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.)
by Jim Heskett

Summing Up

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?

Original Article

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?

To read more:

Peter J. Solomon and Anders Maxwell, "It's Credit—Stupid!" available on PJ as a PDF.

    • Dave Guenthner
    • CEO, BSM Executive Advisor
    An investment by Buffett certainly lends credibility to a company and will stabilize its market value. A government investment may do the same. I wonder, however, if a government would have the same financial only interest that Buffett has. He is investing to make money, not save the economy. Hence 10% interest plus warrants. While taxpayers may deserve that return, government has not always been good at negotiating it.
    • CJ Cullinane
    It seems to me we are intent on giving more money to the folks that got us into this mess. I think we should not 'shotgun' the solution but focus the money where it will have the most impact and do it over time.

    I do not believe this will happen because of the lobbies and political donations of the bankers have utililized. The problem has been politicalized and will remain so until the crisis explodes and panic sets in. I hope this does not occur but greed got us into this and greed will not get us out of this mess.
    • Sameer Kamat
    There are several reasons why a Government bailout may not be perceived in the same way as a Buffett style investment.

    Credibility: Buffett has had a long proven track record of identifying winning institutions led by strong management teams and investing in them. The government doesn't, and is not expected to anyway, in a business-as-usual scenario. I'm excluding Sovereign Wealth Funds here.

    Business Model: Buffett would shy away from investing in businesses that he doesn't understand. Most of the financial institutions in focus here are involved in products that are highly complex to comprehend even for people who create, sell and manage them despite the usage of sophisticated software tools and spreadsheet models. In the current scenario the Government would be forced to choose from exactly that very set.

    Patience: Buffett buys to keep 'for life'. There is no pressure (from his side or his stakeholders) to exit an investment in a fixed timeframe. The Government may not have this leeway as the stakeholder base is much larger (i.e. taxpayers) and people would want to see quicker results.

    However, having said that, there is definite merit in having private institutions involved in the entire bailout/workout process and investing as a consortium. As far as the beneficial consequences are concerned, the challenge for the consortium would be to demonstrate early on to the public at large that this immediate spike in the graph is sustainable and not just a 'dead cat bounce' effect. Given the scale of the impact, a bottom-up approach would be far too tedious and long-drawn.

    Drawing inspiration from the friendly family physician (though the situation here may be far more complex than we can fathom), the ultimate solution may be still be two-pronged.

    1. Treat the immediate symptom (i.e. the fever) for some quick relief. The recent news of the $700bn rescue plan should hopefully address this.

    2. Continue to treat the main problem (i.e. the underlying infection) that resulted in the symptoms. This will be the crucial component of the treatment process and may involve de-risking and de-knotting many of the business models. Many decisions taken by the powers that be could rock a lot of (institutional and individual) boats.

    I'd be very interested in reading what other readers feel about this topic.
    • David E. Moore
    • Chief Executive Officer, Moore Investment & Holding, Inc.
    Are efforts will all be for naught until two things happen:
    1. investment banking and mortgage lending institutions follow strict, conservative and prudent regulations regarding investments and lending; and 2. the American people are not allowed to obligate themselves to loans they cannot afford. It would be nice to get people to conduct themselves with their own financial interests in mind, but we must regulate the areas that we can and not give financial access to people who cannot prove a reasonable probability that they can repay loans, and we must regulate business so that they don't engage in these unsound lending practices for personal and institutional greed ever again.
    • Anonymous
    I agree with CJ - the gov is paying those who got us into the trouble. You made a mistake and now you fix it.

    To the contrary, if I see US government investing in my company that means we are in trouble. If Buffett comes in that means we have something to offer.

    Lastly, why not hire bunch of accounting students and ask them to evaluate all these securities. Long process but a long term solution. I sound like a freshman but it is time we go back to the fundamentals and use common sense.
    • Henrique Abreu
    • Marketing Manager
    I believe that one thing this crisis showed us is that free markets do work, it is the old rule of demand pull inflation, (if someone comes and offers 20 % interest rates a year, should no one start to be suspicious? The old economic rule; low interest rate low risk, high interest rate high risk?) if there are people interested in buying any asset at any risk at any price regardless of his true value, we can have at the end bubbles that will blow when this balance starts shifting.

    So should the government intervene and take care of the so called "toxic assets"? (By the way I still struggle with the content of that definition.) Normally politicians are not the most suitable persons to manage taxpayers' money, that reminds me one of the lessons of the late Milton Friedman, it is a different thing spending your money on someone else (Warren Buffett) or spending someone else's money on someone else (government intervention). Should we let the free market forces act and start a self-healing process? Or should bureaucracy intervene and start to regulate what is anyway difficult to regulate? It is a bit like the old analogy of the glass that is half full or half empty; on one hand we can see this as a collapse of the existing financial system with all its negative impact, but we can also take a look at it as a major and new business opportunity.

    There are solid companies in the marketplace whose share values reached an all-time low in the stock markets. Those willing to buy now will be able to make some excellent deals. There is liquidity out there, so a major opportunity to see companies and individuals start to purchase shares massively. A huge opportunity to invest - probably that is what Warren Buffett is all about. In these times we see true entrepreneurs start a workout and help a deregulated economy to recover from this downturn and start to rise again, but at what cost, in what timeframe and at what speed?

    Those are questions whose answers I do not have, but I truly believe that markets will stay frozen until confidence is restored, and to achieve that goal all involved agents have to behave responsibly and with transparence, acting like they would always and in every situation be spending their own money on themselves.
    • Varun Sethi
    • Associate, Ernst and Young
    Surely the lending and consequent nationalisation of the financial intitutions in distress will add to the credibility of the realisability of the assets of the these troubled institutions.

    The loss of value consequent upon the subprime crisis and the bad mortagages (pursuant to an asset bubble) will have to be compensated to produce any positive effect on the gross national product.

    The bailout will add to inflation and the consequent job losses. It will take time before the net effect of the bailout is ascertained. Anyway the bailout is necessary for the global economy at large.
    • Tom Dolembo
    • Consultant, Disaster Planning Assoc
    Buffet is a nice guy. If he had been a cash drenched murdering Russian Mafioso Thug, our system would have given him the same opportunity. Perhaps Goldman Sachs, etc. deserved the latter, but was blessed with Omaha, not Moscow. We should be tender about extending welcomes to ownership of our "too big to fails". If the top-down strategy is adopted, is it simply just the last step in asset ownership polarization? If we have successfully destroyed the middle class, can the American upper class (and HBS) be far behind? Stocks and commodity derivative based investments are next to tumble, as the remaining two legs of our "institutional faith" stool fail. Devaluation makes social revolution inevitable, and we should be very cautious about lighting dry tinder or accepting candy from strangers.
    • Wilson Kimutai
    • Associate, Quadrix Capital
    If we bring in Government to bail out, we are encouraging the politics to shape the economics of the institution. Political participation in the corporate world has never been a solution to problems brought as a result of financial distress. Unlike the Buffett style which gives credence to the institutions and opens up potential investors in form of equity or debt instruments, more regulation should be brought in to stabilise the market.
    • Amit Maheshwari
    • Common Man
    So one thing is established that things work better and longer when kept simple. The debate also indicates that Warren buffet enjoys characteristics that Govt cannot and market perceives former as more trust worthy.

