Austan Goolsbee to Head the CEA

It looks as if Austan Goolsbee is going to be the next head of the Council of Economic Advisors.  Goolsbee was one of my favorite professors at the University of Chicago, and not merely because he's the most entertaining professor we had*.  He's also one of the sharpest people I've ever met--he has a way of asking questions that cut through your fuzzy thinking to the heart of the problem.

One example:  the AOL/Time Warner merger, with which every good MBA larvae of my year had to be intimately familiar, because just about every bank or consultancy we interviewed with had somehow been involved in the deal.  Goolsbee spent an entire class on it.  He asked us to tell him why the merger was a good idea, and though I don't think the overwhelming consensus in favor of it was merely due to the fact that this suited the beliefs of our prospective employers . . . well, we sure did come up with a long list of reasons for the merger.

Which Goolsbee promptly eviscerated, one by one.  I wrote about one of these arguments when it was much fresher in my mind:

The idea that current price of an asset should equal the future price, discounted appropriately in order to represent the cost of tying up one's cash, seems to be one of the least intuitive out there. I had a conversation the other day with a hedge fund manager of my acquaintance, who knows his way around a balance sheet about eight zillion times better than me, and is cleverer in myriad other ways to boot. Said hedge fund manager offered the hoariest excuse known to man for doing a merger: because you want to gain control of an asset whose owner is (or might threaten to be) charging outlandishly high rents.

I myself offered such rationales for fashionable mergers, such as the AOL/Time Warner megadeal, when I was in business school. Then one of my favourite professors, a fellow by the name of Austan Goolsbee, disabused me of this notion by asking a simple question: What price will the owner be willing to sell the asset at?

The answer, of course, is that he will be willing to sell the asset for the present value of all the future exorbitant fees he's planning to charge you, less a discount because it's nicer to get all the money now in a big pile, rather than in dribs and drabs over the years.

Assuming that your discount rate is approximately the same as that of the asset's owner, you can easily see that it is impossible to make money off the transaction; you'll just be giving him the money now, rather than later. The discount you receive for your troubles will probably be about equal to your borrowing costs, plus the lower liquidity you get from owning, rather than renting, an asset.

In the real world, of course, it is not quite as clear-cut as in an economics class, since mergers often happen when the acquiring party has some overvalued asset, such as AOL stock in 2000, that it can pay with. But even such mergers don't really work as advertised: AOL didn't benefit from getting control over Time Warner's distribution network and content, which it has barely used, but from trading stock in a hideously overvalued business for stock in a more fairly valued one; the deal would have worked out quite as well for AOL shareholders had they traded their stock for shares in ConAgra (probably better, in fact, since little time would have been wasted on consultants trying to wring out "synergies" from the deal.)

That's just one example, however.  Every time I talk to Goolsbee, I come away with some fresh insight--usually, as he shreds some fuzzy misconception I've been cherishing.

I'm thrilled that he'll be CEA chair, hopefully performing the same exercise for the president.  I don't say the president will always listen, mind you.  But as I wrote yesterday, at least he'll get the good argument.  One of the most telling anecdotes about the role of economic staff was related by one of Bush's economic advisors, who noted that while they all opposed the steel tariffs, they also understood that they might be politically necessary to secure fast-track negotiating authority, which would hopefully score larger gains on trade later.  They all simply assumed that Bush, too, understood this--until someone off-handedly mentioned that of course, the steel tariffs were bad economics, and the President hit the roof, demanding to know why no one had mentioned this.  There's a real danger around the president of advisors who recognize that he has to bow to political necessity sometimes--and go ahead and do the bowing on their own, without notifying the president, and letting him choose where to give and where to take a stand.

I suspect that Austan Goolsbee is constitutionally incapable of such concessions.

Indeed, while I'm very happy that he's to head the CEA, I confess I'm a little surprised.  I had always thought of him as being too independent--and independent minded--to spend long in the administration.  The dust-ups over his public remarks--such as the time allegedly told a Canadian official to ignore Obama's campaign rhetoric on trade--seemed to confirm my belief.  But as political reporters like to say, he's "grown" in office.  I'm glad he's been able to stick it out this long, and I hope he will be continue to transcend the restraints of his position.