Wednesday, December 31, 2008

Dell's Failing Turnaround

Today's Wall Street Journal featured an article about the Dell 'turnaround' in the Marketplace section.

Almost a year ago, in January, I commented on a Journal piece about returning CEOs reviving their companies. I wrote about Dell,

"Why do you suppose that these CEOs, as a group, mostly failed to move their firms to consistently superior total return performance?

In Dell's and Starbuck's cases, I question if they ever will. I believe, for reasons I've discussed in labeled posts on both CEOs and their companies, that competition, growth and simple Schumpeterian dynamics have worked to end their time of consistent outperformance."

It won't matter what sort of shuffling of deck chairs on his personal Titanic that Michael Dell does now. He can change executives, shuffle one to another post, but it won't change the business. Or customer behavior.

As this nearby, one-year price chart for Dell and the S&P500 Index clearly demonstrates, the company still struggles relative to the market.
Dell is down for the count. Nothing Michael Dell does is going to change this Schumpeterian fact.

Tuesday, December 30, 2008

UPB & Madoff: Custody Again

Today's Wall Street Journal featured an article in the Money & Investing section detailing Union Bancaire Privee's attempts to explain how it became entangled with Bernie Madoff. According to the piece, half of the bank's 22 funds were invested, to varying degrees, with Madoff.

To me, the most revealing passage was this one,

"..UBP said it had reservations about the way Mr. Madoff ran his investment firm, particularly the lack of an outside administrator and custodian (my bold), which would have provided an added degree of certainty that the investments Mr. Madoff claimed to have made were real. But UBP said it overcame those concerns because of Mr. Madoff's firm's status as a "reputable" broker-dealer that was registered with the Securities and Exchange Commission (my bold), as well as Mr. Madoff's longstanding reputation in building Wall Street's financial markets infrastructure."

As I wrote here last week,

"As I reviewed the mechanics of Madoff's scheme of undisclosed numbers of individual accounts, rather than a single, explicitly-spotlighted fund, with my partner, my belief that Madoff had long ago discovered loopholes that I, too, observed earlier this decade grew significantly.

The most important element of his fraud, without question, was the lack of independent custodial inventory reports of financial assets held in accounts for clients. I can't emphasize enough that this alone left every one of Madoff's clients vulnerable."

So, it seems that even a veteran, experienced private bank looked the other way and simply through prudence and common sense to the wind. They let an unrelated aspect of Madoff's investment business- his separate, registered broker-dealer- color their choice of him as an investment manager.

Anyone in the business knows that just because business A is regulated and supervised by the SEC means nothing about a business B, which is not registered.

But, apparently, UBP's staff knew better. Or so it thought.

These are called "con" games for a reason. Short for "confidence," the schemes always work by getting the mark, er, investor, to trust the fraudster, and give him their confidence.

Surprisingly, that's how easy it was for Madoff to accomplish his fraud. Whether he ever had an investment approach that made money is actually immaterial. And always was.

We now see that he managed to dupe the most experienced banks in the business, simply due to gaining their trust on bases other than his investment performance, a thorough review of his methodology, or any other typical object of due diligence.

Leading me, once more, to state that everyone who lost money with Madoff deserved to, because they were motivated by sheer greed. Greed that overwhelmed diversification and common sense investigations that any other investment manager would have had to undergo.

Monday, December 29, 2008

Sheila Bair's Mixed Signals

Friday's Wall Street Journal's Money & Investing Section carried a lead article entitled "Banks Told: Lend More, Save More." With a picture of FDIC's Chairman, Sheila Bair, accompanying it, the piece explored the mixed, opposite signals now being given to US banks- lend what the Federal government has invested in them, but, at the same time, build capital cushions.

As Brian Wesbury pointed out recently, about which I wrote in this post,

"In a related argument, Wesbury noted something genuinely novel and elegant. He opined that, with the Fed pushing rates to nearly zero, there was no way bank lending could expand.

He pointed out that, at a time when risk in the economy, among borrowers, is still so high, and rates are now so low, there is absolutely no way lending can be cost-justified. The risk-adjusted returns to ultra-low interest loans are negative. Wesbury thus observed that the problem isn't a lack of borrowers, but a lack of lenders willing to effectively take a loss on new loans.

He then pointed out how ludicrous was the situation in which banks have been placed by Treasury and the Fed. They are pilloried if they don't lend out the new, unwanted TARP-based 'capital' bestowed upon them by Hank Paulson.

But, if they do make loans at market rates in this environment, those loans will surely go bad, too, resulting in even more balance sheet damage and reprimands from regulators."

It's never fun to have to note a situation of governmental incongruity and wrong-headedness. In this case, Wesbury called this a full two weeks ago.

This is why, in my opinion, if we're going to nationalize the banking sector, we should do it correctly. Lending standards should be articulated from Washington, with clear, quantitative guidelines. If Federal money is going to back the banking system, let's not have loose, prone-to-misinterpretation signals.

If Treasury, the Fed and FDIC all want more bank lending, they should clearly express that in a formal regulatory message, complete with guidelines and a statement of responsibility for subsequent loan performance.

This is why it's not a great idea to mix Federal funding with private funding of banks. Now we have Federal directives to private shareholders that their bank employees should be doing more lending, though, as Wesbury notes, the chances of getting rates to compensate the risks are nil.

Gee, didn't we just spend about a dozen years doing this in the housing sector, via Fannie, Freddie, Barney Frank and two Presidents?

We could be in for a long, long learning period under the new, quasi-nationalized banking system the US now possesses.

Friday, December 26, 2008

FASB Blinks On 'Mark To Market' Methodology At Last

Earlier this week, the Wall Street Journal published an article reporting on FASB's late, halting steps to modify 'mark to market' accounting for financial sector firms- banks and life insurers.

In the piece, the Journal reporters wrote,

"Accounting watchdogs are fast-tracking an effort to provide a small dose of "mark-to-market" relief for financial firms, as banks and life insurers continue grappling with deteriorating investment holdings.

The Financial Accounting Standards Board last week began steps to loosen a rule regarding when financial firms must book losses on a narrowly defined subset of lower-rated mortgage-backed securities, commercial-backed securities and certain other structured securities.

For those financial firms that hold the relatively small group of securities at issue, managements and their auditors would have more leeway to put off a potential write-down that would clip net income. That could help bolster their regulatory capital.

The possible rule revision falls far short of what banking and insurance executives were seeking because they wanted relief that would give them greater leeway in valuing a wider range of securities. But it illustrates how aggressive they have become in trying to stave off paper losses. Analysts are still trying to figure out which companies might own the particular securities at issue."

Unfortunately, the move seems to be coming as far too little, too late. If, some fourteen months ago, FASB had allowed performing securities to be marked at their economic value, rather than the instantaneous trading value, which might be zero, much of the last year's carnage could have been avoided.

