18 March 2008

10-Q: The Form of a Problem

Okay, here's how we got in trouble—

Every three months, all publicly-held companies are required to file with the Securities and Exchange Commission and make available to the public certain information about their financial performance. On the whole, this is a good thing. The price of shares on the stock markets is, theoretically and ideally, based on everyone having access to the same information when they make the decision either to purchase or sell. Trading on inside information, or 'insider trading', is what Martha Stewart was charged with (though she went to jail for lying to government investigators looking into those charges). Every year, companies must file what's known as a Form 10-K which details the companies' performance for the year. The idea is to provide transparency into the financial well-being of a company to prevent fraud in the trading of its securities.

As I said, that's all well and good, but with this admirable regulation has arisen a perverse set of incentives: the managers of the companies subject to regulation must provide positive short-run performance or the price of their shares will take a hit—as will their bonuses and, eventually, their job-security. Thus, they do things like selling off company assets or diluting equity or borrowing heavily or skimping on planning and Research & Development to fund current operating costs or, in other cases, relying on PR and misleading marketing to exaggerate their poor performance, or, in still others, using accounting tricks like taking certain charges off-budget so they don't appear in the main text of the financial forms.#

Do you see where this is going?

There are the same sort of incentives in U.S. politics. The Congressional cycle is two years, the Presidential cycle is four. There are annual budgets—though the oversight is, one suspects, hardly so comprehensive. After all, the Iraq invasion and occupation have been off-budget items since the inception, in effect concealing their true costs.
[T]he real scandal is Mr. Bush's own preference for financing much of the cost of the Iraq war outside the normal budget process. That is convenient for the administration, which does not have to count the money when it is pretending to balance the budget. But Iraq is not some kind of unexpected emergency, like Hurricane Katrina. It is a highly predictable cost... .

Moving the war's financing off budget is no mere technical distinction. For one thing, it subjects the military's spending requests to less careful Congressional committee scrutiny than they would receive during the usual budget process. More important, this fiscal sleight of hand makes it that much easier for the Pentagon to duck the hard choices it desperately needs to be making between optional and costly futuristic weapons and pressing real-world needs. NY Times, May 8, 2006

This is an old trick, but it still works. The President* managed to make his fiscal performance, dismal enough to begin with, look better than it truly was by an accounting sleight-of-hand. Taxes were cut: this was a political trick to fool us into believing the illusion. The fact is, though some were paying less in taxes (which go to fund measures for the public good such as infrastructure, security, government oversight and regulation), we are paying more for commodities (gold, oil, etc.) which are, for the most part, privately held. Profits in these sectors have been obscene. Crude oil prices are five times as expensive as they were when GWB took office. Do you think it's a coincidence that GWB was an oilman and that his VP was in the oil-services business? But that's off-topic. The larger point is the incentives in the system to make the government managers look good in the short term, with no thought for the long-term good of the country or its people. The CEO mindset.

Think back to the first invasion of Iraq. Pres. GHW Bush refused to pursue Saddam Hussein into Baghdad and ended the action early and before a prolonged occupation. Thus, when the presidential cycle rolled around again, he could no longer claim to be a 'war president' and rally the support of the American people. And, guess what, domestic issues took over and he lost. His second son, as dumb as many think he is, clearly learned his lesson. He extended his own invasion all the way to Baghdad and claimed to be a 'war president' at election time which, you can be sure, was just enough to eke out a highly-contested election against a fairly inept opponent (we won't go into the splitting of the opposition caused by Ralph Nader). He needed our troops to remain in Iraq just long enough to get him (re-)elected. It worked, but created the current quagmire. The short-term incentives outweighed the long-term consequences in the political calculus. And now we have to pay for it.

Fraud, expedience, short-term manipulation of information (e.g., labor and unemployment statistics, war costs and casualties, M3), asset foreclosures, privatizing the public weal, lack of long-term planning, heavy borrowing, currency devaluation: these all appear to be structural problems, perverse incentives in our system of governance which this particular administration has managed to exploit for the cynical purpose of gaining and remaining in power maugre the consequences.

# Rather, they are buried in footnotes at the end of the document.

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