The Wall Street Journal has officially sounded taps for the SIV bailout plan that once garnered front-page business news coverage:
This week’s decision by Citigroup Inc. to bail out seven investment entities and bring $49 billion in assets onto its balance sheet effectively killed one of the centerpieces of the Bush administration’s approach.
The balance of the article discussed other remedies under consideration as well as the notion that perhaps the best move is to let the housing market find its own level, since there may be no other way to get investors back in the water.
The subtext is that the measures proposed by the Administration may fall short, and if so, there will be calls for further action. The assumption in many quarters is that the cause is the Administration’s hands-off bent, which leads to minimalist policies.
While that is doubtless true, I’d like to submit another likely culprit, namely, Paulson’s problem-solving style. I don’t know Paulson personally, but I have a fair bit of experience working with investment bankers, and Goldman investment banking services types (the corporate client coverage group where Paulson spent much of his career) in particular. By all accounts (press and some comments from Goldman staffers) Paulson, aka “the Hammer” is an extreme version of a type, so I believe my generalizations aren’t a stretch.
While investment bankers like to think of themselves as creative, 95+% of what they do is shuffling around existing deal elements. It’s rare indeed to work on inventing and launching a truly new instrument, and smart bankers typically avoid it (much better to jump on the bandwagon if it proves out).
The problem is that investment bankers, temperamentally, are like people in the military. They live to take the hill. Even though they are often very smart, most of them aren’t cerebral by inclination. The tendency to drive quickly for resolution is great on deals, but a danger in a systems design or complex problem solving context. (An aside: Robert Rubin, a former risk arbitrageur, is by all accounts a very thoughtful, deliberate type, stylistically the opposite of Paulson).
The subprime bailout plan came together in about a week, and having worked on deals, that says there wasn’t much time for all that much thinking. I’m not at all certain what the process was, but there was a bit more disclosure on how the SIV rescue plan came about. The image was that Paulson got lots of senior people in a room and knocked heads together. In one meeting, a guy sketched out a vehicle that he had worked with before that was used as a blueprint for the SIV rescue plan. The reporting may be wrong, but it gave the impression that no ideas were developing, and when one proposal surfaced, everyone latched on to it to try to make it work.
Now it is actually very hard to design a process that will come up with good solutions to thorny problems, so in fairness, it isn’t surprising that the process Paulson gravitated towards wasn’t optimal. The reason I am bothering to write this that most people and organizations don’t bother thinking about how to go about undertaking activities that fall outside their normal operations. They use routine procedures by default, and those inappropriate processes often lead to hastily-developed ideas that fail or need substantial revision.
Although there are various ways to go about working though tough issues, one simple technique greatly improves outcomes, and isn’t difficult to implement: separate problem definition and analysis from problem solving. The big reason is not the most obvious: people become very wedded to positions once they’ve stated them. Our society values the appearance of consistency highly. So someone who throws out an idea early on will not be terribly open to other proposals, even if his has a fatal flaw, or even new information about the situation. The discussion can easily devolve into a competition between egos.
It takes some discipline, but the manager separates the problem-discussing and problem solving sessions. The facilitator must nicely but firmly squelch all efforts to propose answers in the first session and make sure people talk about the issues EXHAUSTIVELY. The participants will inevitably be thinking about remedies regardless, but by forcing them to keep them to themselves, they have to weigh them against the various considerations under discussion. Ideas they might have volunteered may be put aside or improved as the debate continues. The other big advantage is that the group shares information, putting everyone on a common footing, and will come to agreement on at least some elements of the situation. By contrast, jumpint to conclusions quickly also means the participants can have considerable disagreements about the nature and severity of the problem that haven’t been aired sufficiently, and arguments about the problem get muddied in arguments about the solution.
At the beginning of the problem-solving session, the facilitator should set aside 15 minutes to discuss any further thoughts about the issues before asking for proposals.
The implication is that even if Paulson & Co. come to embrace the need for government intervention and again go down the path of trying to devise new programs (rather than revive old ones) they are likely to wind up with a repeat of the SIV experience, of launching something that hasn’t been thought through sufficiently (my view: the fatal flaw was the conflict between the SIV owners’ desire to attenuate losses, versus the investors willingness to fund only paper that was priced at current market values. They lost time trying to finesse something that couldn’t be fixed, and lost critically valuable time).
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Yves, your assessment of the Paulson process makes a great deal of sense. Especially where you state the need to “…separate problem definition and analysis from problem solving…” As I’m sure you’re aware, this is a basic tenant “brainstorming”. Couldn’t understand why you didn’t reference that term directly. (Maybe because brainstorming seems to have fallen out of favor over the past few years, per various studies that have shown creativity is enhanced more strongly when people work individually, as opposed to working in groups). What you also imply is that Paulson is probably a creature of a “command and control” culture and therefore conducted the bailout plan working meetings in a similar fashion. This type of leadership style may result in success when you’re king of the hill in your industry, where you have superiority in resources and knowledge, but could never work in a situation such as the one he found himself (whereby you need to cultivate the “buy-in, alignment, trust and coordinated efforts of a large and diverse group of people, not to mention the general public). The plan, from day one, was clearly perceived as “the Paulson Plan”. While he is greatly respected, his reputation does not engender trust. Accordingly, we saw his motives questioned from day one. He was unable to garner the required consensus. The moral of the story is that we, as a society, should seek out leaders not just by their physical stature, stage presence, IQ , persona and communication abilities. Rather, we should look for leaders, who may still have strengths in some of those attributes, but who also have a track record of conducting themselves in a style whereby they first seek to understand what others have to say before decisions get made, and not just try to dictate solutions. They should be of the nature where they deflect accolades of success to others and accept the responsibility of failure upon themselves. They won’t necessarily have to agree with what they hear, but their conduct will clearly affirm to others that they have at least listened carefully. A leader such as this, may have been able create an environment where a truly novel workable solution that would not have be DOA at its introduction.