However, by waiting too long, intangible losses became tangible writedowns, which restricted credit, investment and, eventually has led to a reduction in real economic activity.

Talk about the tail wagging the dog....

Thursday, December 25, 2008

Fraudulent Conveyance In The Madoff Case

In today's earlier post, I referred to the general consensus that many withdrawals by clients from Madoff's accounts in the last six years are subject to seizure, as being fraudulently conveyed by Madoff to those investors.

Apparently, due to recent rulings in the Bayou fund fraud of a few years ago, investors cashing out of a Ponzi-type scheme are not really withdrawing their profits, but, according to a court ruling, taking stolen funds.

Here's what I don't understand. Suppose you invest $5MM with Madoff. And suppose by the time you do, he's totally running a Ponzi scheme. There just isn't really anywhere near the oft-quoted "$50B" in the various accounts.

If you are sent account statements over a period of years stating that you now have, say, $10MM in your account with Madoff, and you choose to take your original stake off the table, and play with 'house' money, how are you fraudulently taking other people's money?

After all, you did give Madoff $5MM. You are certainly entitled to recover your original investment, aren't you?

I can see where withdrawals above the original investment could be seized for pro rata distribution. But not the original investment. That was your money. If you were fortunate enough to take it back, and sufficient funds were available to allow that, how did you take it from anyone else?

Death In The Madoff Case

Wednesday's Wall Street Journal carried the now-widespread news of Thierry Magon de La Villehuchet's suicide.

The French banker was bereft at the losses of his and his clients money in Madoff's scheme.

It's a sad thing, to be sure. But here's what I don't understand.

Villehuchet was said to be working non-stop on 'recovering' funds from the fraudulent investment scheme.

Just how did he plan to do that, when everyone with a brain knows that nobody will be getting any recovery anytime soon. And, if anything, it appears that, due to legal precedent, any investors who withdrew funds in the past six years may be required to return that money as having been fraudulently conveyed.

You could be doing all the work you wanted on trying to get some money returned, but you're not going to be successful.

More likely, the banker was simply overcome with dread at the realization that he had lost $1.5B of blue-chip client, and his own, money in Madoff's fraud.

Wednesday, December 24, 2008

American Express: That's No Bank!

Now we have yesterday's announcement that the TARP will be unfurled to cover $3.39B of American Express assets. CIT is also in for $2.33B.

According to the Journal article,

"Both CIT and AmEx need stable funding sources to make loans to businesses and consumers, but the credit crunch has made raising funds in public markets expensive."

No kidding!

But neither of these firms are part of the deep, crucial web of bank deposits and monetary system. They are simply standalone credit companies.

We had private sector excess which led to the TARP. Now we have the TARP itself going to excess.

If ever there were two firms which should be shotgun-merged with some other companies, or simply closed, via Chapter 11, these two are them.

Ken Chenault should be fired, on the way to American Express' acquisition by a commercial bank, or the sale of its profitable pieces to other firms.

To some extent, with the decline of the travelers check business, the very raison d'etre of AmEx has evaporated. Its former perfect funding/lending hedge is gone.

So, evidently, should the firm.

Tuesday, December 23, 2008

The Wisdom Of John Thain's Job Choice

Back in late October of 2007, I wrote this post discussing whether John Thain would take the top job at Merrill Lynch, as Stan O'Neal was being cashiered. I wrote, regarding Thain,

"Why would a senior executive who has run part or all of Goldman Sachs need to prove himself running a less-robust financial services business model with less talented personnel?"

It was inconceivable to me that anyone with a record of accomplishments, as Thain had at Goldman and the NYSE, and a good job, would be remotely interested in being Merrill's CEO. To do so, it seemed to me, would be a triumph of ego over common sense.

After Thain took the Merrill job, I wrote this post, providing more detail for my reasoning that he would eventually dump the retail side and try to recreate Goldman Sachs,

"No, I think it's safe to say Thain will ditch the current form of Merrill, and build a securities sector firm with the best features, in his opinion, of Goldman, Blackstone, and other private equity/hedge fund firms.

Goldman's time is not yet finished as the premier public investment bank. Thain will do well to incorporate large parts of its culture, senior executives, and business mix at Merrill."

Given that Thain had actually jumped from a relatively secure position as NYSE CEO to head troubled Merrill, I figured that, in time, he'd spin the retail side off, realizing that it is a dying business. Instead, he'd probably recreate something with which he was familiar- the Goldman Sachs model.

Finally, in this recent post, about eleven months after the first linked post, I opined,

"Second, I bet John Thain wishes he'd stayed at the NYSE and never been tempted by the wreckage Stan O'Neal left behind. Too much damage, not enough time. Who'd have guessed that Thain would be out of a job before Vikram Pandit at Citigroup?"

Several of my friends think that Thain couldn't lose in taking the Merrill job. That, like I wrote in this post almost exactly one year ago, people like Gerstner, Ryan and Pandit 'can't lose' for taking such CEO billets.

I suppose Thain might be viewed that way, but, personally, I think Thain made a major mistake. So great that, in simply asking to be paid for doing a decent job piloting the wrecked firm into the arms of BofA, rather than go bankrupt or be seized, he drew a huge amount of scorn and derision.

Already, he is seen not as having done yeoman's work at Merrill, but, simply ended by turning greedy when he requested a $10MM bonus for his efforts.

Now he is reportedly out of the running to ever succeed Ken Lewis.

Before Merrill, Thain was viewed as a capable co-head of Goldman, and a very successful CEO at the NYSE, fundamentally changing the firm in the wake of Dick Grasso's ugly exit.

Now, Thain is also remembered for gulling investors in December and the first quarter of 2008 to put money into the disintegrating brokerage firm, then claiming they didn't need to raise any more capital. To me, Thain is tarnished by some of what he did early on at Merrill, and for even leaping into the mess. I think it smacks of too much ego and too little perspective on the unfolding disaster that was in process a year ago.

Maybe I'm alone in this view, but I think Thain's time at Merrill has diminished his reputation and raises questions about his judgment.

Monday, December 22, 2008

More On Bernie Madoff's Fraud & Its Reprecussions

I wrote a prior post concerning the Bernie Madoff investment fraud last week, here.

Since last Tuesday, more stories have circulated detailing the enormity of the losses among many wealthy individuals, charities, trusts, and institutional funds.

Daniel Henninger of the Wall Street Journal offered a comparison between Madoff's spreading scandal and a recent off-broadway play, "The Voysey Inheritance." It's an interesting reflection on the response of people to such large, outright fraud.

However, I wrote in my prior post,

"I guess, for me, the most amazing stories in the Madoff mess are those once-wealthy people who failed to diversify, and basically gave all of their wealth to Madoff to invest. I don't know the details of Madoff's operation, but, from my time as a registered fund manager, I know that there are safeguards required to prevent the easy looting of client assets in cases like this.

