Wednesday, September 2, 2009

Financial crisis and leadership

The current financial crisis provides some incredible examples of leadership -- especially the challenges and unintended consequences of action. The situation faced by then Treasure Secretary Henry Paulson represents some of those challenges. A recent article in Vanity Fair (as well as other sources including PBS Frontline Series - Inside The Meltdown) paints him as a reluctant government interventionist. Here is a link to the Vanity Fair story that was provided to me by Mike Nothum a student in my MBA class:

http://www.vanityfair.com/politics/features/2009/10/henry-paulson200910?currentPage=1

Despite the still unknown consequences of these decisions, we can begin to see some of the short term consequences, as Erik Ballinger drew my attention to a story by David Cho in The Washington Post about who benefited and who has yet to benefit from the bailout cash -- suggesting that the too big to fail banks grown even bigger.

http://www.washingtonpost.com/wp-dyn/content/discussion/2009/08/28/DI2009082801337.html

Not only are consequences unforeseen, our interpretation of the events is likely to continue to shift for some time.



13 comments:

erik_b said...

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Malikwms said...

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Anonymous said...

Reading the article on Paulson in Vanity Fair, but more importantly referencing the Frontline material discussing Paulson I'm struct that Paulson was possibly overly influenced by conservative politics in Washington, and did not anticipate the fallout of failing to bailout Lehman. The argument that he didn't have the legal authority to bailout Lehman does not carry much weight. If he really needed legislation giving him authority to act on Lehman, he could most likely have gotten it passed. The drastic fall of the markets after Lehman collapsed possibly could have been prevented, if a similar arrangement as the one for Bear Stearns could have been worked out, and a merger partner found for Lehman. It is important to note that Bear Stearns was not bailed out, but that some of it's debt was guaranteed for an acquirer. The shareholders and employees of Bear Stearns probably did not feel bailed out.

Paulson was apparently overly influence by politics and the concept of Moral Hazard, that the investment banks took risks for their returns, and if they made mistakes they should be allowed to fail. He did not anticipate the domino effect this would have on the overall economy, most notably with Lehman's debt holders and the stock market in general.

Paulson certainly had no problem moving to intervene in the markets with his role in the $700 Billion TARP fund, the AIG bailout, and the Freddie and Fannie takeovers.

Anonymous said...

Professor Kayes, I saw an article in the New York Times Yesterday, titled "New Exotic Investments emerging on Wall Street". It can be found at: http://www.nytimes.com/2009/09/06/business/06insurance.html?_r=1

This article discusses how the remaining Wall Street investment houses are beginning to purchase "life settlements", the payouts on life insurance policies, and securitizing them.

This is little different than the packaging mortgages and selling them. Is there any accurate way to assess the risk of these new securities? How can an investor make an educated decision to buy them without carefully examining each underlying life insurance policy.

It seems that the Wall Street banks are off pursuing a new way to make big money after the mortgage business has collapsed on them. I wonder if anyone has evaluated the real risk on these securities. More importantly, I would like to know where the regulators are.

I have no problem with Wall Street coming up with unique products to earn their living from, but I would like to make sure that the regulators have insured that the short and long term impact of these new products is not going to be another collapse of the markets and meltdown of the financial system.

Jim said...

With all the hard work and anguish that Mr. Paulson went through, it seems to me that his bailout program amounted to no more than his 15 minutes of fame. However, he was on the right track with the bailout of these financial institutions but needed to include some kind of incentive, if that is the right word, to pay the taxpayer’s back. I believe that would have made a more complete policy.

Sinead D. said...

Paulson stated in the Vanity Fair article that, “the lessons of history are such that the biggest mistake you can make is not doing enough… he hoped that the administration would do more rather than less, ‘because the cost in terms of the economic growth that is lost is something you will never get back.’”

I believe that history will look back on the economic crisis and see that biggest mistake would have been to do nothing at all. I think Paulson was torn between the concept of Moral Hazard and the potential domino effect on the economy of not intervening. He did make a mistake with Lehman, but he did learn from this mistake and he did change his viewpoint. I think Paulson should be recognized for having the ability to adapt and change when his strategy was not working.

I think that Anonymous comment above is interesting because it illustrates of one of the themes of the attribution theory of leadership (as described in Robbins and Judge) regarding the perception that people view leaders as being consistent in decisions and goals set. This appearance of consistency is actually a more important factor in how people view others as leaders than the actual results of these decisions and goals. Paulson was not consistent in his decisions, but rather changed his decisions and goals as the environment and scenarios played out. I think history will consider this to be Paulson’s legacy and greatest accomplishment in managing the first few months of the economic crisis. However, I think it will definitely be a while before the public will agree.

russell said...

