The day Wall St. failed Main St.

Posted on by j.giglio

Six years ago this weekend, Wall Street was rocked by the collapse of Lehman Brothers. What began as a banking crisis morphed into something that shook the U.S. economy to its core. Only federal intervention prevented an even more catastrophic result.

How the world’s biggest economy came to the brink of depression is a question that will be debated for a long time, but one could argue that the predicament stemmed from a financial system that was “too interconnected to fail.”

On Sunday, Sept. 14, 2008, Lehman CEO Dick Fuld had run out of options to save one of Wall Street’s grandest institutions. In the early hours of Sept. 15, the company issued a press release announcing that it was seeking bankruptcy protection.

On the day of Lehman’s filing, the Dow Jones Industrial Average plummeted 500 points, its largest decline since Sept. 11, 2001. Adding to the anxiety was the Sept. 14 announcement that America’s best known securities firm, Merrill Lynch, had decided to sell itself to Bank of America for $50 billion amid fears for its own survival.

All hell broke loose within hours of the Lehman bankruptcy. Credit markets froze and banks stopped lending to one another. Lenders no longer knew which borrower was a good risk, so they treated all of them as bad risks.

The Feds made an emergency $85 billion loan to the American International Group because of AIG’s enormous exposure to sub-prime mortgages through the underwriting of credit default insurance. Unlike for Lehman, here the feds opened the checkbook because they determined that the company had to be rescued to protect the financial system and the broader economy. They then allowed Morgan Stanley and Goldman Sachs to become bank holding companies and authorized the Federal Reserve Bank of New York to extend credit to both firms.

Lehman’s downfall created widespread panic in financial markets, as investors scrambled to withdraw their money. On Sept. 16, the nation’s largest money market fund was forced to cut its per-share value below the sacred $1 level because a major portion of its portfolio, invested in short-term debt issued by Lehman, was frozen in bankruptcy court.

The announcement brought Wall Street’s problems home to Main Street by undermining the confidence of millions of small investors in money market funds as a safe place to park their savings. That prompted the Treasury to announce a temporary program to guarantee investments in participating funds.

Much has been written about the causes of the crisis and different witnesses provided conflicting accounts. But it may be that being too interconnected to fail counted even more than size.

That’s why the feds decided so many financial institutions had to be bailed out; sold off to others with government guarantees to sweeten the deal, loaned enormous sums of taxpayer money or recapitalized with government equity.

The elaborately interconnected nature of the financial industry greatly increased the speed and efficiency with which money could move through society. But all the sophisticated technology in the world ultimately depends on one sacred principle: A person keeps his or her word. Suddenly people in the financial industry stopped trusting what their counterparts said about the .value of the portfolio being offered as collateral on a loan and a whole host of other avowals.

How can you do business with a person you can’t trust? As a result, the entire financial world melted down. And the feds had to rush in with open checkbooks to stave off the apocalypse.

originally published: September 2014

Looking back – and forward- on collapse of Lehman Brothers

Posted on by j.giglio

Six years ago this month, Lehman Brothers, a 158-year-old institution and one of the nation’s five largest investment banks, went bankrupt. Its demise produced the equivalent of a global financial blackout and marked the beginning of the biggest economic crisis since the Great Depression.

It was also completely avoidable.

Six years after Lehman’s collapse, the economy is still reeling. In July, more than 10 million Americans were unemployed and another 9.8 million were underemployed. The labor participation rate of 62.9 percent is the lowest since 1978.

Lehman Brothers had become increasingly reliant on fixed-income trading and mortgage securities underwriting. This went hand-in-hand with an increase in its leverage ratio, from 24 to 1 in 2003 to 44 to 1 in 2007. Since much of this leverage took the form of very short-term debt, Lehman had to continuously sweet talk its lenders about the “solid value” of the assets it had pledged as collateral for these “here-today-gone-tomorrow” loans.

But this sweet talk was undermined by continued erosion of the housing and mortgage markets during the summer of 2007. After Lehman’s stock price fell 37 percent from June to August, the firm closed its sub-prime mortgage arm, wrote off $3.5 billion in mortgage-related assets and laid off more than 6,000 employees by the end of the year.

Things only got worse in 2008. In January, Lehman closed its mortgage lending unit and laid off another 1,300 employees in a vain attempt to stem further cash hemorrhages from its sub-prime mortgage operations.

