As the vitriolic debate on healthcare reform dominates the news, healthcare industry leaders continue to focus on several issues: innovation to drive growth and promote cost efficiencies; new offerings to generate higher value for each healthcare dollar invested; and the emergence of attractive new global markets and technologies. They recognize that continued economic weakness and new sets of competitive and regulatory pressures create a more challenging environment to drive business growth. At the same time, they see tremendous opportunities to develop cost-effective products and services that can dramatically improve patient care on a global basis.

At Columbia Business School’s 6th Annual Healthcare Conference held on November 6, nearly 500 students, alumni and other professionals heard more than 35 speakers and experts discuss these issues. The attendees benefited from panels on an array of healthcare topics including biopharmaceuticals, medical devices and diagnostics, healthcare services and information technology, venture capital/private equity, mergers and acquisitions and emerging markets. The day concluded with a networking reception and career fair where attendees met with the event’s 20 corporate sponsors.

Fred Hassan, chairman and CEO of Schering-Plough, gave the opening address. Despite economic, competitive and regulatory pressures facing the pharmaceutical industry, he was confident that new therapies and vaccines would be developed to address large areas of unmet needs, most notably Alzheimer’s disease, which represents a devastating social and economic threat to society.

Following his remarks, three concurrent panels took place in the morning. They focused on information technology solutions, growth strategies of Big Pharma and small-cap biotechnology companies, venture capital and private equity investment strategies in healthcare, and the impact of proposed healthcare reform initiatives on payors and providers.

Mike Barber, vice president and head of Healthymagination for GE, reviewed GE’s new $6 billion global commitment to develop new technologies and services to reduce costs, improve quality and expand access for millions of people around the world. Among other objectives, this initiative will accelerate healthcare information technology, support consumer-driven healthcare, create new wellness and healthy worksite programs and facilitate access to cost-effective healthcare in rural and underserved areas.

Three concurrent afternoon panels covered healthcare mergers and aquisitions, medical devices and diagnostics, and challenges and opportunities for healthcare companies in the emerging markets. Alex Gorsky, worldwide chairman for medical devices and diagnostics at Johnson & Johnson, discussed emerging opportunities to develop new therapies to extend and improve a patient’s quality of life, as well as new cost-effective and less invasive medical devices and procedures. He also commented on the changes underway in global healthcare companies and how employees need to expand their skills and experiences, such as seeking new functional roles and positions in new geographic regions to broaden their understanding of different healthcare systems and customers.

Photo courtesy of the Healthcare Conference

“I was told when I graduated that I had to come back and take a few classes,” Warren Buffett, MS ’51, deadpanned as he took the stage with Bill Gates on Thursday as part of a community forum at Columbia Business School. More than 700 students from the Business School were in attendance at the event, which was filmed for global broadcast by CNBC.

A major theme of the 90-minute Q&A session was optimism about U.S. economic prosperity in the long-term, with a nod to future energy issues. That theme underscored Buffett’s comments about Berkshire Hathaway’s recent acquisition of Burlington Northern Santa Fe for $34 billion last week.

“The railroads are tied to the future prosperity of this country. You can’t move a railroad to China or India or anywhere else,” he said. “As the country grows, the transport of goods will grow — [people] will be moving more and more goods back and forth to each other. And you have the most environmentally friendly and the most efficient way of doing that on the railroads.”

The theme returned later in Gates’ discussion about areas he sees with the most growth potential in the United States. He said those include information technology, energy and medicine. Gates discussed the growing field of alternative energy as a driver for a long-term economic development.

“Solar-thermal, solar-electric, nuclear [energy] is going to go through some of the revival and see if it can solve some of its cost challenges. As a country, we want to make sure all of those get lots of R&D and regulatory enablement because one of them is going to give us much cheaper power,” he said. “We don’t have quite as much R&D going into those things as I’d like to see. We have quite a bit, but I think the government policies could drive for more.” He added that he foresees an energy revolution and the United States is expected to lead the way.

Buffett also discussed his value-investing strategy, saying that it had not changed in light of the financial crisis and the fundamentals were the same. “We like companies with a durable, competitive advantage,” he said. On the economy, both Buffett and Gates lauded the actions of the government and the Federal Reserve.

Both men offered advice and inspiration to students. (Marry the right person, said Buffett. Act on your self-confidence, Gates added). Buffett signaled his optimism for future MBA graduates of Columbia Business School, making a promising offer to those in the audience.

“I would pay a $100,000 dollars for 10 percent of the future earnings of any of you,” Buffett said. “If that’s true, you’re a million-dollar asset right now.”

CNBC will broadcast “Warren Buffett and Bill Gates: Keeping America Great” moderated by Becky Quick on November 12 at 9 p.m. and 12 a.m. ET . Join the conversation with other students on Facebook and on Twitter.

Photo credit: Eileen Baroso

Ayn Rand is experiencing a resurgence in popular culture — South Carolina’s Governor Mark Sanford published a glowing op-ed about Rand’s books in the October 23 issue of Newsweek and Jon Stewart dedicated a segment on The Daily Show to an interview with Jennifer Burns, author of the newly published Goddess of the Market: Ayn Rand and the American Right (Oxford University Press). Next week, Burns visits Columbia Business School to speak about her book.

According to Burns, this resurgence is entirely predictable. Rand’s popularity has waxed and waned with political cycles over the years. When a Democrat is in the White House, conservatives tend to more loudly champion her ideas.

	What do you think of Ayn Rand’s philosophy? Please leave a comment.

“Students who are interested in understanding the Great Crash of 2007 should know that Ayn Rand influenced a whole generation of influential opinion- and policy-makers with her idea that all things private are good and all things public bad,” says Professor Ray Horton. “One of her most important acolytes was Alan Greenspan, who as Federal Reserve Chairman stuck to the quaint view that the financial industry could regulate itself — until he recanted last year in Congressional testimony that qualifies as one of the classic mea culpas of all time.”

Rand’s legacy continues to provide grist for the debate mill: Did her celebration of free markets contribute to the current financial crisis or does her work provide a compelling case against bank bailouts and the dire consequences sure to follow?

Professor Horton will introduce Jennifer Burns for a book talk followed by a Q&A on November 11 from 6 to 8:30 p.m. at Columbia Business School. Please register here for the event by November 4.

Photo image from cover of Goddess of the Market.

Monday, November 9, is the deadline for banks to apply for the Treasury’s Capital Assistance Program. Chances are, none will sign up.

The program — CAP for short — is the other shoe of last spring’s stress test. Announced on February 9 as a “core element of the Administration’s financial stability plan,” the program was designed to backstop banks that are unable to raise sufficient private capital. Secretary Geithner presented the plan to the Senate Banking Committee on February 10 and it was featured in Chairman Bernanke’s Senate testimony two weeks later.

Under the CAP, a bank receives government funds by issuing preferred securities to the Treasury. These CAP securities include complex embedded options for both the bank and the Treasury. In current work with Zhenyu Wang of the New York Fed, we have estimated prices at which these “structured products” would sell in a market transaction between private participants rather than as part of a government program. We have applied our method to the 18 publicly traded bank holding companies that participated in the stress test. (The 19th stress test bank, GMAC, is privately held and received funds through a special program for the auto industry.) Our estimates indicate that the CAP securities represent significant value — one might even say a huge potential subsidy — to eligible banks.

So why no takers? In many respects, the lack of participation is good news: the mere availability of CAP funds may have been enough to boost confidence in the financial system. The nine banks that were required to raise additional capital following the stress test all report being on track to meet their targets through the private sector, though some of the new capital, like the $2.1 billion in deferred tax assets claimed by Bank of America, falls short of a ringing endorsement from investors. But even if all the capital raised is solid, the question remains: Why pass up a good deal?

The circumstances suggest several possible explanations. A bank may avoid taking government funds if the strings attached require it to forgo other profitable opportunities. Citi’s sale of Phibro and troubles with Banamex illustrate this possibility, but such costs are unlikely to offset the value of the subsidy. In an odd twist, weak corporate governance may save taxpayers money. This explanation applies if bank executives pass up CAP funds to protect their own positions rather than the interests of shareholders. Senior management at any of the top banks would be unlikely to survive another injection of government capital.

These considerations apply to all the TARP programs, but one other explanation is specific to the CAP preferred securities. In our analysis, much of the value to a bank of the CAP securities lies in the option a bank gets to convert them to common equity. This feature comes at the cost of higher dividend payments than shares issued through earlier programs, which did not include a conversion option. But Citi negotiated conversion of some of its earlier shares, and remarks from Treasury officials and banks indicate that similar conversions have been discussed at other banks. Banks may be reluctant to pay for an option they think they can get for free.

Complex structured products designed in the private sector have drawn criticism for contributing to financial instability through a lack of transparency. The complexity of the Treasury’s design of the CAP shares — intended, no doubt, to avoid direct government purchase of bank stocks — may well have been a final factor in discouraging participation.

	Students at the University of Dar Es Salaam listen to a lecture.

At last night’s Community Forum, Dean Glenn Hubbard, professors Bill Duggan and Gita Johar, and Eric Tienou ’03 of Burkina Faso discussed economic development in Africa. Hubbard and Duggan’s recently published book The Aid Trap (see blog post) advocates for aid investment directly into the small business sector rather than charitable aid through NGOs. Hubbard, who also spoke last week at the “Peace Through Reconstruction” conference, has said that a Marshall Plan-like program is not only a moral and economic imperative, but also good foreign policy for the United States. (Watch a video of his presentation.)

One example of how the development of the small business sector is taking place is emerging through the School’s partnership with the University of Dar Es Salaam (UDBS) in Tanzania, Africa. The partnership is made possible through Goldman Sachs’ 10,000 Women program.

Several faculty members, including Murray Low, Eric Abrahamson and Gita Johar, spent last summer working in Tanzania to teach students and UDBS faculty members. The goal of their work was twofold: to prepare local students to earn a cobranded advanced certificate in entrepreneurship and business management, and to facilitate UDBS faculty members in learning interactive case method teaching. The School is also helping to establish a PhD program at the African university.

“The group of students was incredibly diverse,” Johar said about her experience teaching. “We had chicken farmers and dried fruit distributors to engineers, consultants and a range of microfinance entrepreneurs.” This summer completed the first of a five-year teaching exchange.

While many of the challenges for small business owners in Tanzania are familiar — management, staff turnover and competition — the biggest challenge, said Johar, is access to capital. “Friends and family are the bank,” she says, noting that bank loans are virtually nonexistent. Nonetheless, students were very enthusiastic about the material.

“We were thrilled,” she says. “They were very hungry to learn and apply the teaching to their ventures.”

In September, Professor Bruce Kogut and Cheryl Rathbun, managing director and chief operating officer of Citi’s Institutional Client Group’s (ICG) Risk Management, participated in a question-and-answer fireside chat about the future of financial regulation.

While Rathbun made clear that “we’re not out of the woods yet”, she did say that some of “major contours” of the new financial landscape are appearing.

“I don’t think we’re going to see major money center banks growing and growing and we’ll just have three or four major institutions. I think we’ll see a paring down,” she said. “At the same time we’re going to have increased regulation and capital requirements, which will force the money center banks to have somewhat of a different model. It’s a little more retro and maybe going back to what we saw in the 1970s … we may see some reincarnation [of that era] and some bit separation between [securities and commercial banking].”

To learn more of Kogut and Rathbun’s exchange, watch the complete video coverage.

	Secretary-General Ban Ki-moon with a sample of polar ice during his visit to the Polar ice rim on September 1, 2009 to witness firsthand the impact of climate change on icebergs and glaciers.

Today, the 2009 Social Enterprise Conference: From Vision to Practice is taking place at Columbia Business School. This year’s event features Craig Barrett, former chairman of Intel, as the keynote speaker, and the panel topics touch many areas of business and sustainability. One panel will touch on how the private sector can provide solutions for clean water scarcity; another will showcase successful social entrepreneurs. Many of the themes that are being discussed today came up as part of a debate we took part in last week at the Carnegie Council.

Last Wednesday, a team of second-year students made up of Irene Pipola ’10, Kayvan Parvin ’10, and myself participated in “The Future of Business and Sustainability” debate, hosted by the Carnegie New Leaders. The group debated with teams from the NYU Stern and Baruch business schools and explored various ways of using the private sector to achieve environmentally sustainable outcomes.

The debate took place on a cruise around Manhattan on a “green” boat powered by biodiesel fuel. The evening began with clips of the new film Shattered Sky, by Stephen Dorst, which explored the parallels between the current debate on climate change to the one that led up to the Montreal Protocol in 1987 that resulted in the regulation of industrial gases that were causing holes in the ozone layer. The Protocol has been very effective and levels of harmful gases in the atmosphere rapidly have stabilized in the years since it was passed with no economic impact on consumers.

Dorst was present, and we discussed the similarities between the two cases; in both, corporate lobbyists held up the legislation for years and winning public support was crucial to providing the political will for change. Most importantly, the leadership of the United States is key in both cases; it took 14 years after the discovery of the ozone-depleting properties of certain industrial gases to get global agreement — and U.S. leadership was crucial to bringing the world together to solve the problem. Similarly, the debate on how to regulate greenhouse gases to mitigate climate change has been going on for decades — and the lack of U.S. leadership has been fundamental to the inability of the world’s nations to reach an effective plan of action.

Once the debate started, our group put forth several innovative ideas on New York, business and sustainability. Kayvan identified innovative business models that could address the split incentives problem that causes many profitable opportunities in energy efficiency to go unrealized. Irene discussed how congestion charges and incentives for some businesses to operate at flexible hours could be cost effective tools to reduce the strain on New York’s public transit infrastructure. I insisted that solving the fundamental problem of the externalities associated with greenhouse gas emissions and climate change could not be addressed without putting a cap, and therefore a price, on those emissions.

Photo credit: UN Photo/Mark Garten

Is it time for a new approach to solving world poverty? That question is at the heart of a new book, The Aid Trap, by Dean Glenn Hubbard and William Duggan, a senior business lecturer at Columbia Business School. In it, they argue that direct loans to businesses similar to the Marshall Plan is a more effective way to help sub-Saharan Africa pull out of poverty, rather than direct aid from charities and NGOs.

Hubbard and Duggan argue the current economic aid system — where non-governmental organizations run development projects — isn’t working effectively and there needs to be a “reorientation” of aid directly into the business sector. In many poor countries local business sectors are suppressed, they say, and that leaves economic development to either NGO-type entities or large multinationals. Their answer is to open up the middle of the economy for local business in order to have long-term sustainable growth.

“The question is mid-sized businesses. If you look at growth in the U.S. over the past two centuries or the industrial revolution in Western Europe, it was centered on growth of mid-sized enterprises,” Dean Hubbard said in a recent video interview at Forbes.com. “Mid-sized businesses need a very different credit structure than either microfinance or large multinationals, and that is missing in much of sub-Saharan Africa. A business focus on aid could get that going.”

Read more about The Aid Trap and in a Q&A with Dean Glenn Hubbard.

A year ago this morning, we woke up to the news that Lehman Brothers had collapsed. The overnight demise of the investment bank is an important milestone, but it is only one failure in a series of calamitous events in the last year that shook the financial world and changed it forever.

Entire markets essential for world commerce effectively shut down and some markets continue to remain moribund today. Last year at this time, the whole banking system was on the verge of collapse and the world economy was tanking. Now that the economy is stabilizing — even perhaps tentatively recovering — and the financial sector is healthier, it is easy to forget just how bad things were.

It is true that investors today are now more cautious and banking will (hopefully) become more boring. But the financial and economic landscape has been permanently altered. The single biggest change pre- and post- Lehman Brothers’ failure is the role and the actions of the government and other financial authorities.

Before Lehman’s fall, the government played a relatively small direct role in financial markets. Now, the most important player, and still in some cases the only player, in financial markets is the government. The government essentially chose Lehman’s fate and allowed some of its peers to survive. Masses of money — tens of thousands of dollars per U.S. household — were injected by the United States Treasury to save the banking system from itself and bail out bankrupt industries. Unprecedented intervention by the Fed in markets, still continuing today, has slowly enticed investors back.

But now one year later, we can look back at how the government led us out, but the big question is: Where is it going to lead us next?

Photo credit: T. Shein

If the financial crisis taught business schools anything, it's that the curriculum can no longer turn a blind eye to pressing policy issues that impact business, says Professor Bruce Kogut. (See yesterday’s post about some of the ways the School is incorporating the financial crisis into course work.)

In a recent article in BusinessWeek magazine, Kogut elaborated on his view of the financial crisis and said that it might be best seen through a political perspective, rather than a technical or managerial one. Abundant liquidity and “unprecedented income inequality”, he wrote, paved the way for a flawed incentive system. Kogut argues that there should be more focus on “regulation of the financial markets and less deference paid to financial innovation.”

What does this view mean for business education? Kogut says that politics must have place in the MBA education. He writes:

	Do you share this view? Please leave a comment.

Financial crises are the children of troubled politics, yet management education often eschews political questions. This is a fundamental flaw of most, if not all, business schools. If such questions are left unaddressed, we will produce business leaders with limited perspectives who may not be equipped to deal with the pressing issues of the day. In other words, we must make the case to our students that the political questions, while difficult, are critical to the practice of business — even if this kind of analysis may not appear to serve their immediate self-interest. …

The crisis has reshaped the financial landscape, shifting the value of management education toward pedagogies that strengthen students’ understanding of the fundamental relationships in society — how managerial, technical, ethical, and political elements work together.

Photo credit: Theo La Photo

“How do we make decisions under uncertainty?” Professor Wei Jiang posed the question to an audience of students last week during orientation. The question not only referred to the lecture’s topic — the financial crisis — but was offered as a framing device for students as they begin core classes in the MBA program this week.

“This will be the most important skill you can develop,” she said.

A new orientation module focused on the financial crisis was created this year to give new students an overview of the causes and issues of the crisis and provide key questions that connect it with upcoming courses in the core. In her lecture, Jiang considered different aspects of the crisis including international policy, behavioral bias, compensation structure, government regulation and risk models.

The module is part of a larger initiative by the School to use the financial crisis as a vehicle to foster integrative thinking in business training. Another element of that initiative is the creation of a new cross-discipline class, which will launch in Spring 2010, on the future of financial services. During the past summer term, former chief legal officer of Lehman Brothers, Thomas Russo, taught a half-term course looking at the crisis.

“Look ahead as well as look around you,” Jiang told students at the end of her lecture. “Think in terms of tradeoffs and equilibrium.”

Photo courtesy of Columbia Business School

Despite the jolt of market optimism after the Dow jumped above 9,000 for the first time since January last month, there are less hopeful economic indicators all around.

In New York City, one of the most apparent is empty storefronts. The New York Times reported that the city’s vacancy rate was 6.5% overall and more than 15% in parts of midtown Manhattan. In a citizen-journalism project, the city’s public radio station WNYC has asked its listeners to add their own indicators (more crowded campgrounds, overgrown highway signage, the height of cargo containers in Port Elizabeth).

Elsewhere, another canary: the Better Business Bureau of Chicago reported a steep increase in complaints about payday loan operators. From March 2007 through March 2008, five complaints were filed. From March 2008 to March 2009 this increased to 30 complaints filed.

In a recent column for Slate, Professor Ray Fisman questioned why people take out these kinds of loans that have an APR in the ballpark of 400 percent. Are they desperate or do they not understand the loan’s terms? He cited research that found that “borrowers who were given a chart explaining the three-month cost of carrying a payday loan were 10 percent less likely to take a loan during subsequent months. Among those who did take additional loans, the total amount borrowed averaged around $195, as compared with $235 for the control group.” In other words, financial literacy is a small factor — but for many borrowers, the need for fast cash is too great to be deterred.

	What unusual economic indicators have you noticed? Please leave a comment.

At the macro level, Professor Paul Glasserman pointed us to the VIX volatility index as an economic indicator. “It is a forward-looking measure of volatility in the stock market,” he said. “High volatility is often accompanied by negative returns. From 2004 through the middle of 2007, the VIX stayed below 20%. In the fall of 2008, it jumped to over 80%. It’s been generally declining since and is currently around 24%. A drop below 20% would be a symbolically important event.”

Some good news however: economic indicators are not necessarily mood indicators. Professor Jonathan Levav directed our attention to the research of Princeton economists Daniel Kahneman and Alan B. Krueger and their research on income and happiness. In a 2006 article in Science, they wrote, “People with above-average income are relatively satisfied with their lives but are barely happier than others in moment-to-moment experience, tend to be more tense, and do not spend more time in particularly enjoyable activities.”

Photo credit: Andrew Dallos

The Federal Communications Commission, the agency charged with the task of creating a national broadband plan under the Obama Administration, asked the Columbia Institute for Tele-Information (CITI) to serve as an outside expert and provide analytic review for the program’s deployment last week.

The push to expand broadband coverage in the U.S. has raised a host of questions over ownership, content, speed and other economic issues. Backers of net-neutrality have expressed concern that telecom companies receiving broadband grants will have too much power over how and what information is transmitted. Part of CITI’s task is to provide a capital assessment of companies with future plans to deploy broadband networks, as well as their historical track record doing so. The FCC will make its official recommendations in February 2010.

“Too often, the debates over Internet policy have been driven by narrow agendas, with facts used selectively as ammunition rather than enlightenment,” says Professor Eli Noam, the director of CITI. “By focusing on data analysis of investment plans and deployment figures of upgraded broadband infrastructure, especially in this century — CITI looks forward to helping the FCC to change the past culture and develop a National Broadband Plan grounded in facts.”

Globally, broadband infrastructure reached a new frontier this week. On Monday, a new underseas fiber-optic cable providing faster connections to eastern and southern Africa opened.

Photo credit: Craig Rodway

The Obama Administration released a public report (PDF) earlier this week that said only 9 percent of eligible home loans have been modified under the government’s Making Home Affordable program and named the loan-servicing companies they say have not modified any loans.

Is the public outing a fair or effective way to urge more companies to modify loans? Professor Chris Mayer spoke on Marketplace Radio (listen to the story) on August 4 and said a better way would be to work through the investors. He said:

Well I think the idea of sort of a public outing is not my favorite way to conduct government. You know, these are complicated programs and the government hasn’t made it easy to participate all the time. But no, I don’t think it’s fair to call people out. I prefer other methods. … My sort of preferred approach would be to work with investors to get rid of the servicers who are being ineffective at this.

Should the government publically out home lenders that it says isn’t doing enough to help homeowners?

Photo credit: Meghann Marco

Imports are increasingly high-tech but the way they are measured is decidedly not.

In a case of economic myth busting, new research from professors Emi Nakamura and Jón Steinsson (Department of Economics) reveals that import prices may be substantially more responsive to exchange rate changes than they appear to be in the government’s data. And that has the potential to cause all sorts of problems for the GDP, according to BusinessWeek’s chief economist Michael Mandel. In a recent cover story, he cited their research and discussed how measurement problems in import price data can affect growth statistics.

Import goods like computers, machine parts, services and other items with prices that change quickly and where units are fundamentally hard-to-count can cause data issues. For example, model upgrades for high-tech goods and services happen remarkably often, potentially changing every few months, but the BLS is only able to log price changes for models that are identical from one month to the next. That means that price changes associated with these granular fluctuations (upgrades, discounts, manufacturing changes) are getting lost in the shuffle.

To make matters worse, Mandel notes that many services that are outsourced offshore, which should be measured as an imported good, are not measured at all.

“The kind of analysis the BLS needs is labor intensive,” says Nakamura. “If it’s true that we want to measure the impact of high-tech industries on the economy or the impact of services, we probably need to have these national statistic entities grow with the economy to be able to take on these additional tasks. This requires more funding.”

Nakamura and Steinsson uncovered the import price discrepancies by looking at the relationship between import prices and the exchange rate and started connecting the dots.

“When the U.S. exchange rate depreciates, imported products become more expensive and American consumers theoretically switch from buying imported to domestic products,” explains Nakamura. “But if you look at the data it looked like the import prices were responding very little to the exchange rate. That was a major puzzle: why did they look so smooth? It occurred to us that one of the reasons it might look so smooth was because a lot of the price adjustments during model changeovers were getting lost.”

For example, in the period between 2002 and 2008 there was a 20% movement in the exchange rate, but Nakamura shows that the foreign firms didn’t raise their U.S. dollar prices by nearly that much — raising prices by less than half of the amount they would have needed to protect their margins.

Mandel argues that the measurement problems uncovered by Nakamura and Steinsson have important implications for productivity growth. If import price inflation is overstated then productivity growth would also be overstated. That would mean we would be wrongly attributing the fact that we observe American companies producing more despite spending the same amount on foreign inputs. In fact, these gains might be arising from unmeasured growth in imported intermediate inputs.

And the issues here — both in measurement and types of imported goods — are only growing in magnitude.

“To the extent that the economy moves in the direction of importing more high-tech goods and services, where products are fundamentally hard to count, the problem will get worse,” Nakamura says.

Photo credit: Evan Leeson

The key challenge that healthcare enterprise leaders face is determining how to drive innovation while addressing problems of affordability, inefficiency and gaps in quality. This task is now complicated by strong economic headwinds that limit the resources available to attack these problems. Industry executives are also dealing with new sets of competitive and regulatory pressures on their efforts to drive business growth.

At Columbia Business School’s 5th Annual Healthcare Conference held in New York City on November 21, over 500 students, alumni and other professionals heard more than 40 speakers and panelists discuss these issues.

The featured healthcare leaders said they are embracing change to develop creative solutions to the industry’s growing problems and to provide attractive investment opportunities on a global basis. A career strategies panel of executive and corporate recruiters also presented their views on the skills and talents necessary for healthcare professionals to succeed in this dynamic environment. This was followed by a concluding career fair and networking reception with the conference’s 17 corporate sponsors.

Ed Ludwig ’75, chairman and CEO of BD (Becton, Dickinson), gave the opening keynote address. Ludwig said that a successful global healthcare company must use technology, scale, global reach and operational excellence to offer value-added products. These products should reduce costs, enhance the quality of patient care and generate sustainable earnings growth.

Following his remarks, four concurrent panels took place in the morning session on the topics of pharma and biotech, medical devices, diagnostics and payor/provider issues.

The pharma and biotech panel discussed the trend among companies to narrow their therapeutic priorities, focus on biologics, pursue licensing and target acquisitions and seek enhanced productivity and cost savings. Numerous early-stage biotechnology companies are turning to larger pharma and biotechnology firms to survive as they are unable to secure capital from the public market. Global medical device companies are seeking to introduce innovative and cost-effective products in a challenging regulatory and pricing/reimbursement environment and pursuing acquisitions and new markets to meet growth objectives. The consensus of the payor/ provider panel was that any healthcare reform in 2009 would likely be incremental due largely to economic and political headwinds, and that a key focus would be on information technology and expanding access to those without insurance coverage.

Robert Essner, former Chairman and CEO of Wyeth Pharmaceuticals and now executive-in-residence at Columbia Business School, provided the lunchtime keynote speech. He suggested that although the pharma industry faces significant challenges, the combination of new drugs, biologics and vaccines in key areas of unmet need (e.g. Alzheimer’s, cancer, congestive heart failure) and the massive influx of informed baby boomers, who are demanding health solutions, provides favorable long-term growth prospects for innovative global pharmaceutical companies.

Three afternoon panels covered M&A, life science investments and emerging markets. It is anticipated that healthcare M&A will remain active across all sectors and that consolidation among Big Pharma companies appears inevitable. Early-stage life science companies and investors face a capital squeeze, which is threatening the viability of existing companies with lower levels of funds available for new investment. Emerging markets are an increasing focus for global pharmaceutical and medical device companies that are seeking new markets for their products.

The final panel of the day focused on the changing talent acquisition and development strategies of major healthcare enterprises. Panelists commented that successful leaders will need to have global and cross-functional experiences; that employees should be open to lateral moves that broaden their skills and experiences; and that healthcare companies considering new hires are seeking a broader “toolkit” of skills that reach beyond the traditional focus on healthcare backgrounds.

For more information about the conference and sponsors visit www.cbshealthcareconference.com.

In his address last night President Barack Obama tried to rally support for his health care reform agenda, and announced for the first time that he would consider raising taxes on families earning more than $1 million a year, which is a scaled-back version of an earlier proposal that would have imposed a surcharge on households earning $350,000 or more.

Rita McGrath, associate professor of management and author of Discovery-Driven Growth, worries that the cost of health care reform could still take an overwhelming toll on small businesses.

