The AGA Weblog

The TARP Refund: What To Do With It?

By: Robert Maitner Jr., CGFM, PMP

Robert Maitner Jr. is senior managing consultant with IBM Public Sector Financial Management.

Imagine this situation. You have encountered an unexpected expense that you had not planned or budgeted for, say perhaps a medical bill. So you take a loan in the amount of $500 to cover the expense. When the bill comes, you are pleasantly surprised that is for only $300. What do you do with the remaining $200? Should this be considered a windfall? Or should it be applied to the $500 loan amount? If the $200 would go toward basic necessities, such as food or shelter, the temptation is there to hold on to the cash. If it would mean a few more dinners out, then perhaps applying the money to the loan balance makes more sense.

This is the same scenario we see with the Troubled Asset Relief Program (TARP).

President Obama recently announced that the bank bailout cost about $200 billion less than expected, telling reporters, “It means that some of that money can be devoted to deficit reduction.”

Democratic leaders want to see those leftover TARP funds used for a new jobs bill. That may not be possible, however. The TARP legislation states that any unused money must go toward reducing the national debt, which sits now at a whopping $12 trillion. The Wall Street Journal explains that the Treasury secretary has some latitude in deciding how to use the funds, but that he first must consider taxpayers’ interests by maximizing overall returns and minimizing impacts on the national debt.

The debate here is a matter of priorities—what is more critical at this time, jobs creation or reducing the national debt? If you’re one of millions of Americans still out of work, you’d most likely opt for the jobs bill. If you’re not out of work, and hawkish about our growing national debt, you may say that the money should be applied back to the loan amount (the debt). It’s all a matter of perspective.  

Perhaps some sort of split would make sense here as well. What about using half of the funds for a jobs creation bill, and apply the second half to reduce the national debt? What do you think?

The Myths of Financial Innovation

By: Sunil Datt, MS, MBA, MA, CGFM, PMP

Sunil Datt, MS, MBA, MA, CGFM, PMP, is Senior Managing Consultant, IBM Global Business Services.

One of the enduring myths of the recent financial system crisis has been the oft-repeated belief that financial innovation left regulation far behind; that so many financial products and institutions were created that nobody really understood what was going on. And the other myth now is that we have the danger of over-regulation stifling innovation; innovation that is essential for the efficient functioning of markets, for efficient intermediation between investors/savers and producers/borrowers, and so on. All overstated.

If you boil it down to the essentials, the crisis was a simple case of over-leveraging on a massive scale; binging if you like. There were new institutions and products involved, but those were not innovations.  There were many types of non-banks involved, but those have been around for sometime; nothing new there. There were complex new securitized products, but then again securitization has been around for decades. If you create a more complex financial product, or one that serves a particular segment of the investor community, or even just one major investor, that to my mind is just re-jiggering, or renovation, or adaptation…whatever; not innovation.

By the way, my view is not cynical. Just trying to be a tad more objective here. For an almost cynical view, sample John Kenneth Galbraith. He wrote in his book A Short History of Financial Euphoria that financial innovation through the ages is merely the quest for new ways to create more debt that is leveraged against limited assets. “The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version,” he wrote. The same trick gets played over and over again under a new guise. Kind of true if you take the over-leveraging aspect of this crisis! Yet Galbraith was too sweeping. The financial system does many things. Among others, it provides a means of payment and exchange; it transfers the spare cash of savers to those with investment opportunities; it allows assets to be traded; and it provides insurance, whether in conventional contracts or in such instruments as swaps, options and other derivatives.

In all these areas, innovation has provided tangible benefits. Computerization has improved the payments system, while technology such as automated teller machines has been a huge convenience to retail bank customers. The Internet is transforming the availability of financial information and is lowering transaction costs in broking. Like many other innovations in retail finance, these advances do not involve the creation of debt. One would have to admit though, that these latter innovations were really financial sector adoptions of technology, rather than true financial innovations in of themselves.

The other view of financial innovation is that it happens because of the desire to escape the heavy hand of regulation. Merton Miller, the late Nobel laureate, declared in a 1986 paper that “the major impulses to successful financial innovations have come from regulations and taxes.” In an extreme version it has even been argued that in the credit bubble, much of the impetus for driving loans off bank balance sheets into securitized form came from the risk-weighted capital regime introduced by the Basel committee of international bank regulators. By encouraging off-balance-sheet activity, the regime turned banking into a shorter-term, more transactional business. Once again an extreme view, but with an element of truth.

