Decision Quality Blog

A piece on the AP wire, published in my local paper, draws attention to new research that shows the following . . .

1. Doctors are not discussing end of life issues with their patients.
2. Patients who have these discussions are not more likely to become depressed than those who do not. In fact, they were less likely to spend their last days in a hospital hooked up to all manner of machines.

Here’s a snip from the article . . .

Many people do not get such straight talk from doctors, who often think they are doing patients a favor by keeping hope alive.

New research shows they are wrong.

Only one-third of terminally ill cancer patients in a new, federally funded study said their doctors had discussed end-of-life care.

Surprisingly, patients who had these talks were no more likely to become depressed than those who did not, the study found. They were less likely to spend their final days in hospitals, tethered to machines. They avoided costly, futile care. And their loved ones were more at peace after they died.

Convinced of such benefits and that patients have a right to know, the California Assembly just passed a bill to require that health-care providers give complete answers to dying patients who ask about their options. The bill now goes to the state Senate.

Some doctors’ groups are fighting the bill, saying it interferes with medical practice. But at an American Society of Clinical Oncology conference in Chicago this month, where the federally funded study was presented, the society’s president said she was upset at its finding that most doctors were not having honest talks.

“That is distressing if it’s true. It says we have a lot of homework to do,” said Dr. Nancy Davidson, a cancer specialist at Johns Hopkins University in Baltimore.

I’m no expert on health care (I just play one on TV), but I struggle to see why it’s a bad idea to give patients the information they need to make their own decisions, particularly when it’s the last one of any consequence they’ll get to make.

Tags: endof life, hospice, decision making

Day 2 at the BAI Conference. Here are my notes of a conversation between Tom Brown and Dick Kovacevich, former CEO and Chairman of Wells Fargo Bank.

Tom

When I sat down and thought about if I was only going to have one or two presentations, I thought nobody better than Dick. By the numbers, he’s had the best record by far of any of the large cap bank CEOs.

The first maverick decision I can remember him making was at Citi. It was the late 70s. A thing called the ATM came out and he made the decision to flood NYC with them without knowing what the response would be. He moved shared 3x when nobody was moving share.

Along the way, Wells Fargo had such a great record because he made great moves that didn’t blow up.

Dick, how did you do the pressure not to follow the herd?

Dick

I have a fairly analytical mindset. We look at what people are doing, the returns, and the risks. If it doesn’t make sense, it doesn’t make sense. So we avoid those things. However, the reason we were able to do that is that our business model, which is a broad product line and cross selling, allowed us to do well.

Our business model was developed with that in mind. The business is cyclical. It isn’t different this time. My feeling was that the only way to avoid the pressure to follow the pack is to be so diversified it would still be okay, and you could decrease an element that was too hot because you still had alternatives.

We resisted the push to be a one-product company. You just go over the cliff with everyone else.

You have to slow down. We have often slowed down way too soon. I predicted nine out of the last three recessions. We have these alternative investments. We were able to shift resources and do really okay when the markets turned. We think the market rewards consistency.

Tom

You’re in 84 businesses. You’re the smallest in investment banking.

Dick

There is a need for investment banking. Our customers have that need. Our goal is to satisfy all the needs of our customers subject to two things. Culturally compatible with our values and that we can execute it within the values and culture of our company.

The only way you can run 84 businesses is not by command and control, but by decentralized structure. Allow people to run their company with shared values and culture. We don’t avoid problems with permission to do things. We find problems using a strong audit process. Trust but verify.

We will never add a business or do a deal that is culturally incompatible with Wells Fargo. Teamwork doesn’t occur. They don’t agree to our vision and values. Partnering and cross selling won’t work. Our conclusion was that about the only business that doesn’t fit with our business is investment banking. It is a star based business and we’re team. It’s transaction and we’re relationship. Those are basic cultural elements.

Starting in the 90s when commercial banks were buying investment banks and there were lots of deals that could be done, I said these are culturally incompatible. I said six out of ten wouldn’t work. I was wrong; it was nine out of ten.

Tom

You’ve made more acquisitions than almost any other CEO. With the exception of Wells, they’ve all been small. Why was Wells the exception.

Dick

I said culturally compatible. It turns out that we have more in common with small community banks than with large money center banks. There are more of them and almost all have the cultural compatible part.