After Bear Stearns collapsed in March, Standard & Poor’s rating arm downgraded its outlook on Lehman from “Stable” to “Negative” on the expectation that its revenues would decline by at least another 20 percent. That caused Lehman’s stock price to plunge by an additional 48 percent.

Lehman attempted to counter this by selling $4 billion in convertible preferred stock. But this fresh cash was quickly soaked up by more write-offs, including Lehman’s $1.8 billion bailout of five of its short­ term debt funds. Ravenous short-sellers (the “Vultures of Capitalism”) began circling and rumors flew that other firms were refusing to trade with Lehman.

With its common stock in virtual free fall, Lehman contemplated taking itself private, but the idea was abandoned when it became clear that the necessary financing wasn’t available. An effort to locate buyers for $30 billion of its commercial mortgages (such as office buildings and shopping malls) met with a similar fate.

The federal government had to step in if Lehman was to be saved. But any such move was complicated by the enormous public outcry that had arisen over the $29 billion “federal bailout” of Bear Steams that March. Voices from all sides of the political spectrum screamed about the feds using taxpayer funds to bail out big Wall Street firms that had caused the mess, while refusing to lift a finger to help American families who were losing their homes.

Since a presidential election loomed in a matter of weeks, Treasury and the Federal Reserve felt that nothing short of a congressional directive to “save Lehman” would allow them to move. But the Bush administration did not approach Congress and the federal government was reduced to trying unsuccessfully to convince other financial giants to bailout Lehman.

On Sept. 15, 2008, Lehman filed the largest Chapter 11 bankruptcy in American history to that point, listing assets of $639 billion and liabilities of $768 billion and leaving its viable businesses to be snapped up at fire-sale prices by sharp-eyed bottom feeders. The federal government’s inaction is generally regarded as its most disastrous financial decision since the early 1930s.

In retrospect, it was political fallout from the Bear Stearns collapse that proved to be Lehman’s death knell. The feds underestimated the impact Lehman’s demise would have on capital and credit markets. Only after the true scope of the problem became clear in the subsequent days and weeks did the feds go to Congress to request the controversial $700 billion Troubled Asset Relief Program to protect other troubled banks from insolvency.

originally posted: September 6, 2014

Corporate America must pay fair tax rate

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Both President Obama and Republicans have called for lowering the corporate tax rate, citing America’s global competitiveness. But cuts should be reserved for companies that invest in the U.S. and its workers. Other corporations should pay more, and all should pay their fair share.

The federal government first taxed corporate income in 1909. Corporate rates were initially below 10 percent, but following World War II they increased dramatically, to over 50 percent in I951. Between 1951 and 1986, the top corporate tax rate ranged from 46 to 52.8 percent.

Large corporations were also complaining about the tax rate in 1986, the year of the last significant federal tax reform. The rate was reduced to 35 percent, loopholes were closed and the tax code simplified. At the time, the rate was lower than that of most developed countries. But today the 35 percent rate is one of the world’s highest, and it jumps to 39.2 percent when state and local taxes are included.

This rate is double the European average and more than triple Ireland’s 12.5 percent rate. Over the past 25 years, almost every country in the Organization for Economic Cooperation and Development has cut its top corporate tax rate. Corporate America is again arguing that the U.S. rate is a disadvantage for domestic  corporations.

But while U.S. companies often complain about the 35 percent top rate, they don’t like to admit that hardly any of them pay anything close to it. While the United States’ corporate tax rate is relatively high, it’s not a meaningful measure of the actual corporate tax burden.

A 2013 Government Accountability  Office report showed that large, profitable U.S. corporations paid an effective federal tax rate of 12.6 percent of their worldwide income in 2010, about one-third the statutory rate. Adding in foreign, state, and local taxes increased the average effective tax rate to 16.9 percent, which is certainly competitive with other developed countries and is a lower rate than the average teacher or police officer pays. A 2012 study by Citizens for Tax Justice found that over a recent period, 30 of the largest U.S. multinationals with more than $160 billion in profits paid no federal income tax at all.

According to the Congressional Research Service, corporate income taxes have diminished as a source of federal revenue, from 39.8 percent in 1943 to 9.9 percent in 2012, as corporate profits reached record highs. The GAO reported that in 20I2, corporate income taxes generated about $242 billion in federal revenue, while individual income taxes accounted for $1.I trillion.