True innovation usually brings a paradigm shift. The best example in the physical world, of course, being the cell phone. For the first time, almost anyone could afford to talk to another wirelessly. Not only talk, but also leverage. My favorite story is of the poor Indian fisherman, who would come late in the evening with his catch, only to find that all the traders were gone. The fish would rot. Now, as soon as he has a catch, the fisherman calls five traders, compares prices, and strikes the best deal—all on his cell phone. When he comes ashore late in the evening, the specific trader is waiting to take delivery with cash in hand!

So let’s come to some needed innovations that may really help. The FDIC reports that 60 million Americans are un-banked or under-banked. Un-banked are those who do not have a checking or savings account, and the under-banked are those who do have a checking or savings account but still use check-cashing services, pay-day loans etc. Now financial innovation would occur if products and services were found that encouraged the un-banked and under-banked to walk into bank branches, or bank from their cell-phone! A paradigm shift. Financial innovation would occur if a product or service was found for millions of ordinary investors to manage their 401K accounts with minimal risk. We need some real financial innovation!

The Role of Performance Indicators During Fiscal Stress

By: Anthony Rainey

Anthony Rainey is treasurer and CFO of Hyattsville, MD.

In 1975 Peter Drucker (Management: Tasks, Responsibilities and Practices) identified five prioritization and performance approaches of successful organizations:

• They clearly define the nature and scope of their function, mission and activities.
• They set clear objectives.
• They set priorities, concentrate on the objectives and set standards of performance for themselves.
• They measure performance, analyze the results and work to correct deviations from established standards.
• They regularly conduct audits of performance to ensure that the management system continues to function properly.

Federal, state and municipal governments attempt to utilize these approaches until there is a significant reduction in revenues that will adversely affect the ability to fund the current public service and public product levels. Rarely are significant revenue reductions transformed into a fiscal planning process where the executive and legislative branches base expenditure reductions upon “priorities” and “levels of performance.” This often results in the third “P” of budgeting—politics—to fill the vacuum of leadership in priorities and performance in fiscal decisions. Interest groups who receive public goods or public services, or who are the providers of public goods and public services through government contracts or grants, enter the picture with their respective “priorities” but rarely with new “performance levels.” How can we change this?

Look at What Government Provides

Government provides public goods and public services. The actual production of goods and or the provision of public services are typically classified by their “non-excludability” and/or “non-rivalry.” Non-excludability designates that the difficulty to exclude any person, group, or organization from benefiting from the public good or public service—even if they do not or will not pay for it. Non-rivalry designates that the consumption of the good or receipt of the service by a person, group or organization does not prevent the consumption of that good or receipt of that service by others. In the private sector, a private good or service has excludability for it can be excluded from a person, group, organization benefiting from the good, or service if the consumer or receiver does not pay. Private goods have a rivalry in that consumption of the good or receipt of the service by a person, group, or organization prevents its consumption or receipt by others.

Look at the Cost of Public Services and Goods

In our current economic environment, particularly the decline in federal, state and municipal revenues, the cost of the provision of public goods and services affect short and long-term expenditures, debt service and fund balances. Budget balancing discussions about revenue shortfalls typically focus on immediate or phased in expenditure reductions not tied to prior priorities or stated levels of performance. The federal government’s debt service capacity will soon put them in the same situation as state and municipal governments. Faced with significant revenue shortfalls, budget processes become expenditure reduction exercises greatly influenced by the consumers of public goods, recipients of public services, and the payers of the public revenues for these goods and services. Without utilizing having a “prioritized” list of products and services as well as the expected “performance levels,” the resolution of required expenditure reductions must often be revisited.

Q1. WHY NOT SOLICIT ASSISTANCE FROM PROFESSIONAL ORGANIZATIONS, FOUNDATIONS, AND UNIVERSITIES TO DEVELOP AN INVENTORY OF FOR EACH RESPECTIVE SERVICE OR PRODUCT PROVIDED BY A GOVERNMENT? A table, as depicted below, would be created:

1 Public Service

2 Public Products

3 Budget By Fund

4 Structural Funding Require- ment

5 Levels of Perfor-mance

6 Pri-ority

The “Public Service” column would identify all the public services and the “Public Products” would identify all of the public products in the budget. The “Budget By Fund” column would identify the amount of each “Public Service” by fund. The professional organization, foundation, or university could be utilized to assist the governmental entity in matching services and products with budgets by fund.

