This is the first part of a loosely-envisioned two part series of posts.
The larger topic, which will be the subject of the second post, concerns the long sweep of US economic and business experience from post-WWII to now. How our larger corporations and senior business executives have had incomplete, sheltered and misleading experience such that, in times of challenging circumstances, few of them are qualified and experienced to manage through this environment. And, most importantly, since the days of FDR's Social Security program and the Truman-led wage and price controls during WWII, our society has engaged in deferred promise-making on a scale never before seen in recorded history.
What happens when those two themes collide, and our society cannot possibly fulfill economic promises made by various groups to each other, and, sometimes to ourselves? When promises made in anticipation of straight-line GDP growth and naive hopes of everlasting corporations meet realities of economic cycles, coincident capital market panics and economic recessions, bankruptcies, and temporary value destruction in both real and financial assets?
But, to today's topic,
What might be the global implications and consequences of the ongoing, large-scale US Federal government's Federal Reserve and Treasury outpouring of US dollars, through both borrowing and printing?
I've been pondering this since the TARP bill was conceived and fought over in Congress.
If one were viewing the global financial implosion of the past year from outside of the environment, like some sort of Einsteinian 'thought experiment', what would one have seen, and what conclusions might you draw?
On a broad scale, the US financial markets would have begun to dramatically lose value, beginning with the 'mark to market' impacts on and of the two failed Bear Stearns mutual funds in the summer of last year. As trading ceased in various structured financial instruments composed of mortgages, the most recent of which were increasingly lower-quality 'alt-a' and subprime in nature, the market value of many financial assets plunged, as financial institutions began to sell better assets in order to either raise cash for redemptions or take gains to offset 'mark to market' losses in the structured financial instruments.
Having started, globally, with above-average leverage, financial institutions bearing these losses had comparatively less equity capital with which to absorb the now-outsized losses on exotic securities and, increasingly, more mainstream equities.
As confidence lost in structured finance instruments spread to those institutions operating outside of the Federally-supported banking system, i.e., investment banks, brokerages and hedge funds, their equity values plummeted, counterparty risk rose, and leverage across the entire global financial system effectively began its inexorable shrinkage.
Since leverage, a function of debt, implies confidence in the future returns of loans placed with various enterprises, its unwinding corresponds to a loss of such confidence. The forced reduction in this leverage began, understandably, with the short-term borrowing instruments of both financial and non-financial instruments- commercial paper, most notably.
As this massive de-leveraging of fixed income instruments occurred, the simultaneous drop in real estate values and equity market values caused several consequences.
First, large-scale losses in US, and other nation's market, i.e., societal capital stocks, valued notionally, plunged. Those who previously owned the capital suffered large losses. In the US, the Treasury and Fed moved to support the Federally-registered banks via direct preferred equity purchases and, separately, takeovers of Fannie Mae, Freddie Mac and AIG.
From our external perspective, then, it was as if, following the observance of massive equity and debt capital losses in US society, and others holding US instruments, the US government, choosing to believe that earlier, higher values, were justified, to some extent, simply printed more money and issued liability instruments in order to reflate the financial sector and, indirectly, the business economy.
Whether those choosing to hold US government debt would feel this was purely inflationary, or merely a transfer of wealth from those whose capital value had evaporated, to the US government, is, to some extent, still to be determined.
Yesterday's plunging T-bill yields suggest that, for the moment, the market seeks safety in notes issued by the government of the globe's largest, most free economy, more than it cares about the debauching of the value of the dollar.
The second major consequence of the calamitous drop in price of many stores of value- real property, equity, debt- coupled with the deleveraging, was the cessation of bank lending. Thus, a financial crisis, partially unleashed by a narrowly-defined 'mark to market' rule in a single US law, Sarbanes-Oxley, led to the real effects on non-financial sectors of the US economy. As banks struggled to deleverage their assets in order to both conserve remaining equity from further losses, and abide by regulatory capital requirements, lending suffered. This became a self-fulfilling act, as, starved of normal, short-term operating liquidity, more and more businesses began to reduce operations and cut staff.
The third unforeseen consequence, then, to complete the circle, was the rising joblessness as the economy was already softening, of its own accord, by early 2008.
This last link in the circle of economic causes and effects has now driven a dramatic drop in consumer spending, due to: rising unemployment, lower home values as a source of personal household net worths, and lower financial asset portfolios as a source of personal household net worths.
