Workout vs. Bailout: Should Government Take Advantage of the Buffett Effect?
The depth of the global financial crisis is becoming clearer day by day, says HBS professor Jim Heskett. Respondents to this month's column offered creative solutions, and by and large resisted the temptation to venture into the realm of ideology. (Online forum now closed.)
The depth of the global financial crisis is becoming clearer day by day. In the United States, it is being used as a reason to set aside ideology regarding government ownership of important financial institutions, possibly including those that also manufacture automobiles. Our changing attitudes toward these matters may help explain the reasoned responses to this month's questions, responses surprisingly devoid of emotion. Granted, the emphasis of the column was on how the Government should act, not whether. But responses, by and large, resisted the temptation to venture into the realm of ideology.
Some respondents doubted the Government's ability to achieve the Buffett result, if not the "Buffett Effect" of the column's title. Several argued that the Government, by necessity, has different goals and constraints. Dave Guenthner wondered whether "a government would have the same financial-only interest that Buffett has. He is investing to make money, not save the economy." Sameer Kamat cited several reasons—lack of "credibility" as an investor, a "business model" that avoids hard-to-understand business, and "patience" (the pressure for Government to exit its investments as soon as possible)—as reasons why "a Government bailout may not be perceived in the same way as a Buffett style investment." Henrique Abreu cited a lesson of the late Milton Friedman that "it is a different thing spending your money on someone else (Warren Buffett) or spending someone else's money on someone else (government intervention)." But at the same time, most were resigned to the necessity of government action. In Tom Henkel's words, "Government intervention, while appalling, is really the only short-term fix."
One at least partial solution to these concerns was put forth by Amit Maheshwari, who asked, "Why not ask Warren Buffett to invest the bailout amount on behalf of Govt (he works for money, does he not?) …." Several responding as a group from Bethel University asked whether it would be possible to find an expert investor, including Buffett, who truly is a "disinterested party."
This sparked a side discussion about regulation. As Wilson Kimutai put it, "If we bring in Government to bail out, … more regulation should be brought to stabilize the market." David Moore echoed this thought and went further, suggesting that American people should not be allowed "to obligate themselves to loans they cannot afford." Elizabeth Doty commented, "The promise that individual actions lead to societal gain also means that individual failures of judgment lead to societal risk and pain, as we are seeing…. This is why I think we need to step up to the regulation challenge."
Those trying to fix the blame for the problem pointed in several directions. Bottoms-up (mortgage related) as well as top-down (concerning only financial institutions) solutions were favored. Now the definition of those institutions qualifying for either work out or bail out will be tested further, leading us to the question of whether the U.S. automobile industry should qualify for help. Where should we draw the line? Is it now time for ideology to take over? What do you think?
In view of world financial events, which take new turns every day, it's difficult to think about more mundane topics that were candidates for this month's column. Clearly, an inability to identify and evaluate risk has led to an inability to value assets. What follows is the failure of "fair value accounting" and markets themselves. Without markets, it's hard to "mark to market" in establishing balance sheet value, the outcome of which can mean life or death to an institution. And it's a short step to a loss of trust that people can repay what they borrow and the resulting unwillingness to lend cash, regardless of how much you have or the quality of the borrower's credit. These are complicated issues. Do they require complicated solutions?
In the midst of all the knotty discussions, a simple proposal arrived in my email late last week. It's from Peter Solomon (one of the few "good guys" portrayed in the book Barbarians at the Gates, which chronicled the greed of the 1980s) and Anders Maxwell. In it, they advocate focus, immediate funding, and the U.S. government as shareholder. You might think of it as "Buffett Squared." The government would engage "experienced and disinterested professionals—not politicians" to invest in the preferred stocks of "viable financial institutions deemed beneficial to the public interest." Private institutions would be welcomed to join in such deals as well. The mere identification of institutions in which the government invests would have a beneficial effect on the value of the investment, not unlike Warren Buffett's buys.
The model here is the "top down" response of the Reconstruction Finance Corporation of the Depression era rather than the "bottom up" strategy (involving the purchase of individual properties) of the Resolution Trust of the 1980s. The former returned 100 percent of its investment to the American public. The latter is estimated to have cost citizens about $200 billion, a sum that went to those who were more expert at determining value than the government's representatives.
The proposal would have immediate effects, but they might not be as noticeable to "Main Street" as some other proposals. Its immediate benefits would be to investors, but the long-term effect, it is assumed, would be to reverse the "doom loop" described above. For better or worse, it would be much more straightforward than the proposal on which more than one vote will be taken by the U.S. Congress this week, a proposal which is a mixture of "top down" and "bottom up" provisions, the product of a political compromise.
Some would claim that markets that were too free and not sufficiently regulated got us into this mess. That will be a topic of debate (not unlike the one that led to the creation of Sarbanes-Oxley oversight) over the coming months. But to what degree should the U.S. government take advantage of free markets to free them up when they become frozen? Can it employ the "Buffett Effect" to do so? Or is the analogy even appropriate? Should this be called a workout rather than a bailout? So many questions. So many answers. What do you think?
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