he unwittingly brought down the House of Thebes. This is at least her second reference to Obama and the Twelve Labors, the other occurring in her July 12, 2008 column about Obama's European trip, Ich Bin Ein Jetsetter. In that column she refers to Ms. Clinton as "the Amazon Warrior Queen Hillary." When Dowd says "I have a girlfriend in New York who puts her boyfriends through Feats of Strength," we suspect she is putting Mr. Obama through the same paces, just as she did with earlier references to him as Obambi, a fawn cowering under the withering gaze of Mrs. Clinton during the debates.

Like the devoted followers of the famous Sunday crossword puzzles of The Times, one is encouraged to have reference materials handy when reading Ms. Dowd. The columns are worthy of the effort.

Myths, neither histories nor fates, are sung anew by each generation.

See Bushworld: Enter at Your Own Risk, by Maureen Dowd (Penguin Group, New York, 2004).

For a translation of Dowd's witty but intractable column in Latin, Are We Romans, Tu Betchus, see the blog Ablative Absolute. The comments that follow the post offer further refinements. The translation reveals just how biting Ms. Dowd's satire can be when cloaked by a dead tongue.

To learn more about our work in consulting you may read a few of our Case Studies or Contact us directly.

McDonald's: Relevant Retailer for a Down Economy

McDonald's restaurant, circa 1960


The lead business story in this Sunday's New York Times on the continuing success of McDonald's Corporation sounds a number of themes that readers of this column will find familiar.

The chain has broadened its merchandising appeal beyond kids and young parents just as management's renewed focus on value, quality, service, and cleanliness has taken hold.

Minor adjustments in the menu in the form of fresher food, better coffee and more savory seasonings (including a return to the Big Mac sauce in use when CEO Jim Skinner and I worked on McDonald's crews in 1971) appeal to the tastes of an aging population. Reformatted restaurants feature more comfortable seating, faster drive-thru operations, and flat-screen TV monitors.

Under Skinner this is a company that has rediscovered the secret sauce.

See our newsletter on Restaurant Lifecycle Management here.

See also McDonald's Strategy: Meat, Potatoes and Coffee and Brand, Menu and Store Design and Chain Restaurant Development or visit our Google Group page featuring articles about McDonald's Corporation.

To learn more about our work in consulting, please see our Profile, download a brochure about our Practice, or check out our Case Studies.

Contact JP Farrell & Associates, Inc.

Paul Volcker's Harsh Economic Medicine

Paul Volcker, former Chairman, U.S. Federal Reserve Bank


Paul Volcker speaks in a voice not quite up to the challenge of transiting his imposing frame. It is the voice of a man with nothing to prove: a leader chosen by acclamation when the Vandals have stood at the Gate.

Schooled at Princeton, Harvard and the London School of Economics in liberal arts, political economy and government, Mr. Volcker began his career as a summer research assistant at the Federal Reserve Bank of New York in 1949 and 1950. He returned twice, first as a research economist, then as President in 1975. By then he had already served two stints at Chase Manhattan (first as a research economist, later as vice president and director of forward planning), two stints at the US Treasury during the Kennedy and Nixon administrations, and a senior fellowship at the Woodrow Wilson School of Public and International Affairs at Princeton University.

President Carter, burdened by a deepening economic malaise with inflation running at 13.3%, appointed Volcker to a four-year term as Chairman of the US Federal Reserve Bank in August, 1979. Chairman Volcker immediately set about restricting the growth in the money supply, intent on getting inflation under control.

Ronald Reagan defeated Carter for the US Presidency in 1980, pledging to rebuild the military and restore confidence in the US economy. His economic plan rested on the postulate of USC economist Arthur Laffer that under special circumstances lowering the income tax rate might increase tax revenue by stimulating growth. Reagan's budget featured a massive tax cut concentrated in the upper income brackets. It also included a net increase in government spending, with defense spending increases overtaking the much publicized cuts in other budgets.

