Friday, May 27, 2011

For More Corporate Raiders

There’s welcome news that a hedge fund operator - David Einhorn - has bought up large chunks of Microsoft with the intent of forcing the ouster of the CEO Steve Ballmer, presumably replaced with a CEO more responsive to shareholder interest. The end goal is a more productive use for Microsoft’s capital.

I think this is great news. The key here is that the interests of Microsoft’s CEO and the interests of Microsoft’s shareholders are different; and we as a society ought to sympathize more with the interests of Microsoft’s shareholders.

Basically, Microsoft has been earning monopoly rents based on intellectual property that locks in network advantages. Yet Microsoft’s comparative advantages really extend only to the sort of monopolistic domination embodied in their control of OS and enterprise software. Their subsequent ventures in all other areas — Bing, the Zune, .Net, etc. — have on net been catastrophic failures that have cost the company billions of dollars. Microsoft persists as it’s in the interests of Microsoft executives to control as much market; not to deploy capital efficiently.

And not just Microsoft — as various other companies figure out how to market durable brand advantages in tech, other companies too are generating massive profits. Some of these companies, like Amazon, have figured out how to re-invest their profits in new fields to continue generating value in ways that enrich executives, shareholders, and consumers. IBM has transitioned away from hardware to software in a disciplined manner. Other companies, like Microsoft and Cisco, basically sat around burning money at each new trend. Just now, Microsoft decided to spent $8.5 billion on Skype for no good reason.

It's difficult to throw away this much money without having the occasional hit. The XBox wasn’t bad. But the collective impact of many companies simultaneously burning money is substantially weaker economy-wide capital allocation. We don’t want the people who made a lot of money in the ‘90s deciding what to invest in today; in general people and organizations don’t manage to remain at the entrepreneurial frontier all of the time. We want shareholders to take the billions they made from Microsoft and give it to the Microsoft of tomorrow. And that’s just not possible as long as Microsoft remains hideously mismanaged from the point of view of intelligently handling shareholder interests -- as long as they can neither reinvest assets profitably or have the good sense to give money back to the owners of the company.

This isn’t just an issue for a handful of hedge funds — Microsoft has a market cap in excess of $200 billion, and so must of us collectively own a part of the company via a 401(k) or whatnot.

Yet while activist hedge funds and private equity firms have the ability to take on companies like this in a number of fields -- their actions remain constrained. As Amar Bhidé noted in A Call For Judgement, securities laws have severely restrict concentrated ownership and shareholder management. This problem seems to be particularly severe among financial companies -- the one place you'd like to see more institutional investors, say, call for Dick Fuld's ouster.

Monday, May 23, 2011

Energy Prices

Matt Rognile is blogging again, and has a post up on how the federal government ought to provide some sort of insurance against the cost of rising gas prices.

I’m sympathetic to this sort of thinking. I think it’s clear that a large part of what motivates hard money advocates is the fact that constant energy fluctuations leave an immediate impact on the purchasing power of families. Raj Chetty, someone who I seem to cite all of the time, has emphasized the role of commitment goods (like mortgage or auto payments) in reducing the discretionary income available for families. Fluctuations in the price of an essential good can hurt families tremendously, even if the actual price or consumption impact is small in relative terms, especially if families are credit constrained.

Meanwhile, to the extent that energy fluctuations signal permanently higher prices, they also induce structural changes in the household demand for items like energy saving cars. Yet, again due to credit constraints, households may be unable to adjust their assets — while the higher immediate cost of making gas payments may actually make it harder for them to change cars.
A recent paper by Nick Souleles and co-authors have some evidence suggesting that the Bush economic stimulus payments in 2008 ended up performing exactly this insurance role. Aside from delivering payments around the worst time of the oil shock — these payments (roughly $300-1200 ) also relieved a collateral constraint for many families. Their evidence suggests that many families used the money as down payments for more gas-efficient cars. Jonathan Levin's research (in part, what has won him a John BatesClark Medal) suggests that amounts of this size can indeed serve as down payments for subprime auto loans.

On top of the household benefits of hedging against an unexpected rise in prices for constrained households, there are the larger effects of oil shocks. Increasing durable consumption right at this time may have helped auto companies avoid even worse losses. Also, there's the issue that gas prices make macroeconomic stabilization much more difficult. A large part of this last recession was attributable to high gas prices, while a persistent oil deficit worsens the current account deficit. In classical theory, that isn’t so worrisome by itself, as a current account deficit will eventually be balanced out by higher future exports or capital inflows.

But high capital inflows can be very dangerous. In general, they tend to be associated with asset price appreciation, and a skew in domestic prices away from (increasingly uncompetitive) tradable goods and towards durable, non-tradable goods (like housing and real estate). This has been a contributing factor behind the Asian crisis, and may have been a large factor behind the most recent crisis.