Viewed again from a perspective outside the global financial and business system, the effect of the market and economic events of the past 18 months has been to dramatically reduce overall investor and consumer confidence in near-term investing and employment conditions, leading to rapid deleveraging and, thus, a reduction in effective money supply.
Since, by Fisher's equation, MV=PO, the fall in the effective quantity of M, assuming, at best, a stable V, must drive a reduction in physical output, price levels, or both. It is now becoming both.
To reverse this effect, as any economics student, Treasury Secretary or central bank chairman knows, assuming velocity has fallen, as has been observed via the freezing of bank lending, M must rise at the rate which one desires PO, or global nominal GDP, to rise.
And that is why central banks are flooding the globe with liquidity, heedless now of later inflation. And, given the notional destruction of so much original capital value, as of early 2007 levels, it is not clear that there will be a consequent inflation. There's simply less market-valued capital and current production available to drive said inflation.
Thus, having fleshed out this thought experiment thus far, to our current situation, what might be the most likely answer to my initial question?
For now, it seems that the flood of US-government-printed dollars will not lead to near-term inflation. And, absent another country of with a democratically-elected government, reasonably-stable protection of property and other rights, the economic size and diversity of the United States, it seems global investors have little choice but to buy and hold the dollar for the foreseeable future. What are their other options, the Euro or Yuan? Hardly.
If there had remained an investor or consumer group totally outside of the now-globally-interdependent economic and financial services web, the US might soon experience a rapid decline in the dollar's value, skyrocketing interest rates, and a loss of appetite for US debt- publicly and privately issued. In short, a severe comeuppance for the largest single economy on the globe.
But that doesn't actually appear to be in the cards, thanks to such tight, fast global interdependencies.
How the US government conducts its retreat, assuming it makes one, from the various large-scale intrusions into the financial and banking sectors, and exchanges its investments for cash which is returned to the Federal Treasury, will govern how the longer term effects of its massive funding efforts have an impact on US and global inflation.
Friday, November 21, 2008
What's Up With Larry Kudlow?
Earlier this week, I happened to surf by CNBC during Larry Kudlow's program. I can't recall at exactly what hour he now appears, what with the network having relegated his slower-moving, more cerebral and content-rich program to the middle hours of the evening, after the conceptually emptier but faster-paced financial market candy of 'Fast Money' and 'Mad Money.'
What I saw, however, stunned me. I hadn't realized how hard up Larry is for either ideas, and/or guests.
There, on the set with Kudlow, his lone guest, was none other than CNBC's economics pretender and Senior Economic Idiot, Steve Liesman.
But wait...there's more.
Liesman wasn't being called on to report anything, per se. No, that would have been barely palatable, as the hapless Liesman can't even report economic data without putting his own personal, uneducated spin on it.
No, Larry was actually asking Liesman's opinions on topics such as economic growth forecasts and such. Real economic topics to which a real, educated, experienced, practicing economist might be able to do justice.
Has Larry Kudlow lost his mind? Or run out of economics guests to spar with him? Where's Brian Wesbury? John Rutledge?
Instead of seasoned, experienced economists with real PhD's from real economics programs, Larry is now parading an english and journalism major, that would be Liesman, whose bio lists absolutely no economic training or education whatsoever, as a substitute for critical, informed economic thought.
How the mighty have fallen!
What I saw, however, stunned me. I hadn't realized how hard up Larry is for either ideas, and/or guests.
There, on the set with Kudlow, his lone guest, was none other than CNBC's economics pretender and Senior Economic Idiot, Steve Liesman.
But wait...there's more.
Liesman wasn't being called on to report anything, per se. No, that would have been barely palatable, as the hapless Liesman can't even report economic data without putting his own personal, uneducated spin on it.
No, Larry was actually asking Liesman's opinions on topics such as economic growth forecasts and such. Real economic topics to which a real, educated, experienced, practicing economist might be able to do justice.
Has Larry Kudlow lost his mind? Or run out of economics guests to spar with him? Where's Brian Wesbury? John Rutledge?
Instead of seasoned, experienced economists with real PhD's from real economics programs, Larry is now parading an english and journalism major, that would be Liesman, whose bio lists absolutely no economic training or education whatsoever, as a substitute for critical, informed economic thought.
How the mighty have fallen!
Thursday, November 20, 2008
Earth To Ron Gettelfinger: Wake Up!
I just saw/heard UAW chief Ron Gettelfinger give a completely surreal press conference.