“I’m concerned with the plans for funding it,” says McGrath. “It seems disproportionately aimed at smaller businesses and small business owners.”

McGrath argues that the taxes hikes needed to underwrite the reform program will fundamentally alter the “structure of incentives” (a term borrowed from William J. Baumol’s “Entrepreneurship: Productive, Unproductive and Destructive”), for small business owners.

She points to several ways that could happen: high taxes will diminish the amount of working capital companies have available; the tax structure places artificial constraints for the number of employees (fewer than 25) for small businesses to remain in a lower tax bracket; and small business owners’ energy will be diverted from innovating products to innovating ways to not pay more taxes. Ultimately, she argues higher taxes will diminish a strong spirit of entrepreneurialism in the United States. She writes in her blog:

With the small business growth having led us out of most recessions in the past, get ready for this sector to add jobs far more slowly and with far greater caution than it had previously — a big blow to an economy that desperately needs a vibrant and growing small business sector.

At the macro level, the effects of higher individual taxes on rates of entrepreneurship are without an exception, negative. It is well accepted, and has been for decades, that the desire to have a vibrant entrepreneurial economy is at odds with the desire to operate a welfare state, due in large part to the way in which welfare states allocate resources. When the upside to undertaking the risks of entrepreneurship decrease, and the downside of not doing much at all are limited, it becomes hard to justify making the effort. If it is possible to live quite a comfortable life without too much bother, why take on the long hours, the worry and the headaches of small business ownership?

Photo credit: apox apox

This post is part of a series following the “Pre-MBA World Tour,” a program of international trips organized by incoming students in the class of 2011.

Last week the World Tour visited Iran in order to witness, first hand, a country that has been at the center of controversy over the last 50 years. Just two weeks after the election that sparked riots around the nation (and 18 months after President Mahmoud Ahmadinejad visited Columbia University), we embarked on an adventure would change our lives forever.

When we told our friends and co-workers that we were going to Iran, almost everyone was worried that we would end up dead or locked in prison. When I asked what we had to be afraid of the common response elicited images of anti-American terrorists, shooting guns and taking hostages. However, what we found instead was a progressive culture with a long-standing history of peace and tolerance, and a young generation that simply disagrees with their current regime.

The reality is that Iranians are some of the most friendly people I have encountered anywhere in the world. One of our future classmates, Ali Reza Sadeghian ’11, is joining us directly from Tehran and offered to be our host for a week. We visited Tehran, Isfahan, Yazd and Shiraz and were consistently asked by Iranian students to deliver a message to our friends back home: 1) Don’t believe everything you see on television, 2) Don’t judge all Iranians based on the political rhetoric of our leaders, and 3) “There is nothing to fear here in Iran, you are always welcome to visit.”

The political landscape is yet to be determined, but with a young population of 70 million people, Iran will begin to play an even larger role in global economics.

Photo courtesy of John Shoaf ’10

The debate over fair-value and mark-to-market accounting rules has quieted down in recent weeks but it is far from over. At the heart of the issue is this question: Are hard-to-value securities worth only what the market is willing to pay, or is the market too dysfunctional to set values in a meaningful way?

A new paper, “The Subject Matter of Financial Reporting: The Conflict between Cash Conversion Cycles and Fair Value in the Measurement of Income” published by the Center for Excellence in Accounting and Security Analysis, challenges some basic assumptions in the existing model for financial reporting. (The paper was reportedly circulated among the financial regulators responsible for the recent rule change.) Authored by Andreas Bezold, a former chief risk officer and deputy CFO/board member of a large German Bank, and reviewed by Professor Trevor Harris, the paper concluded that a clearer distinction between fair-value changes as information and fair-value changes as income is essential. The paper makes these key points:

•Business activity is the primary object of financial reporting, which is characterized as investing cash in non-cash resources to be combined according to a specific economic logic to generate future net cash flows. The production of net cash flows is the business activity in its entirety, not single non-cash resources or constructs like “net assets”.

•Different business activities have different business models based on a different economic logic and that the value of a non-cash resource to an activity depends on the way it contributes to the net cash inflows under the economic logic of the activity in progress, i.e. depending on its function and use.

•Accounting concepts and measurement attributes have to be aligned with the inherent economic logic of an activity if faithful representation is to be achieved.

Click here to download the complete paper (PDF).

Photo courtesy of CEASA

In a recent Forbes.com op-ed, professors Bruce Kogut, Patrick Bolton and Tano Santos argue that in order to be effective, a good regulatory system must distinguish between prevention and resolution. The current system, they say, has failed to do so, instead relying on “stop gap” prevention measures.

Kogut, Bolton and Santos say that the current system failed to follow the principles of crisis prevention by allowing incentives to become misaligned, creating risk-blind structural silos and failing to require the disclosure of risk exposure, particularly in the case of credit default swaps. The solution, they propose, is the creation of a new entity — the Crisis Resolution Board. They write:

A new regulatory system must also be capable of crisis resolution, because the hallmark of modern financial crises is that the limits of institutions and markets quickly bleed into one another, and the problem rapidly takes on a global scale. The data show that as the most recent crisis hit, all the crickets began to sing in harmony — all markets behaved erratically simultaneously. A “regulator of regulators” — which we will call the Crisis Resolution Board — should be charged with monitoring and responding to systemic risks.

The Crisis Resolution Board cannot be merely an honorary posting. Effective intervention by the Crisis Resolution Board will require social capital — crises always rely upon the personal knowledge among the players. Thus, this oversight board should include the chiefs of the Treasury, Fed and an FSA regulatory agency, as well as industry and investor representatives. In addition, the board must have more than global access to data — it must have knowledge of the global exposure and the systemic risk provided by a research staff that continually tests its instruments against the dynamic evolution of markets.

Concretely, what would the Board do? First, it will have power to monitor the exposure of all financial institutions and markets, and to issue early warning signals. This is hardly a radical idea. The IMF plays a similar role at the global level in monitoring national reserves. The role is clearly feasible for a national regulator and will lead to a strengthening of global financial market coordination.

Second, like any good fire brigade, which has a deep respect for plumbing, when things get hot the board will ensure that the financial markets’ plumbing is functioning. Markets depend on brokerage, exchanges and settlement. That’s their plumbing, and it’s also the key to systemic risk. It must be charted and tracked globally if we are to know what to do when the next crisis comes.

Regulatory reform should seek to distinguish between crisis prevention and crisis resolution. Prevention relies upon a tripartite structure and clear rules of accountability. Crisis resolution demands an integrated approach to systemic risk. Both structures are required and yet, no country has yet to design such a system. This is the time to do so.

Photo credit: SKPY/Scott

As the debate over the revamped health care system intensifies this week, one of the central arguments on both sides of the aisle is about cost. New research from Professor Frank Lichtenberg suggests that increasing health insurance coverage could be key in lowering rates of health spending. That underscores a central premise of Obama’s healthcare plan to expand coverage while reducing costs.

“It is almost a presumption in the debate that uninsured Americans are not getting medical care and therefore their health outcomes are compromised,” says Lichtenberg.

“But there is a lot of evidence that people who lack health insurance still get medical care, albeit in a costly and inefficient matter. They go to the emergency room instead of seeing a doctor on a regular basis,” he says. “Therefore, it is more costly for people to be uninsured.”

Data from Lichtenberg’s research, published by the National Bureau of Economic Research, focused on the reasons Americans are living longer. Using state-level data, he found that higher quality of medical care, newer drugs and better diagnostics are the principal factors for increased life expectancy. However, he also found a correlation between increased health insurance coverage and a slower growth in per capita health spending.

“States where health coverage is expanding faster actually have lower rates of growth for health expenditure,” he says.

“I think that is part of the reform pitch Obama is making, that we can’t afford not to have a much higher rate of coverage and my results are consistent with that,” says Lichtenberg. “It’s not that people are going to live longer, but they won’t live any less long, and it will actually save the system money.”

Photo credit: Tim Hoffman

On Thursday the Treasury announced their choice of executive pay overseer, Kenneth R. Feinberg, who will have the task of setting compensation of the top 25 executives at seven financial firms. The new appointment challenges the view that it is not what you pay, but how you pay, that matters, says accounting professor Sudhakar V. Balachandran.

“What we have seen to date tells us that reforms in how boards set compensation are warranted, and that there needs to be a better relationship between pay and performance, particularly performance that is not immediately observable, ” he says.

“That said, it is a completely different matter to say that a centralized body in Washington D.C. can do this better, ” Balachandran continues. “Boards have substantially more information about the company and its circumstances and by centralizing the process we might be throwing away a lot of valuable information. There is a difference between providing reform to the compensation process and providing a centralized compensation policies that are determined by a political process. I believe only the former has a chance of success but I’m afraid we may be heading towards the latter. ”

Photo credit: Michael Aston

In an interview with Nightly Business Report on Monday, Dean Glenn Hubbard said that President Obama’s stimulus package gets positive marks for “stopping the free fall in the U.S. economy.” However, the dean also said that improving financial markets and institutions and changing the regulatory structure are key to economic recovery.

Indeed, the Committee on Capital Markets Regulation, which is co-chaired by Dean Hubbard, released its report on Tuesday. The executive summary outlines 57 specific recommendations for overhauling financial market regulations. The recommendations cover an extensive swath that includes credit default swaps, ratings agencies, accounting standards, hedge funds and international regulation (view the complete executive summary).

A few of the Committee’s recommendations:

13. Hold Large Institutions to Higher Solvency Standards

15. Maintain and Strengthen the Leverage Ratio

31. Prohibit or Restrict High-Risk Mortgage Products and Lending Practices from Entering the Securitization Market

38. Develop Globally Consistent Standards [for credit rating agencies]

42. Increase Disclosure as to How Ratings Are Determined

47. Refrain from Reimposing Glass-Steagall

50. Increase the Role of the Fed

51. Establish the USFSA [U.S. Financial Services Authority, an organization to “regulate all aspects of the financial system, including market structure and activities and safety and soundness for all financial institutions”]

56. Enable the IMF to Play an Early Warning Role

The question of systemic risk and how to prevent it has been at the fore since the crisis hit the markets in full force last year. Leading faculty and industry experts explored the issues at the Bernstein Center’s “Preventing the Next Financial Crisis” symposium held last December (download conference proceedings, PDF).

In February, professors Bruce Kogut, Patrick Bolton and Tano Santos also proposed the creation of a Crisis Resolution Board (see blog post). In a Forbes.com op-ed, the professors emphasized that “regulatory reform should seek to distinguish between crisis prevention and crisis resolution. Prevention relies upon a tripartite structure and clear rules of accountability. Crisis resolution demands an integrated approach to systemic risk.”

Photo credit: Joe Hatfield

The Obama administration revealed the results of its “stress tests” on Thursday, causing banks to start a new scramble for capital — $75 billion in total. The banks in need of additional capital, which include Bank of America, Wells Fargo and Citigroup, must present regulators with their plan for raising the funds by June 8.

In an op-ed in the Wall Street Journal on May 6, Dean Glenn Hubbard, writing with Hal Scott and Luigi Zingales, suggests an approach to recapitalizing the banking sector far different from the one adopted by the Treasury. Rather than being offered “carrot” incentive plans, such as TARP, insolvent institutions should be managed by the FDIC, the authors suggest. They write:

It’s time for government to use the stick, beginning with creditors. The first step should be an announcement that the FDIC guarantees of short-term debt, set to expire at the end of October, will not be renewed. Insolvent banks — defined not by stress tests, but as those that cannot fund themselves in the private market — will be taken over by the FDIC. Of course, this takeover plan must be clear and credible. Otherwise creditors will play “chicken” with the government, knowing that at the last minute the government will flinch and fail to remove the guarantees.

… Rather than taking over and running banks, the FDIC should split each bank into two parts. One part (“the bad bank”) will assume all the residential and commercial real-estate loans and securitized mortgages as assets, and all the long-term debt as liabilities. In addition, “the bad bank” will obtain a loan from the “good bank.” This loan is necessary because the long-term debt of the old bank is not likely to be sufficient to fund the assets of the bad bank. The good bank will have all the remaining assets, including derivative contracts and its loan to the bad bank. It will have all the insured deposits and the FDIC-guaranteed short-term debt as liabilities. Once the split is accomplished, the good bank can be cut loose from FDIC receivership.

Photo credit: Joshua Brauer

In a New York Times Magazine article from April 16, Professor Elke Weber, co-director of the Center for the Decision Sciences, suggests that solving climate change requires more than developing the right technology. It requires changing the way we make decisions. “… Climate change is anthropogenic,” Weber says. “That means it’s caused by human behavior. That’s not to say that engineering solutions aren’t important. But if it’s caused by human behavior, then the solution probably also lies in changing human behavior."

But why aren’t we naturally inclined to curb behavior that promotes global warming? Why, as the title of the article wonders, isn’t the brain green? Jon Gertner, author of the article, explains Weber’s findings:

… Weber’s research seems to help establish that we have a “finite pool of worry,” which means we’re unable to maintain our fear of climate change when a different problem — a plunging stock market, a personal emergency — comes along. We simply move one fear into the worry bin and one fear out. And even if we could remain persistently concerned about a warmer world? Weber described what she calls a “single-action bias.” Prompted by a distressing emotional signal, we buy a more efficient furnace or insulate our attic or vote for a green candidate — a single action that effectively diminishes global warming as a motivating factor. And that leaves us where we started.

Weber’s research illustrates how decision science can be used to influence human behavior — in this case, to make our brains green. Gertner writes:

“… Cooperation is a goal that can be activated,” Weber told me one morning. Her point was that climate change can be easily viewed as a very large “commons dilemma” — a version, that is, of the textbook situation in which sheepherders have little incentive to act alone to preserve the grassy commons and as a result suffer collectively from overgrazing. The best way to avoid such failure is by collaborating more, not less. “We enjoy congregating; we need to know we are part of groups,” Weber said. “It gives us inherent pleasure to do this. And when we are reminded of the fact that we’re part of communities, then the community becomes sort of the decision-making unit. That’s how we make huge sacrifices, like in World War II.”

But does employing decision science in such a manner carry ethical consequences?

“We tend to always wonder,” Weber says: “What’s that person’s true preference? What do they really want? I think that’s the wrong question, because we want it all.”

Photo credit: Xurde

This past Monday, President Obama announced a series of proposed changes to the tax code. The changes include a reform of a long-standing tax deferral for multinational companies on revenue drawn from their foreign operations, a permanent extension of an R&D tax credit and a curb on offshore tax havens.

Professor Andrew Schmidt says the Obama administration hopes that the overall effect of the proposed corporate tax code changes results in a shift of more investments to the United States by effectively minimizing the incentive for foreign growth and improving resources for R&D in the U.S.

“The idea is that eliminating the tax deferral will drive up [companies with foreign operations’] tax rates and potentially curb the incentives to invest overseas. The result could be reduced investment in foreign operations as firms may have less cash to expand plants or factories,” says Schmidt.  “The revenue raised by eliminating the tax deferral would then be used to permanently extend the R&D tax credit, which would encourage firms to make some of these investments in the U.S. instead.”

He adds, “The R&D credit was a temporary provision and was re-upped every few years when it was about to expire. By making it permanent, firms can rely on that subsidy and not wonder if it will expire. This will be a big deal to certain industries, like Big Pharma, which has heavy R&D.”

On the issue of curbing tax offshore tax shelters — a political hot potato — Schmidt says that one effect would be a reduction in the tax gap, which according to the most recent figures from the IRS (fiscal year 2001) is between $312 and $353 billion.

Listen to an interview with Professor Schmidt on WNYC.

Photo credit: kalavinka

The SEC announced on April 8 that it is considering reimposing the uptick rule to limit short selling. The old uptick rule prohibited short sellers from trading in a stock at a price lower than the most recent reported transaction. The concern was that without an uptick rule, short sellers might manipulate a stock by selling aggressively and repeatedly, driving stock prices below fundamental value. The SEC has now proposed five different types of possible rules for comment.

Professor Charles Jones says that while a resurrection of the rule will likely reverse the increase in shorting activity that occurred after the rule was repealed in 2007, its impact will be limited.

“No matter what new rule the SEC chooses, it will be a reversal of what we saw in 2007 when they took it off, and we will see modest effects,” says Jones. “It won’t magically raise stock prices. We will see a modest decline in the amount of shorting, but I don’t think it will be more than a minor nuisance for long-term, fundamental shorts.”

Jones’ research (PDF) on the July 2007 repeal of the uptick rule showed that there was a slight increase in shorting after the repeal. However, Jones says that the bout of market volatility that occurred in August 2007 was not related to the repeal.

“A lot of people think that because the volatility episode was so close on the heels of the repeal the two were related in some way,” says Jones. “But there are two problems with that. First, it didn’t happen right away. The volatility was in August, a full month after the uptick rule was removed.

“Second, when we dig in and look at what happened in that volatile period, it doesn’t look like the short sellers are to blame,” he says. “We have detailed, proprietary data from the exchanges on all shorting activity. They are not piling on stocks that went down. It doesn’t look like they are conducting bear raids or being abusive or pushing prices around in any way. When all is said and done, it doesn’t look like shorts were contributing to this volatility in any way.”

Photo credit: kevingessner

Thomas Russo, the former vice chairman and chief legal officer of Lehman Brothers, met last night with students in a Community Forum discussion about the financial crisis. Russo will be teaching the half-term summer course “Credit Crisis: As Seen Through Different Lenses.”

In a 45-minute presentation, followed by a Q&A, Russo gave his perspective on the origins and fallout of the crisis. One topic he focused on was the changing role of leverage for banks.

“Leverage now has a lot of bad things attached to it, but that’s the way we make money,” he said. “If you change leverage, you are limiting profitability.”

He predicted that it will be easier for smaller firms to make money in the future because they will not be encumbered by the enormous cost structures and lack of flexibility that larger institutions have.

“Since banks won’t have leverage down the road, it will be harder in the institutional sense to make money,” he said. “There will be more opportunity to make money outside the institution. Things in the future will be developed by smaller entities.”

Segueing into advice for future CEOs in the audience, Russo said the most important thing to remember was to have multiple points of view.

“You have to put yourself in other people’s shoes,” he advised. “Understand that every problem has many sides and if you’re in the decision-making role, you have to look at all of them.”

Photo credit: Antonio Morales Garcia

Maurice Lam ’78 is not alone when he says that the future of Africa lies in private sector business. Dean Glenn Hubbard and Professor William Duggan’s upcoming book The Aid Trap (Columbia University Press), due to be published later this year, explores the topic.

However, Lam’s position as chairman of the Board of Investment for Mauritius offers a unique case-study perspective on how this future can be realized. After a series of reforms in 2006 to modernize industries and boost investments, the Indian Ocean island country increased its economic growth from 2.3 percent to more than 5 percent.

The first step, Lam told Public Offering in a recent interview, is to simplify the way business is done.

“Make it easy to do business in Africa by simplifying the rules and regulations,” Lam says. “We are doing this in Mauritius, and we have moved up in rankings on the World Bank’s Doing Business survey from 32 to 24. As a result, we have seen more locals investing in the private sector and more investors from overseas.”

Lam, who has also advised Uganda on investment opportunities, argues that African nations allow the opportunity for corruption by creating too many hurdles for success through complicated permit and fee systems.

“You leave yourself open to corruption opportunities when you have administration procedures where there is discretionary power,” he says. “So you must remove them.”

Lam, who was born in Mauritius, now resides in Singapore, where he runs a strategy-consulting firm for family-run businesses. He says a key to success in the private sector in Africa is political will.

“Political leadership has to be willing and particularly the finance ministers,” he says. “These countries lack revenue so you have to convince the finance ministers that the big picture will make more money for the government.”

Another key is business-sector support, in which Columbia Business School has been playing a vital role. In addition to Hubbard and Duggan’s book, students have been engaged in numerous entrepreneurial projects in Africa, including last year’s Master Class (see blog). The School is also working with universities in Kenya and Tanzania to develop better business-education methods.

Photo credit: Lionoche

This is part of a series of posts from the International Development Club.

On a recent Friday morning, we made our way with 25 fellow MBA students to the United Nations World Headquarters for a special visit. We all had one question on our minds: how does one actually get a job at the UN?

We learned that while it’s a difficult place to get one’s foot in the door, networking, perseverance and a willingness to live in relatively less-desirable locations can help you find a job with the prestigious organization.

After a lunch in the Delegates Dining Room, we met with Brett House, from the Office of the UN Deputy Secretary-General. He demystified the organizational structure and gave our group some insight as to where the skills of an MBA might be most valuable. He pointed to the International Finance Corporation (IFC), International Monetary Fund (IMF-Capital Markets), World Bank, Multilateral Investment Guarantee Agency (MIGA), Food and Agriculture Organization of the UN (FAO), United Nations Capital Development Fund (UNCDF) and United Nations Development Program (UNDP) as organizations within the UN that hire MBAs.

Next we met with representatives from the human resources department. They gave us an understanding of the hiring process (long and complicated) and its Galaxy Web site (jobs.un.org). Perseverance, it seems, is critical when applying for these jobs — as is recognizomg that resumés are not just going into a black box.

The human resource representatives stressed the importance of meeting all (or almost all) of the minimum requirements, particularly in regard to work experience. The typical applicants for positions requiring “minimum five years experience” have seven or eight years of experience. Furthermore, they said approximately 300 people apply to each position — with 5,000 applying for 200 internship positions — so make sure the CV you submit is your best effort!

The day’s highlight was a panel featuring four speakers from various organizations within the UN. Lucas Black ’00 SIPA, who works in the MDG Carbon Facility, opened the panel and discussed his work trading carbon credits and supporting emission reduction projects with significant benefits to the Millennium Development Goals.

Dr. Manuel Escudero, from United Nations Global Compact, spoke about his experience and how much one has to believe in the mission of the organization to succeed. He noted that smarts and hard work are great, but that it is the ability to deliver results and creativity that separates the best employees from the mediocre ones at the UN.

Elizabeth Leff ’99 SIPA, who works in Human Resources (Planning), discussed her transition from consulting to development work in Thailand to finding a job at the UN. She stressed that it is critical to have experience in a developing country under one’s belt.

Matthew Hochbrueckner ’06, who works at the Office for the Coordination of Humanitarian Affairs (OCHA) underscored that point, saying that he would not have gotten the job at the UN had he not taken the time to work in Eastern Europe and the Balkans after business school.

The bottom line for MBAs who want to work at the UN?

1. Manage your expectations. It is very difficult to get a job and the recruitment process is very long and extremely competitive.
2. Leverage any contacts inside the organization and try to obtain a short-term contract. This way you can get your foot in the door and have the opportunity to demonstrate your value to the organization. Once you prove you are “UN material,” it will be easier to find other UN jobs and ask for a position in a country in which you are interested.
3. Take big risks. Apply for positions in danger zones like Sudan, Iraq or Afghanistan, for which there is a very short supply of candidates. A couple of years stationed in one of these countries could lead to a lifelong career at the UN.

Photo credit: Ashitaka San

The role of India’s central bank has been a mitigating factor for how the country has fared during the financial market meltdown, Professor Joseph Stiglitz told the audience at last week’s South Asian Business Association (SABA) conference, “India: Rising to the Challenge.”

In his afternoon keynote address, Stiglitz also refuted the theory of “decoupling” that suggested the economic crisis would not spread from the most developed economies to other parts of the world.

“The world has become so integrated that to have a downturn of the largest economy in the world, and one of this magnitude, has to have global repercussions,” he said.

However, Stiglitz pointed to the Indian central bank’s policies as lessening the financial blow to the country of more than 1 billion people.

“India was one of the countries that resisted the wholesale deregulation movement that the United States had been exporting,” Stiglitz said. “They did it against political pressure … and now I think the financial markets are thankful that they did resist those pressures. The result is that India’s financial markets are in better shape than they would have been if they had engaged in the kind of wholesale deregulation that the United States engaged in.”

While Stiglitz still expects India’s growth to be between 5.5 and 6 percent, he believes the country will feel a contraction in the amount of capital investments from developed countries and possibly from remittances, as well.

However, the news for India remains mostly positive.

“The two largest developing countries, India and China, are the least dark spots in this gloomy economic picture,” Stiglitz said. “The prospects for India are that it will continue to grow — strongly by historical standards — but that growth will be much slower than it was before the crisis, and much slower than many people would have hoped.”

Photo credit: Roy Sinai

On April 3, the Columbia Business School Energy Club in conjunction with the SIPA Energy Association held the 2009 Energy Symposium, “Imagining Tomorrow: Meeting Energy Demands in a Carbon-Constrained World.”

Dr. Ivan Marten, a senior partner and managing director at the Boston Consulting Group, gave the morning’s keynote address and asked three questions that directed the conversation throughout the day:

1. Are there enough resources to sustain current growth rates?
2. Do we have access to and security of these supplies?
3. What role can alternative energy and carbon sequestration play in the future global energy market?

The answers, Marten said, all depend on the price of oil. Currently, large international oil companies (IOCs) are still making significant capital expenditures in exploration and production, Marten said. However, national oil companies (NOCs) that dominate world reserves, are now short on income and are generally reducing investments in exploration and production.

According to Marten, this investment imbalance will lead to an imbalance in future supplies and thus result in a shift of power between IOCs and NOCs.

Marten also noted the reduction in investment extended to renewable forms of energy despite the current political commitment to sustainability. Although this commitment in the West will likely drive up production of renewable energy sources, Marten argued the overall impact on global emissions would be counterbalanced by the growing energy production and associated emissions from countries like China.

Other panels during the day-long symposium focused on the impact of a future carbon regulatory structure on the current energy market.

Speaking as part of the panel, “Coal: Then and Now,” Courtney Lowrance, vice president for Environmental and Social Risk Management at Citi Markets and Banking, said a major shift occurred in coal investment starting in 2006 when coal companies began facing problems with public perception and investment.

However, the panel’s consensus was that coal, despite the current concern over its emissions, is essential to meeting energy demands and will be included in the U.S.’s future energy portfolio. The panelists emphasized that in the future, the coal market will incorporate new technologies like carbon capture and sequestration (CCS) and integrated gasification plants with carbon capture (IGCC plants).

Joseph Strakey, chief technology officer of the National Energy and Technology Lab, and Klaus Lackner, a chaired professor of the Earth and Environmental Engineering Department at Columbia University, agreed that reducing coal-based emissions is possible with these technologies.

To provide evidence that CCS could be incorporated and its current price-for-capture could be reduced, Strakey pointed to the changes in the coal market during the 1970s that resulted from regulations on sulfur emissions.

Lackner stressed that the most difficult obstacle facing carbon sequestration is the regulatory issues associated with controlling an amount of carbon dioxide “roughly the size of Lake Michigan.”

Brian Ward, managing director and chief risk officer of GE Energy Financial Services, stressed the need for the energy industry to be involved in developing the new regulatory framework for carbon emissions in his afternoon keynote address.

Photo credit: nelgallan

Last November, I posted a rather negative view of the proposal to bail out General Motors (“Bail Out GM? No Way”). It wasn’t a good idea for a number of reasons, I said. Keeping the company going with government money is essentially a vote of confidence that the current management team — the one getting the bailout — can return the company to viability. Moreover, GM is a classic case of ‘permanent failure’ in which its importance to key stakeholders (employees, dealers, communities) keeps it going rather than its ability to create a customer.

Well, here we are, five months later, and what have we learned? For one, the shocking collapse in demand for cars has continued, affecting all car companies but particularly GM. Second, the restructuring plan submitted by GM — as we might have predicted — wasn’t far-reaching enough to have a sufficient impact. Finally, we learned that the folks in charge of bringing the company to its current state of non-viability were probably not going to be the ones to turn things around. These are just some of the surprises facing the taxpayers whose money is going toward the bailout.

So the CEO of GM has been asked to leave, and now reliable experts are saying that bankruptcy may be the only option for GM. The sad part is that dragging out the march toward what is looking like almost certain bankruptcy is chewing up even more resources, further weakening the company and undermining confidence in our system’s tools for addressing truly significant problems. Some of these wasted resources could have been used to buffer some of the painful social adjustment costs for those who will really suffer from a bankruptcy — GM’s employees.

Photo credit: vetcw3

The ongoing recent global economic collapse is so monstrous, so broad and so deep that it requires a big-picture explanation. This isn’t just about some stupid moves by mortgage brokers in California — how could that have such a vast impact on the global economy? It isn’t just about Wall Street greed — hasn’t Wall Street been greedy forever?