smart is not necessarily creative
Maybe it was ALWAYS a Plan B? They can have plenty of value, but it seems here that the people with all the skin in the game figured to take a sure bet — adopt the SIVs onto the balance sheets — versus the possibility of bickering & breakdown in starting up the SuperFund, and worse, recriminations and lawsuits over false pricing later, if/when things got ugly.
And while we’re at it: what “generally accepted” accounting standard makes it “well, I guess we’ll do it even though we said last week we wouldn’t,” lah-di-dah optional whether you have a $49 billion asset (plus liability, no?) on your balance sheet? Does the SEC enforce transparency of financial statements, or is that just one of those quaint ideas of yesteryear?
Yves, could you take a stab at a question I’ve had for a long time?
How stupid do the economic leaders of the US really think other people are? (and, perhaps as a follow-up.. for the love of god, why?)
Paulson has torched his credibility, both when he tried to get the Chinese to buy more SIV silliness a few months ago – and the M-LEC – er, psychotically moronic endeavor.
Who would trust him after those events? Most importantly, what money fund manager worth half my salary is oblivious to the various analyses of all economic events available on blogs such as just this one?
It seems equal parts stupidity and arrogance to blithely assume nobody will guess that the emperor has no clothes.. when Internet homes like yours and Tanta’s dissect every news item with unparalleled precision.
Grr. I wrote a very long comment and lost it. Here’s a second go at it.
Anon of 5:47 PM,
The appearances were that the Treasury and the sponsors really thought this might work despite the indications to the contrary. How they persuaded themselves is beyond me. HSBC was known from the get-go to be unlikely to join, and investors (save self-interested parties like Federated) weren’t keen either. But a hundred lawyers were reported to be working on the documents. That’s a lot of legal cost. Some serious hard dollars and time were spent on this failed initiative.
Gavin,
Thanks for the kind words. I wish I knew the answer, but I’ll hazard a guess.
I’ve known a few people who have held senior government positions (not Cabinet level, mind you) and they all seem to believe in what they did, which means they are either great actors or self-deluded.
We’ve also seen other instances of senior people locking themselves in a room and coming up with a program that is stillborn. The Clinton health care plan comes to mind.
Nevertheless, Paulson is a special case. He decided to try to take on the problems in the credit markets in a highly visible way. This is grandiose. First, the Treasury, aside from the fact that the IRS and Office of the Comptroller of the Currency are in its purview, has very little power. And the credit market mess is a huge, multifaceted problem, and not confined to the US either. Anyone with a operating brain cell would have stayed as far away from this minefield as possible, or if forced to deal with it, taken on only very discrete elements they could tackle.
By happenstance, the quote of the day on iGoogle si from Daniel Webster, “A strong conviction that something must be done is the parent of many bad measures.” Paulson is constitutionally unable to heed that kind of warning.
But when Paulson was at Goldman, he committed the firm to meeting “green” objectives, which earned him considerable criticism (that wasn’t seen as proper for a public company). So Paulson may have a self-image of being the guy who does the right thing despite considerable opposition.
As to the more general case: I think most people are fooled, successfully. But I am not certain the perps (government and corporations) are completely cynical. I think they are disengaged from reality to a considerable degree (case example: how could you possibly defend hedge funds and private equity funds not having their carried interest taxed as ordinary income? Yet the guys I have spoken to genuinely believe they are entitled to special treatment, that somehow their labor income is different from everyone else’s).
Journalists have told me that companies are now so skilled at spinning stories that they can’t get to the bottom of them in a normal news cycle. And TV is a hypnotic medium. I am convinced the public is mesmerized by TV. However, for most people, if you tell a lie or even a partial truth, you start to believe it, or come up with ways to rationalize it. So I imagine a lot of people in high positions believe their own PR. That’s dangers because they then make decisions out of a distorted world view.
And then you have this Administration. Aside from Karl Rove, who I believe was deeply cynical and didn’t care about what he was selling, the rest are true believers with a very misguided set of ideas. And despite the fact that their nuttiness is increasingly apparent, they still have sway in some circles. Many people respond viscerally to conviction.
Another factor is that the Bushies were not open to outside influence, either ideas or information. Jane’s Defense Weekly calls it incestuous amplification:
A condition in warfare where one only listens to those who are already in lock-step agreement, reinforcing set beliefs and creating a situation ripe for miscalculation.
Or, the “Efficient Mass Delusion Hypothesis.”
“All the world is queer save thee and me, and even thou art a little queer.” Well, we couldn’t take part in these blogs if we didn’t have some minor messianic complex.
The difference between this situation & Cassandra’s is that Finance types can speculate, and at huge profit, on the follies of others. That is, of course, until some crisis sweeps us down the drain with everybody else. There may not be a similarly rewarding mispricing of assets in a decade. Carpe Diem!