1. Take the past as a given – let the historians debate it. Understand the past to guide the solutions, but don’t lament it….it is gone. There’s no time to complain about it right now. Focus on the present and the future.
2. Remember that the interest of the people – the general population - is paramount. The financial sector does not exist for itself – no offense to all the executives who may believe that it does. It exists to provide capital for the real economy – so businesses can access capital to grow and provide jobs. It exists so people can deposit their money, save and make investments, and by doing so, people provide capital for the real economy. It exists so people can access short term credit (now increasingly used to try to afford to live in the absence of rising salaries), and long term credit to buy a home, a car etc. If people have no money, they cannot provide funds to banks. If people have money and have no confidence, the banks won’t get any money to provide capital. No capital, no growth, no jobs, no savings, no capital etc. etc. etc.….a vicious cycle.
3. If you don’t know what you are doing, pretend you do until you can find a replacement that does and then step aside. Confidence rules!
a. So far there have been piecemeal solutions, and forceful statements only to be followed by reversals. You cannot possibly know everything in a global interconnected economy. No one believes that you do know everything, and now everyone believes you do not know what you are doing, or understand the problem. When the prospect of a plan was announced today, the market rallied.
b. Right now, banks don’t trust each other, people don’t trust the banks and no one trusts the regulators. It is very serious when people do not have confidence in the markets. It is an absolute and complete catastrophe if people do not have confidence in the regulators, the regulatory system and the decision making process for government intervention. Any recovery plan must have the restoration of confidence - with tangible measures - as the priority.
4. Never ever act precipitously in public. It is never prudent to cause panic. It is never prudent to create a government induced shock to the system:
a. Do not summon the regulated – in front of the whole world - and expect them to solve their problems in a weekend. The markets are too complex, too globalized. 48 hours is not enough time with the very best of intentions.
b. Do not bring the companies together and then not expect them to act in the best interest of their shareholders over the weekend, and when the markets open. You have provided them with a lot of information they did not have before, and the market does not have. And you have stated that there will be no more government funds for bailouts. That may be good for the taxpayers in terms of a bailout, but the types of interventions, actions and your words have been disastrous to the taxpayers’ savings, job security, potential for access to credit etc. Do regulators not expect the regulated to hoard funds? Well, it happened and is happening – so have a plan to deal with it before markets open on Monday, not Wednesday.
c. Do not ask weakened financial institutions to bail out their peers “or else”. This is a communist principle being imposed in a capitalist system – it will not work. Further, these companies all have regulatory obligations in other jurisdictions…..can they really just do what they want to bailout another company. Unless the authorities across the world all have some blanket agreement, I think the answer to that is no. And if there is some blanket agreement, I would love to see it since authorities in every country are obligated to act in the best interest of its own citizens. That would be the first time the whole world ever agreed on anything.
d. Do not make hard and fast rules about bailouts – everything is a “case by case” basis in a globalized economy reeling from the sub-prime crisis. Hard and fast proclamations send a very bad signal. There are better ways to communicate the same thing. Discourage bailouts, but don’t make people panic.
e. Do not allow shares to trade freely when there is massive – I repeat, massive - information asymmetry in the markets. Small investors and pensioners who are all taxpayers will always be the first to get burned. And please, at the very minimum enforce the existing rules!
f. Always watch your words. The markets are hanging on every syllable.
5. Consider the implications of your actions and put in mitigation measures, such as:
a. In the case in point, why wasn't an announcement made last SUNDAY that the SEC will have no mercy, and zero tolerance? Where was the statement to traders – “Do what is legal or else”? Christopher Cox should have at least tried that. Some people may actually have believed him. Today’s rally started with the FSA's decisive temporary ban and was aided by Cuomo's announcement of an investigation into illegal practices. You can always remove the ban, but SEC inaction is clearly not the answer.
b. Have a comprehensive plan with your counterpart regulators in all the major economies of the world – central banks and those that have jurisdiction over their stock markets.
i. That plan must have examined various scenarios. Lots of people do scenario planning as a profession. Wasn’t there any scenario planning to see what would happen? Didn’t anyone expect banks would have difficulty raising capital? Didn’t anyone expect investors to panic, and raiders to raid? Didn’t anyone expect shareholders to run for cover – the markets are down, the regulators keep coming up with plans that hammer them, the regulators don’t seem to know what they are doing, and where are the safeguards to protect them? $169B has moved from money markets in the last week. Is that shocking to the regulators? The market soared on talk of an actual plan. Just think it through carefully.
ii. Be careful of precedent. Precedent is part of what got the markets into this problem when there are no guidelines for bailouts. Bear Sterns somehow qualified, Fannie and Freddie too (but at the expense of shareholders - who are taxpayers, as well as pension and mutual funds who hold and invest taxpayers savings and are themselves taxpayers), but not Lehman which may be fine but then why not tell them that from day 1, and then not AIG, then OK AIG (again, at the expense of shareholders - who are taxpayers, as well as pension and mutual funds who hold and invest taxpayers savings and are themselves taxpayers), and likely the survival of AIG itself. Have guiding principles.
c. Keep in constant contact with your counterpart regulators and be prepared to act
6. Do not change the rules of the game unless you have very good reason and tell people what that reason is
a. There has only been one consistent position – the shareholders are expected to get burned. Paulson effectively did so and more importantly, said so with Fannie, Freddie, and AIG. The SEC has been deafeningly silent except to state – yesterday - the willingness to enforce existing rules. If the regulators have declared war on shareholders, then why not eliminate it as an asset class? Why allow people to be paid in shares? Investments should be based on a risk/reward determination. But if the authorities can change the risk and the reward without any rules, then how does one make that decision? It is highly unfair to encourage people to buy shares – i.e. own a piece of the company in expectation of a return in dividends and or capital gain – and then eliminate all hope of a return, as well as the amount invested to purchase the shares. What are you expecting rational shareholders to do? It cannot be rational to hold shares when you appear to be dealing with an “anti-shareholders” Government. Are the regulators really surprised at the massive capital flight to gold?