The underlying problem is deeper: For the past 25 years we have been over-consuming and over-borrowing to do it. The problem is debt itself.

Consider the ratio of household debt (all mortgage debt, credit cards, bank loans of all kinds) to the U.S. gross domestic product. This ratio rose steadily in the period after World War II until it stabilized at around 40% to 50% in the 1960s and 1970s. In the mid-1980s, it turned a corner and broke through 50%, hitting 60% in 1988 and 70% in 2000. It then accelerated all the way to 100% in the seven-year stretch from 2001 to 2007.

All that borrowing by individuals had a powerful stimulatory effect on the economy. Business sales grew, and production increased to meet improved demand. The result was an astonishing period of almost unbroken economic growth during the past 25 years.

But debt was growing faster than income, so the aggregate “credit ratio” of household debt to median household income steadily deteriorated. The problem, of course, was worst at the lowest end of the income spectrum. But the pattern of growing debt pervaded society. People maxed out credit cards and pulled the equity out of their houses. And most people stopped worrying about ever paying the debt back, since the abundant liquidity in our system made it seem that debt could always be rolled over and refinanced.

In short, more of our prosperity than we have been willing to admit has been driven by debt. At the global level we were in a huge financial imbalance, borrowing hundreds of billions per year from China and other countries so we could go on over-consuming. But debt-driven prosperity is an illusion, since debt must someday be repaid. That ugly fact remains hidden until the debt ratio gets very high.

Why don’t both borrowers and lenders see this in time to stop? Perhaps borrowers are shortsighted, and lenders are corrupted by large cash bonuses. These are both very likely true. But even if they were not, no one can say when the end will come, and it is in everyone’s interest to keep the party rolling. Consumers want to go on consuming, and banks want to go on making profits.

What finally brings the party to an end is when the banks begin to have funding problems. If a Bear Stearns or a Lehman Brothers starts to look dangerously over-extended, first a few funders will pull back, and then more will follow. The bank’s stock price begins to fall, and the price of insuring its borrowing begins to rise. Then its funding begins to dry up, and a financial crisis is at hand.

We have seen similar events happen in developing countries, most recently in the East Asian crisis of 1997 to 1998, but we never thought it could happen to us. Well, it just has. The current events are not at all like an ordinary business cycle; they are not a mere recession brought on by tight monetary policy or too many inventories. Rather, we are witnessing a systemic crisis, a joint collapse of financial prices, financial institutions and the real economy.

Have we ever seen a systemic crisis in the U.S.? Yes we have — in the 1930s. The data for household debt do not extend back that far, but there is a related series kept by the U.S. Commerce Department called “individual and noncorporate debt.” The ratio of that number to GDP rose rapidly from 55% in 1920 to a peak of 97% in 1932. The 1920s were also a boom time, but in retrospect, that too was debt-driven growth, and it ended in the systemic crisis known to us as the Great Depression.

There are of course many differences between our era and the 1930s. Among other things, government has become much more activist and is far more willing than it was in the 1930s to intervene to stop the slide. But does the government literally have the power to stop the slide? It can no doubt help at the margin, and it is certainly obliged politically to try everything it can. But merely spending money may have no more than a temporary effect. The essential problem is that people have too much debt, and that problem can only be solved by debt reduction.

How do you reduce debt? There are really only two ways: repay it or default on it. A renegotiation of terms is also possible — this is a blend of repaying and defaulting. Repayment of even some debt means that Americans must regain the habit of saving.

Our ratio of household saving to disposable personal income, which had been in the 8% to 10% range as recently as the 1990s, fell to nearly 0% by 2007 but has returned to about 5% in the fourth quarter of 2008. Saving means consuming less, and of course this hurts the economy. Default is happening too, and this clobbers the banks. But there is no way to reduce debt without harm. De-leveraging is as painful as borrowing is pleasant.

Government policies that are directed toward debt reduction, such as the administration’s latest program to promote mortgage debt renegotiation, are well focused. But the government is deeply misguided when it beats on the banks to “lend more”: The banks have lent too much already, and consumers have borrowed too much. If the name of the problem is too much debt, “lend more” hurts rather than helps.

We have met the enemy, as Pogo said, and he is us.

This article originally appeared on Forbes.com.

Photo credit: lemonjenny

At Friday’s community forum, Professors Paul Glasserman, Trevor Harris and Hitendra Wadhwa (pictured at right) held an open discussion with students about how best to move forward from the financial crisis. The forum covered economic issues ranging from risk management to accounting to the importance of not allowing the near-constant stream of negative news to affect your decision making.

Professor Glasserman began the event by speaking about capital requirements for banks as they relate to the banks’ risk management practices. He offered three main points:

1. Tightly linking capital requirements to risk can lead to dangerous procyclical behavior

   “When a bank’s assets start to look more risky [as a result of a downturn], it must hold more capital. How does it hold more capital? It cuts back on lending. So at the worst possible time, there’s an incentive — in fact, a requirement — for banks to cut back on lending.”

   To help prevent this, Glasserman suggested that banks take countercyclical measures, such as averaging out their risk over the business cycle. He also recommended that banks be required to hold additional capital in good times so that in down times there’s a buffer for them to draw on.

2. Banks should continue to bear the responsibility of regulating their own risk
   

   While it’s understandable that the recent trend of forcing banks to regulate their own risk has received a lot of criticism, Glasserman said, putting the burden back onto regulators might make matters worse.

   “If you go to an environment where the regulators are specifying a very precise set of rules, you’ve created an enormous incentive for banks to manufacture products that look low-risk by regulators’ standards but are in fact high-risk in all the ways the regulators haven’t anticipated. And that’s a large part of what’s led to the current crisis.”

3. Systemic risk must be factored into capital requirements
   

   “A traditional view of risk management says, ‘What harm can the market do to me?’” Glasserman said. “When you ask about systemic risk, you’re asking, ‘What harm can I do to the market?’ It’s a fundamentally different approach, and it’s not been part of the way capital standards have been set to date.”

Professor Harris referred to the situation described by Glasserman as a “classic accounting problem.”

Harris spoke about a critical flaw in the subprime mortgage-backed securities that are a big part of the crisis, is that all parties (originators, intermediaries, investors, rating agencies and auditors) lost sight of the underlying fundamentals of people who had borrowed more than they could afford.

“My whole view is that people have forgotten fundamentals, and they’ve created lots of quant-based analytics that actually have nothing to do with reality,” Harris said. “What that leads to in many cases is the illusion of precision. We have so many techniques, including valuation techniques, to come up with point estimates, and the reality is that there’s huge amounts of uncertainty going forward, and we have to deal with that.”

He concluded, “I view [the crisis] as a great opportunity to fix a lot of systemic problems. My biggest fear is that if we come back too quickly, we won’t actually address a lot of these issues. If we don’t deal with complexity and address these fundamentals, we will actually end up in a much worse situation.”

Professor Wadhwa said that while it’s easy to allow the near-constant stream of negative economic news to affect your mood, doing so can impair your ability to make critical decisions.

“[Maintaining a positive outlook] broadens your mind, making you more aware of the periphery of whatever it is you’re looking at. It makes you more mindful of a whole range of ideas.”

To support his position, Wadhwa cited research that demonstrated a link between the mood of physicians and their ability to properly diagnose patients.

To keep yourself in a positive state of mind, Wadhwa suggested taking the following steps:

1. Break the causal link between external events and your internal mood. Do this by injecting behaviors, such as displaying gratitude.
2. Use humor and body language to project a positive mood not only outward but also inward.
3. Turn adversity into transformational opportunities.

“Even with the constraints many of us face,” Wadhwa said, “there’s a potential for us to ask ourselves, ‘What is there within this that might be redemptive?’ By the fact that certain doors might have closed on us, we are forced out of our comfort zone to think anew about our skill set and interests and who we are.”

Photo courtesy of Columbia Business School

Note: The remarks of Professors Calomiris and Balachandran were made prior to AIG CEO Edward Liddy’s call yesterday for employees earning more than $100,000 a year to return at least half of their bonuses.

As anger on the Hill mounts over AIG’s use of bailout funds to pay executive bonuses, a debate has grown about how the bonuses fit into the firm’s contractual obligations. Professor Charles Calomiris discussed the matter in an interview with NPR’s Talk of the Nation on March 17 (listen to audio).

“A lot of these bonuses are being used to pay middle-level managers who have this coming as part of their contractual agreements with AIG. From what I understand … much of this money, if not all of it, is something AIG would like to get out of paying, but doesn’t see any way to do so. The remainder [is] the normal bonuses it feels it wants to pay to retain good people,” said Calomiris. “What we are seeing is a backlash of anger and that’s understandable — but anger is not what gets us out of this mess.”

He continued, “There is a strong economic argument for some bonuses, and I can’t judge without knowing more details what is warranted and what is not, but why are we so sure that the AIG CEO is wrong?”

Professor Sudhakar V. Balachandran said in a recent interview that it is not a matter of the company abrogating contracts but rather a situation in which executives could voluntarily defer bonus payment in order to restore public confidence.

“We’re missing a great opportunity here. If you think about the Great Depression, one thing we saw was that a set of business executives really stepped up to the plate to use their skills and their management capabilities to lead their country and their companies back out. They were voluntarily setting aside compensation that they contractually been awarded and entitled to said they would come to work for $1,” said Balachandran.

He continued, “Maybe the folks at AIG didn’t have to do anything that drastic, but wouldn’t it have been a great idea if they had said, ‘We know we are contractually allowed to take this, but why don’t we change this? We are willing to defer what we are entitled to.’ They could do this as an act of faith and take the bonus after the company has turned the corner and is able to pay back the government and taxpayers. Think about the amount of confidence it would restore to voters and taxpayers who feel helpless right now.”

Balachandran added, “This is the time for business to lead, not for business to sit there and say, ‘We’re contractually entitled, so this is what we do.’ We have to restore people’s confidence. The same thinking that got us into this mess isn’t going to get us out.”

Photo credit: Clarke Thomas

With the economy sputtering, many are looking to a government-funded expansion of our broadband networks to spur a recovery. The recently-passed economic stimulus package allocated $7.2 billion for projects to expand broadband, including bringing service into rural areas. But will increasing our nation’s Internet connectivity create jobs and promote economic growth?

Yes and no, says Raul Katz, adjunct senior research scholar in finance and economics and the director of business strategy research for the Columbia Institute for Tele-Information (CITI). Katz recently spoke about the impact of the expansion at a conference cosponsored by CITI and Georgetown’s McDonough School of Business.

He says that while physically expanding the networks will undoubtedly create jobs, “the most difficult part is determining the jobs that will be generated as a result of network externalities (e.g. the innovation effect, the productivity impact). The research in this area is very embryonic.”

Katz also cautions those looking for a quick pop in economic growth.

“Economists have determined that in order to profit from information and communication technologies, firms have to modify their production processes and organization to adapt them to the new technology,” he says. Katz estimates the timetable for changes in business processes, training and exploration of new applications to be two to three years.

Additionally, Katz says that people receiving broadband access by way of the expansion might be less likely to take advantage of the technology’s benefits than earlier adopters.

And just as the expansion may create new jobs, it will destroy others. New technologies focused on efficiency often leave some professions obsolete. A New York Times article on the subject refers to this as the “John Henry Effect.”

“Productivity enhancement that is not compensated by business expansion necessarily has to lead to job destruction,” says Katz. “If new services/businesses are not developed by firms having a productivity dividend out of broadband, jobs will be eliminated.” The sector most likely to be affected by this trend, Katz says, are professional services, which are information intensive.

There’s also the risk of increased outsourcing, which Katz’s research (PDF) suggests is a likely result of the expansion.

Katz recommends that the following steps be taken to ensure that the U.S. gets the most bang for its broadband buck:

• Provide incentives to companies likely to outsource services to help keep jobs in the region
• Enact job creation programs that include relocation of businesses in the areas where broadband is deployed
• Promote business innovation that can lead to the creation of new services by the firms benefiting from broadband-induced productivity effects
• Train the workforce and entrepreneurs take advantage of the newly deployed broadband infrastructure

Mark-to-market currently requires banks to reprice their balance sheet assets each day based on the assets’ open-market value. Banks claim that the rule is forcing them to unfairly mark down the value of their assets, such as their mortgage-backed securities. Supporters of mark-to-market say that it creates more transparency.

While some investors are putting a bullish spin on the news of the possible rule adjustments, Floyd Norris ’83 has a much more skeptical view. In his Friday column in the New York Times, Norris writes, “Sadly, a victory for the bankers would not help them much. Even if it were true that banks would be held in higher regard now if they had not been forced to write down the value of their bad assets — and that is, at best, debatable — changing the rules now would be counterproductive. Would you trust banks more? Would other banks be more inclined to trust banks?”

In an interview earlier this week, Warren Buffett ’51 came out in favor of suspending the mark-to-market accounting for regulatory capital purposes.

Appearing on CNBC’s The Kudlow Report on Wednesday, Senior Vice Dean Chris Mayer offered his thoughts on the issue. “The problem is, ‘What are the write-downs that are still sitting in the system?’ The continued critique of mark-to-market is that the current values are just based on illiquidity and they’re low. But we have not seen the bottom of the economy, so I don’t know how anyone can say the values are too low.”

New debate over protectionism has emerged in the past week about a clause in the stimulus bill that stipulates that firms building public works must “buy American.” The language has now been softened to comply more consistently with U.S. trade obligations. The irony in the situation is that proponents of the bill, such as many U.S. steel companies, don’t want to be forced to buy their own inputs from only U.S. companies. They know this could raise their cost substantially and that American consumers and firms may not want to pay for that. However, even with new qualifiers, there is still potential for the clause to endanger global recovery in several ways.

1. It violates international trade obligations
This is a violation of the United States’ international treaty obligations as both a member of the World Trade Organization and as a member of bilateral/regional trade agreements such as NAFTA. A fundamental principle of the WTO obligations is “national treatment,” meaning that foreign- and domestic-made products receive the same treatment. When all countries participate, consumers and firms enjoy the benefit of lowest possible costs. This is the principle that the United States — a long-time champion of taking down trade barriers — has been pushing for the last six decades. The United States often accuses other countries, such as China, for not living up to their WTO obligations and for having protectionist policies. But the “buy American” clause does exactly what U.S. has asked other countries not to do.

2. As others may follow suit, this could be self-defeating
Other countries may feel justified to enact their own protectionist measures, following the U.S. example. As a result, American firms such as GE and Caterpillar will be able to sell fewer American-made products in other markets, and that will cost the U.S. more jobs than the stimulus package can save.

3. It opens the door for WTO cases against the U.S.
Not only could the clause itself could be the basis for a WTO case against the United States, it may also lead other countries to challenge the financial sector bailout package that the Obama administration is still designing and expanding. Why? At the moment, no country has challenged the United States for its bailout packages, such as TARP, which are separate from the stimulus package and designed to help its troubled financial institutions. However, other countries might argue that these bailout packages effectively offer government subsidies to the cost of capital for U.S. manufacturing firms, giving U.S. exporting firms an unfair advantage in the world market. This is the sort of thing — launching a WTO case — that the U.S. trade representative often threatens to China, charging that Beijing’s majority state-owned banks are subsidizing the cost of capital for its exporting firms.

The European Union and Japan may not launch such a WTO case as they are also buying non-performing bank assets at an above-the-market price. Others may be willing to give the United States some breathing room to sort out the financial mess. But there are some major trading partners who do not have the same kind of banking-sector problems, such as China, India and Brazil, and their inhibition to launch a case against the United States may be removed if they see that Washington is making some protectionist maneuvers.

4. It undermines broad foreign policy objectives in the long term
The United States prides itself as a nation of principles; it is also looked up to for its ideals as least as much as for its military supremacy (or so we would like to think). This clause will undermine the six decades of U.S. leadership in the global economy, especially in the area of multilateral trade liberalization. If the clause becomes law, it will encourage a cynical perception by other countries that there is a gap between the Americans’ lofty words and selfish deeds. This cynicism could spill over to non-economic spheres, undermining U.S. foreign policy objectives more broadly.

Photo credit: Vards Uzvards

Over the last two weeks, international students and foreign nationals working in the United States under H-1B visas have been forced to grapple with a new reality: under a provision in President Obama’s recently passed stimulus package, they may not be able to continue working in the U.S. (View a list of H-1B employers in 2008.)

The provision, which calls for limits on hiring H-1B visa holders, affects firms that have accepted TARP funds. Major TARP recipients include Citigroup, Bank of America, AIG, JPMorgan Chase, American Express and Goldman Sachs among others. (View the compete list of TARP recipients.)

In response, Dean Glenn Hubbard has written letters to Treasury Secretary Timothy Geithner and National Economic Council head Larry Summers to express deep concern over the provision and how it will be implemented.

“This is absolutely terrible,” the dean told students in a town hall meeting last Thursday. “It gives an advantage to international institutions over American institutions,” he said. The dean did sound a note of optimism, saying, “I believe [the problem] will get fixed.”

It is still unclear how the provision will affect students looking to enter the workforce. Thomas Monaco, director of international advising and outreach, says that recruiters have not yet indicated any changes in their strategies. The School’s Career Management Center is in contact with all of its recruiters and peer schools to continue to monitor developments.

“Many of our recruiters are still translating the legislation,” Monaco says. “Right now it is very much a wait and see situation.”

International students comprise approximately one-third of the class of 2009. Some of those with student visas can stay in the United States for one year after graduation for optional practical training. However, workers who need or have H-1B visas still face some uncertainties.

“The School is doing everything possible to act as advocates where we can and stay abreast of developments as they occur,” says Monaco.

The provision has generated concern throughout financial and academic communities alike. Last month at a conference organized by the Council on Foreign Relations, Columbia professor and economist Jagdish Bhagwati commented on the loss in talent that will occur if the provision is upheld. “In terms of broader considerations like the people who are coming in on H-1B visas,” Bhagwati said, “they’re frequently highly trained and talented people … a lot of our progress and prosperity depend on having such people.”

Photo credit: Columbia Business School

President Obama’s housing plan, which will take effect on March 4, is aimed at two groups of homeowners. The first group simply cannot afford to make their mortgage payments and are in acute danger of foreclosure. The second includes homeowners who are current on their payments but who are unable to refinance in the face of high interest rates due to their homes’ decreased value.

“The nightmare scenario is that this second group of homeowners will all start abandoning their houses,” says Professor Eric Johnson. “But behavioral economics suggests that won’t happen so easily.”

“We need to know one fact: how many people will abandon their houses when that property is underwater. Standard economics makes a clear prediction that when your house is underwater, and you owe more than it’s worth on the market and that amount is more than it costs to move, you will abandon the house and accept a foreclosure.”

“But there are two effects in behavioral economics that suggest that won’t happen so easily,” Johnson continues. “The first is the endowment effect. People tend to value their own house above its market price.” Johnson cites a 1997 study by Senior Vice Dean Chris Mayer and David Genesove of MIT that analyzed the Boston condo market in the early 1990s. The study showed that a homeowner’s equity position determined his or her experience as a seller. Those with a high loan-to-value ratio set a higher reservation price, causing the home to take longer to sell. “Owners don’t want to sell at a loss. They have what we call a loss aversion,” Johnson says.

“Secondly, people weight present outcomes more than long-term benefits. Imagine making a choice between staying where you are and moving somewhere else. That somewhere else might be nice, but what do you have to do to get there? You have to pack up, pay movers and learn a new neighborhood. All those are upfront costs, while the benefits are long-term. People are impatient and weight present costs and benefits more, so they will walk away less often than we might think.”

Photo credit: Eric Hackathorn

“It was very good that Greenspan used the N-word,” Professor Joseph Stiglitz said in reference to bank nationalization at last night’s community forum on the economy. Stiglitz said that temporary nationalization is “not that big of a deal” and that it is essential to changing incentive structures.

“When the economy recovers, you privatize again,” he added.

Bank nationalization was just one of many topics the Nobel Prize–winning economist covered in his 70-minute talk, which was streamed live on the Columbia Business School Web site as well as on the Huffington Post. Stiglitz opened by discussing the macroeconomic view of the financial crisis, citing two factors that are now playing out: the growing economic inequality in most countries and the aftereffects of the 1997–98 East Asian crisis. He called the management of that crisis “miserable.”

“The consequences of the IMF and U.S. Treasury were such that affected countries said ‘Never again,’ and they felt it was just too risky not to have huge reserves,” he said. “Now [those countries] are living within their means, and there is one country that was the consumer of last resort. That was the U.S. That game has now changed — and that’s the important part. It will be difficult for the U.S. to continue to live beyond its means.”

Stiglitz went on to discuss the three aspects of the government’s response to the financial crisis.

On the stimulus: “The consensus was that it was not enough. It is trying to offset deficiency in aggregate demand, but it’s just too small … The guiding principles for a good stimulus are that it should be designed with high multipliers, it should be fast-acting and should address long-term problems … but this is not designed as it should be.”

On the housing initiatives: “Try to get people to refinance mortgages and get interest rates lower. Part of the problem is that homeowners still can’t afford these mortgages, so the government is trying to provide incentives to lenders to refinance and provide lower mortgage rates, but it is difficult because people have no equity left and have no money to take out a new mortgage. The general feeling is that this will only help a fraction.”

On fixing financial institutions: “It is pretty clear that TARP 1 — the first $350 billion — did not work. It gets an F or F–, depending on your grading structure. What we squandered on our banks would have fixed Social Security for several generations … This is close to a zero-sum transaction. The losses are there and people are talking about moving those losses from one part of the balance sheet to another, but those losses don’t disappear from society. They are still there. Most of what’s happening is just moving things around with financial alchemy. It’s not quite zero-sum because it can be a negative sum if you don’t get it right … People talk about the greed of bankers in taking the money the government gave them and using it for bonuses, not recapitalization … Well, they were doing what their incentives told them to do … A big mistake the government has made is that it has confused its ability to make loans with its incentive to make loans.”

Read the live Twitter feed from this event.

Photo credit: Apesphere

Throughout the financial crisis, one question has bubbled to the surface again and again: “Who’s to blame?” While many are pointing the finger at former executives like Stan O’Neal and Dick Fuld, others are targeting something a little more abstract: the models financial institutions use to calculate the risk in their portfolios.

A recent New York Times article chronicled the role that VaR (Value at Risk), the most widely used of these models, played in contributing to the crisis. Joe Nocera, the author of the article, summarizes how the model works: “If you have $50 million of weekly VaR, that means that over the course of the next week, there is a 99% chance that your portfolio won’t lose more than $50 million.”

The potential damage represented by the remaining 1%, however, is incalculable. And while events that trigger losses in this range don’t come along often, they do come along. The subprime crisis and subsequent credit crunch were extremely unlikely events; as such, they were just the type that models like VaR were ill equipped to anticipate.

Taking issue with the model is Professor Eric Schoenberg, who first expressed his frustration in a letter to the editor. “Relying on a faulty measure is fine,” Schoenberg says in an interview, “if the only person who suffers when that measure fails is you. But that’s not the way the system is set up. And unless people acknowledge that they basically are relying on a public utility to allow them to run their business — which very few investment banks are willing to acknowledge — it’s not an exercise in intellectual argument. It’s an exercise in power politics. It’s about what you can get away with.”

While Schoenberg admits that the issue of how much risk financial institutions should be allowed to take on is a difficult one, he believes that leverage lies at the heart of the matter. “In order to address the moral hazard problem, people have to have a lot more at risk themselves relative to what generalized risks they’re creating. There has to be a significant reduction in the amount of leverage we allow these institutions to have.”

Where do we go from here? “We must acknowledge that there is a fundamental disconnect between what makes sense for individuals and what makes sense for the group, and the only entity that can address what’s right for the group is the government,” Schoenberg says.

“Basically, this is the issue of free market fundamentalism, which is the idea that markets are best and any time the government intervenes it’s going to screw things up. Well, if you have that belief, you know, you’re going to have these things happen over and over and over again.”

Photo credit: Travel Aficionado

Treasury Secretary Timothy Geithner unveiled the government’s revised economic plan yesterday. From pundits to economists, response to the plan was lukewarm at best. Professor Charles Calomiris reacted to the Treasury’s announcement by saying:

I have serious problems with the plan. It will move much too slowly and not have a dramatic enough effect. The architects of the plan have added some good ideas, but their concerns to make sure that the taxpayers get a good deal have gone too far, to the point where the package may do little for the banks or the economy, which makes the bill penny wise and pound foolish.

In an interview with BusinessWeek, Calomiris said the plan emphasizes “very careful investments over a period of time with a lot of upside potential for taxpayers, and with all sorts of limits on what bankers can do.” One way he suggested that the plan could be improved was to guarantee banks a floor prices on their real estate assets.

Professor Chris Mayer offered his thoughts on CNBC’s The Kudlow Report (watch video):

“This is perpetuating a broken system… It’s not a good model and we shouldn’t be trying to fund a trillion dollars of it.”

Professor David Beim also commented on aspects of the plan on Forbes.com:

[Beim] estimates the potential losses to banks from the credit crisis at between $1 trillion and $2 trillion, an enormous capital hole that the government needs to find a way to fill, since private investors don’t appear willing to do so anymore.

“They're going to have to find a way to do that. Banks themselves don’t know if they are insolvent because they don’t know the value of their assets. It's a very odd situation,” Beim said.

Photo credit: Treasury Department

President Barack Obama announced a plan this week that would limit executive compensation at companies seeking large amounts of government aid. The plan includes placing a $500,000 cap on the annual salary of senior executives and restricting the cashing in of stock incentives until government assistance is repaid.

But will the limits create a leadership void at these firms? Professor Nahum Melumad said that some of the proposal’s terms could hinder recruitment and retention.

“You need the best talent money can buy and that may be difficult without the right award,” said Melumad. “Currently the administration is saying that a company may pay a large amount in the form of stock options, but that executives will be allowed to exercise those only after the government has sold its equity positions. That may be too long a period to retain any incentive impact and to attract top managers."

“A better way might be to have executive compensation consist of two key components: a ‘reasonable’ base pay and an additional component that is a function of improved company performance,” Melumad said. “The latter should have significant upside potential to attract top managerial talent.”

Professor Sudhakar Balachandran points out that even if firms aren’t too concerned about losing talent, they’re still faced with the challenge of motivation.

“There have been some arguments that there will be an exodus, but I am not too worried because the job market and prospects are tougher now,” he said. “In the past we’ve seen turnover when a firm’s retention mechanisms fail. But today, if someone wants to leave, where would they go?”

“If there’s no upside potential, you now have to worry that people will not work hard or smart, but instead that they will just show up and check off the boxes,” said Balachandran.

Photo credit: White House/Pete Souza

Last Friday, I participated in a dinner conversation at the World Economic Forum in Davos on whether economics itself is in need of a bailout. The consensus view, which included perspectives from several far more distinguished economists than myself, was that as a predictive social science, economics has not failed. That is, people do generally make decisions based on cost-benefit trade-offs and incentives, and thinking about human decision making in this way is a very effective means of understanding what people do in companies, markets and the economy as a whole.

The natural question, then, is why the world out there has such a dismal view of the so-called dismal science? My answer was that we, as economists, have been terrible ambassadors of the profession in two critical ways. First, we have not properly conveyed the limits to economic predictions. An economy is a very complex system with highly imperfect information and many moving parts. Perhaps more importantly, we also haven’t properly communicated — to students and to the public at large — that economics is about more than the straw man of perfectly efficient markets. Any sensible economist — from Berkeley to Chicago — understands this perfectly well.

What are the implications for policy, and for economics as a profession? First, we have to be a lot better at “selling” our ideas to the public. Rather than leaving it to journalists to parody economic theory, we need to get our voices heard in the public debate. Second, we could do with a dose of humility. If the popular perception is that economics should be an all-knowing, precise tool for fine-tuning the economy, it may be because a lot of economists have drunk a little too much of the economics-as-crystal-ball Kool-Aid themselves.

Photo credit: World Economic Forum

Professor Frederic Mishkin, a former member of the Board of Governors of the Federal Reserve System, met with students yesterday in a community forum to present his view of the current financial crisis. Framing his analysis in the historical context of the Great Depression, he said that many elements of the current crisis were “classic” and that they inspired a sense of “déjà vu.”

“The basic issue is that financial markets are the brain of the economy,” Mishkin told the students. “They are key to an economy functioning well because they help allocate capital to productive investments. But when financial systems stop working and they can no longer allocate capital, we see what is happening now.”

