If it weren’t enough that Fiat is trying to expand on the North American front via its alliance with Chrysler (see Now Introducing Fiat/Chrysler), it now seems as if Fiat wants to simultaneously expand its empire closer to home (via an acquisition of Opel). According to various media reports, Fiat is likely to make an attempt to acquire Opel, GM’s European arm (see Fiat Turns to Opel or Fiat Aims for Opel Deal). From the Wall Street Journal:

Fiat SpA Chief Executive Sergio Marchionne is stepping up his plan to acquire a majority stake in General Motors Corp.’s German unit Opel, the next phase of his ambitious campaign to forge one of the world’s biggest auto makers by crafting a three-way alliance among Fiat, Chrysler and Opel.

Mr. Marchionne is expected to meet senior German government officials in Berlin on Monday, according to people familiar with the matter, in an attempt to get support for a potential alliance with Opel. Mr. Marchionne signed a partnership with Chrysler LLC in Washington last week.

Fiat’s board of directors met Sunday and authorized Mr. Marchionne to seek a potential merger between Fiat and GM’s European operations, including Opel and its U.K. unit Vauxhall, according to a statement issued by Fiat on Sunday.

My Comment: Are they nuts??? It is hard enough to pull off one integration the size of Chrysler, but now they are going to try to pull off two? And to top it all off, we’re talking about foreign integrations, where economic, political, and cultural differences compound the complexity. Frankly, I am surprised that Fiat’s board would give Marchionne the approval to simultaneously attempt both deals. A prudent board would counsel Marchionne to eat one cookie at a time, lest he get indigestion. So much for corporate governance.

From the Associated Press:

Marchionne’s proposal is part of a Fiat plan to put together the biggest European auto maker and the world’s No. 2.

Marchionne reckons that the only automakers to survive the crisis will need to be able to churn out between 5 and 6 million vehicles a year.

“From an engineering and industrial point of view, this is a marriage made in heaven,” he was quoted as telling the Financial Times on Monday.

My Comment: Or an integration made in hell. I just don’t get it. Why the preoccupation with size? I remain unconvinced that largess is a means to success. Just ask Jurgen Schrempp and the folks at Daimler, who ran around spewing the same nonsense about scale and survival before their acquisition of Chrysler.

Size certainly leads to increased revenues, which helps justify exorbitant managerial pay. But given the organizational complexities that go hand in hand with size, size does not always translate into increased profitability.

In order to truly benefit from size, there must exist extremely large economies of scale and scope. Perhaps such economies (the ability to economize on platforms, dealerships, suppliers, etc.) exist in theory in the auto industry. However, the power of the auto unions, coupled with the structural characteristics of the countries in which Fiat, Chrysler, and Opel operate make capturing synergies very difficult. As reported in the WSJ:

Mr. Marchionne has suggested that closing down plants isn’t a realistic option in Europe, where many workers are shielded by contracts that make it costly for companies to lay off workers.

My comment: This is a microcosm of the problems that Fiat would likely face in any deal with Chrysler (which would be 55% owned by the auto union), and especially with Opel (given European/German labor law).

Good thing Fiat doesn’t intend to put any of its own capital at risk in either deal:

Fiat is also likely to seek government aid from Berlin to prop up the potential alliance while Fiat retools Opel’s operations, according to a person familiar with the matter. Fiat, which is saddled with €6.6 billion, or $8.8 billion, in debt, doesn’t have the money to finance potential partners.

My comment: Great, so let’s take stock. Fiat almost went bankrupt in 2004. It took a massive debt restructuring to rescue them from the brink. Now, after only a few short years of operating as a quasi-healthy automobile manufacturer, they want to take on two near-bankrupt companies that would nearly triple their current size, …and do it simultaneously. They have very little cash available to make capital investments. And to top it all off, they still have nearly $9 Billion worth of debt they need to service on their own.

I am left to conclude that there only are few plausible explanations for such a set of maneuvers:

1. Fiat is trying to acquire assets in a down market, when valuations are cheap. In so doing, they can take advantage of governments that do not want to be in the position of running large automobile manufacturers. They are thereby engaging in a low risk/high reward strategy in which they are trying to acquire access to products/brands/markets for next to nothing in the off-chance that they can magically make the Fiat/Chrysler/Opel combination work. Given that they will put very little capital at risk up front, if the deals fail, so be it.
2. Marchionne is trying to create another automobile firm that is too-big-to-fail, but in the process, too-big-to-succeed.
3. Marchionne, aided by a board of directors that he has in his back pocket, is engaging in a form of empire building whereby his own personal interests in building the world’s second largest automaker are taking precedence over the best interests of Fiat’s long-term health and prosperity.

