Financial Crisis and Public Policy

This Policy Analysis explains the antecedents of the current global financial crisis and critically examines the reasoning behind the U.S. Treasury and Federal Reserve's actions to prop up the financial sector. It argues that recovery from the financial crisis is likely to be slow with or without the government's bailout actions. An oil price spike and a wealth shock in housing initiated the financial crisis. Declines in stock values are intensifying that shock, threatening to deepen the current recession as U.S. consumers and investors cut their expenditures. An offsetting wealth injection from additional risk-bearing investors could initiate a quicker recovery. Thus, supporters of government intervention justify the bailout's debt-financed fund injections -- in essence, they want to compel future taxpayers to join the group of today's riskbearing investors. However, the bailout is poorly designed and its implementation appears panicky -- marked by a knee-jerk trial-and-error process that may have heightened market uncertainty. Worse, current interventions in market processes and institutions could become permanent, to the probable detriment of the nation's long-term economic prospects. With or without the bailout, the ongoing recession is likely to be deep and long. From a philosophical perspective, any bailout action provides a host of bad incentives. Moreover, we should be mindful that future generations already face massive debt burdens from entitlement programs. Increasing those burdens by expanding the bailout program or enacting a massive fiscal stimulus will hasten the long-anticipated crisis in entitlement programs. Thus, the ongoing economic crisis could usher in permanently higher taxes, greater government involvement in the private sector, and a prolonged period of slower economic growth

Should New Zealand Adopt Say on Pay?

article published in law journalAround the globe, the latest fashion in corporate governance circles is "Say on Pay," a shareholder vote – sometimes precatory, other times mandatory – on CEO remuneration. Country after country has adopted Say on Pay in response to shareholder disgust over the size of CEO pay packets. Beginning with the U.K., and later followed by the Netherlands, Australia, Sweden, Norway, Belgium, France, Switzerland, and the U.S., there has been a widespread acceptance of the shareholder vote on executive pay around the world. In this article, we ask the question: Should New Zealand follow the crowd and adopt Say on Pay, or should it continue down its own path, leaving directors with near total control over executive remuneration levels? Academics are divided over the desirability of Say on Pay – those that believe in strong managerial power are firmly against it, while shareholder activists come out heavily in its favor. The main theoretical arguments revolve around whether: it will tip the balance of power against managers; shareholders are competent to evaluate executive remuneration; third party voting advisors will gain too much power if it is enacted; there will be any reduction in the size, and rate of growth, of CEO pay packets; and it will strengthen the relationship between pay and performance. The experience in the U.K. and the U.S. to date sheds some light on the validity of these arguments. On average, shareholders have voted strongly in favor of executive pay practices at most companies. Say on Pay seems to have had little impact on the size and growth of average CEO pay, but it does appear to have impacted pay practices at poorly performing companies that have unusually high pay. There is a greater level of engagement between shareholders and managers on pay issues at many companies, and firms have become more responsive to negative shareholder Say on Pay votes. Third party voting advisors, such as Institutional Shareholder Services, have become important corporate governance players, whose recommendations have a significant impact on shareholder voting outcomes. In light of these academic arguments, and practical experience in the U.K. and U.S., we believe that New Zealand should carefully consider whether to adopt Say on Pay. We do not view the evidence as compelling the conclusion that Say on Pay is essential, but we can understand why some shareholders might want to see it implemented. However, the existing evidence shows that it is unlikely to have a big effect on current pay practices at most companies in New Zealand if it is adopted

Fourt (or Five) Easy Lessons from Enron

Temptation. It lies at the heart of financial swindles. The promise of 50% returns in three months can lure thousands of investors-so too can a stock that soars 500% in three years. But those who are tempted are often skeptical. Before they invest, they want to know how one can enjoy such supracompetitive returns. The answer usually is a facially plausible story, though with a bit of mystery attached. The mystery is often touted as the reason that the investment opportunity is exclusive to the entrepreneur who discovered it. It is what ensures that the gains are not competed away. The classic case remains that of Charles Ponzi. While not a very adept con artist-he was caught several times-in a six-month period in 1920, Ponzi convinced ten thousand investors to part with an aggregate of $9.5 million. He promised amazing returns-50% in ninety days. As a testament to his financial wizardry, Ponzi often paid off his investors in half the time he had initially promised. How could he work such financial magic? Allegedly, Ponzi had discovered a lucrative arbitrage opportunity in postal reply coupons. Postal reply coupons allowed the sender of a letter to ensure that the recipient in another country would be able to obtain sufficient postage to respond. For example, a letter writer in America would purchase a reply coupon here and send it along with a letter to a relative in another country, say, Spain. The Spanish relative could then redeem the coupon for Spanish stamps sufficient to send a reply. Ponzi noticed a pricing discrepancy in the postal reply coupons. One could buy a coupon in one country for, say, one penny, and redeem it in another for six cents worth of stamps. This opportunity existed because exchange rates had been set in a postal convention in 1906, well before the outbreak of the Great War. The Great War changed the relative value of many currencies, but the rates for postal exchange coupons remained fixed. The failure to adjust the exchange rates on postal reply coupons meant that a trader could buy a postal reply coupon in a country where the relative value of the currency had declined, redeem it in a country where the relative value of the currency had increased, and turn a profit. There were, in theory, gains to be had by exploiting government inertia. But transaction costs limit any opportunity to profit from arbitrage. Consider the steps necessary to exploit this state of affairs. Money would be gathered in the United States. This money then had to be converted into a foreign currency and put in the hands of an agent in the appropriate foreign country. The agent would have to buy the postal reply coupons in large quantity, although there were limits on the number of coupons that could be bought at one time. The agent then had to send the coupons back to the United States. Another agent would have to redeem them. Given these elaborate requirements, it is hard to imagine how anyone could purchase a sufficient number of reply coupons to support the millions of dollars that Ponzi collected