For instance, in the case of private accounts, a custodian institution is usually used. It's not clear if such an arrangement was in force for Madoff's clients. Another typical safeguard is a quarterly statement of holdings in individual accounts.

If these were not used, it shows incredible gullibility on the part of so many wealthy people. If they were, it suggests that Madoff had a lot of help, since these would have been fraudulent statements."

We don't yet know the extent of help and complicity that Madoff had with his scheme, with the probable exception of his wife. But as I discussed this matter with friends in the investment business this weekend, we all agreed that, to concoct and maintain such detailed records of fraud for so many individual accounts, Madoff must have had quite a bit of assistance.

It's inconceivable that Madoff's confederates or minions would have thought nothing of hand-entering so much portfolio position data each quarter, rather than it being generated from existing position statements driven by custodian or brokerage account statements.

To me, the key observation, which I read in the Journal last week, was that an outside analyst had done a sort of 'back of the envelope' calculation to determine that Madoff's portfolios, according to estimates of the assets he ran being in the tens of billions of dollars, must have had trading activity exceeding the entire market for various index puts or calls. Additionally, experienced clients seemed to think nothing of the fact that blue chip equities showed no decline in prices earlier this year, although they were key to the alleged strategy.

This smacks of convenient denial of reality by so many clients. The suspension of disbelief, and a desire to simply believe that unbelievably good, and not just consistently, but uniformly constantly good results, were real.

As I reviewed the mechanics of Madoff's scheme of undisclosed numbers of individual accounts, rather than a single, explicitly-spotlighted fund, with my partner, my belief that Madoff had long ago discovered loopholes that I, too, observed earlier this decade grew significantly.

The most important element of his fraud, without question, was the lack of independent custodial inventory reports of financial assets held in accounts for clients. I can't emphasize enough that this alone left every one of Madoff's clients vulnerable.

Coupling this with a curious lack of diversification, a/k/a greed or stupidity, and you have the recipe for disaster among so-called 'sophisticated' investors.

Many years ago, during the WPPSS bond collapse, I read articles in the Wall Street Journal detailing the loss of entire life savings of many very average Americans. People had actually invested entire retirement accounts into just this one instrument, only to see it fail utterly and become worthless.

At the time, I posited a very personal belief that, for most people, simply reaching retirement with their principal intact is probably better than average performance. Never mind the 10% annual S&P average return, or something more like 3-6% if someone invested in a mix of assets and traded heavily.

Just staggering across the financial finish line with what you saved, while avoiding egregious market downturns, frauds, and other widespread investing pitfalls, was probably an exceptionally good performance.

Madoff's clients now add substantial evidence for my viewpoint. How many once-wealthy Americans having millions of dollars of accumulated financial assets are now simply bankrupt? Or nearly so, with almost nothing to show for decades of successful careers?

And all of this....all of it...would have been minimized, if not totally avoided, had each and every investor insisted on receiving a regular asset inventory report from an independent custodian. This would have prohibited false claims of asset ownership, or required an entire custodian's business to be in league with Madoff.

I don't believe any more regulations will prevent a repeat of this type of periodic investment fraud. There are plenty of safeguards required by current regulations. But nobody can prevent a person from simply throwing caution to the winds, trusting in a manager, and his 'special' inner client circle, without any objective, confirming evidence.

As I described to my friends over coffee on Saturday, you can run hundreds of individual investment accounts as an unregistered investment manager. Sure, the legal maximum is between 15 and 30. But so what?

If you choose your clients carefully, and never let on that you actually have hundreds of them, and they don't all meet, who would know? If none complain to the SEC, why would that agency bother you?

If, as in a proper Ponzi scheme, you cash out any disgruntled investors, so they have nothing to take to the SEC by way of losses or evidence of malfeasance, there's simply no way of being discovered.

It's a lot like being shot by an illegal firearm. Sure, we have complicated laws restricting lawful access to these weapons. That only means you are more likely to be shot and/or killed by an unlawfully-obtained weapon, rather than a lawfully-obtained and carried piece. You won't be less wounded, or dead.

And more laws won't actually prevent illegal guns from existing. Nor illegal investment management schemes, either.

Friday, December 19, 2008

The US as The Next Argentina, Not Japan

Earlier this week, on Tuesday, I happened to catch Larry Kudlow's program on CNBC. Among his guests were: Bob McTeer, retired Dallas Fed President, Brian Wesbury, one of my favorite, and a well-regarded economist, and Rick Santelli, the Chicago-based futures and options market reporter for CNBC.

What I heard struck real fear into me.

Kudlow began a debate by relating a sort of 'thought experiment' he had done regarding the Fed's recent actions. He told a story about his days at Bear Stearns, where, every time the Fed cut rates, Larry would joke that he saw palm trees growing on the trading floor- a reference to so-called banana-republic economies. Specifically, Argentina.

McTeer chimed in to agree, as did Brian Wesbury. They all believe that Argentina, not Japan, is the potential role model for what may happen to the US economy and dollar in the years ahead.

This incited a fierce debate with other guests on the segment.

In a related argument, Wesbury noted something genuinely novel and elegant. He opined that, with the Fed pushing rates to nearly zero, there was no way bank lending could expand.

He pointed out that, at a time when risk in the economy, among borrowers, is still so high, and rates are now so low, there is absolutely no way lending can be cost-justified. The risk-adjusted returns to ultra-low interest loans are negative. Wesbury thus observed that the problem isn't a lack of borrowers, but a lack of lenders willing to effectively take a loss on new loans.

He then pointed out how ludicrous was the situation in which banks have been placed by Treasury and the Fed. They are pilloried if they don't lend out the new, unwanted TARP-based 'capital' bestowed upon them by Hank Paulson.

But, if they do make loans at market rates in this environment, those loans will surely go bad, too, resulting in even more balance sheet damage and reprimands from regulators.

Wesbury then reiterated his concern that 'mark-to-market' had not been modified or rescinded, thus causing needless damage to bank and fund balance sheets by overly-severe writedowns of still-performing instruments. McTeer agreed.

Santelli did, as well, picking a fight with a guest, who argued that mark-to-market isn't relevant to the problems at hand. Santelli challenged the guest to buy some of the toxic waste, whereupon the guest said, 'no, because they will eventually be marked down further.'

Santelli then smiled and said that this was exactly his, and Wesbury's and McTeer's point- that because everyone is worried that these structured instruments will ultimately be written down further, nobody will invest in a bank, nor a fund holding such instruments.

Thus, markets are frozen, awaiting the needless writedowns of performing, or even semi-performing assets, due to the self-fulfilling prophesy of a lack of trading markets for said assets.