b. When you demonstrate a willingness to change the rules without explanation or consultation, here’s what else that gets affected (not meant to be an exhaustive list):
i. No one wants to lend your country money – where is the guarantee or rules to ensure it will be repaid. See http://ap.google.com/artic
ii. No one wants to provide Foreign Direct Investment – you know that “thing” that provides jobs and growth. FDI is the first to suffer when Governments are prone to changing the rules. 5.3 million jobs were due to FDI in the US in 2006 and contribute $17.8B in taxes in 2002 http://www.state.gov/r/pa/
7. Stop allowing companies to create and sell and trade complex financial instruments that you – as the regulator - do not 1) understand 2) have the time to follow on a second by second basis. If you can’t monitor or regulate it, disallow it until you build the capability to regulate it. Companies exist to make money – not to make the markets stable. That’s why ordinary people buy shares – because they expect companies to make money. Market stability is the Governments’ responsibility.
8. Do not fool yourself that more regulation is the solution to this problem. It is not. Regulation needs to be coordinated and efficient. Yes, companies must disclose, but regulators have to understand what the companies are doing, and the interrelationships. Consistent and fair enforcement is critical. Over-regulation can only make it more difficult for people and companies to access credit which will further cripple the economy.
Just a word on Bailouts:
In principle, I do not support bailouts but I think this situation needs to be placed in the context.
What is the problem with bailouts? They are expensive to the taxpayer. However, if the bailout can prevent a complete catastrophe that will cause irreparable damage to the economy, then a bailout is perhaps necessary. I would argue that institutions that deal with the majority of housing and insurance - and materially affect the lives and livelihoods of the majority of the population - would qualify for bailouts. Let’s call that my ”litmus test”.
Now what have been the problems with THESE bailouts:
1) The authorities bailed out Bear Sterns. I am yet to be convinced that the situation with Bear Sterns was necessary. Where was the national or global catastrophe if one had not been provided? The bailout and the type of bailout only created a precedent and an incentive for other companies to seek a bailout rather than clean up their messes. Lehman has been in trouble for a long time – why wait until the 9th hour to publicly state that there would be no funds for Lehman? Didn’t anyone think the company, the economy, and the all possible investors expected that there would be some form of help after what happened with Bear Sterns? This is the problem with precedents.
2) The authorities did next to nothing while the situation became exacerbated at Fannie and Freddie, therefore the bill that taxpayers would have to pay went up daily
3) The authorities stepped in to Fannie and Freddie. If it is to save housing, then given the size and influence of Fannie and Freddie, this situation does pass my litmus test, in my humble opinion. However, the deal and what was said exacerbated the problem – for taxpayers. By emphasizing that the deal is not designed for shareholders and that shareholders are expected to share in the losses, it created a dangerous precedent. It meant that the government could step in without warning into any publicly traded company in a way that preferred shares and ordinary shares would mean nothing. This started the capital flight from those asset classes – as evidenced by the record declines in the stock indices, and the preferred stock index - and the volatility in the market. Was that the intention or should the statement have been more carefully worded? Why does that matter?
a. Because taxpayers have shares in Fannie and Freddie and other companies and all of a sudden shares are not so attractive
b. Because taxpayers have money in pension funds and mutual funds who are investors in Fannie and Freddie, and other companies
c. Because there are other publicly traded companies - that do meet the litmus test for bailouts - that must logically be impacted because they have shares in Fannie and Freddie, and because there is no longer confidence in shares as an asset class. One such company to suffer was AIG.
4) The handling of AIG was less than optimal – to be diplomatic. AIG’s was forced to raise capital in record time in a weakened and shocked financial market. Goldman and JP Morgan were asked to find money for AIG – from where? Public pronouncements were made by the authorities for no money for AIG. AIG Stock gets hammered. AIG asks the Fed for a loan – no, they are told. S&P downgrades AIG – how does one raise capital with a downgrade? Specifically, how does AIG find $75B in 24 hours as it is instructed? Then the Fed changes its mind with a relief package – great, except the terms are so onerous the company may not even survive that. So the authorities have increased the cost of the taxpayers’ bill.
The Government authorities must take some responsibility not only for a taxpayers’ bill, but, importantly, the size of it.
Let’s talk a bit more about taxpayers:
• these same taxpayers are struggling to hold on to their houses
• these same taxpayers need their insurance policies to be honored
• these same taxpayers are watching the little savings that they have being wiped out in front of their eyes as Pension Funds, Mutual Fund and their chosen investments all precipitously decline as a result of a government induced shock to the system (see 4)
• these same taxpayers are struggling to hold on to their jobs with companies that have to try to recover from the costs of this government induced shock (see 4)
• these same taxpayers are already struggling to try to afford increasingly expensive necessary goods and services - all of which are made more expensive when business that produce those goods and services cannot access capital, or face rising costs of capital as a result of this government induced shock (see 4)
Therefore, do not be surprised when taxpayers have no money to pay any taxes – further exacerbating the economic problems.
Finally, it can be fixed - and fixed quickly - but it takes a level of political will and cooperation never before seen. Are you all ready?
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