    The solution could be simple.

    Why not ask Warren Buffett to invest the bailout amount on behalf of Govt (he works for money, does he not?) rather than using the amount as a rescue fund. The market will restore confidence and that's what we need. The inefficient ones have no right to exist in this free market and Warren Buffett would spot the opportunity for the efficient ones.
    • Tom Henkel
    • President, Baiting Brook Research, Inc.
    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.

    In a perfect world where everyone was honest and operated only for the good of the country, I think this plan could work. But reality is different. I don't think it is reasonable to assume a group of truly independent investment advisers could be assembled (not to mention be selected by politicians) to carry out this task. Anyone "disinterested" in a $700B pile of free money probably isn't qualified to be advising anyone about anything.

    You have to accept this bailout plan for what it is -- a short-term attempt bring relative stability to the financial sector. It's an outrageously expensive dose of Prozac. If stability can be achieved, natural selection will kick in and, after a period of M&A activity, a new set of players will emerge -- probably operating under more strict government regulation. The same result would probably have happened without the bailout, it would just take longer.

    I don't think any individual (including Warren Buffett) is influential (or rich) enough to resolve this crisis in the private sector. Government intervention, while appalling, is really the only short-term fix. The real danger lies in the precedents set by government intervention. In that sense, the true long-term impact of this bailout has yet to be seen.
    • Elizabeth Doty
    • Founder, WorkLore Consultancy
    I find this train of thought and the proposal itself interesting for its information component.

    The biggest challenge would be identifying credible "experienced and distinterested" professionals at this point. But if they could be identified, couldn't the information component be useful on its own, without the funding component (eg publishing a list of institutions)? The authors mention that the public may not understand the benefits immediately -- and that makes the proposed funding mechanism a potential showstopper, because restoring public trust in the institutions is urgent and the resentment is huge.

    Secondly, as far as some of the other comments about regulation: I agree it is very hard to do well and is often done poorly. But if I recall correctly, what we're looking at are several "loopholes" in free market economic theory itself.

    1. Isn't the risk assessment challenge Prof. Heskett mentions a result of "information asymmetry"? And can't we say at this point that that assymetry is predictable when the gains are large enough, as during a bubble? I believe that is what we really mean when we blame greed. No one seems to mind an "honest profit", but misrepresenting the facts for gain.... that's another story, and one way to describe the sub-prime situation at multiple levels. (See the NPR story "The Giant Pool of Money".) Besides, Adam Smith and David Ricardo never contemplated the information implications of marketing products even our most intelligent professionals can't understand completely.

    2. Secondly, don't we have to face the question of "behavioral economics"? David Moore above says, "It would be nice to get people to behave with their own financial interests in mind". Paradoxical as this sounds given the foundation assumptions of free markets and the "invisible hand", he is pointing to a very real distortion, which further argues for tackling the challenge of regulation with more energy. Neuroscientists have found that there is a certain point in human psychology when the lure of a financial reward is so compelling, we will undermine our own long-term interests. (See Neuroscientists Now Follow the Money, NYT 6/17/03)

    Sadly, the "invisible hand" works both ways. 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.

    Given these and other loopholes, markets cannot function for their original purpose (creating the most value for society).

    This is why I think we need to step up to the regulation challenge. Because if we do not attempt to level the playing field, markets will be effectively impoverishing their societies (by definition if there's a market failure). In that case, citizens will be justified in demanding a change -- and how they/we do that matters to everyone.
    • Mohit
    There would be unending debate on what the solution should look like or what role the government has to play (if any). But I am not sure if there is even a consensus on what the solution should achieve i.e. what requirements should a solution satisfy. I attempt at listing a few:

    No moral hazard: Any solution is unacceptable if it perpetuates moral hazard. This requirement is backward looking (people who contributed to this problem should not stand to gain from the solution) and forward looking (people who participate in the solution should be held accountable for their actions).

    Healthier long term environment: The solution should not fix merely the current instance of the problem. It should create a regulatory structure that will create a "healthier" environment going forward so problems of this type cannot happen again. Clearly, the current system of incentives is flawed and many decision makers are not accountable for their actions (or are held accountable based on the wrong factors). For example, realtors are only interested in making sure there is a transaction so they get a %age of it. Another example is of fund managers who get paid based on performance of the fund over specifically defined terms, so they have no interest in thinking long term; if they see the holdings will go down for that term, they might as well close down the fund.

    Protect the innocent: It is probably impossible to work out a solution that spares the innocent any trouble at all (and many have been already harmed), but any long term solution should ensure that the common man that did not contribute to the problem (or was a mere victim) should not be put through too much hardship even in the short term(the rich can survive temporary hardships, the poor can't). They should be able to maintain a healthy and dignified standard of living during this period.
    • Paul T. Jackson
    • Consultant/owner, Trescott Research
    First of all, my understanding as a former corporate director, companies can float bonds (debt) and stock (equity) in order to bring in money. Is it the responsibility of Government to be buying up the resulting inflation of the company's worth? I don't think so.
    Flipping real estate seems, in my estimation to be one of the reasons we're in a mess. The cost of buying and then selling, i.e., all the fees by the lender, the sales, the mortgage insurance (which, by the way do little to earn their large fees, and often miss property liens by contractors...and sometimes lenders try to tack on bills that the previous owner reneged on, which should have been caught by the mortgage insurance groups,) escalate the costs/price to a point where one pays/lends more than the property is appraised at just to get the fees.
    So I have to say bluntly, it is greed that got us here, but the question is, should we taxpayers be helping the greedy who are in trouble. I have no idea why the Government thought they could get a blank check in the beginning (the now famous three page proposal,) unless it was the Administration's plan to continue to bankrupt the nation, or line someone's pocket with wealth.
    With regard to mortgage defaults, I think it only fair that the institutions / companies that are in credit crunch should renegotiate those mortgages / loans as a way to keep some cash flowing rather than going for foreclosure or closing small businesses.
    Even big box stores work on cash flow when many stores are losing money, because the cash is made available immediately to the financial institutions as short term loans, usually with higher interest, that income flow is keeping the stores open.
    I think we are in worse trouble now that congress has given up the money. Reason? I have no idea who, what, when, where and how of the money trail. And I don't think congress will know or care either.
    • Srikrishnan
    • Hertel
    Garbage in Garbage Out!