“A basic problem in allocating capital is asymmetric information … It’s an agency problem. What happened in this financial crisis, and in financial development, is new financial innovation, which in the long run is a very good thing,” he said. “The innovation was driven by a couple of features, technology and high-speed computers. This allowed you to do two things: cheaply bundle small loans into a security, so there were low transaction costs, and get information on people and their credit worthiness in a quantitative manner.”

“This allowed you to democratize credit and give credit to people who otherwise wouldn’t have gotten it, and then put those loans into a security and sell it off. A lot of people would like to see subprime lending never happen again but that would be a disaster. It is a real danger that regulation could kill off this market because it is something that, if it’s done right — which it easily can be — is a tremendous benefit to the average person who couldn’t access credit before.”

“But the problem is that sometimes you don’t solve all the information problems,” Mishkin continued. “Although there were all these benefits, maybe people didn’t have the right incentives to pay back [the loans] … Incentives were not aligned with those of the holder of the security.”

“We also had a huge flow of liquidity come in; poor countries were providing capital to rich countries, [like China to the United States],” he said. “As a result we had this global savings glut and huge inflows of liquidity. This, combined with the financial innovation, made the system go wild. Also what you see — and this is classic — is that when you have innovation and a burst of liquidity [together], you frequently have an asset bubble. And in this case it was in the real estate market.”

Photo credit: Randen Pederson

Linda V. Green: He should give top priority to changing the diagnosis-related group (DRG) system, which is the hospital payment system for Medicare (and which is used by private insurers, as well). This system is highly skewed toward compensating for procedures rather than medical care. As a result, hospitals tend to invest in profitable areas, such as cardiac and orthopedic surgery, but neglect to add capacity to often over-crowded clinical units that care for patients suffering from strokes, heart attacks, pneumonia and kidney failure. This has caused the nation to experience increasing emergency department congestion and ambulance diversions, which lead to sometimes-fatal consequences. Also as a result, many unnecessary, expensive procedures and surgeries are being performed. Current estimates are that up to 45% of cardiac bypass surgeries and perhaps the majority of angioplasties are unnecessary. So changing the DRG system would result in both lower costs and better quality.

Murray Low: The top priority has to be to restore confidence in our institutions, both government and business. In recent years there has been a huge erosion of trust because of self-dealing by those in leadership positions. We need to have leaders that inspire.

Garrett van Ryzin: Restore the world’s faith and trust in the American ideal.

Michael Feiner: The most important issues are trust and transparency. If those are addressed, Obama will get it right as it relates to healthcare, the economy and education and so on. People need a dose of the optimism that has characterized the American mindset. And the optics of trust and transparency are as important as substantive fixes and solutions in each area. The first thing to do is hire great people, which he has done for the most part — he has gone for quality, not cronies. The second thing is to become vocal, frank and communicative frequently — both with press and American people. This is not the time to hide and manage and spin the data. He needs to communicate his plans and where he is against those plans. He needs to demonstrate that he will reach out to foreign powers and that he is more collaborative and less isolationist. There are lots of public things he can do using pulpit of presidency to show that the administration will do things very differently.

Photo credit: Jay Tamboli

We’ve been down this road before, and seldom has the ending been pretty. General Motors and the other American carmakers are textbook cases of what one of my colleagues famously called “permanently failing” organizations. The syndrome of permanent failure afflicts supposedly for-profit organizations that create no economic value or that even destroy economic value. This syndrome often persists because a coalition of stakeholders comes to value the organization as an organization — as an institution — and its survival becomes an end in itself. The webs connecting the entities that benefit from the company’s ongoing existence are so strong that they dominate all decision making. GM, depending on whose analysis you read, is widely recognized as having destroyed billions of dollars in economic value, and it has been unsuccessful in its half-hearted efforts at transformation since at least the 1970s.

What seems to be killing the company is a giant-sized version of the same self-inflicted wounds that get in the way of innovation and change at many large organizations: coalitions of value-chain partners; legacy agreements that lock in decisions that made sense in another era but no longer do; and leaders who are so embedded in a given thought world that they find it hard to move to a new model. These issues are frequent topics in our executive course Leading Strategic Growth and Change, in which a key theme is determining how to get your organization to not end up like GM by making necessary innovations and continuously changing as your world evolves.

This is not to say that GM hasn’t had its better moments. Its OnStar system is a textbook example of how to get innovation right, and the popularity of GM’s products internationally speaks well to its ability to produce cars and trucks that significant numbers of people want to buy. The problem is that the bulk of the organization remains unchanged, largely because those who would suffer from any such change conspire to keep things as they are.

So what is to be done? Clearly, a bailout is only going to prolong the death agonies. A bailout will do nothing to unwind the web of dependency relationships that are a huge part of GM’s trouble. Indeed, read any proponent of the bailout’s justification and you’ll hear all about the harm a GM bankruptcy would do to workers, suppliers, counterparties and other interested parties. I’ve yet to read one, however, that refers to the irredeemable loss to GM’s loyal customers, save those that argue that customers will have difficulty finding replacement parts in the future.

Somehow, the road to redemption is for the company to start unwinding the coalitions that trap it in its current situation. A bankruptcy could be a start. So could a slash-and-burn acquisition, though that hasn’t seemed to help Chrysler much. I’m not wild about the idea — who could be, considering the economic carnage it would likely create? The problem is that unless GM feels a compelling need to change, things are highly likely to stay pretty much the same, as they have done for decades, in spite of clear evidence that things are not working well from an economic perspective. As Peter Drucker once said, “The purpose of a business is to create a customer.” GM has not fulfilled that purpose very well.

Where public money could usefully go is toward lessening the pain for stakeholders, ameliorating the damage to innocent bystanders and helping with social adjustment costs. Without a fundamental transformation, the endgame can only be delayed, not avoided entirely.

Federal Reserve Chairman Ben Bernanke announced yesterday that the Federal Reserve will do more to focus on economic recovery, possibly buying up bad assets and providing more capital injections to banks. Bernanke also said that Fed could influence longer-term interest rates by informing the public’s expectations about the future course of monetary policy.

The Fed’s policy response to the crisis was a frequent topic of discussion at last month’s research symposium, “Preventing the Next Financial Crisis.” Floyd Norris ’83, chief financial correspondent for the New York Times, suggested that the crisis could have been tempered had the Fed used monetary policy to keep asset prices from spiraling out of control.

“I still don’t understand why no monetary response is appropriate when asset prices rise beyond reason, but immediate and sharp response is needed as soon as they fall. Basically, I think that economists have learned the lessons of the 1930s, but they have yet to learn the lessons of the 1920s,” said Norris, responding to the keynote address given by Professor Frederic Mishkin on the role of monetary policy in the current financial crisis.

Mr. Norris spoke as part of a panel with Matthew Bishop (The Economist), and Chrystia Freeland (The Financial Times) for the conference, which was held by the Sanford C. Bernstein & Co. Center for Leadership and Ethics.

To view full-length videos of conference presentations, please visit the conference Web site.

As part of his economic stimulus package, President-elect Barack Obama will reportedly propose a significant expansion of the country’s broadband Internet networks. For the program to launch successfully, however, it must address the issue of network neutrality, Professor Eli Noam said in a recent interview with Fortune Magazine.

Proponents of net neutrality argue that broadband Internet consumers should be free of any content monitoring or restrictions. Network providers, such as Verizon, Comcast and Time Warner, however, say that without the ability to control the data traveling over their networks, they are reluctant to expand their services.

Noam, professor of finance and economics and director of the Columbia Institute of Tele-Information, said that the stimulus package should be designed with the issue of net neutrality in mind:

[Noam] thinks the telecom companies, content providers and lawmakers need to acknowledge the net-neutrality issue in formulating any broadband stimulus package — thus far, few have mentioned it — and essentially forge a pact: “The telecom companies want their incentives, the Internet companies want openness, and citizens need stimulus,” he says.

“If the government makes the stimulus strong enough for the infrastructure providers but makes it conditional on policies of openness, you can, in a way, have the government underwrite the openness.”

Photo credit: von Kinder

The massive accounting scandal involving Satyam, one of India’s largest outsourcing companies, seriously hurts investor confidence, not only in India but worldwide, says Professor Sudhakar V. Balachandran.

“They should have been under good accounting scrutiny, and so this is shaking confidence,” Balachandran said in a phone interview Thursday morning. “There will be spillover effects, people will think twice about investing in Indian tech companies, investing in India and, following that, investing in the market. It’s the old story of a few lemons corrupting the entire market.  If you can’t tell the good from the bad, it just becomes too risky to invest. Eventually that poses risk to the entire economic system.”

In an op-ed published on Forbes.com on January 8, Balachandran says that the three mechanisms to prevent fraud — corporate governance, audits and legal consequences — are not doing enough.

The company’s good social standing added another layer of complexity. “[Satyam] was well run and well governed.  They also did a lot of charitable work in rural development in India, so they appeared to be taking social responsibility seriously. They did a couple little things with their accounting early and then it snowballed,” said Balachandran. “These may not have been evilly intentioned guys; they had a history of doing good.”

Especially worrisome to Balachrandan is the failure of the requirements for auditing control systems.

“Satyam has an ADR [American Depository Receipt] and they are listed on the NYSE, so they have to follow American rules similar to those of American publicly traded companies. That includes having audited financial statements, using US GAAP, having signatures from the CEO and CFO stating that their accounting is sound as required by Sarbanes-Oxley Section 302, and so on. With all this, the company reported a lot of cash — a little more than $1 billion — that wasn’t there,” he said.

“Section 404 of Sarbanes-Oxley has very strict and very costly rules on what should be audited in the firm’s internal control systems. Auditors certify the controls so we can believe that the company is not recording fictitious transactions, so that when they say they have made a sale, we can believe they actually made a sale. In addition, auditing standards in India are not trivial and definitely require the auditing of cash. The fact that they didn’t catch the missing cash [at Satyam] raises a lot of questions.”

Prof. Balachandran acknowledges Columbia Business School professors Ray Fisman, Bruce Kogut, Partha Mohanram and Amir Ziv for their contributions in the analysis of the Satyam situation.

The housing market and growing number of foreclosures are placing an enormous strain on American households and the economy. There were more than 2.2 foreclosures started last year and house prices are in the worst decline since the Great Depression. Fixing these problems must be a priority for the next administration.

The government needs to take a two-pronged approach. The first part — stabilizing the housing market — is something I have discussed widely. In a plan developed with Dean Glenn Hubbard, I propose that the government allow new mortgages to be issued at a rate that is 1.6 percent above the rate of a 10-year Treasury bond. That new rate, which may be as low as 4 percent for conforming mortgages, will stabilize the housing market, provide a fiscal stimulus and raise housing demand.

The second part is preventing foreclosures, which I spoke about today in an interview with CNBC (watch video). My Columbia University colleagues Edward Morrison and Tomasz Piskorski and I have outlined a new proposal for reducing foreclosures. We propose a combination of an incentive fee program for service providers and a legislative initiative to modify servicing agreements.

Ours is a new approach that focuses on what has been the most intractable part of the foreclosure problem: the behavior of third-party servicers who manage portfolios of securitized portfolios. Recent research from Thomas Piskorski, Amit Seru and Vikrant Vig shows that third-party servicers opt for foreclosure much more often than banks that service their own loans.

The proposal eliminates the barriers that prevent these third-party servicers from better managing their portfolios. The first step is to create an incentive fee structure to make loan modification rewarding for both servicer and investor. Secondly, temporary legislation must remove explicit barriers for modifying PSAs and should create “litigation safe harbor” that insulates servicers, provided they modify loans in good faith for investors. We calculate that by taking these steps, up to one million foreclosures can be prevented at a modest cost of $10.7 billion to taxpayers.

The way to fund solutions on both these fronts is with TARP expenditures. If the new administration makes this a priority, they can facilitate economic recovery, reduce foreclosures and help struggling homeowners while protecting taxpayers.

As 2009 begins, the economic lessons learned during the financial crisis will quickly be put to the test. Participants in the recent research symposium, “Preventing the Next Financial Crisis: Lessons for a New Framework of Financial Market Stabilization,” which was hosted by the Sanford C. Bernstein & Co. Center for Leadership and Ethics, provided a look at some of the issues and trends that will shape the year ahead:

Monetary policy is still effective, said keynote speaker Professsor Frederic Mishkin. “I think it’s an absolute fallacy that monetary policy isn’t effective during a financial crisis. It’s just plain wrong.”

Bankruptcy should be an option, because it allows for speedy work outs, argued Professor David Skeel of the University of Pennsylvania Law School. “The problem is that if you address one form of moral hazard [with a bailout], you create another. With Bear Sterns the Fed addressed shareholders’ moral hazard, but [in doing so, it] created creditor moral hazard. That is why, I argue, firms like Lehman didn’t do a lot to try and change their balance sheets after the Bear Sterns collapse,” he said.

Regulatory process will undergo a major overhaul in 2009, said Dean Glenn Hubbard. Many panelists agreed that the systemic risk of trillion dollar markets, such as those for credit default swaps, is too great and that such instruments should be traded in regulated clearinghouse exchanges.

The price of homes must be bolstered, said Senior Vice Dean Chris Mayer, who, with Dean Hubbard, has designed a proposal to stabilize the housing market by guaranteeing a 4.5% interest rate for American homeowners. According to Mayer and Hubbard’s calculations, this would allow Americans to refinance their homes, yielding an average monthly savings of $350.

Financial literacy is poor amongst the poor. Data presented by Professor Stephan Meier about financial literacy showed that 30% of people with adjustable rate mortgages do not know that they have them. This percentage is fairly descriptive of all income groups, however Meier said that it is highest among the poorest.

We asked faculty members to look back at the year and give us their pick for the best idea or book of 2008. Here’s what they said.

Professor Joel Brocker
Best idea: Behavioral economics and decision making
Why? “This year it’s been quite exciting to see the related fields of behavioral economics, behavioral finance and behavioral decision making coming into the popular domain,” said Brockner. “The fields refer to the psychological influences on decision making, and how people don’t always adhere to ‘economically rational’ views of decision making. There have been a number of books on this topic in recent years, such as Blink by Malcolm Gladwell, and in 2008, Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler and Cass R. Sunstein.”

Professor Eric Johnson
Best idea/book: Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler and Cass R. Sunstein
Why? The book’s notion of choice architecture is very powerful for firms and policymakers because they can make changes within their organizations for almost no money, said Johnson, who reviewed the book for Science magazine earlier this year.

Professor Rita McGrath
Best books: The Game-Changer: How You Can Drive Revenue and Profit Growth with Innovation by A.G. Lafley and Enough: True Measures of Money, Business, and Life by John Bogel
Why? Both of these topics, growth and a reordering of business values, will be key in the coming year, according to McGrath. “There will be a structural shift and we’re seeing the early warnings that will happen,” said McGrath. “Financial innovation is not the only kind of innovation. It is a great time for innovators to be looking forward for two reasons. First, tough times mean we have no choice but to be creative; a lot of great companies started this way. Secondly, when resources are hard to come by, people have to behave with more discipline. They test assumptions and impose a more disciplined approach.”

Professor Ray Horton
Best book: John Maynard Keynes: Economist, Philosopher, Statesman by Robert Skidelsky
Why? “I read this book last August while capitalism as we’d come to know and love was melting down into what now looks like the most severe downturn since the Great Depression,” said Horton. “Keynes had been out of vogue among most economists and policymakers for more than a quarter-century, dating back to the ‘purification’ of capitalism by Milton Friedman and other monetarists. If anyone wants to understand why we’re all Keynesians now, to borrow a phrase from Richard Nixon, Skidelsky’s biography provides the answer: Capitalism is very unstable from time to time, and from time to time the state needs to bail it out in order to get it up and running again.”

Professor Paul Glasserman
Best idea: The Federal Reserve’s managed sale of Bear Stearns
Why? “It was executed quickly (over a weekend) and creatively (given that Bear was not subject to regulation by the Fed). The Fed’s only exposure is a collateralized loan, backed by the type of mortgage-backed securities the TARP was later created to prop up,” said Glasserman. “Employees and shareholders suffered from Bear’s collapse, but the managed sale may have been the most effective step taken this year to try to limit the spread of the financial crisis.”

Professor Ray Fisman
Best book: Gomorrah: A Personal Journey into the Violent International Empire of Naples’ Organized Crime System by Roberto Saviano
Why? “The Camorra, Naples’ version of the Cosa Nostra, out-Godfathers The Godfather and out-Sopranos The Sopranos. Sometimes, as the saying goes, truth is stranger than fiction (and in this case it’s certainly a lot more violent). As a scholar of economic gangsterism, it is really striking how often Saviano emphasizes that Naples’ mob bosses are rational businessmen of crime,” said Fisman. “You’ll never look at a ball of mozzarella the same way again.”

Globalization is:

A) The future; it is an irresistible and growing part of economic reality.

B) The dominant force shaping the world’s economies.

C) The fate of the world’s workers and businesses, who must adapt or suffer the consequences.

D) The irrational fear that someone in China will steal your job.

If you picked D, congratulations. You’re ready for the central teachings of Professor Bruce C. Greenwald and Judd Kahn’s new book, glob•ali•za’•tion (n): The Irrational Fear That Someone in China Will Take Your Job (Wiley, 2008).

The slender volume sets out to redefine the term which has become a household catchphrase. The authors make the argument that many of the fundamental assumptions about globalization (see answers A, B and C) are “either highly questionable or largely false.” Instead they argue that globalization is not a new trend, that crucial local forces such as improvements in productivity and changes in demand are ignored, and that hard data has been selectively used or underused in favor of anecdotal evidence.

As the book’s title suggests, the authors argue that job security or the lack thereof, is one of the bigger misconceptions in the commonly held idea of globalization. They write:

Do you agree with the authors’ opinions on globalization? Disagree? Please leave your comments.

The incoming Obama administration is reportedly considering a spending package for as much as $850 billion. If you’re wondering where the money will come from, the Fed announced on December 16 that it would print as much money as it needed to in order to battle the deepening financial downturn. The New York Times’s Economix blog asked a number of economists how they would spend the money, using $500 billion as a ballpark figure. Professor Jospeh Stiglitz said:

Right now there’s going to be a major shortfall in revenues for states on the order of a magnitude of $100 or $150 billion per year. This means they may cut back on expenditures, which would be like a negative multiplier and lead to a contraction in the economy. The first priority is making sure to fill in the hole, that shortfall in state and local money …

The second thing I would do is that we need stronger unemployment insurance. Unemployment is growing more long-term again, and we don’t know the magnitude of that. I’d put that at the top of the priorities, including help for those who would otherwise lose their home because they’re unemployed, and health insurance for the unemployed. That’s my second priority.

The third, I think, obviously is spending money to try to prevent foreclosures, whether that’s part of TARP, or a successor to TARP. That would be foreclosures among lower-middle-income people … which would help stem the financial crisis.

Then fourth is the remaining part needs to be divided among several categories. One of the critical issues here is how quickly you can gear up various kinds of spending categories. There are two important criteria: The first is the bang for the buck, how much stimulus we get for every dollar we spend. The second is consistency with our long-run vision. That means supporting R.&D., including green R.&D. as well as basic research. That also means infrastructure, and restructuring the economy for higher energy prices. That also means schools. There are a lot of decrepit schools. That means a broad infrastructure deficit.

I would actually scale back military expenditures which do not stimulate the economy as much as some of these other kinds of expenditures. Given the high deficit, we have to be careful how we spend money, given our various financial problems. We should restructure our health care system, our energy system, and our military system.

Photo credit: Andy Melton

On September 19, the SEC issued an emergency order to suspend short selling. The ban lasted until October 8, a few days after the U.S. Treasury’s $700 billion bailout plan was signed into law. Professor Charles Jones, chair of the Finance and Economics Division, used the rare suspension to measure the ban’s effect on stock prices. According to preliminary research Jones conducted with colleagues, which he recently outlined in an Ideas at Work article, stocks protected by the ban experienced only a temporary price bump and had their market liquidity degraded. That result, says Jones, should not have been surprising given the historical precedent.

“We want all kinds of information to be part of a stock price, including positive information, negative information, optimistic views and pessimistic views. That’s the way we get the best prices, if they reflect all the information that’s out there. Short selling gives a way for people to trade based on that negative information or opinion,” Jones says.

“But when prices fall dramatically, this kind of ban gets trotted out. There are a lot parallels with 1931 in terms of what we’re doing to harass short sellers. The last time there was a ban was in September 1931 during the Great Depression. The ban was put in place after stock prices had fallen by two-thirds. It was a two-day experiment and it went badly. We don’t repeat history, but it certainly does rhyme, like Mark Twain says.”

“During the three weeks of the ban [in 2008], stock prices cratered, falling by about one-third. Financials fell even more, completely reversing their initial gains,” says Jones. “Even more troubling was the ban’s effect on market liquidity. Stocks subject to the ban suffered a severe degradation in liquidity, as measured by bid-ask spreads.”

For the complete article about Jones’s preliminary research and data on the short selling ban, see “Assessing the Shorting Ban” in Ideas at Work.

In a December 17 op-ed in the Wall Street Journal, Senior Vice Dean Christopher Mayer and Dean Glenn Hubbard expressed their support of a U.S. Treasury plan to lower mortgage rates for new homebuyers to as low as 4.5%. The Treasury’s plan closely parallels Mayer and Hubbard’s own plan, which they unveiled in October. The op-ed follows Mayer’s presentation about mortgage rates and homeownership at the Bernstein Center research symposium, “Preventing the Next Financial Crisis,” on December 11.

In the op-ed, Mayer and Hubbard demonstrate the strong relationship between housing prices and mortgage rates and how lowering mortgage rates now will likely increase homeownership rates in 2009. They also argue that house prices are already at or below where they should be based on fundamentals (download research paper PDF).

They also address one of the main concerns swirling around the Treasury’s possible plan: its risk to lenders:

Some have argued that lenders should earn more than the average 1.6% spread, to compensate for the fact that housing is a much riskier investment today. We don't think so. Recall that a mortgage can be thought of as a risk-free bond plus two possibilities that increase risk to lenders: default and/or prepayment. Historically, the risk of default adds about 0.25% to the interest rate. The remaining spread of the mortgage rate over the Treasury yield represents the risk of prepayment and underwriting costs. With falling house prices, the risk of default could indeed add 0.75% or more for a newly underwritten and fully documented loan. But 4.5% would be the lowest mortgage rate in more than 30 years — so the additional risk to lenders of prepayment would be almost nil. And low mortgage rates would substantially reduce the risk of further house price declines.

Professor Charles Calomiris, speaking at the Bernstein Center symposium, supported Mayer’s plan, saying, “The incremental costs to the taxpayers are negative. The GSEs that we now own have $5 trillion of mortgage debt, $1.6 trillion is subprime with 10 times the current default rates of the normal remainder in that portfolio. We also have trillions of dollars of FSA mortgages and, of course, [the ones] in the private sector. If you look at expected losses on those subprime pieces, which are somewhere between 20 and 25% right now, that the effects of [Mayer’s] proposal would be to reduce taxpayer’s fiscal costs going forward.”

Last week’s Senate decision to abandon an auto industry bailout bid has raised the possibility — again — that General Motors and Chrysler will not survive. It also rekindled the debate about protectionism. In a recent interview with Worldfocus, Professor Bruce Kogut discussed whether or not the American automotive industry is suffering from the protectionist policies adopted by several U.S. trading partners.

“By and large it’s not true [in Asia],” said Kogut. “China is a quickly growing market and GM is making a lot of money there; [GM] is also located inside Korea. American manufacturers have already placed investments and have plants operating there, so the case is more on the U.S. export side. There have been some constraints in exports to these markets, but most of them have been tapering down over time. The impact on the U.S. is not going to be very large.”

Do you think foreign protectionism has contributed to the decline of the Big Three automakers?

It’s Monday again, and in what has become a too-familiar weekend drill, major financial institutions — Lehman Brothers and Merrill Lynch — failed to emerge in their last-Friday form. And Lehman’s bankruptcy and Merrill’s takeover have important lessons for policymakers.

Lehman’s demise as one of Wall Street’s oldest and most well known independent firms comes on the heels of the forced sale of Bear Stearns to JPMorgan Chase, the government’s “conservatorship” of Fannie Mae and Freddie Mac, and now Bank of America’s acquisition of Merrill Lynch. Just two Wall Street titans remain.

The Treasury and the Fed have been aggressive. The “blank check” power given to the Treasury by Congress has provided taxpayer support of unknown size to mortgage giants Fannie Mae and Freddie Mac. The Fed’s rush of liquidity injections reflect Walter Bagehot’s classic Lombard Street advice “to lend freely.” And lend freely it has, with extraordinary liquidity provisions — through a more attractive regular primary credit program, the Term Auction Facility, the Term Securities Lending Facility, and the Primary Dealer Credit Facility. Borrowers include banks, investment houses, Fannie and Freddie and, now, AIG. The credit risk on the Fed’s balance sheet will be borne by — you guessed it — the taxpayer.

Now the Treasury and Fed should not ignore systemic risk just to limit moral hazard. But all of this firefighting has left us with problems remaining. Additional write-downs are coming. We cannot and should not try to protect every institution.

But, stepping back, there are steps we should take. To limit the further spread of real estate woes to the broader economy, expanded FHA authority for mortgage refinancing can make sense. In addition, putting in place a clean-up agency like the 1930s’ Homeowner’s Loan Corporation or the 1980s’ Resolution Trust Corporation would help. Taxpayer funds used to support such vehicles offer more stimulus and stabilization than temporary tax cuts or public spending.

The financial meltdown that engulfed Lehman and the uncomfortable responses of policymakers the past several months also highlight the need for regulatory reform. The problem is actually not too little regulation — both lightly and heavily regulated institutions are in trouble. And some regulations encouraged the growth of high-risk mortgage lending.

We do need smarter regulation: a key step is to broaden capital and liquidity requirements and increase them during financial booms to lean against excessive risk-taking.

The events of the past three years highlight that risk misperceptions in a boom can lead to a scramble for liquidity if collateral values decline. Ascertaining this problem in real time will always be tough for regulators (even for the increased number of regulators the Treasury recently proposed).

Bagehot picked up on this, too. His admonition goes on to say: “The time for economy and for accumulation is before. A good banker will have accumulated in ordinary times the reserve he is to make use of in extraordinary times.” That is, regulation of capital adequacy could require more capital to support incremental risk-taking in a boom and lower such capital in a bust. With such requirements, financial institutions would find risk-taking marginally more costly in a credit boom, in which credit risk and liquidity risk are very low. In a downturn, a scramble for liquidity to meet capital requirements would be attenuated.

While strong supervision obviously remains important, this other advice from Bagehot would be an important addition to the policy tool kit. This could be implemented by raising banks’ capital requirements proportionately as risk-weighted bank assets grow. By varying capital cushions over credit cycles, consequences of risk distortions for actual lending and borrowing decisions will be reduced, along with the likelihood of asset fire sales and extraordinary central bank liquidity provisions.

I hope Secretary Paulson will be able to take Chairman Bernanke on one of his famous bird-watching expeditions next weekend.

This column also appeared on Forbes.com.

Photo credit: T. Shein

Understanding the financial underpinnings of mortgage-backed securities, the investments at the center of the financial crisis, is a difficult task. The complex structure of these investments may have even obscured their inherent risk to those parties directly involved with their purchase and sale.

A December 7 New York Times article by Gretchen Morgenson chronicles the predicament of Moody’s, the credit rating agency that has fallen under scrutiny for inaccurately giving high ratings to many mortgage-backed securities, including those with questionable financial fundamentals.

The rating agencies, however, were not alone in their misjudgment. According to a recent article by Professor Trevor Harris in Ideas at Work, all parties to the transactions — including the lenders, mortgage brokers and banks, securities firms and borrowers — failed to understand the fundamentals of these investments.

According to Harris, “[They] were making a bet on constantly rising home prices, while disregarding the real people and real homes on top of which these products were precariously built. Much like a Ponzi scheme, everyone lent to everyone else, creating a bubble and then compounding it. Returns could only continue while new money kept flowing into the system. When the money stopped, the whole system started unraveling.”

Harris suggests that by bringing transparency into the underlying fundamentals and risk characteristics of a business, regulators will be able to provide a more accurate and complete assessment of the related fundamentals and risks.