It was a very informative and densely-packed 15 or so minutes of economic and financial debate. One of the best I've seen in ages.

McTeer continued to back Bernanke's flooding of markets with credit, believing that, at the first sign of inflation, Ben will withdraw said liquidity soon enough to avoid hyper-inflation down the road.

What I took away from the exchanges that evening is that we are, truly, for the first time in ages, in new economic territory. A hideously over-supplied dollar, interest rates too low to be consistent with responsible lending, collapsing asset values now, with a concern over hyper-inflation later.

All very similar to Latin American monetary and economic policies, rather than the Japanese variety. A very chilling prospect for our economic future.

Thursday, December 18, 2008

New Evidence On Consumer Choice & Cars From Bankrupt Producers

Yesterday's Wall Street Journal provided new evidence concerning whether American consumers would still buy cars from producers in Chapter 11 bankruptcy.

The answer is, 'yes,' for 90% of those surveyed. As the article notes,

"A pair of new surveys suggest buyers aren't completely unwilling to buy a car from an auto maker in bankruptcy court, as long as the federal government is willing to play a role in helping the company restructure.

This contradicts the conventional view of Detroit auto makers that suggests consumers would shun a bankrupt auto maker over fears related to the resale value of a car, the warranty and the ability to secure service and replacement parts.

Merrill Lynch & Co. recently completed a study showing 90% of car buyers would consider purchasing a vehicle from a car company in bankruptcy court.

Another survey, by CNW Marketing Research, found 48% would consider buying from a bankrupt auto maker if the company were getting help from the government, but that is up from a previous survey conducted by the Bandon, Ore., company."

Of course, this provides refutation of one of the more forceful arguments with which the UAW, GM, Ford and Chrysler have pursued Federal aid. The Journal provided more detail further on in the piece,

"The Merrill Lynch study, conducted for its clients and which included talking to 500 people, concluded that a "large majority of consumers would consider buying or leasing their next vehicle from an auto maker that is backed by U.S. government funding and may emerge as a strong company, following a restructuring through the bankruptcy process."

Merrill has had a banking relationship with domestic auto makers within the past year.

The CNW Marketing Research survey, of 9,700 domestic car owners completed Dec. 14, suggested 48% of buyers would be willing to consider a product sold by an auto maker in bankruptcy court, as long as the government was involved in the process.

CNW had been the source of an earlier study whose conclusions raised concerns about the impact of a bankruptcy filing on a car company. That survey found 80% of buyers would stay away, and the auto maker's revenue would plunge.

But CNW President Art Spinella said in an interview Tuesday that new research suggests people would feel much better about a bankrupt auto maker's chances "as long as there are loan guarantees by the government."

The results contradict much of what executives at U.S. auto makers and the United Auto Workers argue would be the impact of a bankruptcy on one or more of the companies."

Clearly, a Federal loan for debtor in possession financing would meet this criteria, as would some provision in any package for a separate warranty-funding facility.

Thus, once again, we see that the reasons for avoiding Chapter 11 filings for the US auto makers continue to fall by the wayside under closer examination.

Wednesday, December 17, 2008

Government Intervention's Effects On Risk & Private Capital

Monday's Wall Street Journal featured a very interesting piece in its 'Heard On The Street' column. Entitled "Auto Bailout's Hidden Danger," David Reilly pointed out an insidious aspect of a possible Federal pre-bankruptcy package for the Detroit-based auto makers.

Simply put, Reilly notes that, with Federal involvement causing new uncertainty in the order of creditor seniority for GM and Ford and, in some sense, Cerebrus/Chrysler, such an aid package may further chill any hope of private investment in the sector.

In a manner very similar to that now brought to light by Amity Schlaes concerning FDR's New Deal, such government intervention also brings with it the fear and risk of subsequent Federal legislation which changes the terms of seniority of creditors, or the rights of the Federal government.

For example, it is now recognized that FDR's federalization of power generation, via the TVA, drove investor capital out of that sector for decades.

When the newly-arrived rescuer of a company or sector also has the power to rewrite the laws governing recovery of investment or allocation of loss, it will come as no surprise that private capital may well steer clear of that company or sector permanently.

It's not a trivial matter. Consider what Treasury 'help' did to investors of all the major commercial banks, not to mention AIG. What investor would now be so foolish as to invest in that sector, save for short-term trading gains?

It's a very undesirable, unintended consequence of Federal 'help' for an industrial sector which would, in the end, be so much better-served by joining the rest of American business in using the available Chapter 11 bankruptcy process.

Tuesday, December 16, 2008

Paul Samuelson's Brilliant Idea

As the US finds itself firmly in a recession, with the potential for this phase of the natural economic cycle to worsen before the economy recovers, I am reminded of one standout economic insight, about which I have written before, here and here.

I am referring, of course, to MIT emeritus/retired Professor of Economics and Nobel Laureate, Paul Samuelson's 'accelerator-multiplier' theory.

Regarding the current recession, I wrote in the second linked post,

"Now, however, as Paul Samuelson's accelerator-multiplier work informs us, the same breakneck growth in housing-related spending and lending which drove prices and 'values' up in the expansion, are at work in reverse, coursing through the sector and depressing values.

The values represented by the peak prices of homes bought and constructed were contextual, and have vanished. The real dollars exchanged for those prices did, for a moment in time, also exist.

But the reverse multiplier effect on all these vendors, assets, etc., have destroyed much of the capital created and borrowed to fund these houses."

As this phenomenon from the housing sector spread through banking and into the general economy, I have ruminated recently, at length, as to what factors can turn a deepening recession into an eventual recovery.

What is it that turns a gloomy consumer outlook, vanishing banking assets, shrinking spending levels and spreading joblessness into subsequent economic growth?

The answer, quite simply, was discovered by Samuelson in the 1950s. Inducing cyclicality into a system is often simply the result of including a 'first difference' term. Samuelson's genius was understanding that businessmen and consumers view the 'first difference' between today and some past period- say, a year ago- to judge whether things have gotten better, worse, or are unchanged.

Right now, a look backward shows that volumes are shrinking, so near-term economic behavior echoes this with more belt-tightening.

But in six-twelve more months, business volumes will probably appear flat. This realization will cause businesses and consumers to conclude that the bottom has been reached in this economic cycle. Sales aren't falling anymore, joblessness isn't growing, and economic activity generally has leveled out.

Since this will be a positive change in the rate of change, planning becomes focused on maintenance or growth, rather than more cutting.

Samuelson quantified natural human behavior for economic purposes in a manner never before articulated.

Of course, there is a huge implication due to Samuelson's work on the accelerator-multiplier theory.