Two, for many years, other large banks did not pursue small banks. So they were in love with big deals and paid high premiums for these big deals. The strategy seemed to be pay a big premium, and in order to pay for it you had to slash the cost base. They assumed that when the cost went down and it wouldn’t’ affect the revenues. They got the costs out and it did affect the revenue. Bad decision making that started with paying too much.

With community banks, the decision makers were the founders. They care about the stock price. I can’t think of anything they hate more than paying taxes. They have no basis in the stock. What they want is a stock that they can clip the coupons. They want a good stock. What they want us to do is pay them and then never dilute.

Usually it takes five years from meeting them and saying this is what we’ll offer, a relatively low premium, before they finally gave up and said, “Okay.” I’d say 95% of the small banks we wanted to buy, we buy because they didn’t’ have a lot of other choices and they loved the stock . . . when the owner was the decision maker. When you have someone who is just a hired hand, then it was always different. Then it is always about something else.

So it was cheaper, culturally compatible . . . we bought 45 banks in Texas and became the largest bank before the Wells Fargo deal. There is Highway 35. Our acquisitions guy said I just drive down I35 and if there are two or more exits for that town, I pull off and buy a bank.

We were prepared to continue doing that. We also liked fixer-uppers. Businesses with a little trouble due to headwinds, or some management issues . . . most of our deals were done like that in Texas. If you know how to value the problems, you do the numbers and say, okay, here’s the deal.

If you believe like I do that all segments in financial services are cyclical, which is the bad news, the good news is they’re not the same cycle. If you believe that, when do you buy? Top or bottom? It’s not hard. When do most people buy? Top. It’s not hard.

Tom

So why Wells Fargo?

Dick

So we would say, we can’t pay a 40% premium. Maybe not even 10%. If we’re right about he value of the bank, why should I give you 40% premium and only get 10% of the value in the return. That’s not fair.

What happened was a merger of equals. In the case of Wells, I had a choice of paying a 10% premium to do something as big as 100 deals the size we were used to doing. It wasn’t large vs. small, it was paying a premium vs. sweat equity. Secondly, Wells was consistent with our strategy. We never changed our strategy, it was about execution. It was ring around the mid-west and the west.

Wells came up for two reasons or issues. One, as you know Wells Fargo had decided that a narrow strategy in a single geography wasn’t working. So they did First Interstate. What they did was to execute with First Interstate the way they were executing before. It didn’t work.

They then decided they needed help in running multi-geos. And the narrow product line doesn’t work. So, either spend 20 years to figure it out or go with someone who does it well.

So we started talking. I said Paul [Hazen], “We’re going to do the right business decision. Then we’ll talk about the social issues.” As it turns out it took me two seconds to agree that Wells Fargo should be the name. As much as people in the company liked Norwest, It sounded like a mispronounced airline with bad service.

The good thing about the Norwest name was that we could register it because nobody wanted it. Wells Fargo had huge unaided awareness. Not a very big concession.

Another question: Where should we headquarter the company? A state with 12 billion in assets or 40 billion?

It wasn’t easy on the Norwest side. It appeared that we made social concessions, but we never made a deal on social issues that didn’t make rational business sense. So we were able to get through by being rational. I believe this wasn’t about scale, it was about getting into new geographies and about skill. Never about doing deals because we were too small, but because they made sense.

You should never do an acquisition unless the revenue growth of the combined company is greater than the sum of the two if they stayed separate. The only way you know you’re adding value is if the top line is growing. You don’t have to know anything else. If your top line is growing three times the industry, you must be doing something else. Risk adjusted. The market doesn’t just give it to you.

This deal was done on the basis that the combined revenue growth would be much greater because of the skills. Wells was way ahead on Internet banking. They had the best real estate and commercial banking teams. They were in high growth markets. Norwest brought in a broad product line and how to manage geographically.

Question

When you made the decision at Citi about ATMs, how do you make a decision like that when there was no data . . .

Dick

You do testing. You just keep testing the concept. We knew ATMs would work. When I was in the toy business, I brought ten toys home and let my kids play with them. I would look at what they would pick up first. It’s all scientific. Usually you make mistakes in execution. You reduce uncertainty by simulating in test markets to the best of your ability.

We had a lab set up in New York testing language and so on. We had customers tell us the machine was more polite than the tellers. It was all done by listening to customers. Why do you think we put two machines in at a time? 97% reliability wasn’t good enough. If we told people it was available 24 hours, it better be there.