    We talk about artificial intelligence. All this mess has an origin. The so called credit ratings and mortgage analysis were done based on self standing systems. Valuations had no basis. Qualified analysts tend to use 'systems' to get information, but if the foundation of the so-called systems is itself flawed, what more can you expect!

    Now the bailout. From an investment perspective, growth assets are more valued than existing assets. If these assets are set to have negative growth, who will invest, Buffett?
    • Sahat Hutagalung
    • Engineer, PT Indonesia Power
    Yes, I was agree with CJ and Varun Sethi.

    Effect of that condition will have impact with the global economy (Varun Sethi) and as CJ said: The problem has been politicalized.

    So the problem is how political participation in the corporate world has never been a solution to problems brought as a result of financial distress, as mentioned by Wilson Kimutai.
    • Anonymous
    I would tend to agree with Sameer Kamat that it is best to be free of political influence as much as possible. Politicians should do their part in regulating the whole institution that allows (for example, like the AIG case) some such huge losses.

    I also happened to read an article on the case of Japan. It was not able to recover from its past economic crisis through government interference, and there is no single solution to the problem.

    What is needed is to 'renergize' the whole business institution, as Buffett suggests, if I understand it correctly.

    Then it would be necessary to go back to basics through strategic management to turn around any business unit.
    • Joe Violette
    • Retired Proj. Mgr., Bechtel Corp., Retired
    Our current financial "mess" has deep roots going all the way back to the "Great Society." Fannie Mae was to help more people own their own home--a noble cause--but when something appears to be ". . .too good to be true" it usually is--no down payment, low initial interest rates, no financial qualification and no oversight of Fannie Mae's lending practices, etc. That should have "rang a bell" for someone in Congress, the Fed, the Treasury Secretary. It finally did in 2001 by the Treasury Secretary who advised Congress that Fannie Mae and Freddie Mac needed oversight or these subprime mortgages were going to cause financial problems. No action! They wanted to encourage more people to own their own homes. Congress was advised again in 2002, 2004, 2005 and 2006 including by the Fed Chairman. No action! Now the "chickens have come home to roost" and all Congress can do is try to place the blame--Not me!

    The Administration had no alternative but to "bailout" the financial institutions that held these subprime mortgages--the problem was too big--too many individual investors, or through their 401(k), could be seriously hurt. The sad thing about this whole problem is that no one will be held accountable. Blaming the current Administration because it happened on their "watch" is a cop-out.
    • Brian
    • Grad Student, Bethel University
    The Buffett Effect is a good one to include in the bailout package. The bail out group needs to hire a person who is experienced and has no financial interest in the result of the decisions made regarding the process.

    Leadership Characteristics that this person needs to have is integrity, optimism, strategy. He needs to have integrity to ensure that he will be doing right by Joe sixpack.

    He needs to be optimistic and believe that Americans will overcome and inspire confidence in the citizens of America.
    He needs to have a clear strategy of how to implement his plan and achieve the goals of the package.

    Becky C
    Tery S
    Brian M
    Molly L
    Bethel University Graduate School
    MA in Organizational Leadership Program
    • Mary Jo D., Aaron B., Maggie H., Tamzan M.
    • Bethel University Graduate School, MA in Organizational Leadership
    Ideologically speaking, an expert, impartial person to determine "Buffet-like investments in our economy would provide an interesting and hopeful solution. After all, Buffett has an incredible ability to identify successful investments, so much so that his courageous risks that don't turn out well don't really matter in the long run.

    However, practically speaking, is it possible to even find a "disinterested party" that would have that level of expertise. Who doesn't have some interest on some level? Even Warren Buffet flies to DC on his private jet to negotiate. Everyone has some buy-in.

    That said, were an ideological decision-maker to exist to step in this role of bailout crafter extraordinaire, what would that person look like? First, she/he would be a strategic thinker who allows strategy to emerge and develop in real-time in reaction to economic fluctuations. They would need to make astute decisions by anticipating the future. This ideological leader would, above all, be a courageous person. Even if they began as an impartial, disinterested expert - sooner or later they would wind up entrenched in the politics. Because whether they were successful or a failure, politicos would want to take credit or place blame. It would be difficult to remain disinterested and apolitical for long, hence integrity would be paramount.
    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India)Private Limited
    Warren Buffet has desirable depth in his investment decisions. He doesn't throw good money for bad and is very choosy to select investors for whom he might, if at all, provide financial support to help their turnaround. His would be a deep analysis to ensure that there is a genuine possibility of such investment meeting its basic purpose of really raising such institutions to normalcy.

    He also expects conduct of business in a most transperent and ethical manner once he steps in and no compromise on that.

    How far the decision to provide the $700 bn. bailout is based on critical appreciation of all the connected factors has not been made known. One only hopes that the package achieves its aim and the misadventures that led to the filth are curbed even using stringent unpalatable measures.
    • Umesh Gupta
    • Addl.GM, BHEL
    I find that whole discussions are moving in a very different direction. The realty is that the financial system was trying to give investors returns that had not been earned. Unless goods and services are produced and these are properly valued, money shall not be generated. We can attach prices to any goods and services only when there are users/buyers, and buyers and users have to earn those goods and services to afford it. Fact is that for a long time the American investor thought that somebody else was working on their behalf to earn them required profit and they themselves need not produce goods and services that America needed. Therefore, unless the US starts re-building a brick and mortar economy, this bailout package will only give them short term relief.
    • Nick
    • Tax attorney
    I would like to address the cause--or perhaps trigger--of this meltdown. To me, it's the subprime toxic waste that got fed into the system. I agree with Srikrishnan that it's garbage in, garbage out, but I identify the garbage as the subprime mortgages.

    Wall Street did not create this mess. It stems from subprime mortgages that turned out to be toxic waste. Wall Street, for the most part, does not originate mortgages. Yes, Lehman had a mortgage bank, but that was a small part of the total. And Fannie and Freddie do not and have never originate mortgages, period.

    The real villains are the mortgage originators. These are--or were--Countrywide, Golden West, Indymac, Washington Mutual, and all the other mortgage companies, big and small, including the "mom and pop" operators. They created the toxic waste that they sold to Wall Street and Fannie and Freddie. They knowingly failed to verify borrowers' income. They failed to obtain accurate appraisals. They pressured appraisers to over-value houses to enable borrowers to buy more house than they could afford. They altered mortgage applications after the borrowers had signed to inflate their income (this happened more than one might expect, based on anecdotal evidence from mortgage brokers) to qualify for the loan. They told the borrowers, don't worry, you can always refinance or flip for a profit. They knowingly put home buyers in over their heads. And they, of course, got their cash up front when they sold the loans to Wall Street, Freddie, and Fannie.