It demonstrates a natural cyclicality to economic conditions that cannot be 'fixed' by any sort or amount of governmental intervention. As I noted in the more recent linked post, this is why one-time fiscal 'stimuli' never work. Only permanent tax cuts can deliver a lasting change in incomes that effectively shock the perceptions of businesses and consumers into seeing the present as better than the recent past, so to trigger expansionary activity.

Further, any promises of governmental program activity, e.g., infrastructure spending, won't do much for widespread business and consumer behavior, either. It is simply impossible to arbitrarily, or determinedly lop off the 'recessionary' phase of economic cycles. The latter exist for a reason, and give society the opportunity to clean out unsustainable, unprofitable businesses, recycling their resources for use in better business opportunities.

Not only does Samuelson's work give us confidence that every recession, in effect, automatically brings about its own consequent expansion, but it confirms that this is a necessary phase in national economic cycles.

Bernie Madoff & The "Sophisticated" Investor

This week's panic over the Bernie Madoff investment fraud points out how much of a cottage industry investment management continues to be. And probably will remain.

As a veteran of the business for over a decade, I can attest to the thoroughness with which some potential investors conduct due diligence.

My initial hedge fund partners required me to replicate my strategy's results using their performance data and software system. It was a very clever approach, since I was forced to cede control over the total return data with which, had I been marketing a fraudulent system, I might have fooled them. As it was, their insistence on my reproduction of the strategy on their system resulted in the elimination of some minor errors and some improvements elsewhere in the approach.

In another case, a potential investor required exact times, dates and tickers of equities which I had bought for my personal account, in order to reconstruct my returns, to the penny.

Never did I have anyone simply accept my return series as prima facie evidence of the strategy's effectiveness. At the least, names of the equities held in each period were required, along with a monthly return series.

So it's incredible to learn that Madoff posited a steady, unchanging 1% per month return, and attracted virtually no in-depth investigation from the bulk of his investors.

However, it's not all that surprising to me that Madoff was able to run his scam for so many years.

The keys, it seems to me, were two-fold.

First, by alleging to manage individual accounts, rather than a fund, he avoided any serious SEC inspection and regulation. The allowable minima for a number of accounts managed individually prevents anyone from every really knowing whether you are in violation, or not.

Madoff's insistence on keeping the activity quiet, ostensibly because of his brokerage operation, resulted in nobody ever asking to see regulatory filings on his activities. Or, if they did, the second key to his success came into play.

By beginning with an attitude of, lets be frank, arrogance, Madoff challenged people's self-confidence. Madoff used what my business partner calls the 'club deal' approach. That is, you are favored by a personal contact with the opportunity to 'get in on' a sweet deal. But you have to just sign up and hand over your money- you can't actually delve into details.

Rather, you are supposed to be so flattered with the chance to participate. And, in fact, we have already heard stories of lucky escapes by wealthy but sceptical investors who did ask too many questions, those questions which were either ignored, or the investors were then declined the opportunity to participate.

The list of those who were bamboozled by Madoff grows daily, and even affected investor confidence yesterday, helping the S&P to drop by 1.3%.

As if the last 18 months of financial markets behavior haven't been sufficient to strike fear into equity investors, the Madoff saga seems to be a fitting bookend on which to close out 2008. If not for Madoff being affected by redemptions, like so many other investment managers, his scheme may have run for years into the future.

Apparently some $50B is gone in a classic Ponzi scheme. Some investors with realized gains may even be approached to return the gains. There's no way, at present, to know if any of the reputed performance Madoff ever had was real, or if it was a scam from the very beginning.

I guess, for me, the most amazing stories in the Madoff mess are those once-wealthy people who failed to diversify, and basically gave all of their wealth to Madoff to invest. I don't know the details of Madoff's operation, but, from my time as a registered fund manager, I know that there are safeguards required to prevent the easy looting of client assets in cases like this.

For instance, in the case of private accounts, a custodian institution is usually used. It's not clear if such an arrangement was in force for Madoff's clients. Another typical safeguard is a quarterly statement of holdings in individual accounts.

If these were not used, it shows incredible gullibility on the part of so many wealthy people. If they were, it suggests that Madoff had a lot of help, since these would have been fraudulent statements.

It's still early innings in the case, so we don't know the extent of complicity of various other people who worked in or with Madoff's investment firm.

But the scope of the fraud is staggering. As is the caliber of the people he bilked.

And, sadly, the one thing we know is that it's not the last time this will occur. Jason Zwieg's article in this weekend's Wall Street Journal pointed out how feelings of inadequacy to even ask questions, on the part of most of Madoff's clients, greatly assisted the ease with which his scheme operated. As well as Madoff's judicious use of initial clients to whom others would look up, and, feeling, again, less confident, simply invest without asking questions.

Human behavior seems to have some enduring components through time, and these certainly qualify. That's why Madoff is just the latest in this saga, not, unfortunately, the final chapter.

Monday, December 15, 2008

More Idiocy From Jim Cramer

Last week I saw yet another instance of CNBC's mad- and I mean truly mad- man Jim Cramer's inability to understand logic.

This time, Cramer was arguing with Erin Burnett's reasoned, calm presentation of evidence showing that short selling without the uptick rule has not significantly affected equity markets. And certainly has not 'caused' this fall's market collapse.

At issue was the fact that statistics show no actual, significant downward stock price pressure purely as a result of downtick selling.

Cramer was having none of it. First, he railed against the abolition of the uptick rule. When Burnett presented the data she had read, Jimbo then switched arguments.

Instead of rebutting Burnett's numbers or logic, he said something like,

'Well, there are better ways to drive a stock's price down. Like ETFs and puts. Shorting isn't actually my preferred way to manipulate a stock price.'

Okay. Makes sense.

Doesn't that, on the face of it, put Cramer on Burnett's side? Didn't he just argue that the uptick rule is irrelevant, because shorting isn't even the best way to give a big push downward to stock prices?

Apparently not, because Cramer continued his rant against the rule's removal.

Mind you, the logical next step in Cramer's position regarding options and ETFs is that there is basically no good regulatory solution for stock manipulation because, even without an uptick rule, there are 'better' ways to manipulate stock prices, such ways never having had any rules constraining their usage.

This continued about three times, before Burnett, always smiling, just stopped trying.

I don't watch Cramer at any length or with any regularity. But if this is his brand of reasoning, I wonder why anyone would watch this clown?

The Real Value of A Bankrupt Company's Cars

For the past few weeks, CNBC's mediocre auto- and airline-correspondent, Phil Lebeau, has been shouting to anyone who would listen, that the value of cars made by an auto maker which files for bankruptcy will fall precipitously.

On Friday, he was screaming about the value decline in Oldsmobiles, once GM decided to discontinue the nameplate.

I was talking with my business partner at length on Friday afternoon about the failed auto bailout bill, and brought up LeBeau's continuing assertions.

As I related his ongoing bluster, something occurred to me regarding the entire topic of used car valuations.

