The Global Financial Market Melt-Down

I’ve been at a loss about whether or what to blog about the financial crisis, for several reasons.

  • First, our firm’s largest sector is finance/investments/insurance, and we’ve been up to our eyeballs, on things we can’t talk about.
  • Second, the policy prescriptions for solving the problem have become embroiled in the presidential election campaign.  We try very hard not to be overtly political in our work, and opining on the policy prescriptions risked getting into the presidential election scrum.

But today there’s a teachable moment, so I’ll pounce.

As it happens, this morning the Nobel Prize for Economics was awarded to Princeton University professor and New York Times columnist Paul Krugman.

But before he got the call about the award, Krugman penned a column about the world leaders’ meeting in DC to grapple with the growing global financial crisis.  In today’s column Krugman makes a number of points that resonate, because they track best practices in crisis management, and reinforce several themes from this blog.

We’ll parse the column in a moment.  But first, some quick background on crisis management best practices.

Effective Crisis Management

The first rule of effective crisis management is: Think clearly.  The second is: Take the pain.

Think Clearly: Thinking clearly in a crisis requires three things:

  1. Name the problem.  If you can’t articulate the problem clearly, you can’t craft a solution that will actually fix it.  More likely, you’ll either ignore the real problem, or scramble randomly from one solution to another, all the while  causing further harm and delaying addressing the actual problem. As in medicine, we differentiate between a presenting problem,  which is often a symptom, and the underlying problem, which is often the cause.
  2. Understand consequences.  There are predictable consequences to doing nothing, doing something, and doing something more.  Rather than choosing among things that we may want or not want to do, it’s better to choose among the predictable consequences of actions. So we never ask clients “what do you want to do” or advise clients “this is what you should do.”  Rather, we ask, “what outcomes do you most want to achieve?” and advise by saying “if you want to achieve X outcome, the option most likely to get you there is option Y.” Framing choices based on the real problem and the desired outcomes generally results in better decisions made more quickly than a default to the comfortable or to old ways of doing things.
  3. Focus all your energies on actually fixing the problem.  Just as in medicine, addressing the presenting problem may make you feel better.  But unless the underlying problem is resolved, you’re still at risk.  And even if you get the symptoms under control, new symptoms can emerge.  Worse, while you’re feeling better, the underlying cause can get even worse.  All too often an organization’s approach to managing a crisis falls into one or the other of two camps, each of which expends lots of energy but neither of which is likely to actually fix the problem.  a) First-grade soccer: like six-year-olds on a soccer field, where every kid wants to be around the ball, those dealing with a crisis flail around without role clarity, discipline, or a plan. b) Whack-a-mole: like the arcade game, leaders lash out at each presenting distraction, and lose sight of both the actual problem and of the need to show a clear path to solving the problem.

Take the Pain: Once the problem is identified, options and outcomes understood, and commitment made to actually fix the problem, it’s important to move to the second rule:

  1. Do what you know you’ll have to do anyway.  But do it when it can do you the most good, whether you like it or not.
  2. In other words, taking responsible steps now can prevent you having to take even more dramatic steps later.  Time is your enemy in a crisis, and the longer it takes to marshal an effective response, the more robust that response will need to be.
  3. It’s far more effective to get the response right the first time than to scramble and try to undo an early response, and then mount a second (or third, or fourth) response.   In other words, measure twice, cut once.

Applying Crisis Management Best Practices

In today’s New York Times column, Krugman contrasts the US government’s response to the global financial crisis with Britain’s response, and concludes that Britain has “defined the character of the worldwide rescue effort, with other wealthy nations playing catch-up.”

The column focuses on the meeting in Washington this weekend of the industrial nations’ finance chiefs (and some heads of government).  He notes that because the British economy is so much smaller than the US economy, and the role of the Bank of England pales in comparison to that of the Federal Reserve or the European Central Bank, Britain’s leadership role comes as a surprise.