    They were the ones who then sold this toxic waste to Wall Street, Fannie, and Freddie. Had they sold solid mortgages, had they followed bare minimum underwriting standards, all those MBS's and CDO's would still be around and functioning as expected, or at least close to expected. The modeling wouldn't have been that far off, or at least as far off as it really was. But do modelers and ratings agencies audit the originators for fraud? So if the mortgages fed into the system had been solid, the MBS/CDO collapse that triggered this crisis probably wouldn't have happened. While we had over-leverage and many other problems, it was the toxic mortgages that caused it to be so severe.

    Yes, Wall Street encouraged this, but others did the dirty deeds. They created the toxic waste and knowingly fed it into the financial food chain. Yes, Wall Street has a lot of problems, but let's not blame them for--and let's be blunt--Main Street's misdeeds. Given the vast amount of fraud and misrepresentation involved (and I believe the FBI said 80% of it was committed by insiders, not borrowers), I don't see how Wall Street and Fannie and Freddie can be blamed as the perpetrators.

    As for pushing affordable housing, I don't recall seeing affordable housing activists pushing borrowers to get in over their heads. ACORN and other activists never pushed predatory lending. In fact, they strenuously opposed it, along with various state regulators. Unfortunately, the mortgage origination industry used national banks as the vehicle for their operations. They convinced the federal courts that federal law trumped state law, and that as national banks, they were exempt from state regulation. As the Fed refused to regulate, the mortgage industry was essentially unregulated. Only the markets regulated, and look what that got us. ACORN and affordable housing advocates did not condone fraud, but wanted more regulation to prevent it. Blaming affordable housing advocates for this crisis is off target and not helpful.

    The primary cause of this debacle is the Fed's refusal to regulate the mortgage industry. Then-Fed governor Edward M. Gramlich, who recently passed away, warned Greenspan and the rest of the Fed about the coming subprime problem nearly 7 years ago! Yet Greenspan demurred, saying he didn't like regulation. He had the authority, but sat on his hands. I wonder how he likes the current meltdown.

    Verify incomes. Accurately appraise houses. Disclose and explain terms. What's wrong with that?
    • Adrian Grigoriu
    • EA consultant
    First, causes should be analyzed and regulated: the high level of debt all along the chain, beginning with the home or other loans; the quality of risk management and lack of visibility of the size of the debt and its penetration of the financial system through complex financial products, lack of accountability to shareholders in these cases etc.
    These all should be properly looked at and regulated.
    A free market is bound to regulate itself at painful extremes. Regulation can smooth and prevent this.
    The worst wrong is to leave people livelihoods, like the retirement funds, at the mercy of speculation and gambling on the free market.

    This and other areas could be invested in and guaranteed by the state, rather than fluctuate with financial system.
    People could still invest in the free market if they wish so, at their own risk.

    It is a good idea the state to invest in or sponsor selected areas of the financial system.
    The workout could come after the bailout since without the bailout the rest of economy will die soon.
    But the bailout could be biased towards these select areas.
    • Ulysses U. Pardey, MBA
    • Managing Director, Am-Tech, S.A., Panama, Rep. of Panama
    Does free-market mean wild-market?

    There might be an underlying misconception of what free and regulations mean. They could complement each other fairly well as the present situation provides with such an evidence.

    One workable way to do good to Main Street (consumer-taxpayers, possibly the backbone of America and many other nations around the world) is that the financial institutions in which people have deposited their values (money, cd's, else) protected by the FDIC could issue, on these people's request, safekeeping receipts. These values stay in the same people's own account with their financial institutions in order to remain under the protection of the FDIC and at the same time these skgr's could be lent by Main Street to borrowing companies which will use them as collateral-like financial instruments to get loans from their own bank/financial institutions. These borrowing companies regardless of their size could be publicly certified or approved as safe-enough by a federal agency - eventually the same FDIC - in order to be eligible to tap this kind of source of funds which is people in general who are neither business minded nor financial experts. This could mean a great amount
    of USD soon available for business.
    This way people's values remain protected by the FDIC - as these values are not removed from their protected accounts - people could benefit safely and directly from their lending of their values to corporations of any size and corporations which want to borrow from this source of funds should be transparently properly managed.
    This could mean in the short and long run more money circulating in Main Street for consumption purposes because of the interests paid by the borrowers to Main Street.

    For the sake of a comparison in order to assess the scope of what could be achieved, the Food and Drug Administration is doing a wonderful job as consumers do not have to become experts in this field whenever they are buying - across the nation - goods from supermarkets or grocery-stores shelves.

    This is not necessarily an interference or intrusion from the Federal Government in the private sector but rather a superior management of freedom, safety, profitability and sustainability among those who contribute to make America beautiful and this means the leaders and institutions we-the-people choose to represent them and their way of life.
    • B.L. Francis
    • CEO, MSI Commerical
    The key to any crisis is to remain free of the shackles of ideology; and not be addicted to the past. Remain as flexible as a medic on the battlefield; then we are able to deal with the imperfections of markets and government to save the bigger economy.
    • Jim Winkelmann
    • OPM 38, Blue Ocean Portfolios
    I think we need to go back even further to examine the root cause.

    Back in the 1930s there was a credit crisis when the banks lend out all of there money and had no more capital to support new housing loans. FDR and his pals in overwhelmingly and democratic congress inhaled John Maynard Keynes exhaust and bought into the idea of setting up a government sponsored enterprise called FNMA to buy mortgages from the banks to free up their lending. Actually what happened was that FNMA established a mechanism to create unlimited credit that fueled the real estate valuations for the next 75 years. With no market forces controlling credit availability the price of real estate in the US just kept growing unchecked by natural market forces. Later Fannie Mae's sister; Ginnie Mae and brother; Freddie Mac were set up by politicians to enable Americans easier means to purchase homes. That wasn't good enough. The politicians enacted the Fair Housing Act in 1968 to force banks to lend to less than desirable people. Then in 1993 the Clinton administra
    tion forced through The Fair Credit Act. Then in 1999 Clinton pushed through the Financial Services Modernization Act which repealed the Glass Steagall Act of 1933. Glass - Steagall established the FDIC and prohibited bank holding companies from owning investment banks and insurance companies. Then Bush administration came in with an even a stronger policy to increase home ownership in America. So the stage was set for the current disaster - but no one connected the dots until it was too late. With no barrier between the commercial banks and investment banks all types of Wall Street shenanigans start taking shape with mortgage originations and creative ways to lay off risk. The government just kept printing money to grease all of the activity.