For a more detailed look at how the fundamentals of mortgage-related investments were neglected and what can be done to prevent this from happening again, see Harris’s article, “Back to Basics,” in Ideas at Work.

Two books by Columbia Business School faculty were named to the Economist’s list of the best books of 2008.

Congratulations to Professor Amar Bhidé and his book The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World. Here’s the magazine’s snapshot review:

A counterintuitive view of technology and globalization that will delight those who believe that American innovation is insulated from economic ups and downs.

The Three Trillion Dollar War: The True Cost of the Iraq Conflict by Professor Joseph Stiglitz and Linda Bilmes was also on the list (and was the source for a popular online video circulating earlier this year). Here’s what the magazine said about the book:

With the patience of auditors and the passion of polemicists, two academics, one a Nobel prize-winning economist and the other a public-finance expert at Harvard’s Kennedy School of Government, take an unflinching look at the hidden cost of invading Iraq.

What else was on book critics’ shelves this year? Fast Company magazine has a nifty interactive feature on their best business reads of the year, and for a comprehensive guide to all of the year-end compilations, check out this blog.

The Treasury is considering a plan that may lower mortgage rates to as low as 4.5 percent for people buying homes. Chairman of the Federal Reserve Ben Bernanke discussed the proposal on December 4 (read complete transcript). The plan, still in development, resembles a plan developed earlier this year by Senior Vice Dean Chris Mayer and Dean Glenn Hubbard (read more).

Prof. Mayer, interviewed in the New York Times on December 5, urged the government to consider extending the low rates to existing home owners in addition to new buyers.

"This really is the opportunity of a lifetime," [Mr. Mayer] said. "If you ask someone if this is the time to come into the market, I think anyone who would have bought a house in 2007 and was sitting on the sidelines, or who wants to buy this year or would buy in 2010, would want to take advantage of this."

Mr. Mayer said long-term Treasury rates are so low right now that the government could actually make a profit on the cheap loans. The Treasury can sell 10-year bonds right now and pay only 2.7 percent a year, far below the 4.5 percent that it would be charging home buyers.

But he said his own preference was to make the mortgages available to existing homeowners as well as home buyers.

"I think there are additional benefits one could have by extending the program for people who refinance," Mr. Mayer said. "At 4.5 percent, you might be looking at 25 million people who could refinance and the average savings could be $400 to $500 a month."

He also analyzed the plan on NPR’s All Things Considered on December 4 (listen to audio) and discussed how the move could bolster house prices. He said:

"My own research shows that as many as 1.5 million to 2.5 million people could come into the housing market if such a program were in place. That kind of influx of new home buyers pulls a lot of inventory off the market. That then stops the decline in house prices and eventually leads house prices to turn the other direction. That's an enormous first step in preventing foreclosures because the lower house prices go, the more people face pressure to walk away from their house."

 

Dean Glenn Hubbard met with students in a town hall meeting on December 2 for a discussion on the state of the U.S. economy and career prospects for MBA students. The forum coincided with news from the National Bureau of Economic Research that the U.S. has been in a recession since last December.

A relatively deep recession will last through the middle of next year, predicted Dean Hubbard. He also discussed actions to bolster the economy, including fixing short-term lending, recapitalizing banks and stabilizing housing prices (see his plan developed with Professor Chris Mayer).

Dean Hubbard also voiced some optimism and pointed to market opportunities, including fixed-income securities. “The most senior secured loans,” he said, “are yielding 17-18%. The refinancing in commercial real estate that is likely to happen will yield huge returns.”

The Dean emphasized that MBAs entering the job market focus on where they want to be in five to seven years. He urged graduates to pursue activities and skills that will gradually advance them up their career ladder.

Looking forward to next year, Dean Hubbard said, “2009 is going to look a lot like 1933.” In that year, a newly elected president Franklin Roosevelt took office in March and enacted a series of government measures which restored, at least temporarily, confidence in the shaken banking system. The year marked the end of a recession that lasted from 1929 to 1933, according to the NBER.

Prof. Amar Bhidé’s compelling thesis from his new book The Venturesome Economy, was recently featured in the New York Times and The Economist.

At the heart of his argument is the idea that technological innovation is important for economic development. As important, though, if not more so, is the ability to apply that innovation creatively.

“The largest benefits,” Prof. Bhidé says, “will accrue to those economies that are most capable of taking advantage of these [technological] advances.”

His argument comes at a particularly critical point for American business, which faces ever-increasing technological competition from China and India and the potential for new government policy on research from the incoming Obama administration.

Prof. Bhidé argues that “midlevel innovation” is of greater competitive value than high-level research to companies.

“It is breadth of knowledge,” says Prof. Bhidé, “that underpins this ability to take advantage of innovation.”

His theory bodes well for MBA students, whose breadth of general management knowledge will be of increasing value in the corporate business world.

“The MBA education,” he says, “teaches you to think broadly and quickly about a variety of things.”

A crisis of trust is plaguing investors, says adjunct professor Seth Freeman in a recent column in the Christian Science Monitor. His column discusses the “promise problem” that we’re facing at the economic level — that is, how do investors know that borrowers will keep their word?

Freeman suggests that the solution is a building a “trust support,” and that doing so requires both parties to answer the following questions:

1. Who can serve as a credible bridge of trust? The government, for instance, can back borrowers’ promises.
2. How can we most effectively watch or test the promisemaker’s ability to perform? Helping lenders know what toxic assets borrowers hold might help them test for ability to perform.
3. What incentives and penalties can best encourage performance? My nephew is a case in point.
4. Are there ways to build in mild, moderate, and strong trust supports? A range can help lenders and backers intervene early and late with the least coercion necessary.
5. Does the solution satisfy all parties’ key interests?
6. What if the worst case scenario happens?

“The promise problem is as central to the current crisis as it has been to many others. It’s the issue lurking behind many of the world's biggest problems. Want to stop global warming? The spread of nuclear weapons? Human rights abuses?” Freeman writes. “Tackling the promise problem is the great and often solvable challenge behind the others.”

Nearly 500 alumni and guests gathered in Hong Kong for the Pan-Asian Reunion on October 24-25. “The atmosphere was very warm and friendly,” said Woo Taik Kim ’72, president of the South Korea Alumni Club and a panel sponsor, who attended the weekend event. Faculty panels on topics ranging from healthcare to private equity were held in addition to the reunion dinner. The faculty and panelists received substantial coverage in the local news. A few highlights of the event:

Global Economy

Speaking at a press conference, Dean Glenn Hubbard said that the candidate who wins next week’s presidential election must be prepared to immediately begin work with Treasury Secretary Henry Paulson and not wait for the start of term in January 2009. He also discussed how the strength or weakness of a recession in the U.S. would affect China. From China Daily, on October 22:

Prof. Shang-Jin Wei, who moderated the panel “Asia: From a Major Investment Destination to a Rising Source of Capital,” also offered his view on the on the financial crisis. In an interview with 21st Century Business Herald on October 25, he discussed the safety of the U.S. dollar and said:

Private Equity

The “Private Equity and the Capital Markets” panel on October 24 with Paul Calello ’87, Russell L. Carson ’67 and Henry R. Kravis ’69, and moderated by Prof. Bruce Greenwald was very well attended. Prof. Greenwald discussed his thoughts on private equity before the conference with Asian Venture Capital Journal:

Tokyo’s Lesson

Heizo Takenaka, Japan’s former economy minister, was part of the “Asian Financial Centers: Activities and Aspirations” panel moderated by Prof. Hugh Patrick on October 25. He spoke with the Financial Times afterward and discussed lessons learned from Japanese crisis (watch video). He said:

That diet, at least elements of it, was at the core of a panel discussion with Dean Glenn Hubbard and professors Bruce Greenwald, Pierre Collin-Dufresne and Christopher Mayer.

“We still are in a period of substantial credit stringency,” said Hubbard in his opening remarks. “Financial institutions remain undercapitalized for normal activity.” [In a separate column published on Oct. 3 with Princeton's Alan Blinder, Hubbard suggests expanding the FDIC cap.]

Prof. Greenwald followed with a discussion of monetary policy’s role in the financial crisis with a ‘tale of two decades’. In the 1960s the changes in U.S. money supply were linked to subsequent growth in the nominal GDP. In the 1990s, reforms in monetary policy led to very little movement in the nominal GDP, while the money supply was extremely unstable.

“The real heart of this crisis is that the traditional means for recapitalizing these institutions have gone away,” Greenwald said. “The movement of interest rates down to 2% has had no effect, just as monetary policy has had very little effect for a long time. If you’re going to restabilize the economy, you have to have a direct means to recapitalize the banks.”

Greenwald came out in favor of the Treasury’s bailout plan, saying, “If you don’t want to be Japan in the 1990s, just give [the banks] the money. The return in terms of economic stimulus will far outweigh the cost of any financing they get.”

Prof. Dufresne, speaking next, pointed to the location and foundation — low interest rates, high demand, insufficient models, complex vehicles — of the risks in the 1990s as key factors in the current financial crisis. “This made exposure hard to measure,” he said.

Concurring with Greenwald, Dufresne said the solution to the crisis was in bank recapitalization. (watch video)

Prof. Mayer focused on the housing market’s role in the credit crisis. “As we look at the problem in the U.S.,” he said, “we need to think about how to stop the housing crisis.” Mayer and Dean Hubbard have proposed a much-discussed plan that would allow anyone with a primary residence mortgage to refinance at 5.25% on a 30-year-fixed rate loan. (listen to NPR audio about proposal)

Mayer closed his comments considering the coming year: “We’re going to have to re-create a new lending system in the future.”

This is part of a series of posts on healthcare industry topics that will be discussed at the Columbia Business School Healthcare Conference on November 21. The “Payor/Provider Panel” will discuss new paradigms in medical cost and outcomes management and how these paradigms will be impacted by the election of Barack Obama.

Attempting to restrain healthcare spending in the U.S. is a bit like trying to extinguish a forest fire: while one of the smaller fires on the periphery may be easy to put out, the ones deep in the core of the forest are much more difficult to stop. Many of the propellants that have fueled national healthcare expenditures are deeply entrenched (“core”) aspects of either the healthcare system or our society’s values. As such, they have largely resisted many of the efforts made to control them.

According to the the Centers for Medicare and Medicaid Services, the share of U.S. GDP devoted to healthcare grew from 9.1% in 1980 to 16.0% in 2006. By 2016, healthcare expenditures are predicted to grow to $4.2 trillion dollars, or 20% of GDP. It is clear that it is necessary to control costs; however, the current recession will make doing so even more challenging.

Here is a cross-section of the social and logistical issues that cloud cost-cutting:

National Wealth

In spite of a potential global recession, the U.S. is likely to remain one of the wealthiest nations on earth. U.S. per capita spending on healthcare is 48% higher than that of the next highest-spending country (Norway) and 83% greater than Canada’s, according to the Organization for Economic Cooperation and Development. Princeton’s Uwe Reinhardt points out that the “ability to pay, as measured by GDP per capita, has repeatedly been shown to be one of the most important factors” driving a nation’s healthcare spending.

Administrative Costs

The U.S. healthcare financing system is very complex and entails significantly higher administrative costs than those of other countries. A study by Harvard Medical School and the Canadian Institute for Health Information estimated that approximately 31% of U.S. healthcare expenditures ($1,000 per person per year) are directed to administrative costs, about double what is spent in Canada.

System Inefficiencies

Poorly coordinated care, variations in provider practice patterns and misaligned financial incentives are just three of the inefficiencies of the U.S. healthcare system that drive up costs.

Cost of the Uninsured

A recession could force a greater number of people to live without insurance. The cost of paying for these patients when they show up at our nation’s emergency rooms is exorbitant and borne by the general public.

Cost of Technology/Resistance to Rationing

Most of the major medical technology/life science innovations over the past two decades have been priced at substantial premiums to previous technologies. In the absence of national pricing/reimbursement reform, this pricing structure will probably remain intact. The desire of Americans to always have the best doctors and the newest technologies drives up costs. Modestly intrusive practices that control the use of the most expensive treatment options, such as therapeutic substitution and step therapy, have gained some traction in the pharmaceuticals marketplace. More intrusive restrictions, such as rationing care or establishing annual cap amounts over which all care becomes out-of-pocket (a practice employed in some European countries), are much less likely to take hold. Outside of Oregon, America is probably not ready for measures as radical as rationing care.

Graying of America/Expense of End-of-Life Care

Healthcare expenses for persons over 65 are about three times those of the under-65 population, according to government data. When it comes to end-of-life care for relatives, most Americans want to keep family members alive as long as they have a “fighting chance.” Approximately 10-12% of the total national healthcare budget and 27% of the Medicare budget is spent on end-of-life care, according to the Center to Advance Palliative Care (CAPC). Like rationing, euthanasia is not likely to gain a foothold in the U.S. anytime soon, if ever. With the aging of our nation, this “core” issue will only grow in prominence. According to the U.S. Census Bureau, the percentage of the U.S. population over 65 will increase from 12% in 2006 to 20% by 2030.

What thoughts or questions do you have about healthcare spending? Please share your comments.

In an interview with Bloomberg TV on November 4, Professor Charles Calomiris discussed the economic challenges facing the incoming president, Barack Obama (watch video/WMV). Professor Calomiris said:

The most obvious set of issues is dealing with the financial crisis … We need to increase capital injections to the banks, improve the way they have been managed, and then we need to do a whole set of things to help the consumer: foreclosure mitigation, refinancing at lower interest rates and putting a bottom on how far the value of mortgages can go. The other major immediate issue — which has been neglected — is preventing the implosion of global trade … We are already in a situation where there is a lot of anti-trade sentiment the U.S., and [that] sentiment, especially [in] organized labor, is now ascendant under [an Obama presidency]. We are sitting on three bilateral trade agreements that Obama has been opposing and he’s already threatened to abrogate NAFTA …

The right formula [for banks], which is different than the one Secretary Paulson has been pursuing, is to maintain a more senior position in the bank with straight preferred [stock], no warrants, and to have less of a micromanaging role. But, more importantly, you have to help not just by injecting capital but by helping the consumer and the mortgage markets. That means direct loss sharing to mitigate foreclosures and it means helping healthy mortgage holders refinance at lower rates. And it means putting a floor in the market by guaranteeing a very low price for mortgages. If you did that, it would it preclude all those disastrous death spirals scenarios and have an immediate positive effect in elevating mortgage-backed security prices and CDO prices.

How does the financial crisis affect business in China?

There are two ways: through the trading route and through the asset route. If the US economy goes into a recession and reduces demand from abroad, China will have to cut its exports, causing it to be affected as well.

I think that effect will be estimate-able because we have had, as recently as 9/11 when the stock market and NASDAQ dropped by more than 50% and the overall market dropped by a third, a real recession. China’s growth rate had a very limited drop from 2000 to 2001 because its components are income-driven and driven by internal demand. Thus, when the US economy took a huge hit, China wasn’t greatly impacted. Their domestic growth is increasing faster than the overall economy and that is increasingly more important as a growth-driver.

Secondly, the types of commodities and products that China exports to the U.S. is not super-sensitive to the economic downturn. For example, Wal-Mart accounts for 12% of total imports from China — if Wal-Mart was a country it would be China’s eighth largest trading partner — to just give you a sense of what these exports are. They are not super-sensitive to economic downturns.

What is new this time is the asset market. In the center of Shanghai there is a block of very expensive real estate. Morgan Stanley invested early on and made a handsome profit on paper. But only recently have they decided to sell. So you can tell it’s part of the deleveraging process where they are selling assets in order to raise cash to reduce the debt burden on their balance sheet. They have to sell in overseas markets because they couldn’t sell their subprime assets after market liquidity completely dried up.

Now they are looking at their balance sheet, and suddenly those assets they hold in China become their most sellable assets. Because foreign investments in China are real [estate] assets and are relatively new phenomena, China doesn’t have any experience with the contagions of financial crisis through the asset sales channel. That is what is new and we will have to see what effect that will have.

Photo credit: Aapo Haapanen

In recent years, compensation packages for CEOs and other senior corporate executives have been criticized for both their high level and their growth, often despite poor company performance. Are patterns such as this likely to continue in the aftermath of the recent financial meltdown?

You might think the answer would be obvious. For one thing, the precipitous drop in the stock market reduces the value of stock options, typically the largest component of executive compensation. Even companies that have a history of granting a fixed value of stock options may be unable to continue the practice.

“It may simply be too dilutive to grant the number of options required to maintain fixed value,” says Irv Becker, managing director of the compensation consulting firm The Hay Group, in New York. Second, current economic conditions are likely to depress corporate earnings, which are commonly used to determine incentive-based bonuses. Third, executive compensation packages are designed to attract and retain the best managerial talent, so an executive being recruited by company A is likely to be “made whole” for any compensation that he or she might lose if they leave company B, including unvested stock options. Since the current market is likely to leave many previously granted options “under water,” the cost of attracting and retaining employees is likely to decline.

In other words, when we “pay for performance,” if performance is down, shouldn’t pay go down with it? In theory yes. But many of my academic colleagues and I have observed a very robust pattern in executive compensation over the years that we like to call “pay for pulse.” The pattern is as follows: Suppose we split all companies into two groups: Group one, in which shareholders saw some positive returns to their investment for the year, and group two, in which returns were negative. As you might expect, the executives in group one receive compensation that is greater, with better returns corresponding to larger increases in compensation. So in group one we observe “pay for performance.”

In contrast, executives in group two typically also receive more in compensation, despite their poor performance. Historically this increase has been more than double the rate of inflation in most years. What’s even more troubling is that there is typically no difference between pay for executives in firms with marginally poor performance compared to those in firms with worse performance. Hence the term “pay for pulse.”

What’s driving this?

When performance is poor, the company’s board of directors and its compensation committee face the difficult task of separating the role of the economy from the contribution of management. So when the economy is bad, boards may be tempted to conclude that their management team did a great job given the circumstances. Typically boards rely on two mechanisms to reach such a conclusion.

First, compensation committees typically benchmark their company’s compensation and performance with that of a peer group. Correspondingly we see better compensation in firms where the board concludes that the company has outperformed its competition. Second, executive compensation typically allows the inclusion of subjective assessments of factors such as leadership, which are difficult to measure objectively.

Are there reasons to believe that “pay for pulse” will go away?

I think so. The revised compensation disclosure requirements enacted by the Securities and Exchange Commission (SEC) in 2006, combined with the observed growth in shareholder activism in recent years, is likely to reign in the board’s use of peer groups and subjectivity in awarding compensation. With broader disclosure, shareholders have substantially more information from which to form opinions of the fairness of their company’s executive compensation. For example, companies must disclose the peer group that they used in the compensation process, so shareholders can form their own opinion on whether a reasonable peer group was used or whether the board “cherry-picked” the peer group to justify higher compensation.

Even before the economic meltdown reached its peak, we began seeing examples of the effectiveness of the SEC’s regulations and the actions of shareholders. Specifically, a survey of executive compensation in 2007 by The Hay Group showed — for the first time in recent history — decreases in compensation when firms had decreases in stock price. In prior years, we typically observed small increases in compensation for firms when stock price decreased, and larger increases in compensation as stock price increased.

In addition, we recently began to see firms take steps to curtail “golden parachute” severance packages. Finally, in 2007 we saw the growing use of “claw backs,” which permit firms to take back the portion of compensation that was awarded to executives using misstated accounting numbers.

Overall, the executive compensation process is shaped by many forces, but in our current environment scrutiny from both regulators and investors is particularly high. The rescue of Fannie Mae and Freddie Mac, and the $700 billion federal financial rescue package, impose executive compensation restrictions including the elimination of golden parachutes and provisions for claw backs.

But as you might expect, there are efforts underway to negotiate exceptions to these compensation restrictions. Will our current economic meltdown, combined with regulatory scrutiny, shareholder activism and increased disclosures, eliminate “pay for pulse” going forward? Let’s hope so.

This column also appeared on Forbes.com.

Federal Reserve Chairman Ben Bernanke spoke at the Economic Club of New York on Oct. 15, 2008 and praised the Treasury and Congress for moving to restore confidence in US financial markets. (full speech) However, he warned the process would take time, since the housing crisis continued to be worrisome. He said:

Stabilization of the financial markets is a critical first step, but even if they stabilize as we hope they will, broader economic recovery will not happen right away. Economic activity had been decelerating even before the recent intensification of the crisis. The housing market continues to be a primary source of weakness in the real economy as well as in the financial markets, and we have seen marked slowdowns in consumer spending, business investment, and the labor market. Credit markets will take some time to unfreeze.

Dean Glenn Hubbard, who is also chairman of the Economic Club, responded along with Harvard economist Martin Feldstein, to Bernanke’s speech in an interview with Bloomberg TV. Hubbard said: (watch video)

What is important is ... to stop falling house prices. There are ways to do that and variety of proposals, but they all center on getting the mortgage rate back to where it would be in a well-functioning credit market. The second would be to clarify the capital injections, and how the Fed and the Treasury will resolve troubled institutions so the market knows and private capital knows. And the third would be for the Fed to be very aggressive in guaranteeing interbank lending and providing for commercial paper. … We will have 10 to 15 % further house price decline likely, absent policy action, and that will hurt consumer spending and hurt the job market and, of course, the balance sheets of commercial institutions.

Both Dean Hubbard and Senior Vice Dean Chris Mayer (and Feldstein as well) have been vociferous in asking for policy action on housing. In the Wall Street Journal ("No Quick Fix for Housing Prices", Oct. 14), Mayer called for government to "push mortgage rates down to 5.25% in order to spur demand."

Prof. Charles Calomiris offered another view on solving the housing crisis ("How To Prevent Foreclosures", Oct. 14) and said:

As I understand the new McCain plan, it would buy mortgages from the lenders (or servicers) and then refinance them into the FHA plan. ... A more modest proposal than that of Sen. McCain, which may balance costs and benefits more effectively, would follow the example of the successful Mexican "Punto Final" plan of 1999, which resulted in substantial debt write-downs very quickly and the resolution of much financial gridlock in that country.

The government would share losses borne by lenders from mortgage principal write-downs on a proportional basis. For example, taxpayers could absorb 20% of the write-down cost borne by lenders on any mortgage so long as it is agreed through a voluntary renegotiation between lenders and borrowers, and so long as doing so creates a sufficient write-down for borrowers to be able qualify for refinancing under the FHA facility.

What are your thoughts about solving the housing crisis? Please leave your comments.

Photo credit: Economic Club of New York

The Treasury announced a plan this week to recapitalize banks with $250 billion. Responding in the Wall Street Journal (“A Thumbs Up From the Ivory Tower” on Oct. 13) Prof. Charles Calomiris said:

Prof. Frank Lichtenberg spoke with the Financial Post about the thawing of the credit markets:

Dean Glenn Hubbard, writing with Princeton’s Alan S. Blinder, addressed the Treasury’s plan to broaden of deposit insurance coverage in the Wall Street Journal (“Blanket Deposit Insurance Is A Bad Idea” on Oct. 15). They wrote:

Speaking on National Public Radio’s On Point program on Oct. 14, Prof. Frederic Mishkin discussed the global perspective and the cost in reputation to the U.S. economic model. He said:

Photo credit: Phil Dokas

Tonight, John McCain and Barack Obama will meet in Nashville for the second of three presidential debates. In an op-ed published in the New York Times on Oct. 7, 2008 (“The Dismal Questions”), Dean Glenn Hubbard and Prof. Joseph Stiglitz posed several questions relating to the economy they would like the candidates to answer. Select questions:

From Prof. Stiglitz:

More than a million people have lost their homes in the past two years. A million more are expected to lose their homes in the next 12 months or so. Do you support a more direct program of relief for homeowners? The government pays more of the mortgage costs of rich homeowners, through larger tax deductions, than of poorer homeowners. What would you do to correct this injustice?

From Dean Hubbard:

Does the financial crisis indicate that we need more regulation? Or is the problem less one of too little regulation than of poorly focused regulation? The crisis had its origins in part in international capital flows that led to extraordinarily low interest rates. But high-risk mortgage lending drew some of its breath from regulatory interventions. Some heavily regulated financial institutions managed to get themselves in trouble. And it was government-sponsored enterprises, no strangers to regulation, that stimulated the demand for questionable mortgage products. Shouldn’t the next president be standing up to protect markets instead of sowing doubts about them?

What questions about the economy would you like the presidential candidates to answer?

In an Oct. 2 column published in the Wall Street Journal (“First, Let's Stabilize Home Prices”), Dean Glenn Hubbard and Prof. Chris Mayer propose that bolstering housing prices will improve the intent of the Treasury’s bailout plan. They write:

We propose that the Bush administration and Congress allow all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25% (matching the lowest mortgage rate in the past 30 years), and place those mortgages with Fannie Mae and Freddie Mac. Investors and speculators should not be allowed to qualify.

The historical spread of the 30-year, fixed-rate conforming mortgage over 10-year Treasury bonds is about 160 basis points. So a rate of 5.25% would be close to where mortgage rates would be today with normally functioning mortgage markets. One of us (Chris Mayer) recently published a study showing that — assuming normally functioning mortgage markets — the cost of buying a house is now 10% to 15% below the cost of renting across most of the country. Rising mortgage spreads and down-payment requirements are what’s still driving down housing prices. We need to stop this decline.

The direct cost of this plan would be modest for the 85% of mortgages where the homeowner owes less on the house than it is worth. Lower interest rates will mean higher overall house prices. The government now controls nearly 90% of the mortgage market and can (and should) act on this realization. Remove the refinancing option and you can have lower rates without substantial cost to the taxpayer. Homeowners would have to give up the right to refinance their mortgage if rates fall, although homeowners could pay off their mortgage by selling their home. For borrowers with lower credit scores, the mortgage rate would be greater than 5.25%, but it would be less than their current rate.

Now, what about mortgages on homes that are worth less than the total amount of the loan? These mortgages could be refinanced into a 30-year fixed-rate loan to be held by a new agency modeled on the 1930s-era Homeowners Loan Corporation. New mortgages would be made of up 95% of the current value of a home.

The government might use two approaches to mitigate its losses. It could offer owners and servicers the opportunity to split the losses on refinancing a mortgage with the new agency. Servicers would have to agree to accept these refinancings on all or none of their mortgages, to avoid cherry-picking. Or the government should take an equity position in return for the mortgage write-down so that the taxpayers profit when the housing market turns around.

This week, Columbia Business School faculty members responded to the failure of the Treasury’s bank rescue plan to pass the House. The overall sentiment: something needs to be done, but what form it should take, and what kind of support it will have, is still unclear. On Sept. 29, Prof. Suresh Sundaresan offered his insights on National Public Radio’s Planet Money (listen to audio):

It’s a bit of a shock that the rescue plan was rejected; over the last several days some tight provisions were added on… and safeguards were added and we had two extremely informed and knowledgeable folks — the Secretary of the Treasury and the Chairman of the Federal Reserve — pleading for this assistance. … I could be wrong completely in the sense that the stock market picks up and libor goes back, but I find a low possibility of that happening unless something is done by Congress.

On Sept. 30, Prof. David Beim spoke with Tom Ashbrook on NPR’s show On Point (listen to audio), saying:

Writing in the New York Times, “Lessons From A Credit Crisis: When Trust Vanishes, Worry,” David Leonhardt cited an anecdote from Prof. Frederic Mishkin on the public’s growing skepticism and lack of support for the bailout.

Is the public’s skepticism of the bailout deserved or misplaced? The Senate is expected to vote Wednesday night on the Treasury plan. Please share your comments.

Prior to the recent financial crisis, the biggest economic story of 2008 had arguably been the rising cost of oil. After hitting a low of $50.48 a barrel in January 2007, oil prices have spent much of 2008 above $120. When the price of oil reached a historic high of $147.27 on July 11, Goldman Sachs’ prediction that oil would soon rise to $200 a barrel seemed well on its way to coming to fruition.

However, since the peak in mid-July, prices have fallen sharply, reaching $96.36 on Sept. 29. What caused this decline? Will it continue, or will oil prices quickly rebound?

Contrary to what we commonly hear from business commentators, speculators have little impact on the oil market, and storms, like Hurricanes Gustav and Ike, only cause a blip in the data. The fluctuations caused by the current financial crisis are also blips, short-run effects; however, if the crisis causes or reinforces a recession, its impact on oil prices will be more durable.

There are two main causes of the recent drop in oil prices: the global economic slowdown and the rise in value of the U.S. dollar. While the idea of a U.S. recession is something we’re all familiar with, Europe, too, has been dragged down by the recent credit crises, and even China has seen a slowdown in growth. Together, these slowdowns have caused global demand for oil to fall, resulting in lower prices.