Perhaps LeBeau has it backwards.

Maybe the true value of all these GM cars is actually lower than their present value. The only thing propping them up is the thin reed of possibility that the company won't file Chapter 11.

With CEO Wagoner having caused GM's stock to fall from nearly $60/share five years ago to than $4 now, why wouldn't you expect the resale value of the firm's cars to plummet heavily, as well.
To worry about the loss of additional resale value of GM products is really sort of moot at this point. The company is, on a valuation basis, so near dead that everyone knows there is unlikely to be an independent GM in another twelve months.
Thus, any further drop in resale values is probably to their true value, from a current, artificially high value as the firm tries to get Congress to give it a temporary stay of execution.
All this handwringing about resale values and warranties seems to me to be beside the point. Few people buy GM products anyway, and those people must be purchasing GM cars and trucks for reasons other than resale value.
To try to turn well-functioning Schumpeterian dynamics on its head, and refuse to let a failing auto maker, or two, die, because of the likelihood of their products' values falling to their true level, seems ludicrous.

Sunday, December 14, 2008

Aftermath Of The Senate's Defeat of Auto Maker Bailout Bill

On Friday of last week, with the news of the Senate's defeat of the Detroit auto maker bailout bill, a curious thing occurred.

GM prepared to file a Chapter 11 bankruptcy, as CEO Rick Wagoner declared that the company has insufficient cash with which to operate until a more assured rescue comes, after January 20.

Now, according to Forbes, Wagoner was paid $4.82MM in 2006.

Yet, for an assumedly similar amount this year and last, what did shareholders get?

A CEO so inept that he failed to file for bankruptcy, to reorganize GM, last year. So incompetent that he forced the firm to run through nearly all its cash before seeking court protection to reorganize and renegotiate any and all contracts- union, dealership, suppliers, etc.

Instead of behaving like a real CEO, and having his staff observe, then plan for contingencies stemming from the 2007 credit market troubles, Wagoner dithered on as usual.

Having now run GM almost entirely out of liquid assets, he baldly blames Republican Senators and the President for his firm's bankruptcy.

This is rich, indeed.

A better-run firm would have headed into the safe harbor of Chapter 11 last year, when the gathering clouds of financial crisis and debt market unraveling gave warning of trouble ahead.

No, not GM. Not Wagoner.

In their playbook, all troubles which GM has recently faced are due to Washington, or the credit markets, but none of their own making.

Not even from their sins of omission- failure to notice a crisis looming, and failure to seek Chapter 11 court protection, in which to sort out their mess.

Friday, December 12, 2008

Revisiting Compensation: Lagging Incentive Comp To Match Long Term Performance

The Wall Street Journal's Scott Patterson wrote a piece in Wednesday's edition entitled "Securities Firms Claw Back at Failed Bets."

Mr. Patterson began his article by stating,

"As securities firms rein in risk-taking that ran amok when times were good, the use of clawback provisions is spreading, with Morgan Stanley and UBS AG rolling out rules that allow them to take back money paid to traders and other employees whose bets blow up later.

But the push to clean up an old problem on Wall Street may create some new ones. By giving themselves the power to reclaim bonuses and other compensation, firms might unintentionally make traders too skittish about taking even healthy risks, nudge some of the best talent out the door or encourage employees to conceal their losses, some observers warn.

"It would be hard for traders to hide losses for more than a year or two, but if we incentivize them to do so, they will find a way," said Frank Partnoy, a University of San Diego law professor who has written about corporate malfeasance.

The clawback "has far too long a memory and makes your most successful traders the most risk-averse," added Aaron Brown, a hedge-fund risk manager who used to work at Morgan Stanley."

I must admit, I have no concept of what Mr. Brown could mean. Isn't most of what has befallen traders, and the companies for which they work, in the last year or so too much focus on short term profits of trades, while disregarding the longer term ramifications?

In fact, in this year, of all years, it is ludicrous to be quoted publicly as saying that traders may not take enough risk in the future.

To me, the following comment in the article makes much more sense,

""We're making what we see as a good-faith effort to more closely tie employee compensation to longer-term performance," said Morgan Stanley spokesman Mark Lake.

I have argued for years, beginning with the application of my proprietary corporate performance research for consulting with CEOs, that incentive compensation needs to be vested some 3-5 years after the year in which it was earned. Shareholders benefit from consistently superior returns, not yo-yoing, inconsistent returns. Thus, Morgan Stanley finally seems to be on a credible, effective track for matching employee incentive compensation with shareholder interests.

Regarding other banks, Patterson continued,

UBS, which announced its clawback provision in November, will hold about two-thirds of eligible cash bonuses in an escrow account from which the Swiss bank will dole out payments based on employee performance and UBS's overall profitability."

"UBS acknowledged that its clawback rule could cut into short-term profits if employees become too risk-averse. Overall, though, the policy is expected to result in more consistent and less volatile long-term gains. Reginald Cash, head of U.S. investor relations at UBS, said the provision could create "some limit to chasing the last dollar on any given strategy." "

Again, this is precisely what shareholders should want. Long-tailed investment positions may be profitable trades in the initial year, but come back to haunt the company. Consider how many of the mortgage-backed securities or CDOs may have performed in their early years, versus their valuation changes in 2007 and -08.

Thus, anyone who argues that traders should not bear the risk of their positions in their compensation for the life of the positions is clearly not paying those traders with their own money. And doesn't care about shareholder interests, either.

This is an idea whose time is long, long overdue. In fact, even the name given the approach by financial services companies promotes incorrect thinking.

It's not 'clawing back' compensation from employees after the fact. It's releasing the incentive compensation in concert with each year's successful earning of the money by an employee, on a lagged basis.

Had this type of compensation approach been in place five years ago, there would have been much less damage from toxic structured financial instruments in the most recent cycle.

Thursday, December 11, 2008

10 Lies About Bailing Out GM, Ford, Chrsyler & the UAW

As I have heard and read, like you, countless articles and hours of Congressional testimony and news program interviews pursuant to the question of the American taxpayer bailing out GM, Ford and Chrysler, a list of lies told by Rick Wagoner, Alan Mulally, Bob Nardelli and Ron Gettelfinger has occurred to me.

I can't link each lie with one person, in every case. But this is a list of claims made by one or more of the four which are simply untrue.

1. Bankruptcy is not an option.

Of course it is! This is something basically uttered by all four of these guys.

Ask yourself why they bothered to go to Washington first, rather than Chapter 11? Because, in Chapter 11, an apolitical bankruptcy receiver would restructure the whole mess with abandon, to truly be capable of survival. It won't be pretty, and it will make the efforts of at least Wagoner and Gettelfinger look silly and half-assed by comparison.