    The real issue now is that with no more credit available the housing market has nothing to support crazy valuations and is in free fall trying to find an equilibrium point. This means the collateral value on virtually every mortgage in the US is grossly overstated - the victims are the mortgage holders/banks. People with no credit worthiness bought homes valued at $250,000 with little or no money down just stopped paying. They have no skin in the game - why should they pay? The homes valued just a few years ago at $250,000 are worth maybe $90,000 - and there are no buyers at that level because there are no lenders! Under both McCain and Obama's 'plan' they would let people who are not paying their mortgages stay in their homes. My question is why would I want to continue paying my mortgage if there would be e no consequences for not paying?

    This is a prime example of how government over a very long period of time ignored the natural forces - "the invisible hand" - of the market only to create large and deeper problems later. The more the government intercedes the more the government must intercede. Politicians are on the same moral and intellectual level as a common whore. They understand to get paid they have to commit immoral acts while ignoring the consequences. The Wall Streeters are just masters of the game that Washington created.

    So now the US Treasury has more or less merged with the Federal Reserve creating the world's largest hedge fund it looks like they outsourced the management of this entity to Goldman Sachs. Their mission is once again to ignore the market forces and artificially make credit available so that home values would once again be supported by easy credit.

    I guess when Warren decided to invest directly into Goldman Sachs he dismissed some of the turmoil that he went through in 1989 when he had to risk his reputation by stepping in as CEO at Solomon Brothers to protect his investment. I would have thought that he would have had chose to steer clear of direct involvement with a Wall Street firm after that debacle. What changed his mind? Maybe he was making the bet that the guys on top will make more!
    • Jay Somasundaram
    • Systems Analyst
    1. "The key to any crisis is to remain free of the shackles of ideology". Unfortunately, people making decisions are out to prove that they were not wrong, and are using public funds to do so.
    2. House prices were way too high. The market burst. Have they reached an optimum or should they still fall?
    3. Would Buffet buy into banks now, or wait till they fall further. Would he invest in several banks, or concentrate on one good one, and buy an ownership interest.
    4. Asking a capitalist not to chase money is like asking a raindrop not to fall. The very definition of capitalism is profit maximisation, and it is a red herring to blame the crash on greed.
    5. Electricity networks have fail-safe, back-up systems and fuses. We have a behemoth finance system that lacks professionally designed controls.
    6. The nature of capitalist markets is cycles of growth and recession. Every time we think we have found the solution, we are proved wrong.
    7. What we are seeing is a structural shift in the world order. Expect to see conspiracy theories emerging soon.
    • Kamal Kant
    • Director, PayQuik
    Nobody complained when the stock and housing markets were going up, up and only up. Now everyone is turning to government to save the markets.

    I think we should have stricter policies to govern the stock, housing and other asset bubbles. Cheap credit/capital policy should go away. Actually what is happening in the USA and around the world is a very good thing: deleveraging. For the benefit of readers, deleveraging means taking calculated risk on the based of sufficient capital and not on the basis of interest paying capacity alone.

    Government should selectively buy housing from the foreclosures to buy them cheap and reward taxpayers with huge rewards in years to come. But this program must make sure that taxpayers are not buying assets at more than 50% of the original mortagage value.

    • Luigi Giavina Bianchi
    • Partner, STRULA Assessoria Empresarial
    It's my understanding that, deep in the financial crisis, is the price of the barrel of oil, totally disconnected with the corresponding cost of production.

    The result: an enormous amount of money suddenly at the disposal of groups, governments, companies, that were not readily prepared to use it in an economic way. The consumers of energy bought less products that had an equilibrium price-cost to buy energy with price-cost totally disconnected.

    On my understanding, every financing is "prime". It only turns "sub prime" when the money is pushed on the borrower. The "sub prime" is a euphemism for pushed money.
    To face the crisis the national governments has, in the short run, to be the suppliers of last resource, buying equity position and supply financing. In a permanent way it has to strictly regulate the industry.
    • Ulysses U. Pardey, MBA
    • Managing Director, Am-Tech, S.A., Panama, Rep. of Panama
    Allow me to make further comments on this subject.

    Broadly speaking, poor people must get in debts in order to have access today to a better quality of life. Rich people must get other people in debts today in order to enhance their wealth. This might be one of the reasons why and to some extend, Main-Street and Wall-Street need each other.
    In the present situation, the solution of this shared need - debt - could be the judicious delivery of enough circulating-cash to the workplace, a possible common ground of Main-Street and Wall-Street.
    Then the question could be how to keep cash circulating in this common ground - the workplace - at competitive terms and conditions for both Streets in spite of excessive behaviors exercised by some people involved in the world of business?

    The creation of the Commercial Paper Funding Facility, the special purpose vehicle and their coordination with the Federal Reserve Bank of New York and its related list of primary dealers certainly could be great tools to make enough cash circulate in the workplace in an orderly and timely manner.

    This new program might contribute substantially to turn the current financial system into a modern financial system for the 21rst century perhaps with a variety of independent sources of funds for the commercial-paper market which supplies the cash financial institutions, businesses and households need for their corresponding day-to-day operations.

    The variety of independent sources of funds for the commercial-paper market could be engendered by replicating a similar mechanism in several or all States of the Union, i.e., a CPFF and SPV in several States coordinated with their specific State FRBs' and their own primary dealers list. Something like a financial franchise nationwide and, why not, worldwide.
    This way this cash could be less vulnerable because of the reduced risk of freezing its delivery to the workplace.

    Could the regular replacement, for rotation purposes, of eligible primary dealers favor the generation of more competitive terms-and-conditions for the issuers of commercial paper?
    Could primary dealers have the right to market their business to commercial-paper issuing companies in other States? Would competition among primary dealers, regardless of the State the issuing corporation is in, favor a continuous delivery of enough circulating-cash at competitive terms-and-conditions for the workplace?
    Could issuing corporations choose what FRB and/or primary dealers to do business with? Could this new program become a free market?

    The US commercial-paper business could become a bigger business as it can serve the commercial-paper markets in the US and around the world - through US subsidiaries of foreign corporations - in a free, safe, transparent, profitable, orderly and timely manner. This way the US commercial-paper business could reach a global commercial-paper market for the benefit of all and therefore for social peace and globalization so that we-the-people remains we-the-people instead of we-the-poor or we-the-rich.

    As part of a bold, global and everyone-inclusive solution in order to build a modern financial system for the 21rst century, the Federal Government and consumer-taxpayers would be making a significant and long-lasting difference in and for the World.

    Thank you for the opportunity.
    • Abhishek Raj
    • BE MBA LL.B, IIT Kharagpur
    The solution already exists and its been duly tested and verified.