Fiat’s stock reacted positively to the deal announcement, which suggests that shareholders favor the first explanation. However, Fiat should not underestimate the potential to get bogged down in such a strategy and get stuck with a money pit.

In addition, given the histories of similarly troubled super-sized deals (e.g., DaimlerChrysler, RenaultNissan) and a preponderence of evidence to the contrary, I remain skeptical of what’s behind door #1.

Today I returned from Thanksgiving break to learn that Tanta had passed (see Remembering Tanta or Sad News). The news certainly made me sad.

Tanta was an incredible blogger. She was insightul, funny, and sharp as a whip. It is no exaggeration to say that I received a heck of an education from Tanta. She (among others) inspired me to start blogging.

In this time of reflection and giving thanks, there is much for which I am thankful. One of those is for the privilege of having been able to read Tanta’s blog posts. And while I am thankful for her posts, I wish I didn’t feel compelled to write about them today, because it stands as a reminder that she, and they, will be no more.

I didn’t know Tanta personally, but that does not mean I will not miss her. Unfortunately, to simply say that she will be missed is an understatement.

My deepest sympathies go out to her family.

I’ve been a little slow this week in keeping up with corporate news. I have been busy trying to catch up with e-mails and other, more pressing, assignments after a week’s vacation.

I spent the holiday week with my family in Cape Cod. We had a blast! And given the state of the economy, I feel very fortunate for the luxury of being able to take that kind of trip.

Although I will not bore you with the details of my trip, I do have several economic observations to share:

1. I have never in my life seen as many “For Sale” signs as I did last week, Cape-wide. Although this is not news to most of you, to behold it with your own eyes is astounding. In Manhattan, we don’t get to see many “For Sale” signs. There’s really no place to put them. So I only gain a full appreciation for the state of the housing market when I take trips outside the city. And even though I do get out of the city frequently and have seen conditions across many towns in the New York tri-state areas, I have never seen anything as bad as what I saw in Cape Cod.
2. My wife and I have been making the drive between New York and Cape Cod for the last 10 years. We have family up there, so we try to go as much as possible during the summer (at least every other weekend), and for several full weeks during the year. In my 10 years making that trip (the Deegan to the Merritt to I-95 to I-195 to Rt. 25 and then the Mid-Cape Hwy in case anyone is interested), I have never, ever encountered such light traffic en route. We frequently hit traffic around New Haven, CT; we almost always hit traffic at the Sagamore Bridge (leading onto, and off of, the Cape); and without fail, we get stuck on the FDR (both outgoing and incoming). We have not hit traffic this year at all – not on Memorial Day weekend, and not on July 4th. Again, this is probably no surprise to most of you since the highway miles driven by Americans are down for the first time in 17 years (see Americans Drive Less); however, it’s so strange to me to be able to make that drive at full speed (and in the time yahoo or google tells you it ought to take).
3. We are creatures of habit. We go to the same places every year. We like the Lobster Roll at Cooke’s. We live for the ice cream at the Four Seas. It’s ordinarily not easy to find an open table at Cooke’s during the height of the season during prime hours (12-2pm, 5-7pm). This year the restaurant was half empty – every time we went. Four Seas (a place where the line is usually out the door and around the corner) was uncharacteristically quiet. P-town was even relatively uncrowded. We saw empty parking spaces on Commercial St., the stores looked to have little traffic, the streets were not as lively, and it was even fairly easy to drive (yes drive) from one side of Commercial St. to the other. It was as if the entire island/peninsula seemed to have 1/2-2/3rds of its normal summertime population.

Now I realize that the anecdotes that I’ve shared simply represent one person’s observations (an n of 1 as we like to say in the business), but if my experiences thus far this summer are any indication, I think we’re in for a long and difficult slog. I have never seen anything quite like it…

UPDATE: The Wall Street Journal published the third part of a three-part series on Bear’s collapse today. In the aggregate, the three parts made for a fascinating account of the events. I cannot recommend them more highly. In the third part, the authors discussed some of the events leading up to JP Morgan’s agreement to raise the final price for Bear from $2 to nearly $10 (see Bear Stearns Neared Collapse Twice).