Oil’s connection to the dollar stems from the fact that while oil is priced in dollars, most oil-producing countries — Saudi Arabia, Russia, etc. — don’t want dollars but rather other currencies. As the dollar fluctuates, these countries mark the price of oil up or down to preserve the value of their exports in the currencies that matter to them. If the current crisis leads to a drop in the international value of the dollar — which it will do if it leads to less use of the dollar as a reserve currency — we can expect some subsequent increase in the dollar price of oil.

Over the next six to 12 months, I expect the price of oil to fall further than it has. Aside from another war in the Middle East or the Caucasus — both of which are possible — I don’t see any forces on the horizon that will be strong enough to counteract slumping global demand and cause prices to increase. While OPEC will undoubtedly try to stabilize or raise prices by keeping a lid on supply, they are often not very effective in doing so. Only once have they clearly managed to raise the price of oil and hold it there for a while, and that was back in the 1970s in the context of an Arab-Israeli war.

In the long term, however, global demand will rebound, causing oil prices to rise again and eventually surpass their July 2008 highs. The growth of the economies of developing countries will play an important role in this, as early stages of growth are particularly energy-intensive.

Supply, on the other hand, is not likely to increase much. Quite simply, we are not finding much oil. For example, the Tupi field off the coast of Brazil, which was hailed as a giant find when it was discovered, has about 10–20 billion barrels of oil in it. That may sound like a lot, but when you consider that the world consumes about 31 billion barrels every year, it only adds up to six to nine months of global consumption. That certainly doesn’t represent a fundamental increase in supply. Neither would more drilling in the U.S., which would generate finds that are peanuts relative to global or even U.S. demand (which represents one quarter of global demand).

While lower oil prices may seem like a silver lining of the world’s current economic turmoil, we must realize that when we recover, the laws of supply and demand will once again force us to confront the issue of rising oil costs.

The New York Fed has gotten its long-standing wish: Goldman Sachs and Morgan Stanley have become, like Citigroup, bank holding companies subject to its supervision. The increased power may please some Fed officials — and provide a great security blanket for “value” investors like Warren Buffett ’51. But as far as public policy is concerned, this is a step in precisely the wrong direction: We need more focused, transparent financial players, not more “Too Big to Fail” and “Too Complex to Manage” behemoths like Citigroup.

“How could our CEO possibly certify Citigroup’s accounts?” complained one of his lieutenants, shortly after Sarbanes-Oxley had been passed. “They are just too complicated.” Perhaps, I suggested, Citicorp should be split up into simpler units. Of course not! A flat world needed global financial institutions. If U.S. regulators didn’t back off, they’d all flee to London. Outsiders like me just didn’t get it.

In fact, the insiders didn’t. Stanley O’Neal and James Cayne famously frolicked on golf courses and at bridge tables while Merrill Lynch and Bear Stearns imploded. They weren’t callous, just profoundly — and given the complexity of their firms, inevitably — ignorant of the risks. Nor were they the exceptions. The financial system is paralyzed by fear not just of financial institutions hiding bad loans, but also that the insiders who are supposedly in charge don’t know the magnitudes of their liabilities.

American industry — businesses in the real economy — long ago learned hard lessons in the virtues of focus. In the 1960s, the prevailing wisdom favored growth through diversification. Many benefits were cited. Besides synergistic cost reductions offered by sharing resources in functions such as manufacturing and marketing, executives of large diversified corporations allegedly could allocate capital more wisely than could external markets. In fact, the synergies often turned out to be illusory, and corporate executives out of touch. Super-allocators like Jack Welch and Warren Buffett were exceptions.

The weaknesses of diversification were sharply exposed by the recession of the early 1980s and by Japanese competition. Later in the decade, raiders used junk bonds to acquire conglomerates at deservedly depressed prices and sold off their components at a handsome profit.

Banks missed the 1960s party. Prohibitions on interstate banking and the separation between investment and commercial banking mandated by the Glass-Steagall Act severely limited diversification in the financial industry. But as the rules were dismantled in later decades, financial institutions plunged right ahead.

The early results weren’t promising. Efforts to sell stocks and socks at Sears went nowhere, as did the Prudential Insurance Company’s foray into brokerage and Morgan Stanley’s venture into credit cards. But the forces that had curbed diversification in the industrial sector did not restrain financial institutions. Low-cost Japanese competitors did not show up inefficiencies--in many financial businesses, the driver of long-run profits lies in the prudent management of risks and returns, not costs.

Raiders couldn’t use junk bonds to dismantle conglomerates; financial institutions are too highly levered to be taken over with borrowed money; compensation arrangements made diversification irresistible. Many financial firms pay out nearly half their gross profits as bonuses – even if these profits are secured by loading up on risk. And bonuses paid are paid forever, even if the bets ultimately go bad.

Diversification offered CEOs the opportunity to take ever larger bets – and earn staggering personal returns without much personal risk. CEO Richard Fuld’s Lehman stock may now be worthless – but he gets to keep the $500 million he took out in previous years. James Cayne may have fallen off the Forbes 400 list, but he isn’t in the poor house. Sandy Weil has laughed all the way away from Citigroup, which he turned into a hodgepodge of investment banking, trading, retail brokerage, commercial banking and insurance.

Even now, battered CEOs seem bent on doubling up to recoup their bad diversification bets instead of cleaning house. Last year, Bank of America CEO Ken Lewis declared that he had had “all the fun I can stand in investment banking.” Yet last week, Lewis engineered the acquisition of Merrill Lynch. Now Goldman and Morgan Stanley, in their new holding company incarnation, are looking to acquire deposit-rich regional banks.

Predictably, taxpayers are footing much of the bill for the misadventures in diversification. Regulators, who looked the other way while bankers put the public’s deposits at risk and brought the nation’s economy to its knees, now have an opportunity to redeem themselves. They ought to demand an unraveling of the tangle that would help separate the good from the bad, and create institutions whose books CEOs could honestly certify.

Instead, they are encouraging more diversification, hoping to bury, for instance, Merrill Lynch’s unknown liabilities into Bank of America’s impenetrable balance sheets, and — in spite of their past failures with the likes of Citicorp — welcoming the creation of more megabanks. This is rather like giving the addict in the ER more drugs. It may soothe the tremors, but it isn’t a long-term solution to the diversification debacle.

The column also appeared on Forbes.com.

As the government’s proposed $700 billion bailout plan winds its way through Congress this week, the issue of how to price banks’ mortgage-related assets — and potential taxpayer exposure — has caused concern among economists. Dean Hubbard, writing with Hal Scott of Harvard Law School and Luigi Zingales at the University of Chicago Graduate School of Business, raises the issue of price-setting in a Wall Street Journal column, “Let’s Get The Bank Rescue Right” published Sept. 24.

The [Treasury’s] proposal needs to articulate the price-setting process. Although a reverse auction has been suggested, with asset holders “bidding” to sell their mortgage-related securities to the Treasury, such an approach raises significant problems. Most significant is the risk posed by asymmetric information regarding the value of these securities. Because the holders of complex and incomparable mortgage-related securities have more information regarding their worth than does Treasury, Treasury is at a huge disadvantage and will likely overpay. … How can we design a transparent asset purchase process that avoids arbitrariness and potential favoritism? Any such process will have to be designed from scratch, because there is no U.S. precedent for such a targeted purchase of bad assets.

Professor Charles Calomiris also addressed the complications of setting a fair price for bad loans, suggesting that purchasing banks’ equity, rather than their mortgage-related assets, would limit taxpayer exposure. Writing in the Financial Times on Sept. 19, Calomiris said:

Government injections of preferred stock into banks, advocated by New York’s Sen. Charles Schumer and inspired by the Reconstruction Finance Corporation’s policies in the 1930s, are a better choice. Pricing sub-prime instruments for purchase would be very challenging, and fraught with potentially unfair and hard-to-defend judgments. If the price were too low, that could hurt selling institutions; if it were too high, that could harm taxpayers. Who would determine how much should be purchased from whom in order to achieve the desired systemic risk reduction consequences at least cost to taxpayers? How would the purchasing entity dispose of its assets?

Preferred stock assistance would leave asset valuation and liquidation decisions to the private sector, but would provide needed recapitalization assistance to banks in an incentive-compatible manner to facilitate banks’ abilities to maintain and grow assets. If executed properly, it would limit taxpayers’ loss exposure, and leave the tough decisions of managing assets, and deciding on how to allocate capital assistance from the taxpayers, to the market.

Preferred stock assistance would work best if it were required to be matched by common stock issues underwritten by the private sector, which would ensure the proper targeting of assistance, and force private parties rather than taxpayers to bear first-tier losses. Banks in need of capital would apply for Matched Preferred Stock (MPS) assistance. Initially, say for three years, there would be no dividend paid to the government on MPS. That subsidy would increase the net worth of the recipient and facilitate raising additional capital via common stock.

Goldman Sachs and Morgan Stanley have taken the plunge. They have decided to become “bank holding companies.”

In essence, this means they will enter the brave old world of depository banking, with the regulatory apparatus that this entails, and leave behind the “proprietary trading” business models that have made these institutions the envy of the financial world for the past decade.

The nature of their debts will change (from securities and money market instruments such as repos to deposits), and the level of their portfolio risks will fall as they come under the pressure of a far more intrusive regulatory regime. However, their leverage will remain high and may even increase — access to cheap and reliable sources of debt funding, after all, is the main attraction of becoming a depository bank.

The investment banks’ previous resistance largely reflected the regulatory costs and risk “culture” changes that come with regulated depository banking. Virtually all of the franchise value of Goldman and Morgan is human capital. The folks at these firms are the most innovative product developers and skilled risk managers that the world has ever seen.

Depository bank regulation, supervision and examination prizes stability and predictability over innovation, and banks bear a great compliance burden associated not only with their financial condition but also their “processes” related to both prudential regulatory compliance and consumer protection. None of that is conducive to innovation and nimble risk-taking.

Goldman and Morgan’s moves, therefore, could greatly trim their upside potential and reduce the value of their human capital for developing new products and proprietary trading strategies. What about the benefits? First and foremost, they will be able to use reliable, low-cost deposit financing as a substitute for the shrinking collateralized repo market and other high-priced, market-based debt instruments.

Second, they will be able to preserve their client advisory business and perhaps even compete better in underwriting activities. Stand-alone investment banks have lost market share in underwriting to universal banks over the past two decades because underwriting and lending businesses are linked, and non-depository institutions suffer a comparative disadvantage in funding their lending (as shown in a recent academic paper).

In this sense, the capitulation of the stand-alones marks the final stage of the victory of the relationship banking/universal banking model. Those of us who argued in the 1980s that nationwide branching would allow commercial banks to serve as platforms for universal banks with large relationship economies of scope can now say, “We told you so.”

Bank of America, JPMorgan Chase and Citigroup have all weathered the financial storm and are not under threat of failure because their geographic and product diversification has kept them resilient. It has even permitted them to engage in acquisitions and new stock offerings during the worst shock in postwar financial history.

Somehow, Sunday’s announcements did not make me feel like celebrating. It is not progress, in my mind, to move toward a one-size-fits-all financial system comprised solely of behemoth universal depository banks. Just as community banks still play an important role in small business finance (owing to their local knowledge and flat organizational structures), we need nimble, innovative risk-takers like Goldman and Morgan in the system. What will we do without them?

While I may not be celebrating, I’m also not too worried about the lost long-run innovative capacity of American and global finance, for a simple reason: ultimately, people, not institutions, are responsible for innovation. Smart, innovative people can — and will — find homes elsewhere. The financial landscape will shift, giving rise to new franchises and new structures (perhaps even spin-offs from the current investment banks) that combine features of the old franchises that don’t fit comfortably under the Fed’s umbrella. Global competition, as always, will be a reliable driver of financial efficiency.

A version of this column was also published at Forbes.com.

By happenstance I’m lecturing on John Maynard Keynes in my Modern Political Economy course today. I don’t ask my students to read the whole of The General Theory of Employment, Interest and Money, which would indeed be cruel and unusual punishment, but I do require them to read chapters 10, 12 and 24. Those, to me at least, are most essential to understanding the General Theory. Chapter 12 certainly makes the carnage on Wall Street a bit easier to understand; it also is a reminder that recovery isn’t going to be easy. Quoting Keynes:

A conventional valuation which is established as the outcome of the mass psychology of a large number of ignorant individuals is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield; since there will be no strong roots of conviction to hold it steady. In abnormal times in particular, when the hypothesis of an indefinite continuance of the existing state of affairs is less plausible than usual even though there are no express grounds to anticipate a definite change, the market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning and yet in a sense legitimate where no solid basis exists for a reasonable calculation.

So far we have had chiefly in mind the state of confidence of the speculator or speculative investor himself and may have seemed to be tacitly assuming that, if he himself is satisfied with the prospects, he has unlimited command over money at the market rate of interest. This is, of course, not the case. Thus we must also take account of the other facet of the state of confidence, namely, the confidence of the lending institutions towards those who seek to borrow from them, sometimes described as the state of credit. A collapse in the price of equities, which has had disastrous reactions on the marginal efficiency of capital, may have been due to the weakening either of speculative confidence or of the state of credit. But whereas the weakening of either is enough to cause a collapse, recovery requires the revival of both. For whilst the weakening of credit is sufficient to bring about a collapse, its strengthening, though a necessary condition of recovery, is not a sufficient condition. (emphasis added)

These days, Keynes is not very popular in some circles; in truth, he is a bit hard on the neo-classicists in chapter two. But behavioral economics, which is now mounting a serious attack on the neo-classicists (at Columbia Business School as well as in the discipline), owes a lot to Keynes, as the above quote makes clear. As he wrote more than seven decades ago, strengthening credit is a necessary but not sufficient condition for recovery. We need to restore some confidence too, which is probably where political leadership comes in.

The U.S. government, faced with the country’s worst financial crisis since the 1930s, has announced a $700 billion plan to purchase bad mortgage assets from banks. Is this a good bailout or a bad one? The difference is important, because history shows us that bad bailouts can actually make financial crises worse.

The Japanese government’s handling of its massive bank crisis in the 1990s is an example of bad bailout policy. At first, the Japanese government ignored the problem it was facing, then it decided not to enforce its own rules requiring sufficient bank capital (“forbearance”), then it began investing government funds into insolvent banks through preferred stock and subordinated debt. This caused the crisis to only grow larger, which contributed greatly to Japan’s poor economic performance during the 1990s and for several years thereafter.

A good bailout focuses on liquidity. The government acts appropriately when it helps institutions with liquidity at a time of crisis by lending against collateral or by purchasing bank assets at fair market prices. A bad bailout is one that tries to help with solvency. The government acts badly when it invests money directly into failing banks without closing them. If a bank — even if there is more than one — is actually insolvent (i.e. its liabilities exceed the value of their assets), then best practice dictates that it should be closed.

Closing a bank is less draconian than it sounds. A closed bank is not simply blown up or thrown away; on the contrary, every effort is made to preserve the bank’s franchise value and maintain continuity with customers and employees. Normally, the government cleanses the bank of its bad assets after closure and transfers the cleaned-up business to new owners as rapidly as possible.

Good bailouts wipe out the shareholders of insolvent banks and dismiss their senior management. Why? Because these are the people who created the problem, and they must be seen to pay a high price. Remember that most banks are conservative, well-run and solvent; only a minority get over-extended.

The problem with the Japanese banks in the 1990s was not just the bubble economy of the 1980s but a continuing unwillingness by banks and the government to acknowledge bad lending practices and change them. A few banks were eventually closed; however, one of these names, Long-Term Credit Bank, eventually became Japan’s greatest banking success after it was closed and sold to an American buyout fund, which resurrected it under the name Shinsei Bank.

From 1986-1992, the FDIC closed over 2,300 banks and thrifts. The Resolution Trust Corporation (RTC) was established to move the bad real estate assets back into the economy as promptly as possible. The RTC, much admired for its speed and efficiency, did not try to buoy up failing banks; it handled their assets after the failing banks were closed.

So is the current administration plan a good bailout or a bad one? At this point the proposal is written in a very general way, and the devil is always in the details. The test will be whether the government plans to buy assets at something resembling their fair market value.

Suppose a bank has made a $10 million loan that is actually worth about $6 million. If the government buys the loan at $6 million, then it is providing liquidity assistance, which is fine. But if the government buys the bad loan for $10 million, it is in essence giving the bank a $4 million gift. Handing out gifts to misbehaving banks is characteristic of a very expensive, bad bailout.

Secretary Paulson has spoken of buying the bad assets at a deep discount, but this is not written into his proposal. It should be a requirement. That would minimize the ultimate cost to the U.S. taxpayers and increase the chances that this bailout is a good one.

Tonight, Senators McCain and Obama will speak about public service here at Columbia University. They are likely to talk about creating a program for a year of national service. That is a fine idea, but what strikes me today is that there is a management gap in service: Social organizations need people with managerial skills to better achieve their goals and support their mission.

The greatest constraint in solving the world’s most pressing problems, from health care to environmental policy to poverty, is not a lack of ideas. Many great minds, including those of large numbers of Columbia faculty members, are focused on research relating to society’s most fundamental challenges.

What the social sector still needs, however, is management. Management, along with the ability to get things done, is the scarcest skill among those who devote themselves to service. A desire to do good is an absolute requirement, but in order to navigate complex social and governmental channels and effectively create change, one must be equipped with the knowledge and skills necessary to analyze, decide, and lead.

That’s what business schools do. Top business schools are producing MBAs whose management skills will be invaluable in the social sector—even if they are not necessarily the people who are running nonprofit organizations. I argue that what a lot of development and health care reform efforts are missing is the involvement of people who know how to manage and run large, complicated organizations. If management is the scarce skill, then that means business schools need a seat at the public service table.

Columbia Business School’s involvement in Africa and other emerging markets and its health care management, entrepreneurship, and social enterprise programs are just some of ways we are committed to service. We also have programs to train principals for New York City schools and work with community businesses here in Upper Manhattan. We are taking management skills and actively applying them to public service.

Senators Obama and McCain have already demonstrated their understanding of the critical importance of business in creating and sustaining economic growth. It is my hope that when they take the stage this evening at ServiceNation’s Presidential Candidates Forum, they will also convey the need to engage business and businesspeople in the social sector.

Paraguay is at a turning point. Our new president, Fernando Lugo, was elected into office last spring, and his government’s economic plan and social approach are aimed at promoting development and reducing poverty. We have gross inequality in this country and more than 25 percent of our population lives in extreme poverty.

Last month, Columbia’s Professor Joseph Stiglitz was invited to advise the new government on how to reach these social and development goals. He recommended that Paraguay increase its revenues on all fronts. In particular, he suggested the country increase its revenues from the two bi-national hydroelectric dams, Yacyretá, shared with Argentina, and Itaipu, shared with Brazil. His speech received a standing ovation.

As the chief financial officer for Yacyretá Paraguay, I am in charge of negotiating the payments we receive from Argentina. We have approximately 1,400 full time employees and 600 others on a contract basis, and our current budget is about $100 million in operating expenses and $1.2 billion in investments to finish the dam in 2009.

We must increase our revenue from both Itaipu and Yacyretá to revert the years of unfair payments for the energy Paraguay has produced. For example, we are selling our energy to Brazil at the same price as a cup of coffee in Uris Deli ($2.67 for each megawatt hour sold to Electrobrás). However, the average price of energy in Brazil is $90 per megawatt hour in the wholesale market and $154.12 in retail. Clearly, we need to renegotiate a fair price.

I recently visited Panama, a country similar to Paraguay in many respects. On a trip to the Panama Canal, I was surprised by the huge economic growth of the country, which recovered its main revenue resource fully in 2000. The Canal contributes $1.5 billion annually to their economy. In the case of Paraguay, a newly negotiated solution for these dams can bring in much-needed revenue for our country; we can use that money to finance investments in education, healthcare, land reform and create more jobs.

We expect resistance from different sectors, especially those that will be affected by tax increases and land reform. But as a country with one of the largest inequalities in the world, Paraguay’s support of a well-reputed expert in the field like Prof. Stiglitz facilitates implementation of these measures. Our hope is that it will bring us to a solution before we have a crisis, and help us make an important change for the country.

Financial markets worldwide were buoyed Monday after the U.S. Treasury took over mortgage giants Freddie Mac and Fannie Mae. The rescue, which involves placing the two organizations into a conservatorship, may lower mortgage rates, reduce investor uncertainty and stabilize the U.S. economy. “This is the beginning of the end of the financial difficulties,” Professor Charles Calomiris told the Boston Globe.

Even as the loan crisis could be eased for now, the historical significance — it is the largest government intervention into a private market in U.S. history — is still taking shape. Professor Lynne Sagalyn, director of the Paul Milstein Center for Real Estate, offered insight on the legacy of Fannie Mae:

The government takeover of Fannie and Freddie marks a stunning event in the historical legacy of these financial institutions. Fannie began life as an innovative policy experiment; its creation was designed to foster uniform availability of credit across the nation in an era of regional credit imbalances and develop a national secondary mortgage market when such trading of originated mortgages did not exist. These institutional innovations brought down the cost of mortgage credit, thereby expanding housing affordability and homeownership to millions of Americans. And Fannie benefited renters as well, through its provision of low-cost capital to the multi-family rental sector. Rather than see this policy innovation as a “failure,” we would do well to keep in mind its historical positive contribution to a housing finance system on the day of this sad and disappointing news.

As part of an ongoing series, the Wall Street Journal asked top political and business leaders how they would spend $10 billion to create solutions for some of the world’s problems. Sidney Taurel ’71, chairman of Eli Lilly & Co., expressed his wish list in an op-ed in Monday’s paper.

“I would invest half of the $10 billion in comprehensive treatment programs that could be sustained by the countries with high incidence of [malaria, tuberculosis and HIV/AIDS], and which have leaders committed to long-term solutions,” Taurel writes. “I would use the remaining half of the $10 billion to foster investment in research, and I’d leverage it as I would the treatment programs — by working to make it sustainable.”

What problem would you tackle — and how much would you spend — to make significant progress solving a global crisis? Please add your comments.

Adapted from remarks delivered at the Kikkoman conference, “The Economics of Green: Finding a Balance between Economic Growth and the Environment,” hosted in honor of the 35th anniversary of Kikkoman’s opening of its plant in Walworth, Wisc. — the first manufacturing plant of a Japanese company in the United States.

The challenges of climate change have inspired myriad debates about how best to arrive at an appropriate solution. Within these debates, many wonder: Who is ideally suited to spearhead the charge?

We’ve already seen that, despite public policy foot-dragging, the business community has played a very constructive role in working to solve the problems caused by global climate change. And I believe that in the future, it should be business leaders who shape the proposals currently debated in the political process.

The demands of globalization have long motivated the business community to develop creative solutions to multifaceted problems.

In 1972, Yuzaburo Mogi ’61, chairman and CEO of Kikkoman Corporation, made Kikkoman the first Japanese company to open a manufacturing plant in the United States, an accomplishment that has proven its worth by withstanding the test of time.

Kikkoman has maintained positive relationships with the surrounding community in Wisconsin, and paved the way for other foreign transplants.

Today, the company is a model of corporate citizenship at every level — from the local to the global.

Mogi recently announced that Kikkoman will sponsor an Environmental Studies Scholarship in cooperation with the University of Wisconsin-Madison, and this fall will open a research and development laboratory in Madison’s University Research Park.

This is the kind of active partnering and collaboration that will be the key to delivering workable and sustainable answers to the potentially crippling environmental challenges we face.

As we move forward, the United States should lead and take action early in the mission of environmental stewardship, while encouraging and regularly reviewing the actions of other key nations. The work of the global community needs to be coordinated to address the seriousness of the problem — and it is possible to do this while protecting U.S. economic interests.

If liquidity intervention is inevitable, the central bank must be able to supervise and regulate the beneficiaries of its liquidity insurance. Otherwise, such insurance fans moral hazard by failing to discourage taking on still more liquidity risk (read: the most recent crisis). And making that insurance more available simply raises this concern (read: where we are now).

The events of the past three years highlight that risk misperceptions in a boom can lead to a scramble for liquidity if collateral values decline.

Importantly, Bagehot’s admonition goes on to say: “The time for economy and for accumulation is before. A good banker will have accumulated in ordinary times the reserve he is to make use of in extraordinary times.”

While strong supervision obviously remains important, this other advice from Bagehot would be an important addition to the policy tool kit. This could be implemented by raising banks’ capital requirements proportionately as risk-weighted bank assets grow. By varying capital cushions over credit cycles, consequences of risk distortions for actual lending and borrowing decisions will be reduced, along with the likelihood of asset fire sales and extraordinary central bank liquidity provisions.

Remembering Bagehot’s advice would give the central bank a way to deal with bank-lending bubbles. While a central bank’s tools may be poorly suited to prick bubbles like that of the information technology boom of the late 1990s, a bank lending bubble can — and should — be addressed.

The current policy stance of holding the federal funds rate at two percent will keep monetary stimulus in place. With inflationary expectations not declining, this stimulus will almost surely raise inflationary expectations as the economy improves. This consequence can be seen already in surging commodity prices and the weakness in the foreign-exchange value of the dollar.

It is worrisome that the Fed’s own 2008 projections have risen over the year both for headline inflation and core inflation. Furthermore, the Fed’s projections of receding inflation in 2009 and 2010 coming true will almost surely require increases in the federal funds rate.

A continuation of a negative real federal funds rate and the increase in money growth accompanying it raises the risk of increasing inflationary expectations, a costly mistake to fix.

It is asking a lot for monetary policy alone to carry the burden of supporting aggregate demand.

Fiscal policy can play a role. Congress and President Bush did pass an economic stimulus package centered on tax rebates. But clarity about a positive future for the 2001 and 2003 tax cuts which bolster collateral values — along with a cut in corporate tax rates to promote investment — would offer a much more potent tonic.

Earlier this week, the SEC issued an emergency order prohibiting naked short selling in 19 financial stocks, including Fannie Mae, Freddie Mac, Lehman Brothers and other names in the news. Beginning on Monday (July 21), it won’t be enough to make a good-faith effort to locate shares to borrow. Short sellers will have to have a formal agreement to borrow the shares in these stocks before they actually initiate a short position.

Emergency orders don’t happen every day, so you might think we are in uncharted waters. But when stocks go down sharply, it’s actually a fairly common response by regulators to try to throw sand in the gears and slow down the shorts. Perhaps the SEC was looking to the 1930s for guidance.

Back in September 1931, the world economy was spiraling downward into the depths of the Great Depression. U.S. stocks had fallen about 70 percent (!) from their 1929 peak, and short sellers were blamed. A number of commentators called for an outright ban on shorting. When Great Britain abandoned the gold standard on Sunday, September 21, 1931, the NYSE capitulated and issued an emergency order prohibiting all short selling. The gold standard news should’ve led to a sharp decline, but stocks advanced, mostly because specialists and other market-makers had no ability to provide liquidity on one side of the market. It was clear that the rise in prices was completely artificial, and after two days the NYSE repealed the ban.

An even closer analogy happened in early 1932. By then stocks had fallen even further. Opponents of short selling were encouraging stockholders to throttle short sellers by not lending shares to them. But like today, most brokerage customers held their shares in “street name,” and back then brokers could lend these shares without permission from the investor. On February 18, 1932, the NYSE announced that, effective April 1, brokers would need written authorization before lending an investor’s shares.

There was ample time for brokerage firms to secure the needed signatures, but they were apparently unable to do so in sufficient quantity. This wreaked havoc on the securities lending market. Share lenders were able to extract substantial concessions from borrowers. But the effect was completely temporary. Within two weeks, conditions in the share lending market had returned to normal. Stock prices rose on the announcement, but actually fell on April 1, because the market was expecting things to be worse. Ultimately there was only a short-term, temporary reduction in short interest.

I expect something similar here. None of the 19 stocks on the list are particularly hard to borrow. The vast majority have never been on the so-called threshold list, which identifies stocks with a significant amount of naked short selling. For these stocks, the SEC’s order really just adds more hoops for brokers. There could be a temporary effect if back offices can’t figure out right away how to jump through these hoops, but it will be very short-lived. Plus there are plenty of other ways for investors to take a bearish view. If a hedge fund can’t short, it can still buy puts. The options market-maker who sells the put will hedge by shorting the stock, and it looks like that options market-maker will be exempt from the naked shorting ban. At most, all we’ve done is add a middleman. So I suspect we won’t see much effect on Monday.