    Gordon Brown has indeed taken the lead and shown us the path. Let's get to the task rather than continue with our never ending "intellectual debate".
    • Albert Moon, HBS MBA
    I agree with Nick that the loan originators are responsible for the mess, but there doesn't seem to be any way to make them pay. It then falls to the regulators who tolerated an environment that allowed these actions without associated risk and responsibility. The congress also has some dirty hands by limiting the ability of the rating agencies to review some of this dirty paper.

    Unfortunately, the regulators and the congress can't be made to pay off for their action, or lack thereof. It therefore falls to the taxpayer, who, individually, had no part in creating the mess. However, it might be worth an argument that the economy benefited from the housing boom which accelerated the recovery from the lows of 2001.

    I hope we can find that credible but independent entity who could administer the plan. I'm not optimistic.
    • Dan Wallace
    • Partner, Launchpad Partners
    The economic boat is leaking below the waterline. Bailing water out from the top may be necessary, but it isn't sufficient. You have to stop the leak.

    The optimal solution is a hybrid, although not the one that is emerging from Congress.

    First, a little background and perhaps correction to a couple of preceding comments. The underlying cause of this mess is a dramatic increase in the amount of money available for investment around the world. While Wall Street did not create that condition, it was only too happy to act as a conduit make lots of money along the way. One of the benefits of funneling that money into the mortgage market is that it is possible to keep creating new mortgages. It is much harder to do that with corporate bonds. So Wall Street and the mortgage originators had a symbiotic relationship - "We've got money to fund pretty much any loan you can sell." They and the other institutions that purchased and insured these mortgages and the related securities got caught up in a frenzy, an environment in which even smart, decent people do stupid, indecent things.

    Currently, 94% of US mortgages are performing. 6% non-performance is very high by historical standards, but it certainly isn't as if most American homeowners are in default. The problem is that the 6% default rate is way beyond the bounds of what the market envisioned. The result is that the value of the underlying securities became unclear (actually unknowable), and that, as Professor Heskett points out, drove the value of the entire market to zero. That's the problem that has to be fixed. And the reality is that it's going to take government intervention because a) the market itself is not functioning and b) no one else has enough money.

    Here's a way to do it:

    The government should immediately announce that it will guarantee full payment of mortgages in default. It should then negotiate (presumably without outsourced help) the best deal it can with the affected homeowners and make up the difference. A reasonable estimate is that this would cost about $200 billion. It would keep people in their homes (a good thing), and all of those "toxic" assets would become performing assets without the government having to buy them. This would allow the ship to right itself and let the system start functioning again.

    In exchange for this intervention, the government should require all US institutions that hold non-performing mortgage backed securities to issue convertible preferred stock to the government - convertible into, say, 10-20% of the equity of the institution with a strike price of today's valuation.

    This is surgery with a dull knife, but it will attack the problem at its source, clean up the mess for the least amount of money, allow taxpayers to profit from their role as lender of last resort, and perhaps generate enough of a gain to take a bite out of the national debt.
    • Jeff Daniel
    • finance attorney
    Overlooked so far in the policy discussion of the crisis is any discussion about identifying the actual properties in the "portfolio" of the mortgage trusts. I have encountered cases in which the mortgage trusts were transferred from one mortgage servicer to another. The loan balances were "dumped" by computer, but never audited the actual loan files - indeed actual "hard files" of the mortgages may be lost. So, how can one truly value the cost of a bailout, when you cannot get any basic information of the underlying real estate. I believe that a "loan workout" program would be efficient and most likely to lead to success for the taxpayer and the troubled mortgagor. Everyone loses when homes are foreclosed due to high LIBOR rate loans, which in many instances could have (and should have) been renegotiated with the lender. But first, the government (or trustee) must know what's on the books (or actually under the books). Perhaps a typing pool of auditors could start with a basic spreadsheets of the assets - because, right now, I don't think the lenders even know.

    Indeed, back-to-basics-banking is due to raise its head. The simple ability to apply enforcable regulation (i.e. usury laws that are not void under the National Bank Act, or preepmted by Gramm-Leach-Bliley) would allow the free credit markets to function on a level field. It should be axiomatic that free markets must first have stable consumer markets in order to avoid catastrophy. Stable consumer markets must utilize simple, common sense, enforcable regulation to weed out the Ponzis. If not, the free market violently collapses when the Ponzi stress becomes too heavy.
    • Sivaram Parameswaran
    Irrespective of the merits in the investment opportunities that exist in some key business institutions, the timing of it could be questioned by the skeptics, though, they do appear to have a merit in their argument. Their contention is, why socialize losses and capitalize the profits?

    Government intervention in resurrecting a sagging economy is nothing new, but the intent, viability and exploits may not exactly match that of an investment guru like Buffet.

    While the investment choice and maximizing returns are core to Buffet's decisions, that may not be the primary objective of the government's intervention. How much of the government's decision to bail-out, would be driven by a dire need to maximize returns is yet to be seen, though they are using that argument to justify their usage of the taxpayers' money. How much would the government be inclined towards rewarding the taxpayers and how would they plan to do that?

    Sometimes a conservative outlook could turn out to be a blessing in disguise. Many in India could argue that the minimal exposure of the employee pension funds in the equity market, keeps it more insulated from the current market turmoil and thereby providing a reasonable safety net.

    As we heard in one of the bail-out debates in the US congress, many still perceive government intervention in the form of controls in a private enterprise, as 'totally un-American'.
    • Sujeet Prabhu
    • Manager, Larsen & Toubro Limited
    I feel the current crisis is a combination not just of the high risk strategy of Wall Street financial institutions but the macro economic policies followed by the Fed and the Central Banks around the world.

    These banks not only created the bubble but encouraged the establishment of a financial system where innovation far out-paced their ability to monitor it.

    The government(s) are an integral part of the global financial system today and need to involve themselves in resolving the crisis. They need to involve themselves not just as policy makers but as investors in the market. I think this is a necessity and not a choice.

    Fear is the primary emotion is today's markets, so let the government follow Warren Buffett's teaching, "Be fearful when others are greedy, be greedy when others are fearful." Hopefully in the years to come, this will not be a bailout package but a worthwhile investment of taxpayers' money.
    • Steng
    • Managing Partner, Consultancy
    The 700BN bailout came too late! This is because the financial meltdown in America had been mutated into a hybrid financial-economic crisis (FEC) Like a deadly infectious disease, the FEC has since reached pandemic scale engulfing the whole world. I think the bailout is a short term measure to address the means but not the ends of the intricate FEC pandemics.

    At this moment, there are two uppermost issues without begetting effective solutions:

    (1) The vulnerable economic situations of United States which may reach involvency. As the world's leading economy coupled with its monetary system, USA could not be left to falter or fall or else the whole world economy will suffer.