According to WSJ’s account, the reason JP Morgan agreed to raise it’s price was that

The hurried deal had a loophole that could give angry Bear Stearns investors powerful leverage to seek a higher price: J.P. Morgan had pledged to finance Bear Stearns’s trades for a year — even if shareholders rejected the deal.

Their explanation seems to suggest that their was a legal clause in the contract that made JP Morgan liable for Bear’s trades in the event that the deal did not go through. That would fall under the “bad lawyering on the part of JP Morgan” explanation.

While that may be partially true, I still believe that JP Morgan’s exposure to Bear as its counterparty on a variety of trades had a little something to do with it too (read on for my take).

————————

I do not know how many of you have continued to follow this story, but Bear Stearns shareholders are set to meet tomorrow to consider, and vote on, the proposed acquisition of Bear by JP Morgan. I was recently interviewed on the subject by German Public Radio. They asked my opinion of the acquisition and the likely outcome of the shareholder meeting. The interview is scheduled to air sometime tomorrow (I will provide an update if a link or a transcript becomes available).

Most of you are likely aware of my opinion of the deal. At the time, I actually saw the transaction as a bailout of JP Morgan more so than a bailout of Bear Stearns (see original post). Although some thought my ideas outrageous at the time, Nouriel Roubini recently expressed similar sentiment, as did Christopher Alleva in a recent post on the blog American Thinker (see Ex-Treasury Department Economist Says Bear Bailout was for JP Morgan).

But I digress. Back to the topic at hand.

The interview began innocuously enough. I was first asked how I thought Bear shareholders should vote. To me, this was a no-brainer. I unambiguously believe that Bear shareholders ought to approve the deal. What’s the alternative – bankruptcy and a share price of $0? At this point no other suitors are likely to emerge, the Fed is unlikely to provide as sweet a deal to any other interested party, and it is unlikely that Bear Stearns could ever restore the Street’s faith in it if it were to try to continue as an independent entity. So I say, just get it over with and accept the terms of the deal. 

We then began to discuss winners and losers in the deal. I thought that quite clearly, JP Morgan came out the winner. They were able to acquire some pretty valuable assets on the cheap, and with the Fed agreeing to absorb up to $29 Billion in losses. Not too shabby a deal if you can find one like it. For me, the losers are the employees of Bear Stearns (the ones who did not have a hand in creating their mess – and my sense is that there were many). These are smart and talented folks who find themselves either out of work, or in limbo, but whichever the case, certainly worse off.

Finally, we touched upon the specifics of the deal itself. The interviewer asked me why JP Morgan raised it’s bid from $2 to $10 per share. My response (and supportive of the sentiment that I expressed in my initial post) was that they likely felt compelled to raise their bid. If, as I argued, JP Morgan had a lot to lose if Bear went bankrupt (in the form of assets that JP Morgan would have been forced to take back onto its own books), JP Morgan had to capitulate and pay up. As long as the potential losses from the troubled assets that JP Morgan would have been forced to take back onto its books were greater than the additional cash that JP Morgan would have to pay, it made sense for them.

Think about it, if JP Morgan had little or no exposure to Bear, why would it have budged? JP Morgan could have easily responded by saying, “$2 is our final offer, and if Bear shareholders don’t like it, too bad, Bear can go bankrupt.” Why did JP Morgan add $8 per share (several billion dollars more) to a deal where without it, the target (Bear) was sure to fail? I’m not sure I can come up with any other explanation than, they had to.

So now that I’ve had the time to decompress and think carefully about my experience at the 2nd Sumantra Ghoshal Conference on Managerially Relevant Research (see Off to London for background), I’m more convinced that my time was well spent.

It was nice to be part of a conference with the explicit intention of bringing academics and practitioners together to discuss research papers, and the role of academic research in the everyday lives of managers. The conference was attended by academics from various of the top business schools in both Europe and the U.S. Moreover, there was ample managerial representation from firms such as Accenture, Hoffman-LaRoche, McKinsey, Saatchi & Saatchi, RBC, and the Financial Times (to name a few).