It's difficult to catalogue every single one of his mischaracterizations, lies and errors of reasoning. Among them, however, were these:
-Contending that if the US auto makers file for bankruptcy, then any market share losses will be made up exclusively from off-shore, foreign auto producers.
-The beating that equity prices of GM and Ford have taken is merely a 'distraction,' and doesn't reflect some of the better products which at least the former has developed.
-The auto industry is vital to the US economy, and its failure, by virtue of Chapter 11 filings by GM, Ford and/or Chrysler, would plunge us into a severe recession.
-There must be immediate Federal rescue of the auto makers by the Bush administration.
-The UAW is awaiting January 20, 2009, when Gettelfinger indicated that he and his union feel 'real' help will unquestionably arrive in the form of a Democratic President and Congress.
This is pretty scary stuff. As counterpoints, here is what I believe to be more realistic:
-Market share losses of GM, Ford and Chrysler will most probably continue to be filled in by US-based producers owned by foreign car companies. Thus, more US-based jobs and capital investment will follow, though perhaps not on a 1-for-1, dollar-for-dollar basis, as these predominantly southern-based, non-union plants are more efficient than those of Detroit-based auto makers. Gettelfinger completely misrepresented reality, and, in effect, lied, on this point.
-To most Americans, and especially to Americans as investors, the beating that the equity prices of GM and Ford have taken is precisely the point. Not a distraction, but an important, crucial signal in the lack of confidence by investors that these companies, and Chrysler, will ever be able to provide sufficient value to their customers, in sufficient volumes, to merit higher equity valuations.
-The UAW and its major employers, GM, Ford, Chrysler, and their suppliers, hardly represent the larger share of US GDP that they once did, say, as recently as even 20 years ago. It's not a growth industry, and any employee choosing to work for one of these three auto makers, or their suppliers, made a conscious choice to bet their livelihood on no-growth, or shrinking companies with a track record of losing market share and money.
It's simply not true that, as in the 1950s, the US economy is supremely, or even largely, dependent upon the Detroit-based auto makers.
For example, according to this news piece,
"United Auto Workers union membership has fallen below 500,000 for the first time since World War II, reflecting the massive restructuring undertaken by Detroit's automakers.
The union reported Friday in a filing with the Labor Department that it had 464,910 members by the end of 2007, compared with 538,448 at the end of 2006. UAW membership peaked in 1979 at 1.5 million but has been dropping ever since."
That sure doesn't sound like an economy-wrecking number of laborers, if furloughed, does it? It's about four months of recent unemployment, on current trends. And in a Chapter 11 filing, these wouldn't all be laid off.
So, once again, Gettelfinger is lying about the importance of his union, and its major employers, to the US economy.
Where do we draw the line between natural, healthy Schumpeterian dynamics, a/k/a 'creative destruction,' and a 'too big to fail' case requiring the US Treasury and taxpayers to save an entire industrial sector which has, through its own management, failed?
-Gettelfinger is wrong to lay the entire mess of his employers and his own union's exorbitant benefit and wage demands in the lap of the outgoing Bush administration. If this were so urgent, why did the four pigs wait until the last sixy or so days of the current, conservative, Republican administration to beseech Congress for help? To wait so long, present so thin and unconvincing a case, and then blame President Bush for any subsequent damage from a refusal to rescue a group of failing companies, is completely unrealistic and immoral.
-This, sadly, is a fact. It's clear that Gettelfinger's UAW is salivating at the prospect of raiding the Federal Treasury, courtesy of the Illinois rookie, Frisco Nan and Harry Reid, without taking any wage or benefit cuts whatsoever. So desperate are they that Gettelfinger is trying to mau-mau President Bush to cough up the funding in advance. The greed and lack of a sense of reality on the part of the UAW's senior officials is just mind boggling.
It's difficult to catalogue every single one of his mischaracterizations, lies and errors of reasoning. Among them, however, were these:
-Contending that if the US auto makers file for bankruptcy, then any market share losses will be made up exclusively from off-shore, foreign auto producers.
-The beating that equity prices of GM and Ford have taken is merely a 'distraction,' and doesn't reflect some of the better products which at least the former has developed.
-The auto industry is vital to the US economy, and its failure, by virtue of Chapter 11 filings by GM, Ford and/or Chrysler, would plunge us into a severe recession.
-There must be immediate Federal rescue of the auto makers by the Bush administration.
-The UAW is awaiting January 20, 2009, when Gettelfinger indicated that he and his union feel 'real' help will unquestionably arrive in the form of a Democratic President and Congress.