However, despite bemoaning this state of affairs, the Fed has decided to do very little about this. Bernanke’s research has pointed to the need to respond to an energy shock by loosening policy; yet the dictates of an inflationary target would demand a contractionary response just as the economy is reeling from the effects of higher oil prices. His paper in fact found that energy shocks are contractionary exactly in part due to a misguided monetary shock. This debate is basically going on now, as higher oil prices driven by global factors are hurting the economy; yet are used by hard money advocates as evidence that easing has gone too far.

Bernanke has also complained about the impact of a global “supply glut” that led to large capital inflows, and fueled the demand for structural financial products that could offer seemingly high rates of return at low cost. Yet he hasn’t taken the next step of thinking through (publicly) how the US should respond. Some set of measures imposing capital controls or active management of foreign reserves to target international currency rates would affect net financial flows. Yet these ideas, while implemented routinely in the world’s central banks, remain verbotten at the Fed. This sort of stuff is the job of the Treasury, which has no tools to implement any of these targets, and in any case is mostly interested in obtaining as low interest rates for federal debt as possible.

However, even without trying out capital controls, simply lowering the level of imports of oil would have an enormous effect on current accounts deficit, and so on the degree of net capital inflows that result. As Calculated Risk always points out, America would be much closer to trade balance excluding the impact of oil.

America's dependence on oil is bad. It's bad for households and it's bad for the economy. It's not crazy to think about ways to move away from oil, both to avoid the impact of transitory shocks, as well as the costs of long-term dependance.

Sunday, May 15, 2011

Were Mellon and Hoover Liquidationists?

Josh Green's profile in The Atlantic of Ron Paul contains this section on interpreting Great Depression era policies:

The Austrian school had peaked in the early 20th century but had fallen away after the Great Depression, which it claimed was caused by an expansion of the money supply and could be met only with chastened submission as the market corrected itself. Herbert Hoover’s Treasury secretary, Andrew Mellon, offered similar counsel, famously urging Hoover to “liquidate” and “purge the rottenness out of the system.” But this failed to stop the catastrophe. Only when Roosevelt took the dollar off the gold standard and committed to deficit spending, and the Fed adopted consistently low interest rates, did the economy finally start to recover. This validated the argument of the Austrians’ intellectual adversaries, economists like John Maynard Keynes, that rather than stand aside, governments should intervene to mitigate recessions.

The idea that Mellon advocated "liquidation," and that the adherence to this strategy were among the major contributors to the depth of the Great Depression are widely held views. However, they are simply not true, as Lawrence White explains.

First, the quotations attributed to Mellon in fact come from Hoover's own autobiography. Here's what Hoover had to say:

First was the “leave it alone liquidationists” headed by Secretary of the Treasury Mellon, who felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” He insisted that, when the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. He held that even a panic was not altogether a bad thing. He said: “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.”

While apparently damning, White explains that this passage was primarily intended to highlight the differences between Mellon's views and those of Hoover. The "quotations" likely do not reflect Mellon's actual words, but are rather exaggerated for effect.

While Mellon recognized the need for painful readjustments, he was in reality not the extreme liquidationist portrayed either by Hoover or Josh Green. He supported successive interest rate cuts by the Federal Reserve, and tax cuts and spending measures by the Federal Government.

Nor did Hoover follow a liquidationist policy either. Rather, as his own autobiography and the historical record amply demonstrate the extent of his intervention in the economy. Deficit-fueled spending grew dramatically under his tenure. Among many other initiatives, Hoover's Reconstruction Finance Corporation lent billions to banks, states, and other firms.

In fact; it was Roosevelt who re-introduced fiscal balance by 1937-8. This period also saw dramatic monetary tightening by the Federal Reserve, a move convincingly linked to a recession that began at that point.

Though tempting to think of historical figures solely through a stark moral lens, the lessons of the 1930s are more complicated than commonly realized. Far from being a stark "liquidationist," both Hoover and Mellon worked to orchestrate dramatic federal interventions that nonetheless failed to secure recovery. More durable recovery happened under Roosevelt; but even under his tenure Federal Reserve officials erred badly in sharply contracting the money supply and plunging the country into a new downturn. Finally, federal interventions by both Hoover and Roosevelt that regulated prices and wages throughout the economy likely had negative effects on economic recovery.

While analyzing the beliefs of long-dead historical actors may be tedious, the depth and duration of the current crisis have brought increased relevance to the actions of Great Depression-era policymakers who faced similar problems. Their actions, real or perceived, continue to inform policy debates today. That's why it's important to set the record straight on their actual policies.