The “Structural Funding Requirement” would serve to identify whether laws, statutes, contracts, or agreements require these services and products to be funded. The “Levels of Performance” would depict those measures of performance that was approved based on the budget by fund.

Q2. AFTER THESE FIVE COLUMNS WERE CONSTRUCTED, WHY NOT ENGAGE THE INSPECTOR GENERALS AND STATE AND MUNICIPAL AUDITORS TO ASSESS AN ANNUAL PRIORITIZATION BY THE ELECTED OFFICIALS AND FIND OUT WHAT THEIR ANTICIPATED LEVELS OF PERFORMANCE ARE? When it comes to performance, many in the Legislative Branch may delegate the assessment of performance to the auditor. The auditors would serve as the objective interpreter of the information identified. I would expect that there could be different priorities by agencies, departments, divisions, bureaus, directors, agency or department heads, budget offices, executive offices, legislative offices. Such disclosure at the beginning of a process could aid in resolving differences.

Q3. RATHER THAN AWAITING THE PRIORITIZATION OF A GOVERNMENT’S PUBLIC SERVICES AND PUBLIC PRODUCTS DURING A FISCAL CRISIS, WHY NOT HAVE THE ABOVE CONDUCTED ON AN ANNUAL BASIS? Note, may governments or agencies will assert that this already happens within their budget process. Citizens and others often question the proper role of government, and often have concerns about government intrusion. This approach could clarify the specific product and/or service. Citizens and policy makers often question the effectiveness and efficiency of government programs. I see a program providing a bundle of services and products. This approach could identify redundancy and duplication as well as what constitutes an acceptable level of service or even quality of a product.

Q4. WOULD THIS TYPE OF PERFORMANCE REPORTING SPECIFICALLY TIED TO PUBLIC SERVICES AND PRODUCTS, ASSIST MANAGEMENT, STAFF, DECISION-MAKERS AND CITIZENS DURING TIMES OF FISCAL STRESS? When a reduction in force is undertaken or a budget gap filled by a “one-time” versus “ongoing” revenue, would this depict the effect on the particular public service or public good?

The Dilemma of Auto Demand

By: Sunil Datt, MBA, CGFM, PMP

Sunil Datt, MBA, CGFM, PMP, is Senior Managing Consultant, IBM Global Business Services.

The January 30, 2009 issue of USA Today says: “Gyrating gas prices are playing havoc on auto industry planners, who've been adding small cars to their lineups, even as customers are showing more interest again in bigger vehicles… In May (2008), 56 percent of the vehicles sold were cars, not trucks. By last month (January 2009), the share of cars had fallen to 47 percent, according to Autodata.” Gas prices are averaging $1.85 a gallon at the pump now, less than half their summer 2008 peak of $4.114.

So while American car makers scramble to submit plans for fuel-sipping small autos to a get a government bailout, the market has already turned the other way! How do they deal with this volatility? Here is a range of options:

1. Have a range of cars of every kind to respond to every 50 cent differential in the price of oil.
2. Manufacture just one kind of vehicle, small fuel-efficient, or large fuel-inefficient. Stay open in times of high demand, and close down in times of low demand. Employ low paid temporary workers.
3. Merge with your counterpart a la Chrysler and Fiat, even though the earliest resulting product would hit the American market two years from now, at which time you may find that everybody has shifted to public transport and bicycles.

But let me not be facetious. What I am saying is the answer lies in stabilizing the prices of oil, rather than the auto industry dancing to meet fickle oil prices. The Gas Tax, yes. The ‘Great Economic Stimulus’ bill has been passed, and signed into law, agreed. But, Mr. President, in economics disincentives are as important as incentives. Putting more money in the pockets of folks will lead them to buy what, if the choice is only between trucks and cars, and the price of gas is $1.85 per gallon? Trucks, right? So what is the incentive for auto makers to manufacture fuel-sipping little wonders? I am harking back to just step one of what I had mentioned in my weblog of December 12, 2008.  

The policy of doing the palatable things first is smart politics. But the unpalatable ones will have to be done sooner or later; sooner the better. That’s good economics. The gas tax can at least be begun with a small increment like 10 cents per gallon. And then as the economy improves, it can be raised to ensure that the price of gas remains at a level just unattractive enough to deter the buying of trucks when a car can do the job just as well.

