Thursday, March 5, 2009

Telling the truth or being positive?

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It is always quite a dilemma isn’t it? No matter if you are a politician or a company executive, you are faced with this crucial decision once things start to go wrong. Which one? Telling the truth or painting a more interesting picture of the situation. So you think this is an obvious choice? Not so I would say.

I always find it interesting that citizens think it is always in our best interest to tell the truth about the financial situation. Of course in theory it sounds so obvious. But there are so many examples. Take General Motors (GM). I think every single planet in North America (and many other parts of the world) know they are in a major danger of going bankrupt and that they need a massive intervention by the US Federal Government. Will it happen? Who knows really? But if you are buying a car, don’t you think that could come into play when deciding about buying one brand as opposed to another? Wouldn’t you think for a second that you might have more problems with your warranty for example? And so it does become self-fulfilling in a way. GM is in trouble, it announced to everyone that it could face bankruptcy without help. Because of that, the few that are buying cars right now are mostly staying away from GM creating an even bigger problem for the executives and the government. How long can it go? Probably not very long unless the government takes out the uncertainty about what will happen in GM’s future. Want numbers? Toyota has suffered a 32% decrease in sales this January in the US market. Terrible isn’t it? But GM has suffered an even bigger loss with a number about 50% lower than in 2008!!! Let’s not remember that in the US, GM and Toyota (TM) have a similar market share.

I think the same applies to financial markets in general. We all know that we rely on a system based on trust. Trust that the US dollar and other currencies is worth something. Trust that the government will provide services but also trust that our banks, despite having very little liquid assets, will be able to provide liquidity when needed. But with the banking crisis that has been ongoing for over a year now, it is that exact confidence that is under attack. What would happen if consumers started doubting that their banks could give them back their money? Sure, the FDIC insures deposits in the US, but we all know it is in theory possible for the FDIC and the entire system to collapse.

And so the US government had a tough challenge in my opinion. On one hand, you do not want to worry the citizens or generate any panic that could become self-fulfilling, but on the other hand, how do you convince citizens that Wall Street requires a $800 billions bail-out if you do not explain how dire and serious the situation is? Probably the best way is the one that has just happened. Bring in a president that inspires so much confidence that citizens will trust him when he tells them it is necessary and that it must pass. That is probably the best thing that could have happened and probably the way it should be.

Ask for answers and explanations, but always know that it is potentially better to have Americans not waking up to news about a possible system collapse. We’ll never know for sure what happened but when Lehman Brothers and a few others collapsed, a major part of it was rumors about their liquidity problems generating margin calls that in turn created more liquidity issues, and so on… do we really want to risk that happening with an entire system?

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