    (2) The league of developed nations (led by USA and EU) and the league of developing/emerging nations (notably the BRIC group) do not seem to work for the same goals. They are like strange bed fellows tending and caring for its own national interests more than the world's.

    It is my humble opinion that for the US to resolve its current FEC woes, two things ought to be done:

    (A) To review and reform its economic-financial structures and monetary system, and

    (B) To find, by all ways and means, to convince the league of developing-emerging nations to work together for the overall good of the global community. In doing so, it may have to eat some humble pie not to exert its 'big brother' status to other nations.
    • Jeff Wells PMD1
    • Retired
    Not workable as long as members of Congress and others are not aware of what would be a good investment and, instead, designate their "good causes" as required investments.

    Imagine if Social Security contributions were invested in the private sector. Every special interest, including reelection of politicians, would skew it and, eventially, ruin it.
    • henry kwok
    • partner, consultant in stratetgic management
    are we not falling the trap of the reductionist's mindset with the question which is better - bailout or workout? must they be exlusive? is there any wrong of them being inclusive?

    no offense intended.

    it is obvious that the workout offerred by Buffett is very focused and has the benefit of some immediate impact. he put this money where he thinks he can get it to work for him! he instills confidence on the company. It is also obvious it does not have the scope and reach of the bailout of the government. this is necessary when we are not talking about cracks. we are talking about the whole floor giving way.

    there are many ways to skin a cat so they say - hope i do not get the brunt of animal's lover here! should we restrict ourselves to one approach. the answer somehow lies in a combination of bailout-workout initiatives. in fact if the government perhaps works together with a group of people like Buffet, we will get better results. divided we fall, united we stand.

    • Ulysses U. Pardey, MBA
    • Managing Director, Am-Tech, S.A., Panama, Rep. of Panama
    Further comments on this subject.

    Some simple comparisons which hopefully could help us understand the nature of the underlying matters.

    Wall-Street and Main-Street might have more things somewhat influencing each other and which could be considered in a solution.

    When someone is driving a car (circulating-cash) he/she knows that the driver's license is not a corsair's license because the driver must respect traffic lights and other complementary street traffic-signs intended to guarantee a safe circulation of cars out there so that you are not in the wilderness.

    A driver driving a high-luxury car in any regular street of a western city - it is highly possible that the main regulated-purpose is transportation (need) - he/she must respect the same traffic signs as the person driving a low-price car in those same streets, in order to ensure a safe circulation of cars for people and things around.

    When a professional pilot drives for competition purposes a Formula One car in a Formula One circuit, the driver must respect the specific traffic signs and regulations corresponding to the purpose and expectations of this competition.

    If these two kinds of car drivers are allowed to circulate together with their respective cars (or to switch cars) and use either a Formula One circuit or regular western-city streets according to their own corresponding driver's purpose, expectations, attitude, and regulation regardless of the other driver's, what is likely to happen?

    A traffic crash?

    Knowing what Formula One competition and regular western-city streets dynamics are all about might help mull over conceivable and unbelievable outcomes.

    The source of the crash is not necessarily the cars themselves - a car is a car - but rather the permission for these two drivers to drive - according to their respective characteristic-definitions - in the same street/circuit as just two car drivers.
    How to imagine that this could be ever accepted?
    Could these two ways of driving coexist trouble-free in the same street/circuit disregarding each other?

    When cash or money is circulating in "streets or circuits" in order to solve needs and meet expectations of corporations and people ........ money is money ........

    A financial crash?

    How compatible are the later-identified specific-definitions of drivers' respective purpose, expectations, attitude and regulation which beforehand both drivers had in common in wide-ranging terms?

    Indeed some people get married and then get divorced. A family crash.

    It is possible that these specific definitions might change over time, therefore, what to do - and how - to become aware of this change before it happens with its consequences? Could you be blamed for someone changing to the point that he/she becomes incompatible or unreliable imperceptibly?

    What could be taught and learned by all of us from the above situations which could be useful in order to help frame the dynamic of a workable long-lasting solution of the need-and-cash related disorders that Wall-Street and Main-Street are facing today?

    Thank you.
    • Frank W. Chen
    • MBA 1949, Retired, Oak Crest Village
    All said I like the comments of Sameer Kamat and Tom Henkel especially. There need to be more Work Out than Bail Out. Consult the likes of Jack Welch and Jeff Immelt.

    A superpower world leader has learned a painful lesson; we must move on with truth, wisdom and unusual confidence. Then, may be, the U.S. will rise again -- better than ever.
    • S P Goel
    Until and unless the guilty are identified and punished, such crisis will keep happening. Isn't greed the main ingradient of this crisis and the business schools are as much responsible for this as the politicians in DC. Spare them and you will sow the seeds of the next crisis.
    • David Albert Newman
    • Project Leader, Province of Manitoba
    Look at Buffet's recent common share investment in GE. He received warrants for common shares worth $12 Million while GE floated $3 Million common shares to the public. The total common share value is $15 Million. Simple arithmetic shows that the public received 20% common share value while Buffet has warrants for 80% common share value.

    Now, is that the Pareto Principle or is that Buffett reflecting control while the public is dispersed from implementing significant influence at 20%?

    Similarly, the USA Government took ownership in 80% of AIG for an $85 Billion loan at LIBOR rate + 8.5%. (See article.)

    Again it seems to be a Government emulation of Buffett. Or is it Buffet emulating the Government? It depends on the timing but who knows which deal really came first even given public news reporting? There are many closed doors where decisions are made.

    Nevertheless, with AIG the 80/20 Principle arises again. Is this right? Someone knows of the Pareto Principle and is applying it or at least it is an unlikely, but possible, coincidence.

    What is interesting is Government control but with a loan to AIG. How many free market investments provide control with debt in return? I cannot think of any, other than convertible bonds into shares. But even those do not provide control until exercised. Convertible bonds only impact is lower coupons to the investor given the conversion feature, the calculated dilutive effect on EPS, and greater debt leverage.

    I would make a strong assertion that the Government loan to AIG is really convertible into shareholdings upon negative events transpiring at AIG. Thus, I bet AIG is still independent much like the banks where the USA Government purchased non-voting preferred shares.
    • Joanna
    • Project Lead
    Before we determine solutions and/or an approach, shouldn't we understand scope? If it is true that only 6% of mortgages are 'toxic' and need resolution we should be able to put both college students and retired financial professionals to the task of identifying the status of these mortgages. This employment could be considered part of a stimulus package.

    While not pretending to understand the world of stocks and high finance, Credit Default Swaps and short-selling seem contrary to everything capitalism stands for. Am I na?ve to think that we should invest in instruments that add value? What happened to "build a better mousetrap and they will come"?