U.S. corporate tax collection equaled just 2 percent of gross national product in 2011, according to the OECD. That was the lowest in a ranking of 27 wealthy countries.

The reason they pay less in taxes is not because corporations play a less important role in our economy or that corporate profitability has diminished. Rather, it is that corporations have learned how to exploit loopholes in the tax code and retain lobbyists who move well in Washington. And let’s not forget the $2 trillion in profits stashed abroad.

Much of the simplification from the comprehensive 1986 tax overhaul has been lost. Between 2001 and 2010 there were over 4,000 changes festooned to the tax code, resulting in a code of nearly four million words with a sky-high impenetrability quotient.

Nearly six years after the financial meltdown, the economy is still far from recovery. Over 20 million Americans who want a full-time job can’t get one and labor force participation is at its lowest level since 1978. Low wages and stagnant incomes prevail.

Congress should create incentives for companies that invest and create jobs in the U.S. and impose higher taxes on firms that do not. But any tax reform should start from the premise that corporate America has to pay its fair share, and that means no profitable corporation having a lower tax rate than your child’s teacher.

originally published: August 30, 2014

Navigating a free Market (Basket) economy

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The bitter clash between factions of the DeMoulas family, the major shareholders in the Market Basket supermarket chain, once again raises the issue of corporate responsibility. Is the sole responsibility of executives and boards of directors to maximize the value of stockholders or are they responsible to a broader array of stakeholders that include customers, employees, suppliers and host communities?

In recent decades, a grand total of two options have evolved for dealing with the issue of corporate responsibility. If you believe businesses should exist unmolested, solely to serve the interests of stockholders, then the late economist Milton Friedman is your man. He was the most outspoken advocate of that view and argued that corporate social programs add to the cost of doing business. Spending money to reduce pollution, for example, makes a business less profitable.

Many management gurus counter that there is danger in focusing solely on profitability. An overzealous pursuit of stockholder returns can encourage maximizing short-term rather than long-term returns. Such an orientation leads to actions like cutting expenditures judged to be nonessential in the short term such as research and development. The resulting underinvestment jeopardizes long-term returns.

The near financial meltdown in 2008 and the subsequent Great Recession demonstrated the large and diverse group of stakeholders who are affected by companies’ actions. In the wake of this shock to free­ market capitalism, the traditional view of corporate responsibility is giving way to a belief that enlightened self-interest requires a business to consider all important stakeholders when running the enterprise, not just stockholders.

Stockholders provide the business with capital, but if customers don’t get value for their money they can take their business elsewhere, employees provide labor and expect commensurate income and job satisfaction in return or they can leave their jobs, suppliers seek dependable buyers , and local communities want firms that are responsible citizens.

To create customer value, most firms rely on a network of stakeholders. In determining company goals and strategies, executives and board members must recognize that each has justifiable reasons for expecting and often demanding that the firm take its interests into account. Family-owned businesses such as Market Basket are no different.

As Southwest Airlines founding CEO Herb Kelleher noted, the key to delivering outstanding customer service is putting employees first. “If they’re happy, satisfied, dedicated and energetic, they’ll take real good care of the customers. When the customers are happy, they come back. And that makes the shareholders happy.” At Southwest, people and profits are explicitly linked and that has accounted for outstanding profitability over several decades in a highly competitive industry.

Leaders at Market Basket and other companies don’t realize that they don’t hold all the picture cards. If they don’t reform their behavior, an angry public will do it for them by boycotting their businesses.

originally posted: August 16, 2014

 

The unimaginable catastrophe of World War I

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A century ago, on June 28, 1914, Archduke Franz Ferdinand, heir to the throne of the multi-ethnic Austro-Hungarian Empire, made an official state visit with his wife, Duchess Sophie, to the Bosnian city of Sarajevo, which the empire then occupied.

Late that morning, the cars in their imperial procession made a wrong tum on the unfamiliar streets of Sarajevo and halted to get their bearings. At that moment, Gavrilo Princip, a young Bosnian freedom fighter (or terrorist, take your pick) stepped out of the crowd and fired two shots into the back seat of the open car carrying the Archduke and Duchess. Both died within minutes.

And Europe proceeded to come apart at the seams.