Some highlights from the conference included:

• The organizers of the conference administered a survey before the conference began and presented some interesting data on the most important issues managers and scholars believe are facing businesses moving forward (credit concerns aside). What I found most interesting is that managers generally agreed about the most critical issues facing their businesses. They identified the following strategic issues as crucial: How to attract and retain talent; How to build and leverage knowledge; How to Identify the next area of growth for the corporation; How to align the organization toward common goals; and, How to draw up an appropriate mission statement. The academics, by contrast, were all over the map. We didn’t agree on much of anything. About the most you could take away from the data for the academics is that all of us in attendance have very different research interests. Some of us thought that “Building and leveraging knowledge” was important, some thought that “Identifying the next area of growth for the corporation” was important, some thought that “governance” was important. But for the most part, there was little agreement among us.
• There was general agreement among most of us that academics influence practice in a multitude of ways, and that influencing practice is not always about getting our research directly in front of the eyeballs of managers. In fact, if anything, this is probably a small part of how we influence managers. We obviously have the greatest impact through our teaching, at the undergraduate, MBA, and executive levels. We also influence managers through consultants (who borrow and implement our ideas), and on occasion, by consulting directly with firms. Scholars also influence practice through our impact on policy – by proffering informed opinions to politicians or testifying on business practice. In this sense then, we help shape the game and inform the agenda – helping decide which issues are important and which are not.
• One of the McKinsey representatives suggested that she (and other management consultants) routinely scan and read academic research to extract the latest ideas, concepts, and tools to apply on client engagements. Interestingly, one research paper presented at the conference suggested that those ideas, concepts, and tools are often applied inappropriately, and sometimes without effect. However, the research also suggested that although sometimes applied incorrectly, they get people within the organization to openly communicate about strategic issues, thereby generating some value, if not exactly that originally intended.
• With respect to our research, there was considerable debate on the type of research we ought to be doing – whether research that directly addresses specific management problems, or research that we ourselves consider important, irrespective of whether it’s managerial relevance is immediately obvious. One view expressed (with which I must say I agree) was that we must not lose site of the fact that as business school faculty, we are a part of an applied, vocational program with a mandate to train business leaders. We therefore cannot lose sight of, or become completely detached from, our audience when conducting our own research, for taken to an extreme, research that is disconnected with the interests of our constituents will ultimately repay us with lower enrollments.

All in all, I got a lot out of the conference. It was fun to spend a few days interacting with a bunch of really smart folks (both academics and managers) discussing some really interesting issues.

I will be heading to London tomorrow to attend the 2nd Sumantra Ghoshal Conference on Managerially Relevant Research at the London Business School (LBS). I’m really looking forward to attending again this year. Last year’s conference was interesting, …and London is always fun (the painful £1:$2 exchange rate notwithstanding).

But back to the conference. The purpose of the conference is to address one salient issue facing business schools today – specifically, the relevance of research produced by business scholars. The central question of interest is, “Does our research matter to practice?” (see On Managerial Relevance for my insights from last year’s conference). I will report back again this year.

In addition to any insights I may glean from the conference, I also plan to write next week about private equity, and how the folks from that industry have been passing their idle time in the absence of any meaningful dealmaking activity. Until then…

I have been asked my opinion of the Delta/Northwest deal by several students and friends. Quite frankly, I do not know enough about either firm to comment in great detail. But that has never stopped me before. So here goes…

Provided that regulators and the employee unions at both firms allow this deal to go through, the success of this merger hinges on two specific factors:

1. The ability to wield increasing market power – restricting supply and eliminating routes in an effort to gain more pricing power, raise fares, and generate additional profits.
2. The ability to generate cost saving synergies – in fleets, gates, reservation systems, maintenance, management, etc. – thereby raising profits.

With respect to the former, there will no doubt be opportunities for the combined firms to exercise some pricing power. Moreover, with gasoline prices at an all time high, this rationale for their combination makes economic sense.

With respect to the latter, both of these firms are struggling. Each has recently emerged from bankruptcy, and both have cost structures that are too high relative to the competition. I have never been a big proponent of the idea that bringing two bad firms together suddenly yields one good firm. This deal is no exception. I am therefore skeptical about their ability to generate meaningful synergies by combining forces.