We introduced this thing in April in 1975; we had to redesign every store. It took us a year to get it done everywhere. That was part of the research, how to introduce it. It meant we needed people to show customers how it would work.

In February of 1977 we had one of the worst blizzards in the history of New York. It was awful. I couldn’t make it home. I said, “We have to do a commercial. Even in the worst blizzard in the City’s history, the Citi Never Sleeps.” That was our tag line.

We had a camera crew coming in from Brazil. We were doing an internal film about what it would be like to work in the company. So I went and got the camera crew. It was a beautiful sunny day the day after the blizzard. Customers were coming down Park Ave. on cross country skis coming in to use the ATM. We interviewed them about what it was like. We had a cameraman blowing smoke across the lens to make it look like a blizzard. We were on television within 48 hours.

When we introduced ATMS, the CEO of Manufacturers Hanover said, “I’m sure glad my head isn’t in that noose.” Later he apologized [and later his head was in the noose].

Question

Tough times look like the best time to buy.

Dick

War, pestilence, and famine, I just lick my chops. There is just tons of opportunity. Not only in deals to be done, but customers, spreads, and so on. Our assets are up 100 billion dollars in the past 12 months. We just couldn’t put more assets on. Spreads went from historical lows, none of them made sense, to the end of the year to fair value, to most asset classes are under valued. So we’re buying with both hands. You buy the assets, then the companies. We now have the best share in Colorado by a factor of two by buying the best bank in the worst of times.

Tom

Let’s talk about courage. When you bought Wells, you bought a commercial loan portfolio with huge individual exposures. You don’t like that. How did you get comfortable with that?

Dick

The reason we didn’t take large exposures is we didn’t have experience with that. They had issues because of geographic and product line concentration. I would never have let it get that concentrated. But now it’s much more spread out.

Question

Comment on the future of the retail banking franchise. It looks like we’re still doing brick and mortar.

Dick

You get back to our strategy of a broad product line. 35% of our stores aren’t traditional banks. We have mortgage, financial consultants, insurance, and finance. 40% of all the checking accounts are for near prime or sub prime customers. But we only do prime lending in the bank. We’re going to convert most of Wells Fargo Finance offices into banks. We’re testing it to figure out how to do it most effectively.

The way to preserve the store as an important element is to have more things to do in that store than was traditionally there.

This is just one person talking, but I think that narrow product providers are doomed. Monolines are gone. Next it will be three or four product companies that will be dead [interesting in light of Bill Taylor’s comments on focus and simplicity].

You have to decide. Which kind of company do you want, an easy company to manage with a small number of products that analysts understand with a worse business model, or a superior business model that’s harder to do? Pick your poison.

A broad line company is harder to do, but you’ll always have products in the sunshine. For example, when rates are low, it’s great for mortgages. In a recession when commercial loans aren’t being made, asset-based loans are great.

Money never goes away. It only moves. It move for two reasons: economic cycles or customer life cycles. If you can keep the customer’s money as they decide to move it for either reasons, you’re going to make money.

Second, the cost to sell an additional product to an existing customer is about 10% of selling the same product to a new customer. You have to advertise. Five come in and two buy. You have to set them up on the system.

So who has the margins? It’s not about the product, it’s how you distribute. Why can WalMart beat everyone on cost? It’s not their buying, it’s their low cost of distribution: The logistics of the interaction.

Question

Wells was an early proponent of putting banks in super markets.

Dick

When we merged, they had 900 in-stores, now we have 550. Wells said you could substitute in-store for traditional. I didn’t ever believe that. I think of it as a hub and spoke. They took some stores in the Pacific Northwest. They took a $100 million branch and put it in a Safeway.

Think as an engineer. Ask yourself, what is the percentage of bank customers that shop at Safeway? The easiest answer is their market share. Next, ask which they’re most loyal to? Where they buy food, or where they bank? As much as I like banking, do I think we can compete where they buy food? It didn’t work. So I like hub and spoke. It’s a service proposition. Even that’s questionable.

Question

Talk about your interaction with your senior team.

Dick

If and when I get comfortable with someone to run company, my attitude is I am there to help them run their company. There are things I know, I’ve been around awhile. They come to see me because they have an issue. If I come to see you, that’s not going to be fun. I’m not talking about doing visits; I do that all the time.