But Britain’s leadership derives not from its size or strength, but rather from the fact that British prime minister Gordon Brown is thinking clearly and  taking the pain.  Says Krugman:

“…the Brown government has shown itself willing to think clearly about the financial crisis, and act quickly on its conclusions. And this combination of clarity and decisiveness hasn’t been matched by any other Western government, least of all our own.”

Krugman, channeling Brown, defines the problem and various proposed options:

“What is the nature of the crisis? The details can be insanely complex, but the basics are fairly simple. The bursting of the housing bubble has led to large losses for anyone who bought assets backed by mortgage payments; these losses have left many financial institutions with too much debt and too little capital to provide the credit the economy needs; troubled financial institutions have tried to meet their debts and increase their capital by selling assets, but this has driven asset prices down, reducing their capital even further.

What can be done to stem the crisis? Aid to homeowners, though desirable, can’t prevent large losses on bad loans, and in any case will take effect too slowly to help in the current panic. The natural thing to do, then — and the solution adopted in many previous financial crises — is to deal with the problem of inadequate financial capital by having governments provide financial institutions with more capital in return for a share of ownership.”

But however natural such a solution might seem, it isn’t the path initially embarked upon by the US government.

“This sort of temporary part-nationalization, which is often referred to as an “equity injection,” is the crisis solution advocated by many economists — and sources told The Times that it was also the solution privately favored by Ben Bernanke, the Federal Reserve chairman.

But when Henry Paulson, the U.S. Treasury secretary, announced his plan for a $700 billion financial bailout, he rejected this obvious path, saying, “That’s what you do when you have failure.” Instead, he called for government purchases of toxic mortgage-backed securities, based on the theory that … actually, it never was clear what his theory was.”

A Study in Contrasts

Krugman says that the British government “went right to the heart of the problem” by promoting a plan for equity injections into British banks last week.  On Sunday in Washington other nations hopped aboard the equity injection bandwagon — including the US.

But Krugman notes that this reversal, while getting the US to the more promising solution, came at the cost of delay and perhaps worse:

Treasury Secretary Henry Paulson“And whaddya know, Mr. Paulson — after arguably wasting several precious weeks — has also reversed course, and now plans to buy equity stakes rather than bad mortgage securities (although he still seems to be moving with painful slowness).”

Why the delay and mis-steps?  In previous posts I’ve described how important it is for organizations to have defenses against their charismatic leaders, to prevent them, in the words of Wall Street Journal columnist Holman Jenkins, from bullying and seducing others into supporting their vainglorious illusions.

Krugman proposes three reasons Treasury Secretary Paulson may have missed the real problem and therefore the real solution:

  1. Refusal to consider any approach that would admit “failure,” per the comment noted above.
  2. Seeing the problem through an ideological prism.
  3. The possibility that there was no-one in his circle to give him a forceful reality check.

Says Krugman:

“As I said, we still don’t know whether these moves will work. But policy is, finally, being driven by a clear view of what needs to be done. Which raises the question, why did that clear view have to come from London rather than Washington?

It’s hard to avoid the sense that Mr. Paulson’s initial response was distorted by ideology. Remember, he works for an administration whose philosophy of government can be summed up as “private good, public bad,” which must have made it hard to face up to the need for partial government ownership of the financial sector.

I also wonder how much the Femafication of government under President Bush contributed to Mr. Paulson’s fumble. All across the executive branch, knowledgeable professionals have been driven out; there may not have been anyone left at Treasury with the stature and background to tell Mr. Paulson that he wasn’t making sense.”

Leaders are judged based on how they deal with their greatest challenges.  And in crises, leaders who think clearly and take the pain not only help solve the problem quickly and with less harm than would otherwise occur; they also see their personal standing and that of their organizations rise.  (For more on effective leadership response in a crisis, see my article in the peer-reviewed management journal Strategy & Leadership.)

Krugman concludes by noting that Gordon Brown (whose own popularity at home and abroad has suffered this year), comes out as the clear-eyed realist with a steady hand:

“Luckily for the world economy, however, Gordon Brown and his officials are making sense. And they may have shown us the way through this crisis.”

We’ll continue to follow the financial crisis and solutions as they are rolled out, and we’ll continue to look for teachable moments.


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