All told, although I believe that the potential for pricing power is there, the additional pricing power will not address the fundamental problems that each firm faces. Moreover, the synergies will not make up the difference. For this reason, my off-the-cuff priors would be to expect the combined firm to fail, …as would either firm left to its own devices.

The real question though is whether Delta and Northwest have more of a fighting chance together or separately. Unfortunately, my answer is that in this case, it likely doesn’t matters much either way.

The most recent issue of the Economist has a nice analysis of the deal (see Trouble in the Air). They write:

Darkening economic clouds, oil at $114 a barrel, cut-throat competition and disappearing credit lines are confronting airlines with their biggest crisis since the dark days after September 11th 2001. It is a measure of the panic sweeping the industry that Delta and Northwest said this week they would push ahead with their $3.6 billion merger to create the world’s biggest airline by traffic…[T]he two airlines have decided to take the risk of a potentially long-drawn-out and fractious integration of their operations because they calculate that a merger is their best chance of survival as the industry’s woes deepen.

Delta and Northwest…having only recently emerged from Chapter 11 bankruptcy protection themselves…know that time is not on their side. After a strong recovery by America’s airlines in the past few years, profitability has fallen fast this year. And balance sheets are still weak, even at the big network carriers.

Delta has 117 McDonnell Douglas MD-88s with an average age of 18 years; Northwest soldiers on with more than 90 DC-9s with an average age nudging 40 years. These planes are up to 40% thirstier than their more modern counterparts, a crippling burden given the price of fuel. They are also more difficult to maintain—as last week’s grounding of American Airlines’ similarly elderly MD-80s highlighted.

Delta and Northwest have little scope to cut front-line staff or replace their ageing fleets any time soon—production lines at Boeing and Airbus are fully booked until 2012. But they think they can secure cost reductions of about $1 billion a year by centralising their back-office operations and cutting management jobs. They also hope to boost revenue by combining route networks and strengthening their appeal to lucrative corporate customers.

So there you have it. My opinion on the deal given what limited information I have on each firm.

Many of you likely saw the following article in the New York Times detailing Bank of America’s plea to the government for a bailout of the mortgage markets (see A ‘Moral Hazard’ for a Housing Bailout). Edmund Andrews writes:

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.

This, in essence, would represent a public bailout of the banks. Mike Barnett, a guest blogger to this site, recently expressed his concern about the message that such a bailout sends to the bankers, and some broader implications it might hold for our society at large (see Reward Without All That Nasty Risk).

With that in mind, I asked Mike if he’d like to comment on this piece. Here’s what he wrote back:

Mike Barnett’s comments: The New York Times article talks more about the moral hazard we’ve been seeing in action — few morals, many hazards. The same folks who wanted government to stay off their backs now want government to carry them on its back. It’s like the kid who wants his parents to stay out of his affairs until the bills and the problems mount, and then fully expects mommy & daddy to bail him out. And that’s really the problem here — because mommy & daddy (the government) have an attachment to little Johnny (the banking industry), they’re prone to covering for him; little Johnny knows this, and he abuses this, time and time again. What’s a parent to do?? As the article notes, what’s good for Bank of America is good for America . . . then again, for the long-term sake of America, maybe we need to let little Johnny make his own way for once, or he’ll never learn.

My comments: Mike is pointing out how the moral hazard plays out in this case. In the previous post he pointed out some of the second order effects (aside from saving the banks and incentivizing the moral hazard) that might result from such a bailout (e.g., a larger U.S. populous feeling disenfranchised by a system as that privatizes profits but socializes losses). Realistically, I think it’s becoming clear to most market participants that some form of public bailout is likely to occur. The issue now is what form should that bailout take. We’ve recently seen proposals similar to that of Bank of America floated by Rep. Barney Frank that would allow the government to buy distressed mortgages (see Bernanke Calls Plan to Buy Mortgages ‘Worthwhile’). Likewise, Alan Blinder offered a thoughtful alternative in which the government would revive an agency (HOLC) created during the depression to rescue families from foreclosure (see From the New Deal, a Way Out of a Mess). As I’ve mentioned before, I am not an expert in issues of social welfare; however, I agree with Mike Barnett that if we are to move forward with a bailout, it must take a form that: a) penalizes those who had a hand in creating this debacle, and b) enacts regulatory measures to make sure that we never end up in a situation like this again.