While Volcker was encouraged by members of the Reagan administration to continue to restrict monetary growth, he publicly worried in 1981 about the consequences of simultaneously pursuing restrictive monetary policy and expansionary fiscal policy:

I know that in concept a case can be made that restraint on money and credit alone, sustained long enough and strong enough, could control inflation and thus lay the ground for renewed growth. But is that a realistic, believable and tolerable course if other instruments of policy and opinion are running counter to our purposes? Will the sustainability of the policy be credible if the costs in growth and employment seem excessive? And the costs fall unfairly on the industry and elements of the population most dependent on credit?**

He had concisely laid bare the inherent contradiction in the policies of the Reagan team: supply side theory was to be crushed by a predictable monetarist outcome. When the excess demand for money set off by the unprecedented budget deficit was not accommodated by the Federal Reserve, interest rates spiked (spectacularly), inducing the recession of 1981-82.

Volcker seems to have set the terms for the harmonization of monetary and fiscal policy that ensued in 1982. Volcker began to loosen his grip on the money supply just as Reagan put through a major tax increase to check increases in the federal deficit, taking back 1/3 of the value of the 1981 tax cut. Reagan again raised taxes in 1983 and 1984, enacting a major increase in taxes to fund Social Security, increasing taxes on gasoline, and closing certain business tax loopholes.

Many remember Reagan's tough stands against the strike of the air traffic controllers in 1981 and his unrelenting escalation of the arms race that contributed to the virtual bankruptcy of the Soviet Union. Nonetheless, in large part the economic success achieved during Reagan's second term was due to his willingness to follow the advice of his equally resolute Fed chief. By forcing Treasury Secretary Don Regan to finance the arms race with higher taxes, Volcker burst the inflationary bubble and set the stage for two more decades of prosperity. When President Reagan reappointed Volcker in 1983 the rate of inflation was 3.2%.

Perhaps Obama is looking to the doctor of the 1980 economy to administer some bitter medicine early in his own first term.


*To view his Oct. 9, 2009 interview with Charlie Rose in its entirety and other clips featuring Paul Volcker, see the Charlie Rose website.

**Secrets of the Temple: How the Federal Reserve Runs the Country, by William Greider (Simon & Schuster, 1989), pp.358-359

A collection of posts about the US Economy is maintained here.

To learn more about our work in consulting, please see our Profile, download a brochure about our Practice, or check out our Case Studies.

Contact JP Farrell & Associates, Inc.

Responses from Readers: Auto Industry Bailout

Chevy Suburban

Last week we posed a simple question to readers of some of the new discussion boards on LinkedIn:

Do you think funds from TARP (Troubled Asset Relief Program) should be used to help the U.S. automotive industry? How about other troubled industries, like retail?

Readers from the Strategic Business and Competitive Intelligence board had the least sympathy for the industry. Eric Garland's first post favored the market-oriented approach:

If we really believe business is about innovation, then having businesses "too big to fail" is likely incompatible with future success. Plus, as a U.S. taxpayer, this is starting to get maddeningly expensive. Break them up, or let them fail.

Jorge Buhler-Vidal added a few populist licks:

I am generally not sympathetic to a bailout to an industry led by people that have consistently ignored trends towards better quality, higher fuel efficiency and safety, while collecting high bonuses and keeping their golden parachutes.

Some cited the high cost of U.S. health care and the generous U.S. auto industry benefits packages as factors that reduced American competitiveness.

The US does not have "socialized" health care, the costs are directly in the vehicles. For Europe and Japan, the health care costs are a bit removed and spread out in the form of higher taxes for their national health care. - Bryan Gavini

The cost structure of health in the U.S. is strangling the nation's ability to compete. Once we lose a few vital industries, corporate executives will be crying out for some form of social net that doesn't sit on their balance sheets. - Eric Garland

Until the Big 3 can at least shed the legacy costs saddling them from the UAW, I don't see why they should get relief from us. - Anders Bjork

Responses to the University of Michigan Alumni board tended to show greater concern for the welfare of workers and pay less heed to free market thinking.

I would support a bailout if the funds were used to lessen/deplete the legacy costs (retiree benefits) alone. We're going to pay to support the retirees if the companies go under anyway. We're also going to pay a ton to support the 3 million unemployed. If we could remove the legacy costs from the balance sheets, re-negotiate the UAW contracts and fix our trade agreements, maybe we could pull out of it. -Jennifer Ray

The financial bailout has done nothing to help credit markets as of now. No credit markets have been thawed and the banks are being admonished for not lending the money. This has led to the further spiral of the auto industry because customers with good credit are being turned away because they cannot qualify for a loan.
I am disturbed by anyone who invokes the "free market" as if we are a purely capitalistic society. We are not. There is no such thing as a pure capitalistic society because each and every system has some sort of government control to either prevent catastrophic success (i.e., a monopoly) or catastrophic failure (what is going on now). The US did not emerge from the Great Depression by letting the free market have its way. -Jon Liu

Guy Powell on the Executive Decision board wondered how best to manage our way out of the crisis.