I believe that great leaders have confidence in themselves and create confidence in others. My job is to build the leaders such that once you give them a thought or idea, they never have to come back to you. We’re trying to teach and learn so they know what to do so they can do it.

Tags: DickKovacevich, Tom Brown, BankStocks, Second Curve Capital, Wells Fargo, Norwest, BAI, First Interstate, In-Store, Citi, The Citi Never Sleeps

I am spending the next couple of days as a participant/observer/agent provocateur at the BAI Mavericks in Banking Conference.

Tom Brown led off the proceedings with a conversation with Bill Taylor, business guru, Fast Company editor, and author of Mavericks at Work. This is a reasonably accurate/clean transcript of the conversation.

Tom:

When you look at the mavericks that you’ve gotten to know, what are the similarities?

Bill:

The first is a very clear understanding of what they see in their markplace that the rest of the industry doesn’t see . . . how you think and do you think differently. In an age of hyper-competition and non-stop innovation, do you have a set of ideas that will fundamentally differentiate you? The idea that there is one playbook to success . . . that’s like being on the George Jetson treadmill. It just doesn’t work that way.

One of the talks that stuck with me from one of Tom’s CEO round tables was by Jim McCormick at First Manhattan. He does all sorts of field research.  At every branch visit they do, he has his peole ask a very simple question, “Why should I do business with your bank vs. another.” Two thids of the time, they have no answer. I was amazed that people in the room weren’t surprised at that. I was sutnned. If your people can’t explain why you’re different, how will your customers know?

So the first sign is, what do you see that the competition doesn’t see? Every maverick I know has a vivid, rich answer to that question.

A second is that all demonstrate a real intellectual humilitiy. They know what they believe . . . the old model is that I do the thinking and the others do the doing. I’m the smartest person in the room. So many of the mavericks I’ve gotten to know have broken with that. It’s like “How can I be a leader in a world where nobody in the room is smarter than the other?”  It’s not so much that I have the greatest idea and how do I push that down. It’s I need a great idea, and how do I tap into the group mind to find and develop it?

Most of the Mavericks I know share those ideas.

Tom:

You think the group as  whole is smarter than the individuals. In this industry, we suffer from group think. How do you get past that?

Bill:

What I see more and more is that the most powerful ideas come from the most unexpected places. So the more people you can invite in from someplace else . . .  

I’m less and less a fan of benchmarking. Why is it interesting to benchmark yourself against best practices in your field when they’re not that good to begin with? The best people I know look way outside their field.

Find things that are proven. See if you can import them and improve them.

I’ve been spending a lot of time with Lexus. They’ve gone in 20 years from nothing to the nuber one luxury brand in North America. They’re not successful primarily because the car is that much better than the competition. Lexus as a company has dramatically rethought the luxury car experience.

When you think about luxury, what do you think of? Four Seasons. So they took a bunch of people and spent four days with Four Seasons learning what they did and how they did it. For example, at the Four Seasons, they get together before every shift change and talk about who’s going to be in the hotel that day.

So at Lexus, they do what they call “Standing around in a circle.” They talk about who’s in that day, what’s going on in the press, etc. When you pick up your car at the Lexus dealer I go to, you get two bottles of water and a godiva chocolate. They think about it as their “turn down service.”

Who’s the best retailer right now? Apple. One of the best things they have is the Genius Bar. So now Lexus does that too. People buy a Lexus. It has all this technology and nobody knows how to use it. So now they have something called the Answer Bar. So a week after you buy the car, or whenever, you can come back and get help. No charge. No appointment.

It’s easy to mistake people who are bright and articulate for people who are smart. I’ve seen people try all sorts of ways to allow people to support and evangelize ideas in ways that are natural to them . . . instead of saying the only way to win is in a board room with a power point.

In a world that is so competitive, with so many ideas to be solved, we need some new apporaches to creativity and finding ways to solve problems.

Tom:

Tom Watson would say that if he presented an idea and everyone agreed, he would table it. If a complicated idea has that much agreement, it can’t be right.

How do you get groups of people . . . .

Bill

There’s a company called Rite Solutions in Newport RI. They make software for the Navy.  The two guys that started it are 60- yers old now and they’ve started several software companies and made a lot of money. They know what they know and what they don’t know. All these kids comding out of MIT are so much closer to the technology and the market . . . “how do we create a system that surfaces great ideas?”