Mike Barnett expressed some serious concern about the functioning of our capitalist economy in his prior post. Nouriel Roubini recently expressed a similar view. He writes:

This is indeed a one-sided game where financial insiders privatize profits while the massive losses of their reckless behavior – searching dangerously for yield, gambling for redemption, being subject to distorted incentive not to monitor their lending and risky investments – are systematically socialized during a crisis. This is actually “crony capitalism” of the worst kind, as bad as the one that plagued emerging market economies and led to their severe financial crises in the last decade.

Any government-led intervention (bailout) must, at all costs, try to avoid being perceived in that way.

I’ve recently exchanged e-mails with Mike Barnett, a friend and colleague from the University of South Florida, who has not taken too kindly to the socialization of losses as a result of the credit crunch. Issues of social welfare are not my forte, but it is right up Mike’s alley – as one of the foremost young scholars in the field of corporate social responsibility. So I decided to give him a forum to express his ideas as a guest blogger. Hope you enjoy his perspective. I’m hoping he will chime in from time to time with his thoughts.

—————————————————————————————————

I hate losing money – can’t stand it. On the other hand, I love gaining money – nothing better than a major windfall. Problem is, you typically have to risk losing money in order to get the opportunity to gain money; be it a trip to Vegas, a wild ride on the stock market, or the financing of a new firm. Most people, like me, are risk averse. Our hatred of losing money outweighs the joy we get from winning money by enough that we seldom take big risks, and so we don’t usually lose big, but we also don’t usually win big. However, we respect the risk takers, and we don’t begrudge their windfalls, because we know that the winners had the courage to bear the risk of losing big, and so they deserve the rewards of bearing that risk.

Now let’s modify that a bit; more accurate is that I hate losing my money. I’d be glad to lose someone else’s money all day long. And I especially love gaining huge sums of money for myself while risking losing someone else’s money. Imagine if a casino offered you the opportunity to gamble without the risk of loss; all losses would be forgiven, but all gains would be yours to keep. If you’re playing with house money, why not bet the house? It’s only rational.

We should expect exactly this type of behavior – moral hazard – when the government bails out failed risk-takers. In recent decades, the government has pulled back the taxes on large gains, giving the risk taker more and more of his reward; and so we get more risk-taking. That’s typically good for an economy in the near term (though it can harm tax bases & middle classes over time, and so be bad in the long term; a whole other issue). But the government has not pulled away the safety net, and so the risk-reward ratio has become asymmetrical – the rewards are high and the risks are low. If you fail, the government (through the taxpayer) bails you out. So why not take a lot of risks?

Consider what’s going on with the mortgage meltdown. The banking industry made huge profits off of writing risky loans, often in very creative fashion. But now that defaults are on the rise, and profits have turned to losses, bankers seek to shift the losses to the government. For example, Credit Suisse is pressing HUD to have the FHA guarantee mortgage refinancings (see Worried Bankers Seek to Shift Risk to Uncle Sam). Should we, the taxpayers, guarantee a bad mortgage that Credit Suisse probably should not have made in the first place? And sadly, Credit Suisse is not the only culprit. Other examples of shifting losses to the government abound.

We can admire the tight rope walker who spans the skyscrapers. He deserves the attention; he’s crazy enough to take this risk. But if we come to find out that it was a camera trick, and left outside of the frame was the fact that he was only three feet in the air, with a cushioned mat below him, then we lose respect. And this is how we lose respect for the free market system, too. If gains are privatized but losses continually socialized, we run the risk of disenfranchising many in society who will come to perceive the system as “rigged”. Socializing losses can be likened to a form of corruption, and in the long-term this is risky to the stability of our society.

Ultimately, we can’t justify huge winners unless they’re risking huge losses. So when we find out that they got their huge gains in prior years without walking a tightrope, we do begrudge their gains, and we don’t feel sympathy for their losses. And now they want us to absorb those losses??

We all love a free market, so long as we get to control it. The folks making obscene gains in some years gain the power to pervert the regulatory system and build a personal safety net for lean years. And, as taxpayers, we share less and less in their gains and bear more and more of their losses – the losses are increasingly socialized while the gains are increasingly privatized. Yip, it’s as corrupt a system as it sounds – Robin Hood in reverse.