There are tons of precedents. All of Europe charges gas taxes, in some cases taxes make up as much as 75 percent of the cost of a gallon of gas. Of course, comparing gas prices across nations is always difficult. For starters, one would have to take into account different income levels and different exchange rates. And then there's the varying distances people drive, the public transportation options available, and the different services people get in exchange for high gas prices. For example, Europe's stronger social safety net, including cheaper health care and higher education, is paid for partly through gas taxes. Sounds like a good solution for us, too.

There is some evidence Europe's high gas taxes have capped its oil consumption. Oil use in the United Kingdom has basically stayed flat from 1980 to now, while in France it's dropped 17 percent, according to figures from the Energy Information Administration. In the United States, meanwhile, oil use is up 21 percent over the same period, although the country has added more people and seen its economy grow slightly faster.

Americans have taken advantage of cheap gas prices to do other things—like buy bigger cars and bigger houses further away from city centers. On a per capita basis, Americans use three times more oil than Europeans. That means Americans are more exposed to rising gas prices than their counterparts across the Atlantic. Five-thousand square feet in the suburbs, that's much rarer in Europe. We dug our own hole. Let’s get out of it fast!

Alternative Energy = Good Economics. We All Know That, Right?

By: Sunil Datt, CGFM, PMP, MBA

Sunil Datt, CGFM, PMP, MBA, is Senior Managing Consultant, IBM Global Business Services

I have a confession to make. I still lust for a gas-guzzling Corvette! Me, who is known as ‘Mr. Green’ among friends? Yup, the very same. Brings me back to something I said in my weblog of Aug. 20, 2008: Thoughts on Post Sustainability Models.

“The spread of awareness and consequent behavioral change are good, but not enough. If people do not see results in the near term, they get disheartened, and revert to old habits. Good old economic incentives and disincentives, I think, are still the best model for achieving real results.”

So now that gas is down to $1.75 or so at the pump, all of us who had made resolutions to buy smaller, more fuel-efficient cars, replace our light bulbs and install that solar water heater, are having sudden lapses of memory!

That’s one reason why the gas tax makes more sense now than ever before. Higher taxes! Heavens no, even the President-elect prefers to talk about a tax cut for 95 percent of the people rather than a tax hike for the other 5 percent—the latter is just a restoration of the right taxes of the Clinton era, or expiration of the wrong tax policies of the Bush regime! But hey, I am just blogging, so up with the gas tax! Yes, disincentive to go back to the bad gas habits and the Corvette, now that even the Detroit trio is promising fuel-efficient hybrids. Adversity makes for strange friendships.

Here’s a thought: “Sixty years ago, we could create a calorie of food with less than half a calorie of fossil fuel. Today, a single calorie of modern supermarket food requires 10 calories of fossil fuel to produce.” (See IBM.Com/think.) Bad economics, right? Worse distributive justice: If fuel costs rise (OPEC is cutting back production), it becomes increasingly difficult to get enough food to the populations that have come to depend on distant producers. At the same time, 30 percent of the food purchased in developed nations ends up going to waste.

So, if a well-planned gas tax succeeds in keeping gas prices in a relatively reasonable price range, will it accelerate the use of solar, wind and “grass” (biofuels)? No, not until the alternative energy sources become cheaper than fossil fuel sources. Until then, the gas tax will have to be complemented with incentives for solar, wind and grass. The great thing is that it will give you the maximum bang for your  economic stimulus buck.

On the one hand, the gas tax will give you: more fuel-efficient cars, more use of public transport, less traffic congestion, less pollution, less urban sprawl, less dependence on foreign sources of fossil fuels, and so on. On the other hand, it will give you additional revenue to provide performance-linked incentives for solar, wind and grass. More alternative energy sources will mean reduced degradation of the environment, new jobs, and the multiplier effect that new jobs bring—higher income, higher spending and growth—the virtuous cycle.

But wait, the Janus-faced predilection of us ordinary folks toward alternative energy is just one factor that made me put a question mark against the belief that we all understand alternative energy = good economics. The Exxon-Mobils of the world ask, “Good economics for whom?” After all, they point out, oil, natural gas and coal provide 80 percent of our needs, and will continue to do so through 2030. I have always wondered what makes that latter part of the statement so deterministic—the determination of Exxon-Mobil to make it so, or the probabilistic projections of academics that factor in the Janus-faced nature of ordinary folks and the malleability of the energy policies of President-elects when faced with intense lobbying pressures? Neither, perhaps. What about the fat bottom line of oil companies? I said oil companies, not energy companies.