The pre-borrow requirement is actually a good idea. You can’t buy stocks unless you have the money or borrow it. You shouldn’t be able to sell stocks unless you have the shares or borrow them. I just think it won’t make much difference for these 19 stocks.

The U.S. government has made it clear that Fannie Mae and Freddie Mac, the two big mortgage guarantors, are not going to run out of cash. Yet the stocks of both are still tumbling; what is going on?

The issue is equity capital. Both institutions are seriously undercapitalized compared to their risks. The right solution is to issue more capital, lots of it. But the price of both stocks is very low, so lots of new capital implies major dilution of the old capital. The more the stocks fall, the more dilution new capital implies; and the more dilution is anticipated, the more the stocks fall. It is a vicious circle.

The basic facts about capital and risks are simple and stark:

For comparison, commercial banks are required to hold a minimum of 8 percent capital against their risk assets, and most choose to hold at least 10-12 percent.

Both Fannie and Freddie insist they are in compliance with the statutory and regulator-imposed capital requirements. That is true. The trouble is that neither institution has ever been required to hold a level of capital appropriate to their risk, and that is now coming home to roost.

Once an institution is in financial stress, it is very hard to sell equity capital because the price falls and stock buyers become frightened. The time to sell new issues of stock is when things are going well. As with friends, the time to make friends is when you don’t need them.

Raising capital is not impossible, just very slow and painful. Fannie Mae raised $7 billion of new capital in the second quarter. But the above table makes it clear how very much further both companies have to go.

Is government the solution? The last thing we need is for government to take over the two institutions. Some people are advocating this because they say that private ownership is a sham. But it is not a sham — real investors are losing real money here, and real investors can put pressure on managements to behave responsibly.

If government were to take full control of Fannie and Freddie, you can be sure that both institutions would soon own the entire subprime crisis. Politicians could not resist forcing both institutions to lower their standards so far that they absorbed everyone else’s mistakes. Even though some of this is going on, it is small compared to the total of subprime assets. Fannie and Freddie are prime lenders/guarantors and should remain so. They have trouble enough without taking on the nation’s subprime portfolio.

Rather, the government should begin by raising both companies’ capital requirements. It then might purchase a large issue of nonvoting preferred stock in each to help meet such requirements. The nonvoting feature would help to suppress political intervention. If the preferred carried an appropriate dividend, the government might someday sell it to the public after the present crisis has passed.

Fannie and Freddie are a mixture of public and private interests; the public interest is to preserve liquidity for prime mortgages. They should not be tools to bail out imprudent subprime lenders — they should be preserved in their present state with adequate capital.

A recent article quoted Professor Bob Hodrick on whether or not oil prices were being artificially driven up by the coordinated efforts of an influential group of speculators.

“The market is so competitive that that's nonsense,” Hodrick was quoted as saying. “There’s no way for everyone to communicate and get together and say, ‘We’re going to buy and drive the price up.’”

The article, from U.S. News & World Report, reports on how speculators play an important role in the oil markets and the global economy.

In an effort to reduce turnover, the NYC Department of Education established a formal teacher-mentoring program several years ago based on a nationally recognized model. Recently, I studied the effects of this program on New York teachers.

One of the most interesting findings was that teachers were more likely to return the following year if they were assigned a mentor that used to work in their school. In contrast, it did not seem to matter whether their mentors had many years of experience, used to teach the same subject as them, or had a similar demographic background — things that you’d think might be characteristics of an effective mentor.

What this signals to me is that what is important in the mentoring process in regards to retention is providing employees with what economists call location-specific or firm-specific human capital. Learning how to navigate the local environment seems to be an important issue for new teachers, whether it is dealing with the school administration, connecting with the particular kinds of students at the school or understanding other local institutions. Mentors can even help provide some of the small details that make life on the job easier, like where to get a good, inexpensive lunch or how to shorten the morning commute.

Finding policies that reduce teacher turnover are important for two reasons. First, research that I and other economists have done shows that more experienced teachers are more effective at raising student achievement. Second, turnover is typically highest in the schools serving the most disadvantaged kids. Quite simply, more experienced teachers tend to migrate to schools with fewer poor and low-achieving students. So, the benefits of increasing retention among new teachers are going to accrue to the children who need the most help.

Turnover is an important issue that all firms face, not just in teaching, and the lessons from my work with teachers in New York can also apply to professional development and training in other industries and occupations. One way to reduce turnover is through financial incentives, but another important tool is giving employees the support that makes their job more pleasurable and less stressful. Mentoring — with an eye towards local issues — is a policy worthy of attention.

Yesterday was the last day of school in the New York public school system.

This got me thinking about the helplessness that I and many others feel about the situation there. We desperately wish that Thabo Mbeki would do something to topple Robert Mugabe, the anticolonial crusader turned brutal warlord. But that doesn’t seem to be in the cards. And if local politicians are going to let this happen, what’s to be done?

In recent years at CBS, I’ve grown accustomed to hearing many around me proclaim the potential of business to solve the world’s problems. And I actually believe it myself, to a large degree.

But if this is the case, what (if any) is business’s responsibility in humanitarian disasters such as the one we’re witnessing in Zimbabwe? (or Darfur or Chad or Myanmar?) At a minimum, it surely includes holding off on shipping arms to Zimbabwe to keep Mugabe’s reign of terror alive. But is there a more proactive approach that the business community should be playing in South Africa? And what about here at home?

The Washington Post reported yesterday that although Americans’ perceptions of the economy are very negative, two key measures show that the economy is not as bad as it may seem: unemployment is at 5.5 percent and inflation at 4.2 percent.

One reason for this disparity, according to Professor Eric Johnson, may be the frequency with which consumers are seeing higher prices. “Things that you buy more frequently and that have large percentage increases will weigh more in people’s perception of inflation,” Johnson was quoted as saying.

He elaborated in the article with the following example: a person paying an extra $25 to fill up the gas tank is reminded of that cost once a week, or more often if you count the times he or she sees a $4-per-gallon price in giant numbers on a sign. In contrast, a rent increase of $100 would only happen once a month but would have the same financial impact.

Image credit: Cole Huggins

According to a 2008 report from the Aspen Institute, MBA programs definitely influence the way students think about the role of business and its relationship to society once they become managers and leaders.

Many of the report’s key findings were related to shifts in student attitudes on corporate social responsibility. The Institute reported that:

• Business school students are thinking more broadly about the primary responsibilities of a company. In addition to citing shareholder maximization and satisfying customer needs, the students surveyed in 2007 also said that “creating value for the communities in which they operate” is a primary business responsibility.
• MBA students are expressing more interest in finding work that offers the potential for making a contribution to society (26 percent of respondents in 2007 said this is an important factor in their job selection, compared with 15 percent in 2002).
• Though MBA students are clearly seeing the benefits of social responsibility in terms of a good public image, they aren’t seeing the connection to such other business benefits as increased revenue, fewer legal or regulatory problems or reduced operating costs.

After the deregulation of the Reagan and Thatcher eras, corporations did not become ethically focused overnight. So how can we account for this?

What I’ve found is that there’s been a shift in corporations’s mindset about the relation between high ethical standards and the bottom line, which might best be understood as “enlightened self-interest.”

Corporations now see that a narrow understanding of self-interest is going to hurt them in the long run. Thanks to globalization, corporations have had to make significant ethical decisions. For example, when expanding into regions of the world where there is little corporate governance legislation (or where it’s not implemented), U.S. corporations face the question: “Should we operate according to U.S. standards, or should we take advantage of the fact that this country’s standards are lower than ours?”

Corporations have learned that operating according to the bare-minimum ethical standard does not serve them well in terms of both public image and bottom line. Quite a few corporations had to contend with consumer backlash, boycotts and significant declines in sales thanks to NGOs who called attention to subpar practices relating to labor and the environment.

The capital markets have also provided incentives for corporations to behave responsibly. Roughly 10 percent of all professionally managed funds are explicitly designated as socially responsible investment funds with prominent environmental, social or ethical components — and this does not include the many other funds, such as University endowments, that also take these aspects seriously. It is therefore reasonable to say that approximately 25 percent of all professionally managed money has some socially responsible component attached to it.

The bottom line is that companies have learned that abiding by a narrow understanding of self-interest is going to hurt them in the long run. And we’ve seen evidence of how ethical behavior is good for the health of organizations of all sizes, across all industries — particularly those that sell directly to consumers. Risk reduction, lower employee turnover, cost savings, increased profits and stability in the stock market are just some of the benefits companies have experienced by taking CSR seriously.

It’s becoming clear to both corporations and their consumers that we all affect one another, and in some ways, we all depend on one another.

This post is part of a series following the “Pre-MBA World Tour,” organized by Shoaf and members of the class of 2010.

Dubai is clearly one of the fastest-growing cities in the world. Just compare a satellite image of five years ago with that of today. What was once a small desert city along the gulf coast is quickly becoming a large metropolis with miles of skyline and hundreds of man-made islands emerging from the Arabian Gulf.

What is most fascinating about this rapid growth is that it’s not based on slow economic progression. It’s based on the decision of a single ruler who has realized that the emirate’s oil reserves may be gone someday and he needs to diversify the framework of his economy . . . and quickly.

To understand what is happening in Dubai, simply take a blank sheet of paper and use your imagination to design a brand-new city that would rival any of the world’s largest — including New York, Los Angeles or London. And then, find a way to build it within 10 years.

In Sheikh Mohammed bin Rashid Al Maktoum’s design, he subdivided the city into several economic free zones intended to be the world’s hub for nearly every major industry. Some of these zones are designed for the services sector (e.g., Media City, Internet City, International Financial Center, etc.), while others are designed for education and liberal arts (Knowledge City, etc.).

Another important component of Sheikh Mohammed’s plan was to establish Dubai as the most visited tourist destination in the world. In order to attract tourists, he commissioned several iconic attractions (such as the World, the Palm Islands and the Burj Dubai) that would give tourism magnets such as the pyramids or the Eiffel Tower a run for their money.

Right now the population in Dubai is nearly 1.5 million (and it’s estimated that only 15 percent are actually Emirati citizens), and there are hotels and housing developments being built with an expectation for more rapid growth.

The obvious question is: If you build it, will they come?

Fortunately, much of this investment seems to be trickling down into every level of the emerging market economy, and everyone in the system seems to be making a lot of money. This new land of opportunity is creating such a huge demand for jobs and materials that it’s attracting top talent and capital investment from all around the world.

The other important component of this economic plan is that the large sovereign wealth funds and government agencies have two bottom lines: profit and GDP growth. From what we can tell from visiting with several of these organizations, Dubai is probably experiencing a real estate bubble, but it is still on a fast track to becoming one of the most fascinating and diverse cities in the world.

Next Stop: Mumbai

Photo Credit: .EVO.

• Drastic cuts of the discount rate;
• dramatic reductions of the target Fed funds rate;
• setting up special liquidity facilities, which allow banks to tap into the Fed’s balance sheet to acquire term funding; and
• opening up the discount window to investment banks and dealers.

While these actions have helped to calm the markets, two structural problems remain: excess housing stock and banks’ uncertainty about the subprime exposures of other banks. These problems have contributed to elevated levels of LIBOR.

How will turmoil in global money markets affect the world economy? And what can central banks do to prevent a future credit crunch?

These questions were the focus of a research conference held May 29-30 at the Federal Reserve Bank of New York and cosponsored by CBS.

The conference was attended by more than 100 participants from academia, central banks, hedge funds, investment banks, rating agencies and regulators. Opening remarks were delivered by Timothy Geithner, president of the Federal Reserve Bank of New York. Dean Glenn Hubbard and Donald Kohn, vice chairman of the Board of Governors of the Federal Reserve System, delivered keynote speeches and offered policy perspectives for the road ahead.

Hubbard noted how the evolving credit crunch has placed the relationship between capital and liquidity into sharp relief. After reviewing the actions taken by the Fed, Hubbard noted that moral hazard is a risk of prompt central bank action in providing extraordinary liquidity support, especially in the present U.S. context. He also noted that the time for economy and accumulation of capital and liquidity is during “good states” before the crisis arrives. Finally, he added that the regulatory policymakers should carefully think through the links between capital and liquidity.

Many participants in the conference noted that the actions of the Fed might induce moral hazard and encourage risk-taking behavior in the future. The opening of the Fed’s discount window to investment banks came under considerable debate, given the excessive leverage and risk-taking behavior of the investment banks.

The Fed-assisted takeover of Bear Stearns by JPMorgan was also the subject of considerable discussion. The consensus was that the actions of the Fed saved deadweight costs associated with the potential bankruptcy of Bear Stearns but might have encouraged risk taking in the future.

The conference ended with a panel discussion of the credit crunch. One consensus was that securitization will now focus on core constituencies with standardized collateral, and highly customized securitized products will not find risk capital in the near future. Participants noted that the elevated levels of LIBOR indicate that the crisis is not over yet.

This post is part of a series following the “Pre-MBA World Tour,” organized by Shoaf and members of the class of 2010.

This week the Pre-MBA World Tour traveled to Istanbul in order to better understand the current business environment in Turkey and to see what types of opportunities might be available to CBS students and alumni during the next decade.

Before arriving, we knew that (as the song goes) Istanbul was once Constantinople. But we didn’t know that Turkey is currently undergoing a significant social, economical and political transition. And somewhere in these winds of change lie several interesting opportunities.

For nearly 25 years, Turkey has been attempting to transfer its state-owned businesses to the private sector. Following a financial crisis in 1994, and another in 2001, the country’s financial system has finally shaken off hyperinflation and has begun to privatize many sectors of its economy.

Furthermore, since 2005 Turkey has been in negotiations to join the European Union. Many of the requirements to join the EU have provided an incentive for Turkish policymakers to change the way business is done.

Among these changes has been a significant movement toward privatization, and this movement (along with a new currency to curb inflation) has made foreign investors more confident. Private equity has begun to flow into the economic system, and GDP has been growing at nearly 8 percent per annum.

Although many people believe that Turkey won’t be admitted into the EU for another five to seven years, the changes that have been made to prepare for this transition have positively impacted the economy.

Whether Turkey should join the EU remains a controversial issue, yet there are clear benefits. One is that Turkey has a young and dynamic population that can contribute immensely to the workforce in Europe (where the average age of the population is increasing every year) and thus can play a role in increasing Europe’s competitiveness with such countries as China and India.

In addition, an interesting political shift has arisen relating to the election of the conservative AK Party. The AKP won the election in August 2008 for the second time, which led to the stabilization of the Turkish economy and an increase in foreign direct investment. The AKP has very strong connections with the United States and has a vision of using aggressive economic growth vision to gain admission into the EU, yet ongoing judicial debates and the party’s nonsecular policies have created uncertainty about its sustainability.

While these controversial topics remain to be tackled on an international level, Turkey is experiencing GDP growth, a stronger currency (fluctuating between 1.18 and 1.39 USD/TRY) and a lower inflation rate, leading to increased urbanization and development at the intersection of Europe and Asia.

The natural beauty and historical richness in this melting pot have increasingly attracted tourism in the past 10 years, and Istanbul remains the center of Turkish history, culture and business. We have found Istanbul to be a wonderful city full of diversity and opportunity.

Next stop: Dubai

When I was an undergraduate, I volunteered in a Bosnian refugee camp in the former Yugoslavia. It was there that I first heard about modern-day slavery.

After I graduated, I became an investment banker and got my MBA. But I remained haunted by those stories.

I knew that very little was being done to stop the industry of human trafficking and exploitation and that its size and scope were only increasing with time. So I made a radical decision.

I thought: There are a lot of MBAs in the world, but there don’t appear to be many applying their business backgrounds to solve the problem of modern-day slavery.

So, in the summer of 2000, I decided to set aside my corporate aspirations and embarked on a series of research trips. For the past eight years, it’s been my mission to decipher how best to attack the economic forces that perpetuate human exploitation, specifically, sex slavery.

To my surprise, there was almost no hard data and no cogent analysis of how the sex-slave industry worked globally. I realized that someone with a business background needed to analyze how the industry works from an economic perspective, because that’s the best way to ascertain how to eradicate it.

The essential economic formula of slavery is to minimize the cost of labor so as to maximize profits (the cost of labor represents 60 to 75 percent of the cost structure of most legitimate businesses). Sex slavery takes this equation and puts it on steroids, because the operating costs are paltry compared to the massive revenues generated by millions of consumers purchasing sex from slaves every day.

In the unit economics of a sex-slave operation, there tend to be modest up-front fixed costs (mostly slave acquisition), minimal operating costs and almost no cost of risk (the penalties for being convicted of running a slave operation). Entrenched socioeconomic factors, such as global poverty and bias against gender and ethnicity, create an enormous supply of potential slaves — putting the up-front cost of slave labor at historic lows. In the United States before the Civil War, slaves were purchased for about $40,000 to $50,000 and might generate a return of about 5 to 10 percent per year. Today, sex slaves can be bought for as little as $200 throughout Asia to up to $10,000 in parts of Western Europe and the United States but can generate annual profits of greater than 1,000 percent.

The supply side of the global slave industry could take generations to ameliorate, therefore short-term abolitionist tactics should focus on the market force of demand. To materially disrupt demand, we have to create an upward shock in the cost structure of operating a slave business, and the most vulnerable component of this is the real cost of risk — which is now basically zero around the world.

The most poignant aspect of my research in the midst of all this economic analysis has been the humbling, inspiring courage of the victims. Some of these slaves recounted their experiences for the first time to me and a translator, believing their stories might make a difference. I hope these stories will motivate people not only to be outraged but also to be part of the targeted steps that are required to abolish slavery once and for all.

Based on his eight years of international research, Siddharth Kara’s book Sex Trafficking: Inside the Business of Modern Slavery will be published in January 2009 by Columbia University Press.]]> Tue, 3 Jun 2008 13:16:07 EDT ]]> Business Economics and Public Policy Social Enterprise World Business

Professor Charles M. Jones talked with Leonard Lopate last week on WNYC’s Please Explain about the intricacies of the futures market.

Just last week, the Commodity Futures Trading Commission announced an investigation into possible price manipulation in the oil futures market.

“It’s too soon to know exactly what might be going on in oil prices, although this big run up I think has some people’s antennas up,” Jones told Lopate.

According to Jones, the last case of real manipulation was almost 30 years ago, when the Hunt Brothers tried to corner the silver market.

“Cornering the market and these types of manipulations can really reduce confidence in the market,” Jones said. “They’re really the regulators’ nightmare, and it’s the main thing they’re trying to prevent.”

There has been a lot of emotionally charged rhetoric surrounding sovereign wealth funds, especially with politicians and the media magnifying the “straw man” of suspicious foreign motives to conjure up advantages and ratings.

I just don’t buy it. Calls from politicians and the media for sovereign wealth fund regulation miss the larger point. Singling out sovereign wealth funds as bad guys suggests that they have the potential to be more hazardous to U.S. interests than other funds — and allows the rest of the investment field to roam freely, going largely unchallenged.

We should ask whether a fund’s national origin even matters. After all, hedge funds have an enormously extended reach and diverse investor bases. What if 49 percent of a hedge fund’s investors were U.S. endowments and 51 percent were foreign entities? And what if that calculus was opaque because the capital was disbursed through an offshore fund of funds? Variables such as these can make determining who wins and who loses far from clear-cut.

In the final analysis, it isn’t just what type of company, how big of a stake or what debt or equity instrument is owned that underlies plausible U.S. vulnerability — it is whether we have a strong political alliance in place, and the extent to which our dependence can be used against the U.S. in a negotiation for trade, security, intellectual property or what have you.

For the global economic environment to survive, we must cooperate with each other. The U.S. has a spiraling current account deficit that some argue resembles precrisis Argentina: the dollar has slid precipitously, oil prices have risen.

That we haven’t had a severe avalanche of dollar selling seems to be due to political good will with foreign central banks and the moral persuasion of the Treasury and the Federal Reserve. None of our trailing data are owed to the alpha-decision making of supposedly sovereign-neutral portfolio managers.

Given all this, pointing a finger exclusively at relatively mundane entities, such as Singapore’s GIC, seems like a diversionary tactic to distract the public from much larger, more complex issues.

Commencement seems an appropriate time to reflect on the meaning of a business education. In the spirit of taking on the question, the Social Enterprise Program at Columbia hosted a discussion by Rakesh Khurana, a professor from Harvard Business School, who recently came out with a somewhat critical assessment of the state of business education in his book From Higher Aims to Hired Hands.

In his discussion, Professor Khurana traced the history of modern business schools from the late 18th century, when they first appeared in universities such as Columbia. Prior to this, there had been many business schools, but they were all for-profits and more like today’s vocational institutes.

The move of business schools to America’s elite universities was decidedly controversial. At Columbia, the trustees voted to keep business out, but they were overruled by Nicholas Butler, president of the University at the time. He argued that the rise of modern business had created a class of professional managers who were now essential to society’s well-being, and it was incumbent upon Columbia and other institutions of higher education to provide a training ground for America’s future business leaders.

Underlying this was the assumption that business and management should be elevated to the status of a profession, like law and medicine, based on a common body of knowledge and a sense of higher social purpose — and hence belonged in universities.

But Khurana expressed skepticism that this “professionalization” has been successful. To condense his 500-page book’s arguments into a single sentence: Modern business schools provide a hodgepodge of course offerings that teach a disconnected set of tools; they have lost sight of their social purpose; and their graduates leave prepared to be investment analysts and consultants, not leaders.

You may or may not agree with Professor Khurana’s claims (you can watch the video of his presentation here). Regardless, he presents a useful opportunity to consider what business schools are all about.

It’s a little late for this to be useful for exam time, but Slate is running a week of stories on procrastination. My contribution is an article on overcoming procrastination from a behavioral economist’s perspective. Or I should say it’s a joint contribution with Eric Johnson, my colleague in the marketing division, though I get all the credit.

When I was asked to write about procrastination, rather than trying to write something based on my own nominal knowledge of the topic, I walked down a flight of stairs to consult Eric, one of our local experts on such topics.

I knew the article would be centered on thinking of procrastination as a problem of present versus future costs and benefits. This can help us to figure out how best to overcome procrastination — by bringing future benefits closer to our procrastinating selves and/or magnifying the costs of delayed action. But when it came to specifics, I was coming up a little short. Eric quickly directed me to some of the more interesting work in procrastination and public policy, and also described his own work on visualization (bringing the future coming closer to the present).

Hopefully, the column will provide some tips that will help you get the lawn mowed this weekend or meet deadlines at work. If so, please drop Eric a quick note of thanks.

During spring break we traveled to Ghana with the mission of developing a marketing strategy that would increase tourism and investment in Kumasi, Ghana’s second largest city. Our goal was to collect information and make the necessary contacts to help us implement our recommendations.

Kumasi, as part of Columbia’s Millennium Cities Initiative (MCI) is working on a number of projects in infrastructure, health and education that will hopefully bring the city closer to the Millennium Development Goals (MDGs). Our project is a key component of that effort due to the obvious benefits that the increased economic activity can bring to the city.

The first lesson we learned might seem obvious, but is very important: You can’t market a product you don’t know. The many hours we spent reading reports on Kumasi and browsing what was available online didn’t give us much of an idea of what we discovered in the end.

What we discovered was a city with a rich history as the capital of the Ashanti Kingdom and the home of many local crafts such as Kente cloths and Adinkra prints. We also learned about areas with untapped tourism potential such as Lake Bosomtwe and the Bomfobiri Wildlife Sanctuary. On the business side, despite all the challenges, we found a local administration working to improve the infrastructure and we discovered some intrinsic advantages of Kumasi over other cities in Ghana.

Even though it is the second largest city in Ghana and has more than a million inhabitants, Kumasi has serious infrastructure challenges surrounding its road network, electricity, water and Internet (getting our emails in Kumasi took a painfully long time). Many businesses complain that the centralization of government services in the capital, Accra, is a heavy burden to their productivity.

The team has been working hard on the project and we are in the process of developing an actionable set of recommendations for the city that we think can make a difference. The rest of the team — Kenny Hsu, Dario Cacciatore and Andre Le — will travel to Kumasi again in May to formally present our proposal and to start working with the project stakeholders to help Kumasi achieve the MDGs.

This consulting project was supported by the Social Enterprise Program’s International Development Consulting Project Fund, for the Earth Institute at Columbia University.

The following excerpt is drawn from Ben Bernanke’s remarks at last night’s Annual Dinner, at which he was honored with the Distinguished Leadership in Government Award. download the full text

Many foreclosures are not preventable. Investors, for example, are unlikely to want to hold onto a property whose value has depreciated significantly, and some borrowers — perhaps because they were put into an inappropriate loan or because personal circumstances have changed — cannot realistically sustain homeownership. However, if a foreclosure is preventable, and the borrower wants to stay in the home, the economic case for trying to avoid foreclosure is strong.

Clusters of foreclosures can destabilize communities, reduce the property values of nearby homes, and lower municipal tax revenues. At both the local and national levels, foreclosures add to the stock of homes for sale, increasing downward pressure on home prices in general. In the current environment, more-rapid declines in house prices may have an adverse impact on the broader economy and, through their effects on the valuation of mortgage-related assets, on the stability of the financial system. Thus, finding ways to avoid preventable foreclosures is a legitimate and important concern of public policy.

To determine the appropriate public- and private-sector responses to the rise in mortgage delinquencies and foreclosures, we need to better understand the sources of this phenomenon. In good times and bad, a mortgage default can be triggered by a life event, such as the loss of a job, serious illness or injury, or divorce. However, another factor is now playing an increasing role in many markets: declines in home values, which reduce homeowners’ equity and may consequently affect their ability or incentive to make the financial sacrifices necessary to stay in their homes.

On the principle that a picture is worth a thousand words, Federal Reserve staff, using detailed, county-by-county information on mortgage performance, have developed a series of heat maps, which summarize the incidence of serious mortgage delinquencies across the nation as well as some of the key drivers of loan performance. As the examples will make clear, the figures use warmer colors — orange and red — to show counties for which the factor being considered has a higher value or change. Lower values or changes are indicated by cooler colors — shades of green and yellows — indicate areas where the factor under consideration has a moderate value or change.

download all seven heat maps

What are the implications of these relationships, particularly the linkage of mortgage payment problems and falling house prices? Loan servicers are used to dealing with mortgage delinquencies related to life events such as unemployment or illness, with the most common approaches being a temporary repayment plan or the folding of missed payments into the principal balance. A widespread decline in home prices, by contrast, is a relatively novel phenomenon, and lenders and servicers will have to develop new and flexible strategies to deal with this issue. In some cases, when the source of the problem is a decline of the value of the home well below the mortgage’s principal balance, the best solution may be a write-down of principal or other permanent modification of the loan by the servicer, perhaps combined with a refinancing by the Federal Housing Administration or another lender.

To be effective, such programs must be tightly targeted to borrowers at the highest risk of foreclosure, as measured, for example, by debt-to-income ratio or by the extent to which the mortgage is underwater. Finding the right balance — particularly the need to avoid programs that give borrowers who can make their payments an incentive to default — is difficult. But realistic public- and private-sector policies must take into account the fact that traditional foreclosure avoidance strategies may not always work well in the current environment.

Most Americans are paying their mortgages on time and are not at risk of foreclosure. But high rates of delinquency and foreclosure can have substantial spillover effects on the housing market, the financial markets, and the broader economy. Therefore, doing what we can to avoid preventable foreclosures is not just in the interest of lenders and borrowers. It’s in everybody’s interest.

One of the more remote places to do business is Tajikistan, a mountainous republic in Central Asia. Recent events aren’t helping: an energy crisis appears to have set in motion a food shortage, and the IMF claims that the National Bank of Tajikistan misrepresented its creditworthiness to secure loans.

Still, the economy is growing, and we were excited to see it firsthand over spring break. All semester we had been working with a local bank, the First MicroFinanceBank of Tajikistan (FMFB), on assessing the viability of providing commercial loans to small and medium enterprises (SMEs). In mid-March Lukas Bauer ’09 and I traveled there to gather research that could help us identify the factors that would determine whether or not that could work.

After arriving in Dushanbe, the capital, we went first to the bazaar to meet with small-business owners. We found retailing practices that would usually cause great concern: bags of cash were transported hundreds of miles to pay suppliers; there was no maintenance of current accounts or accounting books; and monthly sales tracking (or any, for that matter) was conspicuously absent.