There are two ways to go – go with a true free market and let folks fail, not just win; or put in a safety net via regulation that does not provide incentives for market participants to take reckless risk in the first place. Like I said, I’m risk averse, and so I don’t like the volatility of the former. Going for the latter would remove the asymmetry at the root of today’s turbulent market and create sound rules for a “fairer” game. So let’s not pull the net; let’s just lower the roof and use the excess material to build a stronger net. In Senate testimony today (Feb. 14), Bernanke reaffirmed the role of the Fed in providing “adequate insurance against downside risks.” It’s a question of who pays the premiums, who provides the reinsurance, and who acts as the ultimate backstop that determines the fairness of the system.

The Economist today published its first ranking of distance-learning MBA programs (see The Socratic E-mail). I found this ranking rather fascinating.

In the interest of full disclosure, I have to say that I haven’t fully kept abreast of the distance-learning movement in higher education. I know that it’s there, but I thought it hadn’t quite caught on. I remember that it was all the rage for awhile – circa 1997-2000; however, I thought that most schools had come down in favor of the face-to-face education paradigm – arguing that the quality of the face-to-face model exceeded that of the distance model. For this reason, I was shocked to see some really reputable universities on that list.

But it also made me wonder: Is there an economic difference in the value of a distance-learning MBA degree versus a face-to-face MBA degree? I think it would be really interesting to examine some of the issues. There are several really interesting, and fruitful, angles to explore, including some of the following considerations:

1. cost differential to earnings differential – Is any difference in price between the two forms of education offset by ex post earning differentials? That is, distance-learning degrees might cost less, but are the benefits/salaries upon graduation significantly different?

2. quality of enrollees – Is there a difference in the “quality” of the “typical” student that enrolls in distance programs versus face-to-face programs? This might have an impact on ex post earning potential as we would expect higher quality inputs to receive higher quality outcomes. In economic parlance, this is a selection effect. If higher quality students are overwhelmingly choosing (selecting) to go to face-to-face programs, this can cloud our interpretation of any earning differential we find as we would, of course, expect higher quality students to eventually earn more money. Thus, it would not be the difference in the programs (distance versus face-to-face) that determines the outcomes but the ex ante sorting (the matching of high quality students with face-to-face programs and lower quality students with distance programs) that drives the results.

3. quality of curriculum – Is there any discernible difference in the quality of the offerings between the two programs? Do students in one program “learn” more than students in the other?

4. signaling value of the type of degree earned – Might there be any stigma among employers toward students who graduate with one type of degree versus another? Do the schools that offer the distance MBA programs require graduates of that program to reveal that their MBA is somehow different? Is the actual diploma that they earn different? Should it be different?

5. reputational impact of offering distance-learning programs – Do the schools that offer distance-learning programs bear any reputational costs? For example (and not to say that this is true, just a hypothetical), let’s assume for a moment that the students that do go to distance programs are somehow inferior on some quality metric. Now, you have two sets of graduates (distance graduates and face-to-face graduates) from the same school carrying the same brand (both sets of students went to Florida let’s say, which by the way is an exceptional institution). Now let’s assume that for whatever reason, the distance graduates end up doing poorly ex post – they aren’t as successful, their employers find them less capable, etc. Does that have a negative impact on the school? Also, does that have a spillover effect on the face-to-face graduates, who, when others find out they graduated from Florida, are then painted with the same brush as the face-to-face students. Face-to-face students who fork over big bucks to attend their MBA programs understand very well that the school’s overall reputation impacts them, and the value of their degree. So they should be concerned about the school’s distance offerings.

And Finally, and in my opinion one of the most interesting angles to pursue,

6. value of the social networks – It has been argued that one of the most valuable parts of receiving an MBA is the opportunity to network with, and befriend, the future captains of industry while on campus. Developing a strong social network can be extremely powerful for future business opportunities. One of the interesting things about distance-learning programs versus face-to-face programs is that it seems that the opportunities to network with classmates, professors, and industry-types who visit campus are greater for face-to-face students. So the question then becomes, to the extent that ex post earning differentials exist, what portion of those earning differentials could be associated with the added-value of the social networking benefits provided by face-to-face programs?

Anyhow, these are just a sampling of some of the interesting considerations associated with distance-learning programs. I’m sure there are many, many more.