Why Experts Failed To Predict Cowboy’s Failures And Why Phillips Had To Go

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When I heard Wade Phillips was fired from the Dallas Cowboys, I did what all sports fans do – run to business appraisal principles to explain what just happened. Two terms jumped immediately to mind. If both terms were part of the pre-season predictions the so-called experts would have tempered their high expectations that the Cowboys were likely to go deep in the playoffs and perhaps be the first team to play the Super Bowl in their home stadium. ?Both business valuation terms, if included in their analysis would have lowered expectations. That is important because I have lived long enough to disappoint often, and can testify that disappointment is often a function of unrealistic expectations. With lower expectations, the bubble would not have been so large, and the burst would not have drowned the players and fans so irrepressibly and fatally. And perhaps the weight of those lofty expectations may not have crushed the Wade Phillips career so abruptly.

Term one: Entity Synergy. It has been defined by businessdictionary.com as when two or more entities work in concert “in a particularly fruitful way” that produces an effect greater the sum of their individual effects, i.e. “the whole is greater than the sum of its parts.” The example provided is when two or more employees excel when working together but who, when working alone are ordinary.

The Cowboys have great talent at many positions. So much so, the experts said, “End of story, talent wins out – see you in the Super Bowl.” ?They have not one but two All-Pro cornerbacks from last year, Mike Jenkins and Terence Newman. They have not one, but two All-Pro receivers in Miles Austin and Roy Williams, not to mention the super-talented Dez Bryant waiting on deck. Then there is Marion Barber to run the little pigskin, and All-Pro Leonard David to open holes for him to run through with the little piggy. And to keep the opposition from scoring there is linebacker DeMarcus Ware. But he may not have to tackle anybody because All-Pro Jay Ratliff is on the defensive line.

But if something was amiss amongst the players as a whole, or between the players and the coaching staff, or with ownership, they may well get it backwards. Instead of ordinary players becoming excellent through synergistic magic, they were excellent individuals that became ordinary. Based on their current 1-7 record, they are less than ordinary. The ability to “work in concert” for qualitative business synergy is the same harmony needed for a successful football team. The good quarterback can be ordinary without an effective offensive line. Without holes to run through, the running back becomes the run-down back, and the receiver gets no passes if the QB is sacked. They need that well-oiled oneness and hugability that does not come from just an assemblage of plant and equipment – or in this case individual player assets. ?The great predictions of the excellent Dallas defense failed to incorporate whatever lost faith that caused the implosion over the most recent games where they gave up over 30 points a game. Perhaps at some level they gave up before the points were actually scored.

The other business valuation term is “going concern value”. It refers to a type of value – the operational value of the entire enterprise. This incorporates the tangible assets (e.g. land, improvements, and fixtures) and intangible assets. In both cases what really makes the entity valuable and successful is the very special way the intangibles and tangible assets come together to generate a present value of future net income.

Simply put, the Cowboys did not have those intangibles coming into the season, and appear to have less of them now. The experts would have been wise not to myopically look at whether the “assets” are individually impressive. Yes, the aforementioned list of 2010 All Pros arguably presents more individually valuable assets than any other team in the NFL. But as corny as it sounds, the team is not as successful if the intangibles are not there. This may be the biggest unrecorded asset collapse since the Wall Street mortgage crisis. The lesson I hope to remember in making sense of this is that the way the players, coaches, and owners come together still has to be “special”.

We hear players from great teams say all the time, “we believe in each other”, “we’ve got each other’s back”, “if he needs to go the bathroom, I’ll hold his… locker open.” And because the experts have heard it before they discount it. Perhaps that is because they either never played at that level or never felt the power of that synergy and operation as a going concern. But most truth has simplicity and longevity. The axiom that the whole is greater than the sum of the parts is exactly what the Cowboys needed to succeed, no matter how many All-Pro caliber individual players are in the locker room. They need to hold it open for each other on and off the field to have a going concern value that generates future wins.

It is not the same as just adding up all the telephones, plant and equipment. It is not just lining up All-pro talent. This is not fantasy football. Until we see that beyond talent, there is synergy, we should be careful about glorious predictions. Before this past Sunday’s Farbonoics, the Vikings were a Super Bowl prediction that was also about to be buried in embarrassment for much the same lack of those fruitful intangible attributes.