If the auto industry goes bankrupt, then it takes money out of the banks. Will this then ripple over to the banking market again causing another higher bailout of the banks. It would seem that 'in for a penny, in for a pound.'

Respondents to our board, A Management Consultant @ Large, took a long-term view.

The longer term fix is to retool that work in Michigan to cars that fit a better vision of low energy usage and elimination of emissions. -Rudy Westervelt

Consolidation appears inevitable, given the ferocious international competition and sustained overcapacity in the industry -- so why not have two (or even all three) of the Big Three merge together as part of the bailout? -Ben Petree

What if GM & Ford could "draft" assets from Chrysler--would they take any? How about people? -Joe McKinney

The US auto industry (as distinct from the auto industry in the US) reminds me of the UK situation 40 years ago. Government bailouts failed. The lesson learned is that the best government involvement is that which greases the skids of change, and not that which just delays the change. Tax policy can be used as an incentive for value-added entrepreneur progress, and for humane retraining. -Robert Munro

A collection of posts about the US Economy is maintained here.

To learn more about our work in consulting, please see our Profile, download a brochure about our Practice, or check out our Case Studies.

Contact JP Farrell & Associates, Inc.

↑ Grab this Headline Animator

Credit Default Swaps: Recent Stories from NPR

National Public Radio

In a previous post I mentioned, without much explanation, that credit default swaps (CDS) were instrumental in creating the 2008 credit crisis. As it happens, Alex Blumberg has done some of the clearest reporting on CDS for a National Public Radio (NPR) program, "This American Life."

Credit default swaps, which have become featured players in the troubled asset drama, are over-the-counter contracts that have been widely used to hedge investors against the risk of mortgage-backed securities. Unlike insurance policies, however, they do not require that either party actually own the assets being protected. As one of their inventors, Gregg Berman, explains:

It is exactly like buying insurance for a house you don't own.

And that is the very definition of moral hazard. Speculators can enter the market to bet against houses they consider at risk, thereby creating a market for arson. And bet they did. Berman and Satyajit Das, a risk consultant, were interviewed for the story, How Credit Default Swaps Spread Financial Rot.

Das says that during his time in the industry, the amount of credit default swaps that were speculative grew to dwarf the amount that were used for insurance...There are $5 trillion worth of bonds issued in the world, but the total amount that people have bet on those bonds is $60 trillion.

Because they were traded over-the-counter, CDS have been unregulated and are nearly invisible to investors. We now know that many of the obligations to cover mortgage-backed securities are held by AIG, an insurance firm. On 16-Sept-08 the U.S. Treasury seized control of AIG and has now invested about $122 billion to prop it up.

This week I received a letter from AIG offering me an Essential Health insurance plan. The envelope exclaimed:

You Can help get greater control of your medical expenses. (And for less than you think.)

Imagine my excitement as I raced to read the fine print.

A collection of posts about the US Economy is maintained here.

To learn more about our work in consulting, please see our Profile, download a brochure about our Practice, or check out our Case Studies.

Contact JP Farrell & Associates, Inc.

Financial Crisis: Stepping Back from the Precipice

Tarpeian Rock, Rome

Economists, bloggers and amateur historians will read with interest the rich exchange of ideas on the Paulson bailout plan instigated by Christopher Carroll, the economist from Johns Hopkins University, on the Economists' Forum blog of the Financial Times, TARP and the Ruin of Pompeii: An Analogy.

Professor Carroll poses a simple model of a financial system in crisis that results when an under-capitalized bank holding mortgages of the citizens of Pompeii learns that its balance sheet has been compromised by an unforeseen event, the eruption of Mount Vesuvius. Writing during the critical days immediately following passage of the Emergency Economic Stabilization Act of 2008, Carroll and a cast of contributors try out a number of policy alternatives as they enrich the model, in the process making it ever more analogous to the present situation.