Less than six weeks later, on Aug. 3, Kaiser Wilhelm’s Germany invaded Belgium as the first step in their longstanding Schlieffen Plan to score a quick military victory over Republican France.

France had a military alliance with Tsarist Russia, which had already begun mobilizing its huge army in support of its client Balkan state of Serbia, the “spiritual leader” of occupied Balkan states like Bosnia. Serbia was being threatened with invasion by the Austro-Hungarian Empire (with the support of its German ally) for “refusing to cooperate fully” in the investigation of Archduke Ferdinand’s assassination.

Germany regarded Russian mobilization as a threat against its eastern provinces and assumed Russia’s French allies would attack from the west, so it decided to mount a preemptive invasion of France through neutral Belgium.

However, the constitutional monarch of Great Britain had guaranteed the territorial integrity of Belgium. The British declared war against rampaging Germany on Aug. 4 and began landing contingents of its small but highly trained army in France on Aug. 7 to support the French and Belgian armies.

By the middle of August, the major league lineup was basically set: The alliance of Britain, France, and Russia was at war with Germany and Austria-Hungary.

Clear? I thought not. But the parties plunged ahead with great enthusiasm into the five local wars that broke out during August in different parts of Europe. Austria-Hungary was fighting Serbia in the Balkans and Russia in southern Poland and Galicia. Russia was fighting Germany in East Prussia. France squared off against Germany in Alsace-Lorraine and Germany fought Belgium, France and Britain in Belgium and northern France.

All confidently expected the war to be over by Christmas. They got the Christmas part right, but not the year.

The unimaginable catastrophe of World War I, which would remake the world, dragged on with maximum mismanagement by all parties until November 1918. It destroyed the remains of 19th-century European society and wouldn’t really be settled until the end of World War II, when the western allies and the Soviet Union finally smashed the resurgent monster Germany had become in the wake of the 1918 Armistice and established a new Europe amid the ruins.

World War I may have been inconclusive, but its cost was staggering. All told, the 16 nations that ultimately ended up fighting spent the equivalent of some $3,000 trillion (in inflation-adjusted dollars) on the war. They mobilized 65 million troops, 12 percent of whom were killed and another 33 percent wounded.

The Austro-Hungarian Empire collapsed and was replaced by some half-a-dozen ethnically based nations, most of which were overrun by Germany in World War II and later became puppet states of the Soviet Union.

The people of Europe, having borne the brunt of the suffering, lost all confidence in the so-called “ideals of western civilization” they had taken for granted before 1914. They also lost faith in their governments, which they were convinced had persistently lied to them, protected their elites at the cost of everyone else and squandered millions of lives by mismanaging the war.

Virtually everyone, victor and vanquished alike, was left bankrupt and owing more money to the United States (which sat out most of the war and became the world’s leading creditor nation) than they could ever possibly repay.

It was quite a scorecard for a war that settled virtually nothing.

originally published: August 9, 2014

Time to make overt corporate tax inversions

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Every political season brings new issues and controversies. One of the big ones this time around is “corporate tax inversions.” Unfortunately, the trend is a symptom of a bigger problem that will require the kind of long-term solution that is rarely crafted in even-numbered years.

In business terms, inversion is the restructuring of a U.S. company’s corporate form such that it becomes a foreign corporation based in a country with low corporate taxes, basically turning the corporate structure on its head. American multinational corporations undertake these transactions because the top U.S. corporate tax rate of 35 percent is higher than in many other countries and the U.S. taxes worldwide income at a time when foreign income is increasing substantially.

One example is Medtronic Inc.’s recent agreement to buy Covidien for $43 billion. The move enables Medtronic to domicile to Ireland, take advantage of low corporate tax rates and access its overseas cash without having to pay high repatriation costs.

These inversion deals allow American corporations to reduce their average combined federal and state corporate tax rate of 40 percent. This rate is one of the world’s highest, double the European average more than triple the 12.5 percent rate in Ireland. Over the past 25 years, almost all countries in the Organization for Economic Cooperation and Development except the U.S. have lowered their top corporate tax rate.

The increased number of American firms that have incorporated abroad to reduce their tax burden has prompted a series of congressional hearings, where representatives can express their frustration and anger at maximum strength about firms reducing the U.S. corporate income tax base. The Joint Committee on Taxation estimates that future deals will cost the U.S. almost $20 billion in corporate tax revenue over the next 10 years.