"irrational exuberance" - just like greenspan said in describing the onset of the mortgage frenzy. a circumstance deserving of neither pity nor pittance for those who were caught with their proverbial pants down. no whining. just a reverent gesture at the steel reserve leadership exhibited by Bill Demchak, who knew when things started to smell too foul it was time to clean house. we'd all be enjoying a finer taste of prosperity if that type of resolve was the norm rather than the exception.

Anonymous said...

I agree that Paulson learned from the mistake of not bailing out Lehman, but how could he have not? The collapse of the stock markets and meltdown of financial markets that followed the collapse of Lehman were a lesson that no policymaker could have ignored. The record unemployment that eventually resulted would have also been hard to ignore.

I agree that it will be a very long time before Paulson is recognized for changing his approach to managing the economy, abandoning the concept of moral hazard, and moving to prevent a complete collapse of stock and financial markets.

Paulson learned and changed his approach, but his initial commitment to moral hazard, and his lack of flexibility, was dangerous as he was unable to rapidly reevaluate his approach before economic disaster struck.

PJ said...

"Despite the still unknown consequences of these decisions ...."

Closing paragraph to Gladwell, "Blowing Up."

Last fall, Niederhoffer sold a large number of options, betting that the markets would be quiet, and they were, until out of nowhere two planes crashed into the World Trade Center. "I was exposed. It was nip and tuck."
Niederhoffer shook his head, because there was no way to have anticipated September 11th. "That was a totally unexpected event."

Too many things outside of our ability to predict. Perhaps just as many things that we mist in retrospect. All this forces us to be cautious in our assessment of leadership.

Anonymous said...

There is an article in the July 2009 Scientific American titled "The Science of Bubbles & Busts". While essentially an article on economics, it discusses how the recent financial crisis has prompted economists and business leaders to reassess how financial markets work and how people make decisions about money.

The article goes on to discuss how the worldwide financial meltdown has caused a new examination of why markets sometimes become overheated and then come crashing down. How the housing and credit crises highlight how psychological behavior trumps rational decision making and leads to booms and busts. Lastly, economists have learned from the current financial crisis new ways to protect against financial blowups by more accurately deciphering how markets will work, and providing models for more intelligent regulation that may at some time be able to gently steer the home buyer or the retirement saver away from bad decision making and toward good decision making.

The discussion of how the economists and business leaders are learning from the mistakes of the current economics crisis and attempt to find ways to regulate markets so individuals learn to make better decisions in the future is interesting. I wondering if they will actually be able to carry through with effective means to stabilize markets in the long term.

Chris said...

I would believe that Moderating Variables outlined by Robbins Judge is a factor to consider with the situation. Social pressures continue to pop to mind while reading through the articles and comments posted. Although there are many factors, moderating variables aspect helps to bring light as to the “why.”

russell said...

consider this. it's been less than one "average" life span (70+ years)that our economy has suffered TWO major financial crisis. 1929, and the brink of the current could trace back to 1999 with Enron, later Worldcom, Mae and Mac, into the latest string of banks where it really precipitated - TWO major economic crashes in only ONE essential lifetime. I would argue it was not painful enough the first time to learn a very valuable lesson about how to keep regulation and de-regulation carefully balanced. To keep pace with the clever regimes that sprout out of the dark corners of short-term marks and greed. Perhaps this time, bail-outs or no bail-outs the policy makers, the financial leaders, the educators, and the less than careful consumers will learn from this painful mistake. applying the right amount of flexural-rigitity to the financial markets is vital to long-term viability and survivability. time to keep on keeeping on.

Garrett said...

Looking at the financial crisis as it relates to leadership reminds me of two books I have read recently that also relate to past financial crisis and the leaders that guided both private and public insitutions through these crisis:

The first is called Lords of Finance and it examines, in a very biographical way, the impact the four bankers that had the largest impact on causing and in some ways reversing the Great Depression. Looking at a historical event in the context of a biography offers a unique perspective and personifies the events.

The second book is called When Money Was In Fashion about the founding of Goldman Sachs and more specifically Henry Goldman. His leadership style was unique especially in regards to World War I and shows how financial leaders can have signficant impact on world events not just related to finance.