They’ve created an internal stock market for new ideas inside the company. So you don’t raise your hand in a meeting to put an idea forward. Instead, you fill out a stock prospectus and float it on the internal market. They all get a ticker symbol. Each idea gets a $10 initial price. Every employee gets $10,000 in opinion money. People bid up ideas. They can also volunteer to help out.

For example, they make casino software. An employee saw this and figured out that it could be adapted into a game that could be licensed to a company like Hasbro. She put the idea on the exchange and the price went through the roof. Now they’re licensing it.

They thought they could take the simulation software they do for the Navy and thought they could improve it by making it more X-Box like. This product line is now 30% of the total business of the company.

The basic decision making is through a system that allows you to be at your best. This is a company with a lots of smart people. This approach takes out the sting of failure. You want to surface a lot of good ideas. By definition, most of them will be crappy ideas. How do you let people down without demoralizing them?  The exchange gives people a way to tell themselves a story about why their idea did or didn’t make it.

Tom:

Is there a corollary about surfacing bad news in a company? Somewhere between two years ago and now, something happened. It took too long for the industry to recognize that something changed. There had to be people in the organizations the knew that things were going wrong.

Bill:

The easy answer is more transparency inside companies. The technology is easy, it’s more about he culture.

I have seen so many companies employing younger people. They’re used to this style of interaction. The notion is that there is no longer one VOICE for the company, but a company with a collection of voices, some of which will be directed at the outside world, some towards the inside world.

Another example is a company called BzzAgent. They do viral marketing. As an organization, it’s the most transparent I’ve ever seen. Everyone has a blog. The stuff that gets surfaced on the blogs would make your hair hurt. It has also prevented them from having all sorts of problems. They recently opened a Lodon Office. The person they picked was a bad fit. The reason I know about it is that it was told on the the CEO’s blog. Very embarrassing. By virtue of writing about that, it made it clear to the people they were interviewing next what they were going to sign up for. It was much more successful the second time.

Like a lot of companies, they have a board of advistors. They wondered if anyone read what they sent them. So in one of the reports they sent out, they put in huge type on one of the interior pages, WE CAN NO LONGER PROVIDE INSURANCE TO OUR ADVISORS AND DIRECTORS.  Only one person got back to the company. So they put all this on the blog.

It seems to me that transparaency is easier in a new organization. I think that’s the world we’re going into.

One of the challenges for big organization is how do we get form here to the future.  Another company is MGM Grand, one of the biggest hotels int the world.

Gamal Aziz took over the hotel in 2002. It was the Ford Taurus of hotels. It wasn’t remotely like what he thought it could be.  He used something called “working backwards.” Let’s look at every element of the hotel and ask ourselves what each space should generate in an ideal world? Forget what’s there. Then compare what’s there to our ideal.

They had a Brown Derby restaurant. It was doing $5 million and 1 million in profit.  So then they asked themselves what if they went and got some all star chef and did twice that and 4 x the profit? So now you’re not making 1 milion, you’re losing 3 million. Relative to what they could be doing, theyu’re losing. It’s now the first billion dollar hotel. The process has been pretty trauma free.

They go offering by offering and ask, what is the highest and best use of that space. We’ll change something new every 90 days.  Don’t start with the present and work to the future. Start with what you could be doing and work backward.

Tom:

Who has a good example of making bad news flow up?

Randy:

Bankers are risk managers. It’s hard to step out of the crowd. It’s hard to get out of the CEOs risk model.

Margaret:

Two things. In brainstorming exercises we don’t allow voting. Any version of voting overemphasizes the ideas we talked about the most or people’s own ideas.

The biggest thing I try to do to avoid group think is to try and step back from the “yeah buts,” and figure out the point of resistance and figure out an easy way to get past that. You can’t be glib about risk if you’re a bank.

Todd

Thinking about the diversity of people we put in a room around any given thing, you want to put people together who think  different. When people are quit, figure out how to bring them out.

Brad:

We’ve adopted many of the approaches Kevin Hoffberg at DQI teaches.  We examine the full range of possibilities that could be used to solve the problem. You encourage the extremes. If you were going to grow market share without regard to shareholder value, what would you do? If we were going to “Starbucks” the bank, what would that look like? This rewards creative thinking.

Tom:

As CapOne pushed the credit card model some years ago, they specifically designed tests to fail in order to figure out the limits of what could be done.  Testing the extremes.