    Finally when mortgage originators knew they were not going to hold the debt, natural consequences evaporated. Consequences help minimize negligence as does the light of day.
    • A. Lauder
    • Policy Planner, City of Waterloo
    I believe government should provide the framework for markets to work within. I have a hard time agreeing that governments should prop up markets when they fail. However, it is obvious that the economy is in jeopardy, and the government has a responsibility to save the economy from complete collapse.

    In very rare circumstances (like now), it is likely appropraite for governments to make investments in companies that will produce returns for taxpayers. Its important to note that those who created this mess are being partially saved in such circumstances, which does not sit well with me.

    I think the larger question is: How can the government introduce oversight to ensure such a destructive phenomenon cannot be repeated.

    Anyone interested in a little deju vu should read the last 2 chapters of "The New Economy: What It Is, How It Happened, and Why It Is Likely to Last" by Roger Alcaly. His writings on the Savings and Loan crisis are especially relevant to today's crisis. The bottom line: these are business cycles we're dealing with, but government (in my view) should appropriately regulate to avoid major collapse.
    • Christoph Spitzenpfeil
    • MBA student, University of Michigan
    First of all, the mortgages that are defaulting recently which supposedly have caused this crisis only represent 5% of all mortgages out there. A strong market based economy like the US should be able to fender this off and absorb this without any government intervention. This is not an economic crisis but rather a strategically well-planed party coup. It is ridiculous to see the results of a policy that started 30 years ago under Jimmy Carter, which got fortified under Clinton basically paving the road to these events now is bailed out by the exact same party that caused these effects and now they are playing the White Knight on the White Horse making the broad, unreflecting, non-critical thinking masses believe they are the saviors in this so-called economic crisis - the timing is perfect!

    I have to agree with Mr. Moore (posting #4) that America should regulate mortgage lending and barring irresponsible lending practices. A look back to the old world, e.g. Germany, would work miracles. There mortgage lending for real estate is done very carefully and underlies strict rules particularly w.r.t. the credit-worthiness of borrowers. The rule to be forged here as a lesson learnt is: Anybody who cannot make a 20% down payment in cash and does not have enough income to pay the monthly installments does not get a mortgage. Period!

    The $700 billion of good money thrown after bad would be better invested if it would have been used to pay off all those defaulting mortgages. That would have had the effect that the debtors would be relieved from their debt immediately and their incomes would be freed up to flow back into the economy as spending money. But now the money is in the hands of banks that caused the problems and these banks first take a big portion of those $700 billion and pay overdue fees with it. Does this have any economic impact? No, because the defaulting debtors are still sitting on their debts and are still strangled by the newly strengthened banks that caused the trouble.

    I think a rigorous unbiased study should be made by a renowned economic institute analyzing the causes and the effects. Then based on those results a new mortgage-lending bill must be drafted. Furthermore that bill should include, that members of Congress may not have any other income besides their salaries they get for their mandate. If they get offers, i.e. bribes, from lending institutes or other freely money giving companies, then the members of Congress can say "with pleasure I'll take this, but please transfer the money to this or that charity where I am not a board member, chairman, and have no other ties to it."
    • Kamal Gupta
    • CEO, Delta Petro Additives
    Reminds me of an earlier discussion in which i participated - the relevance of Galbraith vs Friedman. Should gov step in?

    Yes, i think so, for the simple reason that the crisis is far too huge and widespread to simply work its way out in a sensible time frame, without doing a humungous damage to the world economy.

    But govs have a habit of making a mess. Politicians love to cling to the power that gov intervention brings.

    The gov, govs around the world, have to step in to boost liquidity, guarantee bank loans, but with a pre-set time frame for its end. My belief is that once this is done, confidence will gradually restore in the markets, and then the economic forces will take over.

    If otherwise sound corporates and citizens can still borrow, it will create markets for actual products, boost manufacturing and services and primary products and create a virtuous spiral.

    Will there be another bubble? Yes. Stocks and commodity markets are essential for price discovery, but these tend to get out of hand with reckless speculators who play with others' money. Chinese stock markets had notched up PE ratios of 55+, oil went up to $143, home prices skyrocketed, the commodity boom was attributed to China's infrastructure building (as if the Olympics consumed a billion tons of steel, aluminum and plastics) and so on.

    We need to find a way of imposing stricter margin money reqs on markets. Speculation is essential, but come on, there has to be some relation with the underlying trade volumes. A situation where the hedge market is 2,000 times larger than the underlying "Main Street" market, is ridiculous.

    I have seen CFOs of companies with $400 million of foreign trade do $10 billion of hedge transactions. Is the guy hedging?
    • Sunil Varughese
    • Director, Brand Indigo FZ LLC
    Warren Buffet can be likened to the "poster boy"of free market capitalism at its best. In fact, recently Buffet compared the credit crisis in the US economy to a massive heart attack threatening the very life of a great athlete and he opined that resuscitation in the form of "intravenous capital infusion" is the "need of the hour".

    Today, the very construct of "unregulated capitalism" is being questioned and even Alan Greenspan in his recent congressional hearing has admitted that he made 'a mistake' in his hands-off regulatory policy. Thus, the "Buffet effect" is merely a "placebo" at this emergency treatment stage to revive the "great athlete".

    Thereafter, to put the great athlete back on his feet and back on the tracks will entail a much thought-out treatment regimen if this great athlete wishes to participate in the next Olympics----of course the Paralympic Olympics will always be there if this great athlete refuses to undergo the full treatment regimen.
    • David Physick
    Criticism seems somewhat one sided towards the banks. Yes, there is massive culpability there in respect of risk assessment. When I started work in a UK bank, for every ?1 of capital, a bank could lend ?8 or something like that. Innovation has enabled economic growth to enjoy a massive uplift but from the stability afforded by the tighter principles in place 30 years ago, we have built an edifice on weak foundations. As remarked, it is not just the banks, but it is all participants in the economy that are culpable, surely? Consumers have wanted it all today. The sense of saving to buy has been displaced by borrowing to buy. The shear choice of "stuff" is massive and we are compelled and urged to upgrade everything every couple of years. I look around shops and see loads of plastic rubbish manufactured in the Far East. Heaven knows what making and shipping this around the world is doing for the environment. That, perhaps, is, as some people say, the bigger problem than the current economic hiatus. There is an old American Indian saying, "Only when the last tree has died and the last river been poisoned and the last fish been caught will we realise we cannot eat money". We should, I suggest turn our attention to social and environmental problems we are creating and read Alfie Kohn's excellent HBR article "Why Incentive Plans Cannot Work" (Sept / Oct 1993) about rewards systems in which he so presciently indicates that reward only motivate people to get the reward. Our rush for growth has been synomous with the difference between speed and velocity. The former has no sense of direction; we hurtle headlong striving for our reward. We do so without the requisite purpose, reason and objectivity.