In the framework of commercial finance, these business practices would preclude an assessment of the chance of default, a necessary element to judging the risk that the bank would incur by providing a loan. However, the framework of microfinance allows lenders to protect portfolios through diversification: while a default of the size of most commercial loans could cripple the financier, the combination of multiple borrowers and the small size of individual loans protects the bank’s lending portfolio from collapse.

The next day we boarded a plane for Khorog, the capital of the Gorno-Badakhshan Autonomous Region (GBAO), the remote mountainous province that comprises nearly half of the country’s territory. In ninety breathtaking minutes we flew over the 20,000-plus foot Pamir range, observing the isolated villages and seasonally passable unpaved roads below (we would spend nineteen hours driving back). We were beginning to understand the complexity of the challenges faced by GBAO businesses.

Over the next three days we visited clients in the rural districts of Roshtkala and Rushan, discussing the finer points of locally significant activities such as Pamiri residential construction and chicken incubation. They pointed to real challenges facing their business, ranging from changing consumer preferences to across-the-board inflation on basic commodities.

We were awed by the lengths to which owners went to start their businesses. One dentist brought fragile equipment over steep mountain passes from China. Other aspiring industrialists drew deeply on capital loans to create outbound supply chains.

By the week’s end, we had a real sense of the needs of the customers. They called for more credit, lower interest rates, less up-front paperwork and most vociferously, longer loan durations. From the bank’s perspective, however, these requests had to be balanced with risk level, transparency and the costs such changes would pose.

Our challenge now is to resolve this disjunction. Over the next month, our team — Ossama Soliman ’08, Gervasio Guareschi ’09 and Michael Hsueh ’09, along with Lukas and myself — will be researching microfinance institutions around the world that make loans in similarly inhospitable terrain.

After final exams, part of our team will travel to Dushanbe to present our recommendations and plan the next steps with the bank.

Microfinance will not be a panacea for Tajikistan; even if the FMFB succeeds in meeting its clients’ financial needs, deeply rooted economic and political problems will still limit business opportunities.

Nevertheless, the bank has already demonstrated that the provision of finance markedly improves the odds that entrepreneurial endeavors will blossom into productive and profitable enterprises. We aim to convey the insight from more mature organizations that will enable the bank to both succeed commercially and make as broad a social impact as possible.

This consulting project was organized by the International Development Club and sponsored by the Social Enterprise Program.]]> Tue, 29 Apr 2008 15:22:00 EDT ]]> Business Economics and Public Policy Corporate Finance Social Enterprise World Business

In our “Game Theory and Incentives in Business” course, Professor Paolo Siconolfi and I use experimental methods as an active teaching tool, simulating a strategic market environment in which students can actively participate.

In our most recent experiment, we simulated George Akerlof’s market for lemons (faulty used cars). In his paper “The Market for Lemons: Quality Uncertainty and the Market Mechanism,” Akerlof illustrates the failure of a market due to asymmetric information between sellers and the buyers.

For this experiment, we divided the class into two groups: buyers and sellers. Sellers were able to chose a price, quality grade and whether they wanted one or two units. The sellers were told the monetary costs of producing each of their units, and these costs depended on the quality grade: a higher quality grade meant a more expensive unit. Sellers did this all without knowing what their competitors chose.

After all seller decisions had been submitted, both prices and quality grades were provided to buyers. Buyers then were allowed to make purchases of at most one unit at the posted price.

Of course the purpose of all this is to make a profit, so the sellers are trying sell at a price above the cost of a unit and buyers are trying to buy at a price below the value of the unit.

This experiment had two treatments. In the first four rounds, the buyers were able to see the quality grades before they bought a product, whereas in the last four rounds the quality of the product was hidden.

Buying and selling grade-two units is the socially and individually optimal outcome (it maximizes the income for both buyers and sellers) and this was indeed the case in the first part of the experiment: the majority of the transactions involved grade-two units at approximately right prices, with very little excess supply or demand. (You can see the results in the figure below, where the theoretical demand and supply is given on the left hand side.)

However, when the quality became unknown, the buyers reacted to the possibility of buying low-grade products. In fact, in round five, only four transactions (out of a possible 10) took place. The sellers responded quickly to the demand and lowered the prices. The market quickly converged to the lowest possible price level, and only low-grade products were sold.

Some students were playing in groups, and we overheard them reacting to adverse selection and moral hazard effects in a way that proved Akerlof’s theory. Our students were masterful in understanding the incentive problems in the market.

Of course none of this could have worked without enthusiastic students. We were very lucky to have a select group who took the theory and experiments very seriously and brought their insights into the classroom.

We like to conduct these experiments before discussing key economic ideas and principles, and during the spring term we conducted a good number of them: the pervasive winner’s curse phenomenon in auctions; a persistent bubble in a limit-order market; failure of auction mechanisms in the existence of asymmetric information; behavioral considerations beyond rationality in a trust game; and many other phenomena that arise in strategic market environments. Besides giving us a chance to illustrate the shortcomings and teachings of these theories, we find that these experiments allow students to gain firsthand experience with market theories and encourage them to ponder the underlying questions and issues.

My purpose in writing these columns is to help people understand how we economists spend our time, and what we have to contribute to our understanding of the world. So they’re often geared towards illustrating big economic concepts (like barriers to entry, or signaling models, or search frictions in product markets) in a way that the average reader will find to be engaging. It’s a source of enormous satisfaction that I’ve gotten positive feedback on the columns from top-flight economists as well as random people who track me down via the web and let me know that I’ve somehow informed their views on life and society.

For better or worse, to grab people’s attention, you need more than interesting economics — it helps to have some drug smugglers, mafia characters, warlords or Sex and the City thrown in to motivate the reader (my dating column, based on work with Sheena Iyengar, is the closest I’ve had to “a shot heard around the world” — at least in part because it was picked up by the New York Times’s Maureen Dowd and Al-Jazeera’s Riz Khan).

I also try to write about things before anyone else does. It’s, well, unsatisfying to describe work that’s already showed up in a dozen blogs and appeared on the front page of the New York Times. It’s one of the privileges we have as academic researchers that we actually spend a lot of our time listening to people talk about preliminary work before it shows up on professorial Web pages.

In my Slate column this morning, I write about some very recent work on the impact of attending the Hajj (the pilgrimage to Mecca) on racial and religious tolerance. This isn’t economics, per se, but it’s about the hugely important question of whether exposure to people from other backgrounds can help us all learn to get along. It’s impossible to learn much about this by comparing integrated versus segregated communities, for example, since people who are racists probably settle in segregated places and tolerant people move to integrated places.

But the authors have a very clever way of getting around this “self-selection”problem — Pakistanis apply to a lottery to attend the Hajj, so making the pilgrimage is a matter of random assignment, not self-selection. And this means that any difference in tolerance between pilgrims and nonpilgrims is the result of their exposure to other Muslims in Mecca, rather than a preexisting condition (like an openness to travel and new experiences).

I’m always in search of new material, and also feedback on topics that would make for interesting columns. So if you have any ideas, drop me a line.

Should the U.S. join the Kyoto Protocol, or at least play a positive role in the search for a successor? Or is this too costly, or otherwise “fatally flawed,” as our president has suggested?

Humanity as a whole needs to address climate change: it has the potential to alter the world around us dramatically, and for the worse. Preventing or at least minimizing climate change will not be cheap, but it will still be a good buy.

Roughly speaking, reducing greenhouse gas emissions to the level consistent with limiting climate change to around 2 degrees Celsius (about 4 degrees Fahrenheit) will cost in the range of 1-2 percent of world income.¹

We need to compare this cost with that of allowing climate change to continue — a harder number to compute. The most thorough and most recent estimate put the cost at “at least 5 percent” of world GDP, with “at least” here indicating that this assumes a rather conservative estimate of temperature increase and includes in the calculation only the costs of climate change that are captured in market transactions.

So this estimate would include the costs of land lost due to increases in sea level, or of reduced agricultural output, but not of species driven extinct by changing environments, or of the spread of disease vectors in a warmer world and many other non-market costs.

My own estimates are that the nonmarket costs are probably going to be bigger than the market costs, so the total could be 10 percent or more of world income.

If you can spend 2 to save 10, that’s a good investment — if the 2 and the 10 are both spent and saved today. A problem in the climate change case is that we spend the 2 now, well before we save the 10: we invest 2 to make 10, but we invest the 2 now and get the 10 spread over many years starting in 2040 or thereabouts. So we have to worry about the discount rate: over long periods it makes a big difference. I argue that the right discount rate for society to use here is very low, so investing 2 now to make 10 in the future still makes sense. But some of my colleagues disagree.

Another element in the calculations is that there is always a small but non-zero risk that the extent and impacts of climate change will be far greater than the central estimates of the IPCC. They admit this and give quite large error bars around their figures. These error bars are asymmetric: the mean increase is in the range 2-4 degrees C with no chance at all of less than 1 degree (we are already at 0.75) and some chance of 6 to 8 degrees. The upper end of this range would not just be costly: it would be disastrous. So we have to see climate policies as insurance policies, insuring against the small risk of a disastrous outcome. We can apply techniques from risk management to work out how big a premium it is worth paying: it could be several percent of GDP.

Back to the Kyoto Protocol. If we want to reduce emissions, then there are three ways of doing this:

• Order firms to emit less (command and control)
• Tax emissions
• Introduce a cap-and-trade system, as the U.S. did for SO2 under the 1990 amendments to the Clean Air Act.

Kyoto chose the last of these three, and the European Union has embedded this in its internal approach to reducing emissions. This also seems to be the preferred method in the U.S. states that are moving to reduce greenhouse gas emissions.

To economists cap-and-trade or taxes are clearly the preferred options, and politically it seems that cap-and-trade is way ahead. Taxes are a political liability, and cap-and-trade has the merit of generating new tradable securities, which the investment banking community loves. If we follow this route, then the CO2 market could become a multi-trillion dollar market within ten to fifteen years.

Photo Credit: Mila Zinkova]]> Tue, 22 Apr 2008 10:07:29 EDT ]]> Business Economics and Public Policy Risk Management Social Enterprise

This post is part of a series in honor of the School’s Leadership and Ethics Week and was first published in the Columbia Daily Spectator.

A common way to define business ethics is as the interplay between two agents: the company’s stakeholders and the law. But a company has many stakeholders, and since it’s impossible to do what’s best for each one — how do companies decide where the tradeoffs occur?

Consider coal mining in West Virginia. In the Appalachian Mountains, coal companies employ techniques called mountaintop removal and valley fill, in which they use huge amounts of explosives to remove tons of topsoil and rock in order to access seams of coal within the mountain. This resulting topsoil and rock is than scraped by dragline cranes into the adjacent valleys.

Photographs of this process are quite striking — the environment around these mines is devastated. The clear-cutting and topsoil removal destroys whatever native forest existed on the site. The valley fill creates havoc in the local watershed, and thus the surrounding water table is often unsuitable for anything, let alone human consumption.

Ask an environmentalist about this process and watch out. The destruction of pristine mountain wilderness eliminates the possibility of sustainable tourism revenue for the local inhabitants and destroys the intrinsic value found in the natural world (although some would argue against this point). Burning coal also produces a great deal of harmful emissions, including carbon — the main culprit in global warming.

Ask a union worker and you’ll get a slightly different — but equally big — response. Mountaintop removal has caused the coal industry to shed thousands of mining jobs over the past few decades, effectively breaking the power of the mining unions and the protection they engendered.

But in looking for solutions, this example unravels into a more complex ethical dilemma.

Underground coal mining is extremely labor intensive and dangerous, and the additional costs are likely to be absorbed by the end consumer — raising a number of issues as to how low- and middle-income families could afford higher energy prices.

And according to the Energy Information Administration coal generates 48.6 percent of our country’s electricity — yet there is no easy alternative. Natural gas is subject to severe price fluctuations and requires importation terminals near which no one wants to live. Not to mention that most of the world’s proven natural gas reserves are located in Russia and the Middle East — not exactly regions that one would categorize as ideal sites for a reliable energy source.

Oil carries the same risks, and solar, hydro, wind and nuclear power are in no position to provide this much electricity. Based on their current levels of output, it will take decades until they are as efficient as coal.

So the fact remains that coal companies are providing an affordable and necessary service to the electricity consumer and high returns to their investors, and yet industry practices are ruinous to the natural environment and the human communities around the mines.

Here lies the new frontier of business ethics. The idea that an ethical business must simply follow the law and provide the highest returns to shareholders while doing so is dying a long-overdue death. There are far too many examples of laws being designed and interpreted to suit powerful industries for this myopic belief in the rightness of the letter of the law to be anything but wishful thinking.

Right and wrong in the business world must be constantly examined by all participants in the decision making process and answer the question: What are our priorities? Tradeoffs must be weighed, sacrifices must occur and eventually, a decision must be made in which there are winners and losers. As a society — and especially as a business community — it is our responsibility to determine the balance between these winners and losers in a manner that reflects the ideals we wish to pass on to future generations.

Later I attended a dinner hosted by Kunho Cho ’78, vice chairman of Lehman Brothers International, that included a small group of alumni. We had a frank insiders’ discussion on the current state of the world’s financial markets. We also talked about private equity strategy in Japan. One camp shared the typical American viewpoint, which is that firms must change board membership to add value to the company. Others thought a different strategy would be appropriate in Japan, given the culture and market realities, and proposed that PE firms should keep the senior leadership to help turn the company around. There is no doubt however that entrepreneurialism in Japan has become more prevalent as a byproduct of deflation as companies have had to innovate.

On Thursday, I spoke at the Tokyo American Center, where I presented an overview of the current economic outlook in the U.S. and Japan, forecasting a slight increase in GDP for both countries in 2009. I noted several issues revolving around political uncertainty: for the U.S., protectionism and tax policy, and for Japan, the political wrangling over Bank of Japan leadership.

Though there are challenges for the global economy, I do remain optimistic about prospects for long-term growth in the U.S. economy (productivity is the key) and also about Japan’s ongoing productivity growth prospects, with needed emphasis on structural reform.

For me, this type of story underscores the value of understanding the basics of cost-benefit analysis and incentives, which is a big part of what I hope I’m communicating to my students in Managerial Economics. It’s central to making good decisions, whether in government, nonprofits or business.

And hopefully, pointing out such missteps in business or policy is an important role that scholars have in connecting their work to real-world practice.

I do think that the effects of the three-strikes law in its current form were simply the result of a lack of foresight. And this has mattered a lot for current and future policy.

There have been attempts to amend California’s three-strikes legislation, but laws are sticky — once they’re in place, it’s really hard to change them. So despite a recent (failed) statewide referendum on the issue, California is still saddled with a bad piece of legislation.

Two weeks ago, I blogged about the mounting combination of anxiety and excitement leading up to my trip to Nigeria. Outside of the exceptional opportunities for investors in the country’s capital markets — which did little to soothe my fears as a traveler — I’d heard few reassuring stories about Lagos. Meanwhile, my imagination went to work on the news reports, rumors and exaggerated tourist tales I had heard, conjuring up images of an urban center descended into anarchy.

I should have known better!

Jindra Zitek ’08 and I arrived at the Lagos airport expecting to be harassed by an unruly mob of aggressive taxi drivers, con artists or worse. We found instead only a few families waiting for their loved ones. The first person to approach us was our smiling classmate, Gbolade Arinoso ’08, wearing his finest traditional Nigerian clothes. From the moment we exited the airport, we knew we’d have to throw all preconceived notions about Lagos out the window.

In fact, throughout our week in the city, we were struck by how poorly we’d misimagined the place. At no point did we feel threatened in any way. Rather, we were welcomed warmly by everyone we met, from security guards and restaurant workers to private equity investors and government officials.

In the end, it was this inviting stance toward foreigners that made our project such a success. Our goal was to write a world-class business school case study about Computer Warehouse Group, West Africa’s leading IT systems integrator. As soon as we explained our project, we found that the local business community was quick to rally around us. Even normally secretive private equity firms were willing to openly discuss their valuations of the company!

Ironically, it was the very hospitality that made our trip so exhausting: the 9–5 work days were simply too short to speak with all the people who so generously offered their time. We frequently found ourselves meeting deep into the evenings, exploring the intricacies of valuing the IT services company in the Nigerian context. We learned more than we ever imagined — about the firm, the country and, most of all, about the tricks our imagination can play on us when we operate on incomplete information!

Photo credit: The New Black Magazine]]> Wed, 12 Mar 2008 15:56:17 EDT ]]> Business Economics and Public Policy Organizations Social Enterprise World Business The physical demands of a dancer are strenuous, yet many dancers smoke cigarettes to the detriment of their health. Why do they do it?

In 2001, a study of 120 dancers in New York found that relaxation and enjoyment were their main reasons for indulging. (Weight control was one of the least-cited reasons).

Professors Nachum Sicherman (CBS) and Lalith Munasinghe (Barnard) recently put this in economic terms: time preference. Dancers, like most professionals with low wage growth, often choose immediate gratification over future effects.

According to the researchers’ study — which won the 2006 Eckstein Prize — people who are less future oriented (i.e. have a higher discount rate) are less likely to invest in human capital and hence more likely to select into careers with lower and flatter earnings profiles.

The gross hourly pay is substantially lower for smokers compared to nonsmokers. On average, the nonsmoker wage premium is more than 15 percent.

The authors posit that dancers smoke because they are more present-oriented.

To give you an example of what I mean, that first year I found myself guiding the late Yasser Arafat to the men’s room and having a tête-à-tête with Oprah Winfrey.

Nine months later, as the Forum was gearing up for Davos 2002, September 11 changed the world. Soon thereafter, Klaus Schwab took the unprecedented and risky decision to bring the forum’s annual meeting down from the Swiss Alps to the heart of Manhattan as an expression of solidarity with the people of New York City and the United States. Not only was the entire atmosphere of the event changed, it was also the first time social entrepreneurs were included in the forum’s annual meeting.

Since then, social entrepreneurs have become a growing fixture at Davos, and business and government representatives welcome them happily and warmly. One of the most important approaches we have used is to give them speaking roles on key panels and in workshops where their issues are being discussed by other experts.

This year, we organized a session entitled “Innovations in Leadership” to explore new models of leadership that are urgently needed in an increasingly interdependent world. We heard from living legends like Muhammad Yunus, Jimmy Wales and Nicholas Negroponte. The session brought leaders in business, media and technology innovation together with social entrepreneurs to discuss the benefits and challenges of operating through networked and open systems. Such approaches eschew traditional “command and control” models in favor of a more “viral model” — emphasizing that the minds of many are far more powerful than those of a few.

So, while the mainstream media reporting from Davos has focused on the U.S. and global economies and their woes — serious issues indeed — there is an untold story. A band of Davos attendees, including some 45 social entrepreneurs, have been seizing the opportunity brought about by present chaos to advance new business models that ultimately promise to combine markets and meaning.

“First, labor productivity, the source of all value to Smith, could max out; second, the state could intervene too much; and third, capitalists could eat up the natural resources upon which production rests.”

Horton, who is head of the Social Enterprise Program at Columbia, thinks Smith’s third factor is the reason that interest in social enterprise is spreading. The past decade alone saw a tenfold increase in interest.

“There is a growing awareness in the business community — and among business school students in particular — that we can’t continue to behave as we have in the past without destroying the environment,” said Horton.

“Most students still place a lot of value on making money, but they have a much more pluralistic sense of value than they did even a decade ago.”

Many of my students responded, and the blog editor chose a couple to publish.

From Sean Murtagh ’08:
Needless to say, the current debate over a government-backed housing bailout is a thorny subject, with strong arguments on either side. While I personally am not in favor of excessive government intervention in the functioning of markets, I believe there are rare times when such intervention is necessary not only to restore the functioning of these markets but also to promote the overall health of the economy.

In today’s environment I fear that such an intervention may be necessary, as the albatross around the economy’s neck that is the residential housing market seems to be spreading dangerously into other important markets, such as the commercial real estate and leveraged-loan markets.

If this ripple effect shuts down these and perhaps other credit markets, I believe the consequences for the economy would be disastrous: a large portion of economic activity would grind to a standstill due to the resulting scarcity of credit, a condition that as a result of expectations could persist for a long period of time.

The real issues to be analyzed are whether or not this credit shutdown is likely to happen, and if it does occur, how long is it likely to persist, questions that are difficult at best to answer.

If, after a thorough analysis, the answer to either question suggests a mild interruption either in terms of scope or time, my recommendation would be to allow the market itself to sort out the current housing crisis. As long as credit does not totally dry up, at some price home buyers will once again enter the market eventually restoring a new equilibrium.

If, however, best estimates are for a protracted disruption in the overall credit markets, I believe government intervention in the housing market — provided it is done in as minimalist and expedient a way as possible — is sensible despite the moral hazard and other compelling arguments against such an intervention.

While I am certainly not in favor of bailing out the speculator or any of the scores of individuals who engaged in blatant fraud during the recent housing boom, I am in favor of seeing the economy as a whole remain well-functioning. I don’t believe we should allow the overall economy to suffer unreasonably just to teach certain individuals a lesson.

From Erik Diehn ’08:
I’m not sure that letting an institution like Citibank go bust is the best answer to a financial crisis — while the investors, managers and other parties who turned a blind eye to lax CDO repackaging and lending would certainly get their comeuppance, having a major financial institution melt down would result in all sorts of damage to the various completely innocent parties who hold accounts, loans, etc. in Citi’s diverse businesses. I think, in fact, that Aaron [fellow MPE student commenter] is right on when he points out that some relief is needed to keep the wheels of credit turning so that businesses and individuals can continue to borrow to expand their economic undertakings.

What concerns me more than the specific moral hazard created by bailing out bad mortgages is the impact this kind of intervention might have on the millions of nondefaulting but nevertheless indebted Americans who borrowed heavily against nonproductive assets (houses) to fuel a continuing consumption binge (cars, flat-screen TVs, etc.). We have been living through at least 15 years of continuous asset-price inflation; will a government intervention in this deflation — whether through buying up mortgages or reducing interest rates — just create more of the same?

It seems to me that ultimately, there's no quick fix for the fact that in the long run we’re going to have pay for these bubbles one way or another. My hope is that any sort of government proscribed remedy (a) lessens the pain of this readjustment so that we perhaps have a longer but less severe period of austerity and rebuilding rather than a shorter but more painful shock and (b) provides regulatory tweaks that shift incentives so that the chances of another bubble are reduced.

Of course, some people think that bubbles are inevitable and more or less a required part of the modern U.S. economy — see “The Next Bubble” and related postings from the February 2008 edition of Harper’s Magazine for a prime example of this theory. I’m not sure I subscribe to a view that extreme, but I do think that as a country we have developed an awful lot of dependence on speculative growth and create a lot less fundamental value than we used to.

“That's not going to make a great deal of difference to people's economic well-being or their pocketbooks,” Professor Lichtenberg said. “The idea that if you're on one side of the line you're in a recession and if you're on the other side you're fine — that's not really the case. Clearly, we are in a very difficult period.”

I think education is important in ways that are obvious to every human being out there. You think about what education did to your life, you think about the teachers who changed your life, you think about the knowledge you developed.

For the country and for the city, education is important for two reasons, and one is that we have a racial and ethnic achievement gap in this country that is the greatest shame of this great nation.

The idea that skin color or poverty can determine the quality of the education you get is wrong. It’s fine for rich people to have bigger houses, larger cars, more diamonds — but a better education is morally wrong.

That moral issue takes on another dimension as we move forward in an increasingly globalized competitive economy, and I think it’s going to create enormous economic challenges.

We cannot have an education underclass in an increasingly competitive global economy. If you watch what’s going on in the rest of the world, there are people out there — quite literally — looking to eat our lunch.

And it is so critical to the transformation to have people who are bringing entrepreneurial, innovative juices — who instinctively get accountability, who understand leadership and care deeply about management. In the world of education, when I talked like that in the beginning, people looked at me like I was nuts. This was an alien language.

But at its core, education is a service-delivery challenge — if you don’t lead it, manage it and create the proper incentives in order to make it happen, it won’t happen. It’s about cultural transformation. That’s why the kids from business school want to come and be a part of it.

The core leaders that I have at many levels in the system are not people who came from the education schools — they’re people who came from the business schools, and from the business sector.

That causes me a lot of political heat, but that’s just fine, because if you don’t inject entrepreneurialism, accountability, innovation, differentiation, all of those things — you know what? We’ll continue to get the same pitiful results that we have gotten for the last 50 years in American education.

“Whenever journalists write about emergency room delays, they tend to oversimplify the problem, and they usually connect the increase in emergency room wait times to the increased percentage of uninsured patients. It’s true that the percentage of the uninsured is increasing, but all the research I’ve seen shows that the percentage growth in visits to emergency rooms is greater for insured patients than uninsured patients.

“So it’s not about uninsured people, it’s about people in general. And the reason more people are going to the emergency room is that the wait time to get an appointment with a primary care physician has gone up to an average of three and a half weeks. There are just are not enough primary care physicians, and there’s no financial incentive to become a primary care physician when other specialties are much more high-paying.

“And while the growing difficulty in access to primary care is certainly a factor in the growth of emergency department visits, it’s likely not the only cause. We are also experiencing increased numbers of people with diabetes, heart disease and other serious chronic diseases, and these also contribute to the increase in visits.

“There is also a growing number of patients being ‘boarded’ in emergency departments while waiting for an inpatient bed. These require the attention of the emergency department physicians, which results in the physicians having less time available for the new arrivals into the department.

“Hospitals do try to adjust the number of physicians that are on call to accommodate patient flow — for example, they realize more patients show up at noon than at two in the morning. They just don’t do it very well because they don’t know how to do it very well. Most hospitals are not run by MBAs. They are run by physicians, and physicians aren’t familiar with management techniques that are used in other industries. Banks, supermarkets, airlines and call centers all use mathematical models. Hospitals don’t use these mathematical models so it’s not surprising that they don’t operate efficiently.

“It does take up a lot of time and energy from the hospital managers to keep the hospital afloat. Most hospitals are in financial straits — one third of them operate in the red, and they don’t focus on emergency rooms because it’s not where they make money.”

One of the reasons that Modern Political Economy is such an enjoyable course to teach is that every term a real-life issue emerges that underscores the course’s contemporary relevance. What to do about the credit crisis that cascaded from the home mortgage debacle is the latest case in point.

Reports are circulating that Wall Street firms, led by Bank of America, are pushing a plan that would have the federal government buy up troubled mortgages at a discount, forgive debt above the current market value of the homes and then use federal loan guarantees to refinance borrowing at lower rates. In other words, bail out everybody who forgot about the concept of risk — from homeowners all the way up the food chain to financial institutions and investors.

Some people have viewed this gambit as somewhat ironic because Wall Street has successfully preached a laissez-faire policy on the part of the government that would encourage all sorts of financial innovations, but of course it isn’t ironic at all. As Adam Smith, the father of modern political economy, recognized more than two centuries ago, when the vicissitudes of the free market strike home, everybody from the poorest of the poor to the richest of the rich looks to the state for protection.

The case against state intervention is that if you bail out those who didn’t pay enough attention to risk, the same dynamic will be repeated in the future. That’s the moral hazard argument of the free-market purists, who argue that in the long run the market will correct itself and go forward with everybody a bit wiser about risk.

The case for state intervention was put succinctly by the always pragmatic Lord Keynes: “In the long run, we’re all dead,” he said to those who argued that market forces would eventually cure the Great Depression. He actually agreed with that perspective, but he favored government pump priming because he worried about the social and political instability that might result from a prolonged economic crisis.

So I asked my Modern Political Economy students to share their views on whether the federal government should intervene in the current crisis or simply let the market work its painful way out. A couple of the students will post their answers on the blog tomorrow. I’d be interested in what others think as well.

Photo credit: Sean O’Flaherty

They became friends, and over the next 14 years Perelman played for Buckley and his guests many times. Perelman was preparing to play for him again last Wednesday — Beethoven’s Diabelli Variations — and dined at his house on Tuesday, the night before he died.

NYT columnist William Kristol wrote of Buckley’s last supper with Perelman:

“It’s fitting that he spent it with someone who had sought Bill out because of his uncompromising defense of freedom, the lodestar for his political and intellectual efforts. It was a fitting end to an admirable life.”

]]> Wed, 12 Mar 2008 11:36:38 EDT ]]> Business Economics and Public Policy