Debby:

Talk about the importance of talent and talent management.

Bill:

It’s one of the things that struck me about the companies we got to know. They really look at the human factor of the business as every bit as urgent as the other parts of the business. In most companies, HR remains a backwater. That is not the way it works inside Maverick companies. They use words like “War for Talent.” An urgent strategic priority. Why would great people want to be part of your company? It can’t be about pay or stock options. What is it about your ideas in the marketplace?

Another big question is, “How do we know a great person when we see them?” They’re getting over credentials and where you worked last and more towards who you are as a person and what makes you tick.

The company that does this better than anyone is Southwest Airlines. For those feeling badly about being in banking, airlines suck. SWA has never had a down quarter. They have more market cap than all the others combined.

Part of it was inventing a better way of doing business. Part of it was a completely different psychology about people. Figure out who their superstars are and what makes them tick. Then go find more people like them.

Last year they hired 3000 people out of 250,000 applications. They take it very seriously.

Kevin:

Banks think they need to be everything to everyone, yet all the innovation seems to come from companies that set very clear expectations for their customers . . . they’re not everything.

Bill:

What people are hungry for is simplicity and clarity in the companies they do business with. For example ING Direct.  They are the ipod of financial services. Just a couple of products and services.  Brutally simple. It makes all the sense in the world. For the people it fits. They also rules out lots of others.

The question to ask is, “Are you the most of anything?” So many companies are pretty good at everything. A great forumula for going out of business slower than the other guys. In the 1950s it was the formula for success. So ask yourself, are you most flexible? The most affordable? The most something. You can only be the most of one thing.

Maverick companies all are the most of something. Therefore they are imposing constraints on themselves.  That means you can’t do other things. In this era of complexity, customers are desperate for clarity, simplicity . . . figure out how to be the most of something.

I’m a runner. We call it the spandex rule of strategy. Just because you can wear spandex, doesn’t mean you should. Same with strategy. Just because you can, doesn’t mean you should. Leaders don’t have the confidence and courage. . .  we all want to think outside the box. Find a couple of boxes you can do really well, and stay there?

Question:

Where do consultants fit in the world?

Bill:

An important source of learning about what’s going in your field and others.  I do think that so many leaders treat business ideas and shop for business ideas like they shop for food. Oooh, a pound of six sigma. They see that it worked somewhere else and then wonder why it didn’t work for them. The best ideas are authentic and homegrown.

I’ve been looking at big companies doing just okay and then realize there is another level. The way to build a disruptive future is to go back to their own past. They all started with a distinctive idea and a maverick future. And they lost that.

I’ve spent a lot of time with the Girl Scouts. This organization was on the verge of being completely irrelevant. An out of date brand. Incredibly irrelevant. There has been such a huge turn around since their new CEO, Kathy Cloninger. One of the most liberating thing they did was look back at when they were founded in 1912 and reread and writings of Juliette Gordon Low. This woman was a compelte radical of the first order. If she were alive today, she wouldn’t recognize the organization. WWJD. What would Juliet do? An effort to give themselves permission to be like their founder. Cultural permission to be like we were founded.

Tags: BAI, Mavericks in Banking, Tom Brown, Bill Taylor, Mavericks at Work, First Manhattan, innovation, disruption, Lexus, Apple, Genius Bar, Answer Bar, RIte Solutions, BzzAgent, Gamal Aziz, ING Direct, Girl Scouts, Kathy Cloninger, Juliette Gordon Low

Several weeks ago–it seems like years ago–I sat in a conference room with Howard Dean, major domo of the DNC, listening to him explain the beauty of the Democratic nominating system.

• Everyone gets a chance to play
• Everyone gets a chance to be heard
• Candidates have to campaign everywhere in front of everyone
• Inclusion, inclusion, inclusion

He even likes the super delegate system . . .

• Gives minorities and unheard voices a place at the table
• They all (mostly) answer to someone so they won’t do something nutty

So here we are in the death throes of the most expensive primary in the history of the Republic without a Democratic nominee, forced to read tea leaves to figure out who the candidate will be. Winning is losing, losing is winning, numbers aren’t what they seem. And in the end, a candidate will emerge from the scorched earth . . . The folks in the other party must be pinching themselves every morning when they wake up. "Can the other side really be that dumb?" Not the best decision making process I’ve ever seen.