So where am I going with this? A gas tax on retail gas for the consumer, and…? Precisely! Tax the oil companies on the bottom line unless they convert themselves to energy companies—companies that diversify into alternative energy production. Over time, of course. Disincentives and incentives, my friends, both are needed. And the closer to the pocketbook, the better.

Talk me down on that one, if you like! Thanks.

A True Financial Markets Meltdown or Simply an Accounting Problem?

By: Jeffrey C. Steinhoff, CGFM, CPA, CFE

Jeffrey C. Steinhoff, CGFM, CPA, CFE, a member of AGA’s Northern Virginia and Washington, D.C. Chapters, retired earlier this year after 40 years of government service. His most recent position was managing director, Financial Management and Assurance, U.S. Government Accountability Office (GAO). He is an AGA Past National President and is known in the Association as the “father” of the Certified Government Financial Manager (CGFM) Program.

In the past month, the country watched the federal government provide financial support to facilitate the acquisition of Bear Stearns, take over Fannie Mae, Freddie Mac and AIG, and now approve a massive financial institution bailout. We all watched the venerable Lehman Brothers collapse, Washington Mutual tank, and a household name, Merrill Lynch, be acquired by the Bank of America to stave off possible bankruptcy. President Bush went on national television to discuss the precarious position of our financial markets and the urgent need for immediate action by the federal government to avoid a meltdown. The Secretary of the Treasury demonstrated leadership in fighting what was a burgeoning forest fire on several fronts using a variety of garden hoses and calling for high-pressured fire hoses backed up by billions in taxpayer dollars. When the House of Representatives rejected the first bailout bill, the stock market responded with an all-time record one-day drop of 778 points. But after all, members of Congress had all of about a week to act on a proposal that put untold billions of taxpayer money on the table. Based on my experience, the average person spends more time picking out a sofa.

Pundits have ruminated over the causes, whether it be Wall Street greed, deregulation, political inaction, the wrong incentives, naiveté by home buyers, flat-out stupidity or a combination of all of the above, which is most likely the case. A lot of fingers have been pointed. While one can certainly disagree as to the solution, the bottom line is that there is a serious problem, with a range of culprits, requiring some type of intervention by the federal government to avoid further disruption of the financial markets and serious impacts to our economy.

One rationale cited for the market meltdown was the decision by the Financial Accounting Standards Board (FASB) to adopt fair value or mark to market accounting, whereby assets are reported at their fair value. Some now want the clock rolled back on that standard. If fair value accounting pushed the crisis over the edge as some claim, it simply did so sooner than later by helping shed much needed light on the seriousness of the situation. We are in a financial market crisis because banks made a lot of shaky loans and bad business decisions resulting in an avalanche of bad assets, not because in its wisdom FASB required the mark down of these assets to their proper worth for financial reporting! In fact, fair value reporting is one step toward rethinking the financial reporting model. We should go further in moving financial reporting in a direction that helps facilitate the identification of financial problems and risks much earlier in the cycle.

It is most unfortunate the problem was not on the table much earlier in the process so that all options could be fully explored. One lesson that we should learn from all of this is that financial reporting has to tell a story and be more anticipatory. What is the substance of a transaction and the risk associated with various financial instruments? For example, the present credit crisis might have been averted or its impact lessened had management and auditors been required to look more at the substance of transactions and disclose the degree of leverage and the related risks involved in the mortgages and related derivative paper that the banks and investment companies were holding.

Following the Enron and WorldCom debacles, steps were taken to deal with corporate fraud and enhance corporate governance. The risk of implosion of the financial markets and the related worldwide economic risks—not just to Wall Street but to Main Street as the President and Treasury Secretary pointed out in making their case for immediate action—should cause us to reexamine the financial reporting and audit models.

The time is right to ask fundamental questions as to their adequacy in today’s complex economic world. If fair value accounting pushed us over the edge, we owe FASB a debt of gratitude for getting the ball rolling. We just want to do that pushing a little earlier next time and through a financial reporting and auditing model that helps support early intervention or, better yet, enable us to avoid government intervention altogether.

My questions to the bloggers:

Do you think that fair value accounting was a culprit here or is it getting a totally bum rap in being cited as a contributor to the problems in the financial markets and should FASB be applauded?

Do you think we should reevaluate the financial statement model in earnest in light of the current financial market crisis and be willing to make bold changes as needed?

Do you believe the present audit model works or is it mission impossible for auditors where the risk of the underlying financial model is tenuous at best?