The flurry of inversion deals has also angered President Obama, who has said the practice is “wrong” and urged Congress to close the loophole.

High corporate tax rates are not the only problem. What is frequently overlooked in these contentious discussions is that the United States, unlike many other countries, employs a worldwide taxation system, taxing corporate foreign income at the same rate as domestic income while permitting corporations to claim limited tax credits for income taxes paid to foreign governments to mitigate the possibility of double taxation.

By anyone’s standards the U.S. has a very complex tax code. Corporate tax reforms must recognize global economic changes and resolve the fundamental contradictions in the current corporate income tax structure.

All this strongly suggests that truly solving the problems created by the current corporate tax regime requires a long-term fix and cannot be solved unilaterally by the U.S. Some second-order benefits may be gained by plugging specific loopholes, but a real long-term solution requires better international coordination of tax rules to minimize tax avoidance activities by multinational corporations.

Not too long ago, a corporation could be successful by focusing on making and selling goods and services within its national boundaries. Profits earned from exporting products were considered frosting on the cake but not really essential to corporate success. That is no longer the case, and the U.S. needs to reform its corporate tax code to reflect this new reality.

originally published: August 2, 2014

The slide of the ‘average’

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Much more has been written than read about the divisive subject of income and wealth inequality in America over the last decade. It is the reading equivalent of a dance marathon, painting a gloomy picture of American society. If we are to address it successfully, we must start by enacting policies that recognize the importance of the middle class rather than simply relying on the invisible hand of the free market.

Earlier this year, the number one book on the Amazon bestseller list was “Capital in the Twenty-First Century” by French economist Thomas Piketty. Its central message is a call for wealth redistribution to reduce inequality, an approach that has never been popular in America, a country where economic growth comes first and distribution last.

Despite President Obama’s repeated statements that inequality is the “defining challenge of our time,” things continue to slide for the average American. For those living close to the ground, inequality is alive and well in America.

While there is disagreement about how to measure inequality, most studies focus on income, wages and wealth. For example, the bottom quarter of American households have seen almost no increase in real income for the last 25 years.

The top one percent of Americans, however, seems to be getting on quite well. They have seen their real incomes almost triple during the same period. Their share of national income has reached 20 percent and they own nearly 35 percent of the country’s wealth, figures not seen since the Roaring Twenties. The rich are running up the score.

As few as 16,000 families have a combined wealth equal to 5 percent of America’s gross domestic product, a level of concentration reminiscent of business monopolies. There’s also the legitimate concern that as the economic power of the richest one percent increases, their political power increases with it and they shape the rules governing our economy and society. Can you imagine this group raising taxes on themselves to finance new investments in education, job retraining and infrastructure that are routinely suggested as solutions to the inequality problem.

Americans are witnessing the Matthew effect. To paraphrase Matthew 25:29 in the King James version of the bible: “that to those who have, more will be given, while to those who have less, even that will be taken away.” Or in popular parlance, the rich get richer and the poor get poorer.

This widening gap between the rich and the poor brings with it all kinds of bad implications. Rising income and wealth inequality and the lack of opportunity to move up the income ladder threaten the nation’s economic growth and fundamental values; the middle class is growing thinner and thinner.

A strict free-market capitalist, the economic equivalent of a religious fundamentalist, argues that because inequality puts more resources into the hands of capitalists, it promotes savings and investment that in tum generate economic growth and increase the size of the economic pie. Just lower taxes on rich folks, cut the federal deficit, and deregulate and they will invest in the economy, creating millions of new jobs and lifting the unemployed out of poverty. This holds a grain of truth, but just.

While the issue of what is to be done about economic inequality is not one that lends itself to easy answers, especially in our politically polarized environment, we must start with policies that recognize the important role the middle class plays in driving economic growth.

originally published: July 19, 2014

The Highway Trust Fund is crumbling; maybe it should

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The federal Highway Trust Fund, which provides transportation funding to the states, is projected to run dry in August. But with a technology-driven revolution underway in the way Americans use surface transportation, applying yesterday’s solution and simply replenishing the fund won’t solve the problem.

According to the Obama administration, if the fund is exhausted, states will be forced to put off 112,000 highway construction and 5,600 transit projects, resulting in the loss of 700,000 jobs. When dealing with the government, there are always plenty of zeroes to go around.