But Wade still had to go, don’t you think? Some of us will blame the players, or the owner. But Wade had the ultimate responsibility to generate wins. And for an owner to remain confident there are wins in the future, you don’t want to see the inability to even compete with a team of substantially similar talent in Green Bay. No confidence oozes from a 45-7 loss, coming on the heels of a 35-17 lose to a team, Jacksonville, which is struggling to stay 500. Traditional wisdom is you don’t make a mid-season head coaching change unless things are really, really, bad, as in “can’t get much worse” bad. That would seem to be the case. But before the experts claim next season’s Super Bowl contestants before the season starts, I hope they remember to value the synergy and going concern value of the enterprise.

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Top Finance Experts To G20: The Basel III Process Is A Disaster

By Simon Johnson

The Group of 20 summit for heads of government this weekend will apparently “hail bank reform,” particularly as manifest in the Basel III process that has resulted in higher capital requirements for banks. According to leading authorities on the issue, however, the Basel process is closer to a disaster than a success.

Bank capital can be best thought of as the amount of financing of a bank’s operations (lending and investment) that is covered by equity and not by debt obligations. In other words, it describes how much of the assets of the bank are subject not to the “hard claim” of debt but rather to a residual or equity claim, which would not lead to distress or insolvency when the value of the asset goes down. For global megabanks, equity capital is thus a key element in preventing the failure of an individual institution (or a couple of banks) from bringing down the financial system.

The framing of the Basel “success,” according to officials, is that the big banks wanted to keep capital standards down — and this is definitely true — but that governments pushed for requirements that are as high as makes sense. The officials implicitly conceded the banks’ main intellectual point, that higher capital requirements would be contractionary for the economy.

But according to top academic experts on this issue — people who know more about banks and bank capital than anyone else on the planet — the banks have misrepresented and the officials have misunderstood reality.

In a letter published in The Financial Times this week, Professor Anat Admati (Stanford University) and her colleagues — a Who’s Who of finance — make three main points.

First, the basic economics behind official thinking is wrong.

“Some claim that requiring more equity lowers the banks’ return on equity and increases their overall funding costs,” thus lowering economic growth, the professors write. “This claim reflects a basic fallacy. Using more equity changes how risk and reward are divided between equity holders and debt holders, but does not by itself affect funding costs.”

They go on to say: “High leverage encourages risk taking and any guarantees exacerbate this problem. If banks use significantly more equity funding, there will be less risk-taking at the expense of creditors or governments.”

Second, the Basel process uses dysfunctional methods to adjust capital requirements to reflect the risk of various kinds of assets.

“The Basel accords determine required equity levels through a system of risk weights,” they write. “This system encourages ‘innovations’ to economize on equity, which undermine capital regulation and often add to systemic risk. The proliferation of synthetic AAA securities [around U.S. housing loans] before the crisis is an example.”

Third, capital requirements should be simplified and greatly increased — relative to what the Group of 20 leaders will congratulate themselves on.

“Lending decisions would be improved by higher and more appropriate equity requirements,” they say.

And they are also completely on target with regard to the political economy problem here: “Many bankers oppose increased equity requirements, possibly because of a vested interest in the current systems of subsidies and compensation. But the policy goal must be a healthier banking system, rather than high returns for banks’ shareholders and managers, with taxpayers picking up losses and economies suffering the fallout.”

This is not extraordinary language per se — you can see the same sentiments, for example, echoed throughout the new movie “Inside Job” (which I highly recommend, as does the reviewer for The New York Times; disclosure, one sound bite from me appears in the movie). And I have advanced similar views on this blog over the past 18 months (e.g., see this post).

But to have the intellectual leaders of the finance profession weigh in so heavily and with such language is huge. Officials claim that they are the custodians of best practice in economics. If you criticize them on this or any other issue, they will roll their eyes — implying you do not understand reality or the insights of the truly deep thinkers.

So here are the deepest thinkers — founders and mainstays of the entire field of finance — finally standing up and saying: Enough of this nonsense. You may wish to pretend that keeping capital requirements low is a good idea, but you should understand that this is pretense and bad science, pure and simple.

Remember that most productive firms in our economy are financed with equity — shareholding is at the heart of the American economic model. Bankers make it sound as if something is wrong with being equity-financed, but all these big banks are publicly traded in any case. They just need to raise more equity and rely less on debt. This would not be difficult — and definitely not disruptive to the nonfinancial “real” part of the economy.

There is no intellectual case for the Basel process on its current basis or for the outcome that will be discussed this weekend. The Group of 20 leaders are kidding no one but themselves when they endorse this approach.

The Group of 20 has completely failed to do what is necessary to rein in global megabanks — and to make them safer.

Listen to the leading minds of the finance profession and take corrective action now, before it is too late.

An edited version of this post appeared today on the NYT.com’s Economix; it is used here with permission.? If you wish to reproduce the entire post, please contact the New York Times.

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