2. Filing bankruptcy will bring down hundreds of suppliers and cripple the US economy in the midst of a recession.

No, it won't. This is a bald-faced scare tactic. GM, for example, only has something like a 25% market share. Chrysler is even smaller. The few cars that actually turn a profit could be bundled into one unit and either spun back out or sold to another car maker. The suppliers for these cars will still have demand.

For any share lost by GM, Ford and Chrysler, other US-based, foreign-owned brands will pick up the share, and, with it, demand that feeds back to the suppliers.

This argument is just baseless on the face of it. No matter how many times CNBC auto-blowhard Phil LeBeau contends this to be true, it simply is not.

3. Nobody will buy a car from a car maker in bankruptcy.

This hasn't been demonstrated, by research, to be true in the proper context. Plus, it's never clear that the question is asked with a proviso that a third-party warranty would be provided. If anything, many buyers, assuming they even want some of the junk peddled by GM, Ford and Chrysler, merely would expect to pay lower prices.

4. This is a loan, not a bailout.

Lie. If this were merely a loan that was truly expected to be repaid, the capital markets would be handling the transaction. It's precisely because nobody expects this money to ever come back that only the taxpayer, via Congress, would provide it.

5. Without GM, Ford and Chrysler, the US will lose an important manufacturing base and be hostage to other world powers, plus become less capable of self-defense.

Nice try, but, this, too, is a lie.

First, we have a dozen or so foreign-owned auto plants in the southern US which, together, manufacture- actually, more correctly, assemble- fully as many cars as GM currently manages to sell. Losing GM doesn't lose this capability, but, merely the worst-performing, least-efficient amount of capacity.

Second, car making is more about assembly nowadays, less about manufacture. So this argument is wrong and specious on this point, alone.

Third, real defense-related production comes from companies like Boeing, General Dynamics, Lockheed and other similar contractors. Not to mention their suppliers.

Last time I checked, Wagoner, Gettelfinger, the governor of Michigan,, were not Nobel-winning economists capable of credibly assuring US taxpayers that the precise capacity and capabilities of car assembly represented by Detroit-based auto assemblers is vital and necessary to a vital US economy in the future.

We've been moving to a service-based economy for over a decade. The real high-end, value-added manufacturing base is more efficient, requires fewer workers per dollar of value-added, and resides in other sectors than auto production.

6. There's light at the end of the tunnel for GM, Ford, Chrysler and the UAW with this 'loan.'

No, there isn't. Look closely at the CEO's promised dates of return to profitability. The earliest, I believe, is Ford, in 2009. Wagoner keeps babbling about 2010 and his cherished 'Volt' electric car. But his own EVP, Bob Lutz, let slip recently that green cars won't actually make money if priced so that consumers can afford them. Ooops!

Chrysler is a recurring disaster, profitable only during peak years of US economic cycles.

Republican Senator Tom Corker, among others, was correct when he noted, on CNBC, earlier this week, that none of these three companies have a plan to become truly viable and profitable in a reasonable timeframe.

No sane investor or lender would accept, today, from an existing large US industrial concern, a business plan which does not promise a profit for the next two years. It's just insane.

7. The current dire situation of GM, Ford, Chrysler and their common, primary union, the UAW, was caused by the US financial market crisis which began earlier this year.

One of the bigger lies propagated by everyone pushing for this bailout.

These three auto makers, and their greedy union, have mismanaged their situation for well over a decade. True, their situation worsened since September, when credit tightened/vanished. But that's part of running a large corporation- planning for many scenarios.

GM, in particular, has been headed for bankruptcy for nearly the entire term of Wagoner's ineffectual reign. The recent financial crisis merely offered an opportune occasion for these parties to raid the Federal Treasury and taxpayers' pockets.

8. Rick Wagoner is the best person to 'lead' GM.

Another big lie. Wagoner has misled GM for eight years. He's a major part of the problem, not any part of a solution, such as it may be.

A bankruptcy receiver would be far better and more objective for doing what needs to be done at GM to survive.

9. Bankruptcy of GM, Ford or Chrysler will be a disaster for the US economy because these companies will "go down."

Another lie, similar to lie #2.

Bankruptcy is not liquidation.

Putting GM into receivership, via Chapter 11 bankruptcy, does not mean it ceases operations. It means a trustee is in charge of reorganizing the firm to survive in the future.

Liquidation occurs when the operations, under bankruptcy, prove to be unable to be sustained, even with reorganization.

For example, the retailer Dave & Barry's went bankrupt this past summer. But it was not in liquidation until a few months later. Prior to that, the chain still operated, albeit under court protection.

See the difference?

That's why all this handwringing about GM filing Chapter 11 is a hoax. They won't stop production lines the day after the filing.

10. The UAW and the Detroit auto makers have already made a lot of concessions and done a lot of restructuring, so they deserve this Federal help.

Nice try, but the market doesn't reward efforts, only results.

Veteran auto-sector reporter and writer Paul Ingrassia, late of the Wall Street Journal, has written for months that the Detroit Three have been slow and ineffective in coming to grips with their troubles, and realistically fixing them. Bloated costs, too many brands, and too little effort spent attacking Congress' CAFE regulations have left them incapable of surviving in their current shape.

The UAW, for its part, points to concessions, but Gettelfinger badly needs to avoid his union's employers filing bankruptcy. If they do, he and his union are history.

Not because anyone is out to 'break' them. Rather, their own greed and shortsightedness has resulted in them crippling their employer.

In truth, a great deal of GM's, Ford's and Chrysler's troubles are co-owned by prior UAW rank file and leadership. Including Gettelfinger.

He, too, must go. Most likely with the decline into near-obscurity of his once-influential union.

Washington's Bailout Bill for Detroit

Take $20B, divide into 400,000 employees, and you have $50,000/person.

That's what you could do with a little more than the money currently being offered to Ford, GM and Chrysler, in exchange for something less than bankruptcy.

After all, not every employee of the three US-based auto makers will be out of work. Some will transfer with their successful, profitable product lines to other owners. So, between out-of-work auto employees, and some among their suppliers, you could assist a lot of non-management employees without 'bailing out' shareholders and management.

Let's help the non-management employees, and let management and shareholders pay the price for decades of lousy management.

Force Wagoner to file for Chapter 11, and probably Nardelli, too.

But under no circumstances should Congress give any of the three US auto makers money prior to a Chapter 11 filing.

Wednesday, December 10, 2008

Disbelief and Denial On "Wall Street"- Or What's Left of It

I read Dennis Berman's piece in yesterday's Wall Street Journal, entitled "On the Street, Disbelief and Resignation," with great interest, and more than a little surprise.

Berman wrote, in part,

"Inside what's left of Wall Street, investment bankers are doing all they can to cope with a business that is disappearing before their eyes. Yes, there are tens of thousands of people still with jobs. They just don't have much work. Debt and stock markets are virtually shut, merger volume is down by 28%, and whole lines of structured finance are closed for good.