The traditional source of revenue for the trust fund is the federal fuel tax of 18.4 cents per gallon, which has not been increased in over two decades. Given that it’s an election year, an increase is not only dead but already decomposing.

One reason the federal fuel tax doesn’t generate enough revenue is more fuel-efficient cars. But that isn’t the whole story. Surface transportation is in the midst of a quiet but profound transformation because technology is fundamentally improving urban mobility.

Technology advances make it easier for people to navigate public bus and rail transportation. Personal ride-booking and car-sharing services are available in nearly every major city, resulting in an interactive transportation network that generates fewer vehicle miles traveled.

As is always the case, technology is outpacing traditional institutions’ ability to adapt. Customers and markets have embraced the digital revolution. The country is witnessing the emergence of an integrated surface transportation network where each transportation mode no longer operates as if it exists in a separate universe.

Technology is in place that allows cities to operate roadway, rail and water transportation modes that complement each other. This gestalt shift represents a fundamental challenge to the traditional approach of the road gang pouring more and more concrete. This is all happening in the name of market solutions, the kind that would make Adam Smith smile.

The proliferation of innovative mobility tools has major implications for traditional approaches to planning, funding, and delivering surface transportation. Recent lifestyle changes, especially among the millennia! generation, are transforming the surface transportation marketplace. It is hard to resist the temptation to conclude that it is time to deliver the eulogy for traditional surface transportation planning and funding.

History- specifically the Japanese Navy’s strategic failure at Pearl Harbor- can teach us something about not letting business as usual blind us when it comes to the need to overhaul surface transportation in the U.S. The Japanese Navy’s officially sanctioned model for everything it did was the British Royal Navy. Standard histories of the Royal Navy emphasize its victories in spectacular naval battles like Trafalgar during which Royal Navy warships attacked and destroyed opposing warships.

Thus, Japanese naval thinking focused on attacking the U.S. Pacific Fleet’s battleships while they were moored at Pearl Harbor. Lost in the shuffle was any serious consideration of trying to cripple Pearl Harbor’s ability to function as a forward naval base. The Japanese were intellectual prisoners of a past that they believed would shape the future.

So it was that, in a brilliant display of tactical management, six aircraft carriers furtively approached the Hawaiian Islands just before dawn that fateful Sunday, launched their planes into the rising sun, caught the U.S. Pacific Fleet with its pants down and wrought havoc in spectacular fashion. On paper at least, this rivaled the triumph at Trafalgar, the Japanese Navy’s benchmark of success.

But as the sun set on Dec. 7, Pearl Harbor’s all-important fuel storage and ship repair facilities remained untouched by Japanese bombs, allowing it to continue serving as a forward base for American naval power in the Pacific. In reality, Japan’s tradition-bound naval leaders chose the wrong targets at Pearl Harbor.

Tradition is often the worst guide when it comes to doing anything really important. Things that have survived long enough to be venerated are often obsolete. American surface transportation is beset by a host of traditions that have helped produce the problems we face today. We must free ourselves of them if we’re to come up with a truly effective vision for what transportation should look like in the future.

originally published: July 12, 2014

The D.C. tempest that is the Ex-Im Bank

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All the world, as the man said, is a stage, and the little-known Export-Import Bank is center stage in Washington’s latest political tempest. Conservative lawmakers are mounting an unwise push in the House of Representatives to pull the plug on the bank ahead of a Sept. 30 deadline for its charter to be renewed. The so-called Ex-Im Bank is funded by the U.S. Treasury (a.k.a., taxpayer dollars) and encourages the sale of American exports by providing direct loans, loan guarantees, working-capital guarantees and export credit insurance to foreign buyers and assists U.S. exporters. All these financial products carry the full faith and credit of the U.S. government.

In recent years, the bank has been the target of conservative lawmakers who want to shut it down. Currently, they are mounting a push in the House of Representatives to pull the plug on the bank ahead ofthe Sept. 30 deadline.

President Franklin D. Roosevelt established the Ex-Im Bank in 1934 to help finance overseas sales of American goods to combat the global collapse in trade and trade credit during the Great Depression. In 1945, it was made an independent government agency, which made it easier to obtain capital from the U.S. Treasury to help reconstruct war-tom Europe.