This is pretty scary stuff. As counterpoints, here is what I believe to be more realistic:
-Market share losses of GM, Ford and Chrysler will most probably continue to be filled in by US-based producers owned by foreign car companies. Thus, more US-based jobs and capital investment will follow, though perhaps not on a 1-for-1, dollar-for-dollar basis, as these predominantly southern-based, non-union plants are more efficient than those of Detroit-based auto makers. Gettelfinger completely misrepresented reality, and, in effect, lied, on this point.
-To most Americans, and especially to Americans as investors, the beating that the equity prices of GM and Ford have taken is precisely the point. Not a distraction, but an important, crucial signal in the lack of confidence by investors that these companies, and Chrysler, will ever be able to provide sufficient value to their customers, in sufficient volumes, to merit higher equity valuations.
-The UAW and its major employers, GM, Ford, Chrysler, and their suppliers, hardly represent the larger share of US GDP that they once did, say, as recently as even 20 years ago. It's not a growth industry, and any employee choosing to work for one of these three auto makers, or their suppliers, made a conscious choice to bet their livelihood on no-growth, or shrinking companies with a track record of losing market share and money.
It's simply not true that, as in the 1950s, the US economy is supremely, or even largely, dependent upon the Detroit-based auto makers.
For example, according to this news piece,
"United Auto Workers union membership has fallen below 500,000 for the first time since World War II, reflecting the massive restructuring undertaken by Detroit's automakers.
The union reported Friday in a filing with the Labor Department that it had 464,910 members by the end of 2007, compared with 538,448 at the end of 2006. UAW membership peaked in 1979 at 1.5 million but has been dropping ever since."
That sure doesn't sound like an economy-wrecking number of laborers, if furloughed, does it? It's about four months of recent unemployment, on current trends. And in a Chapter 11 filing, these wouldn't all be laid off.
So, once again, Gettelfinger is lying about the importance of his union, and its major employers, to the US economy.
Where do we draw the line between natural, healthy Schumpeterian dynamics, a/k/a 'creative destruction,' and a 'too big to fail' case requiring the US Treasury and taxpayers to save an entire industrial sector which has, through its own management, failed?
-Gettelfinger is wrong to lay the entire mess of his employers and his own union's exorbitant benefit and wage demands in the lap of the outgoing Bush administration. If this were so urgent, why did the four pigs wait until the last sixy or so days of the current, conservative, Republican administration to beseech Congress for help? To wait so long, present so thin and unconvincing a case, and then blame President Bush for any subsequent damage from a refusal to rescue a group of failing companies, is completely unrealistic and immoral.
-This, sadly, is a fact. It's clear that Gettelfinger's UAW is salivating at the prospect of raiding the Federal Treasury, courtesy of the Illinois rookie, Frisco Nan and Harry Reid, without taking any wage or benefit cuts whatsoever. So desperate are they that Gettelfinger is trying to mau-mau President Bush to cough up the funding in advance. The greed and lack of a sense of reality on the part of the UAW's senior officials is just mind boggling.
What About Those Swaps?
Last week's Wall Street Journal of Wednesday, November 12, sounded an alarm regarding AIG's continuing credit default swaps positions.
However, just this week, a Journal article contended that, of all the malfunctioning fixed-income markets, the CDS market had actually done remarkably well during the past few months, including settling the now-defunct Lehman positions.
According to the editorial, CDS pricing now provides a better, more continuous measure of the value of debt of many firms than their own, non-trading debt does.
Even so, I can't help but believe that the CDS market would do better in the future if two things were changed, as I have suggested in prior posts: create a formal exchange, and; restrict the leverage allowed for entities holding and trading CDS.
The first change would provide greater transparency for many aspects of the CDS market, including gross and net outstanding volumes, trading volumes, and a better identification of the major players who, therefore, are exposed to risk in the market.
The second change would limit the damage to the CDS market and, by extension, to other markets, by assuring the availability of equity for CDS positions which require more collateral, as could be required by the exchange on an intra-day basis.
Together, these improvements would limit the likelihood that another mess like that which consumed AIG could occur. Exchanges monitor the financial ability of members to fulfill their obligations to other members, which would have provided a more public warning regarding AIG's over-extension in CDSs.
I don't doubt the CDS market is vital. But leaving it to exist as an over-the-counter market with no clear rules or standard clearing mechanisms invites another disaster by another firm as inept as AIG was at correctly assessing its risks under the many billions of dollars worth of securities price protection it sold as CDSs.