Mr. Carroll takes the question directly to Secretary Paulson, wondering rhetorically why the classical, free-market solution--let the banks fail--would not be more sensible than the approach initially suggested by Paulson, by which agents of the U.S. Treasury would inject capital into financial institutions by purchasing troubled assets at prices to be set by auction on exchanges to be named later. Carroll doubts that any auction can establish the real value of these securities and thus suggests that policy-makers consider direct investments in bank equity.

The contributors poke at Carroll's model and his history, variously:

• Defending TARP (Troubled Asset Relief Program) as a mechanism for creating liquidity in the short term
  
• Introducing complexity (e.g., suppose Pompeii's mortgage had been insured by entrepreneurs at Vandelsbank)
• Considering the fallout of market failure ("it will trigger a run on all the other banks in the Empire, putting millions of potential tourists to the new Pompeian ruins out of work and unable to afford the trip") and
  
• Noting that Titus and not the despised Nero was Emperor at the time of the Eruption

One commentator remarked:

How strange to call this plan “TARP” when the old Romans used to say “The Tarpeian Rock is not far from the Capitol.” (Editor: Following his link, one finds that the Tarpeian Rock is the precipice from which ancient Romans flung traitors, murderers, and those "cursed by the gods.")

Within days of Carroll's article the finance ministers of the G7, led by the UK, announced plans to battle the world liquidity crisis by directly injecting capital into their respective banks. Secretary Paulson, in what seemed a remarkable turnabout, shifted his policy focus from purchase of troubled assets to direct investment in financial institutions. Calling a meeting of the leaders of the nine largest U.S. banks, Paulson called on each of them to contract immediately with the US government for a direct infusion of federal cash in the form of escalating loans, along with warrants for preferred stock and limits on executive pay. In dramatic reporting for the The New York Times, Mark Landler and Eric Dash wrote:

In addition to the capital infusions, which will be made this week, the government said it would temporarily guarantee $1.5 trillion in new senior debt issued by banks, as well as insure $500 billion in deposits in noninterest-bearing accounts, mainly used by businesses.

All told, the potential cost to the government of the latest bailout package comes to $2.25 trillion, triple the size of the original $700 billion rescue package, which centered on buying distressed assets from banks.

Carroll and his contributors have provided a masters class in political economy, open to the public. In it we read the thinking behind policy as it is crafted and revised in real time. More than that, we are witness to the development of economic theory. Hypotheses are set out. Models are postulated, tested and examined for implications. (One commentator, Professor Perry Mehrling of Columbia University, interprets the technical balance sheet entries of the U.S. Federal Reserve Bank on October 1, 2008 to conclude that the Fed had run out of ammunition to battle the crisis.) Consequences of policy provisions, with their inevitable compromises and disappointments, are weighed against the risks of doing nothing.

For the moment, the consensus view that banks should be forced to recapitalize despite concerns about damage to free market principles, seems to be carrying the day. And it should.

• Direct investment in bank reserves is considerably more efficient than purchase of troubled assets in producing liquidity because such action dramatically improves banks' reserve ratios.
  
• Under the latest plan banks remain responsible for their balance sheets.
  
• The government has agreed to charge a fair price for the required capital investment and has provided banks incentives for banks to buy back the the government's stake through privately financed equity. (The Treasury will purchase preferred stock paying 5% dividends initially, but rising to 9% on shares held beyond five years. Treasury will also get warrants to purchase common shares equivalent to 15% of its initial investment.)
• Compulsory action against the largest banks provides cover for others to volunteer for the program without suffering the financial taint of appearing weak. Without compulsion, which bank would have been first to appear at the government's lending window? Which executives would have volunteered to cap their own pay?

The crisis is not over and the full implications are not well known. Governments around the world will need to act responsibly and in coordination to bring the world economy to a soft landing.

Our thanks go out to bloggers like economists Christopher Carroll, Paul Krugman, Greg Mankiw and Peter Orszag for raising the level of discussion above that achieved by the mainstream media.

See also previous reports on the financial crisis, including A Review of the Economic Stabilization Act of 2008, The Bailout Explained by the CBO, The Case Against the Paulson Plan and Can the Banking System Hold Water?

A collection of posts about the US Economy is maintained here.

To learn more about our work in consulting, please see our Profile, download a brochure about our Practice, or check out our Case Studies.

Contact JP Farrell & Associates, Inc.