More recently, the bank extended a multi-million-dollar direct loan to finance exports of gas turbine generators from General Electric to three power plants in Saudi Arabia. Alternatively, if a foreign buyer of an American product sought a loan from a commercial bank, that bank could apply for a loan guarantee from the Ex-Im to cover the debt in the event of a default and pass the costs to the buyer.

Ex-Im Bank also offers export credit insurance to American exporters to protect against the political and commercial risks of defaults by foreign buyers. Finally, the bank guarantees working-capital loans extended by commercial banks to eligible exporters with exportable inventory or export receivables as collateral.

The bank does not give these services away. It uses the interest and fees it charges borrowers to reimburse the U.S. Treasury.

Critics claim the commercial lending market, not the government, ought to fund trade finance deals. The bank is derided as an expensive boondoggle, providing large, politically connected multinational firms with an unfair competitive advantage. Critics also argue that there is little evidence to support the notion that the bank is a major export driver, since it finances less than 2 percent of the $2.2 trillion worth of goods and services American firms exported in fiscal 20 13.

Ex-Im supporters say American exports are tied to jobs and economic growth and that the bank supports exports by assuming risks that commercial lenders are unwilling to take on. They say it provides small and medium-sized businesses with important services at reasonable prices.

America needs the bank because, in the current global economic landscape, other countries have export credit agencies that offer comparable services. Without it, American exports would be at a competitive disadvantage.

In an ideal world, businesses would obtain trade financing from privately owned banks. But since more than 60 countries have export credit agencies, shutting down the bank would amount to unilateral disarmament.

Unilateral disbarment doesn’t work any better in global trade than it does in warfare. That’s why America should not abolish the Export-Import Bank without securing reciprocal action from other trading countries that have their own export credit agencies.

originally published: July 5, 2014

How myths shaped reality in World War I

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Myths have an unfortunate tendency to cripple imaginations. This can lead to the worst kind of unintended consequences, especially when such myths are based on assumptions about how the world ought to be rather than how it actually is.

The bloodiest day in the history of the British Army is a real world example of what this can mean:

Shortly after 7:30 on the morning on July 1, 1916, some 100,000 British soldiers climbed out of their trenches in France’s Somme Valley, arrayed themselves in long lines against the morning sunlight, and began moving forward across No Man ‘s  Land towards the German trenches. They were fully confident they would achieve the long-sought breakthrough in the German lines that their officers assured them would be a piece of cake.

The commanding general of the British army in France was Sir Douglas Haig. He was a long-standing military professional, a member of a Scottish distilling family, and a Presbyterian fundamentalist who believed that he was in direct communication with God (an illusion that he shared with a surprising number of top military commanders throughout history).

In theory, Haig’s strategy should have worked. But there were problems.

Only 40 percent of the British artillery consisted of heavy guns. The rest were lightweight field pieces that could do little damage to trenches and barbed wire. Nearly one-third of the shells fired by the British heavy guns failed to explode because the British munitions industry had not yet come to terms with the need for quality control in shell production. In any case, the Germans housed most of their soldiers 30 feet below the trenches in elaborate dugouts that were impervious to even the heaviest artillery shells.

So when the largely ineffective artillery barrage finally ended at 7:20 that morning, German defenders emerged from the dugouts with ears ringing, but otherwise ready to withstand the British attack that the barrage had told them was coming. They quickly set up their machine guns, which fired .30-caliber bullets at the rate of 600 per minute for hours on end.

By the end of the day, the British army had suffered the greatest single-day calamity in its history. More than 19,000 of its men lay dead in No Man’s Land; over 38,000 had been wounded. Nearly three out of every five British soldiers who had gone over the top that morning had fallen victim to the myths on which Haig based his strategy (presumably after long conversations with God), with little to show for it in the way of captured German territory.

Today, the idea of deadlock sounds pretty good in Iraq. Sunni Muslim radicals who make the Taliban look tolerant are sweeping toward Baghdad in a way that reminds those of us of a certain age of the lightning-fast North Vietnamese drive toward Saigon in the spring of 1975.

We made the wrong call about invading Iraq in 2003 because of flawed intelligence about Saddam Hussein having weapons of mass destruction and because we assumed the Iraqi people would treat U.S. troops as liberators, rise up against their government and welcome us with open arms.

It may have been nearly a century later, but just as in the Battle of the Somme Valley, failure to raise basic questions about the assumptions underlying our decision to invade Iraq are once again yielding tragic results.

originally published: June 28, 2014