Tags: Obama, Clinton, McCain, Red State, Blue State, Pennsylvania Primary, Howard Dean, Decision Making

Sometimes I wonder what the “experts” see in the numbers that I don’t see. An example of this is the raft of headlines today about the Fed trying to balance the “contradictory pressures of slowing growth and inflation.” For example, here are some snips from the NYT . . .

In testimony prepared for the House Financial Services Committee, the Fed chairman acknowledged that the central bank faces increasingly contradictory pressures of slowing growth and rising consumer prices.

But his bottom line appeared to be that, at least for now, policy makers are more worried about averting or at least softening a possible recession.

And this . . .

He predicted that the housing downturn will continue to slow the economy “in the coming quarters,” noting that financial markets are still in turmoil and that it has become more difficult to obtain credit. Consumer spending has “slowed significantly,” he said, partly because of rising gasoline prices, slowing job growth and the decline in household wealth as a result of falling home prices.

At the same time, Mr. Bernanke tried to make it clear that the Fed is watching inflation closely. He acknowledged that inflation may climb slightly more rapidly than the policy makers projected in January. Fed officials then estimated that consumer prices would climb to a range of 2.1 percent to 2.4 percent in 2008.

“Any tendency of inflation expectations to become unmoored or for the Federal Reserve’s inflation-fighting credibility to be eroded would greatly complicate the task of sustaining price stability and could reduce the flexibility of the F.O.M.C.,” Mr. Bernanke warned Wednesday, referring to the Federal Open Markets Committee, which sets interest rates.

Often when you read this sort of thing the writer will go on to draw the distinction between inflation and “core inflation” which is somehow meant to mean something.

To back up just a second, the Fed has been especially watchful of inflation for decades now. But what are we really talking about here?

Inflation is generally calculated using the Consumer Price Index or CPI. Core Inflation is usually the CPI minus the effect of energy and food. It’s also calculated using the “outlier” method which tends to get at the same thing by a different means.

So what goes in the CPI you might ask (and there are a couple of different CPIs it turns out)?

• Food and beverage
• Housing
• Apparel
• Transportation
• Medical Care
• Recreation
• Education and Communication
• Other goods

Hmmm. So when you take out food and energy, there’s not a lot left is there? Oh wait, there’s health care. Except those costs are completely unhinged from reality. They just go up and up at multiple rates of the CPI every year. In fact, they’ll consume 20% of the GDP in ten years, or so they say. So if we’re excluding outliers, why not that one?

Or how about education. Same thing. The price of a university education bears no relationship to any underlying economic dynamic other than inflation. Universities are virtually immune to the kinds of pressures companies face to manage costs, conserve, etc. So they just hike the price and everyone follows suit in a non-colluding sort of way they say.

How about housing. Well we all know what’s going on with that.

So what is this inflation thing that the Fed is so concerned about if it’s not anything that’s going up other than all the things that are going up for reasons that have nothing to do with monetary policy?

There are several points worth considering here that relate to decision-making.

The dynamic that most concerns the Fed is inflation. They respond by fooling around with monetary policy. But the one lever that has the biggest impact on the whole system is energy costs. And that’s not driven by US consumer or even industrial behavior. It’s driven by the actions of OPEC, the huge demands by China and India for energy (just to pick two), and the speculative behavior of financial actors. In other words, what drives the price of oil has nothing to do with anything that the Fed can influence.

Good statistical analysis requires that you normalize for outliers . . . forces that artificially impact the behavior of the model. But looking at the list that makes up the CPI, I would say they’re all outliers or none of them are. I don’t know about you, but I pay for food on a pretty regular basis. I pay for energy at least monthly.

Energy isn’t the only component of the calculation that is non-responsive to the actions of the Fed. It doesn’t matter what interest rates are, if you’re sick, you’re going to the doctor (assuming you have the means to pay for it). The same is arguably true for education.

So I guess that leaves “other.”

I’m sure there are “real” economists who would tell me I’m all wrong. I say bring it on. I can’t conceive of how anyone can make good “fact-based” decisions when the facts they’re using have no causal relationship with the decision they think they want to make. Or coming at this from the other direction, I can’t see how you can make a “fact-based” decision if you choose to ignore data about drivers you find inconvenient.

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Tags: inflation, core inflation, consumer price index, cpi, recession, Fed, decision making, decision quality