This would appear a moment of natural self-reflection. Perhaps the time to consider a career move out of New York, or pursue an abandoned passion. Oddly, few of the senior bankers seemed to be able to accept the basic reality of their own profession: that an overleveraged world created an excess of bankers, too.

It is a testament to Wall Street's inherent optimism -- and exactly why the boom-and-bust cycles will continue -- that bankers remain so committed. As the Goldman banker summed it up: "People are busy. They're just not getting paid."

Here's what I don't get.

Ten, five, even a year ago, these whiz kids were supposed to be able to out-think corporate CEOs and CFOs, identify mergers, create novel financing approaches, and, generally so it was presumed, add value.

How can a group of largely kids, with a few adults riding herd on them, be so currently misguided, blind, and clueless, yet be in a position to 'assist' US companies with financial consulting and engineering?

We're dealing with global deleveraging. A serious pollution of the world's financial markets by toxic securitized waste. Credit is being retracted, or only extended in rollovers at very high rates of interest.

Underwriting is probably headed back to the stone age, since nothing glitzy will be trusted by most investors for maybe a decade. There is no 'Wall Street' anymore, simply corporate finance and M&A divisions of commercial banks.

I was around in the 1980s, when investment bankers and corporate raiders routinely merged companies, engineered leveraged buyouts, and purged hundreds, sometimes thousands of employees from the affected companies.

Guess whose turn it is now?

Thaaaat's riiiiiight! Investment bankers, M&A mavens, and traders, both buy and sell sides.

The underlying markets and demand for much of what these typically-younger, well-educated, highly-financially aspirational financial service workers are gone. Vanished. Vaporized.

Thus, so are the jobs serving those vanished markets and demands. And they likely will not ever return. Period. It is a new era. Publicly-held investment banks are gone, and will not return.

It's revealing to see how, when it is now apparent to all who understand these markets and sectors, that there has been a one-way sea change in employment opportunities and careers in investment banking and trading, these young worthies still cling to the hope that there will be a dawn following this night.

If this represents their considered business judgment, that's just another reason for the once-vibrant, overheated investment banking sector to have vanished as publicly-held companies.

Tuesday, December 09, 2008

Today's Auto Sector Woes Are A Rerun of The 1970s Steel Sector

As the current drama involving GM, Ford and Chrysler has taken center stage on business news for the past week and weekend, I've written quite a few posts about it, here, here and here.

In discussing the topic this weekend with my business partner, I was reminded of another US industrial sector which experienced the same pressures and difficulties in the 1970s and 80s.

I am referring, of course, to the once-significant US steel industry. In fact, while researching some history for this piece, I found, to my shock, this article, appearing recently in the Herald Tribune, a unit of the NY Times.

The opening of that piece observes,

"A few years ago, an industry whose history and mythology were indelible parts of the U.S. identity was dying. The great steel mills of Pennsylvania and the Midwest had literally built the United States, but the twin burdens of competition and self-inflicted wounds had brought them to the edge of extinction.

If they were allowed to go under, their partisans warned, the consequences would ripple through the economy at a cost too high to bear. The old saying, "As steel goes, so goes the nation," was as much a threat as a boast.

The Detroit automakers are using the same argument as they seek a $25 billion bailout from Congress. "What happens in the automotive industry affects each and every one of us," a General Motors Web site declares, warning that the consequences of a shutdown would be "devastating."

Yet steel's savior was not the government bailouts it ardently sought but exactly what it tried so long to avoid: bankruptcy. Only when the companies failed were they successfully slimmed down and retooled into smaller but profitable ventures. As debate continues over what, if anything, should be done for GM, Ford and Chrysler, the steel industry may offer a model."

I could not agree more.

Back when I was in graduate school, the old-line steel industry in this country was on the ropes. The situation was eerily similar to that of today's US-domiciled auto sector.

Just to refresh your memory, I am referring to: US Steel, Bethlehem Steel, Lukens, LTV, Republic, Armco, to name a few.

As the Herald Tribune article correctly notes, the steel industry- both companies and their union- claimed the same disastrous results if they were allowed to go bankrupt as GM, Ford, Chrysler and the UAW now do.

Back in the 1970s, it was mini-mills, cheaper foreign steel, and bloat USW contracts that led to Big Steel's demise.

And, make no mistake about it, they were left to file Chapter 11, consolidate, and, ultimately, emerge as a smaller, profitable sector.

The sky did not fall. Economic ruin did not visit America once these firms began to reorganize.

And it won't, now, either, when the auto makers are allowed to choose filing for bankruptcy.

The Herald Tribune piece notes, near the end,

"Over the decades, the companies had shed employees to stay afloat. Soon, retirees greatly outnumbered the actual workers. At Bethlehem, the ratio was six retirees for every worker. All these retirees had good pensions and good health care plans, which they thought were guaranteed. But these costs were a tremendous weight on the companies.

Bankruptcy changed the rules, allowing the steel makers to unload billions of dollars in pension obligations onto the government's Pension Benefit Guaranty and to cut more than 200,000 workers from their supposedly guaranteed medical care.

The failures also allowed for the renegotiation of labor contracts, something Wilbur Ross Jr., a specialist in distressed assets, realized when he began looking at the moribund industry. The only bidder for the bankrupt LTV Steel, he proceeded to buy Bethlehem and other old-line companies, putting them together as International Steel Group. He cut more employees and revamped work rules, taking Bethlehem, for example, from eight layers of management to three.

Steel's turnaround was dramatic. The 17 leading companies went from a combined loss of $1.1 billion in 2003 to an after-tax profit of $6.6 billion in 2004, according to an analysis done for an industry trade group. Ross sold International Steel to the Indian entrepreneur Lakshmi Mittal for $4.5 billion in 2005, earning a tremendous return.

Thanks to all of steel's tribulations and consolidations - and a world economy that was booming until recently - the industry is relatively healthy."

The article goes on to note some issues which could make an auto sector bankruptcy result in a different outcome than that of the US steel sector. For example,

"Not so fast, Ross said. He doesn't dispute that the auto companies are as bloated as the steel companies were, and certainly doesn't think they should get a blank check. But he thinks the consequences of what he calls free-fall bankruptcies - ones without any government role - could be disastrous.

GM would drag hundreds of suppliers down with it, and they would all have trouble getting back up again.

Furthermore, it is a tremendously problematic time. The final collapse of the steel industry came when the economy was relatively healthy and could absorb the blow. The current economy is the weakest in decades."

Well, a Federal DIP loan is solution in which the government will play a role. Just not one which puts a dead corpse on life support.

In my opinion, it's more than worthwhile to learn from the success of letting market forces work in the sector of 30 years ago, and do so, again, in the auto sector.