However, just this week, a Journal article contended that, of all the malfunctioning fixed-income markets, the CDS market had actually done remarkably well during the past few months, including settling the now-defunct Lehman positions.
According to the editorial, CDS pricing now provides a better, more continuous measure of the value of debt of many firms than their own, non-trading debt does.
Even so, I can't help but believe that the CDS market would do better in the future if two things were changed, as I have suggested in prior posts: create a formal exchange, and; restrict the leverage allowed for entities holding and trading CDS.
The first change would provide greater transparency for many aspects of the CDS market, including gross and net outstanding volumes, trading volumes, and a better identification of the major players who, therefore, are exposed to risk in the market.
The second change would limit the damage to the CDS market and, by extension, to other markets, by assuring the availability of equity for CDS positions which require more collateral, as could be required by the exchange on an intra-day basis.
Together, these improvements would limit the likelihood that another mess like that which consumed AIG could occur. Exchanges monitor the financial ability of members to fulfill their obligations to other members, which would have provided a more public warning regarding AIG's over-extension in CDSs.
I don't doubt the CDS market is vital. But leaving it to exist as an over-the-counter market with no clear rules or standard clearing mechanisms invites another disaster by another firm as inept as AIG was at correctly assessing its risks under the many billions of dollars worth of securities price protection it sold as CDSs.
Wednesday, November 19, 2008
Four Pigs At The Trough: Auto CEOs & UAW Chief Beg For Government Rescue
Today, as I worked on various posts and equity/options management activities, I listened and watched the morning's entertainment. By that I mean the appearance of the Four Pigs from Detroit- CEOs Wagoner of GM, Mulally of Ford, Nardelli of Chrysler/Cerebrus, and Gettelfinger of the UAW.
Yes, even UAW chief Ron Gettelfinger has cheerfully pitched in. In a moment of pure deceit, Gettelfinger alleged that, failing a massive, immediate cash infusion by the government into GM, Ford and Chrysler, at least GM would be forced to file a Chapter 7 bankruptcy.
Gettelfinger's wrong. I checked online, and chapter 7 means, in effect, immediate liquidation. Nobody is suggesting that for GM.
Instead, a Chapter 11 reorganization is the logical alternative. Of course, in this scenario, Gettelfinger knows he's going to have to force his UAW members to swallow massive benefit cuts. And Gettelfinger's days as a powerful union boss will be shortened, as perhaps the largest remaining, old-line unionized sector in America takes a giant step closer to oblivion.
Among the more hilarious moments I saw before dashing off to a business meeting were these:
-Rick Wagoner fumbling for about five minutes, with no clear 'elevator pitch' reply to the question,
'Just how much money do you need? When are you going to run out of money now?'
Wagoner failed miserably to provide a clear, concise grasp of his own company's financial situation. If he were applying for a management job at the company he misleads, and provided such a response in a job interview, I'm sure he'd be rejected forthwith.
-A Democratic Congresswoman noting, while unable to pronounce the name of Cerebrus, and being obviously totally unaware of what it is or that it owns Chrysler, that by bailing the auto company out, Congress was essentially providing public financing to a private equity firm partially-owned by two vociferously free-markt Republican former-office holders; John Snow and Dan Quayle.
When Nardelli generously offered that Cerebrus would surrender 'all upside potential' in Chrysler, in exchange for this public bailout, he was tacitly admitting, as my partner agreed, that Cerebrus sees no hope whatsoever for any profit from its Chrysler deal. Thus, it is willing to surrender 100% of nothing, to get a percentage of the requested $25B 'loan.' A loan which only Wagoner, Mulally and Nardelli may actually believe will ever be repaid.
-Various Democratic Congress members reading from obviously-scripted statements provided to them by auto maker staffs, declaring that all sorts of catastrophe will befall the US if these three companies' awful management teams and too-richly-priced union workers are not given money immediately.
-A very articulate Republican Congressman from North Carolina asking why the three ailing, failing auto makers should be given aid, when, as he noted, picture by picture, so many of their cars are made in Canada, Mexico, and Germany. He then noted that the newly-elected President promised to deny tax credits to US companies which export jobs to other countries. How, then, he asked, could the US Congress, at the same time, give $25B to GM, Ford and Chrysler.
-A Congressman asking which, if any, of the testifying CEOs (and, one presumes, Gettelfinger) flew to Washington on commercial flights, would return on commercial flights, and would sell the company fleet of private jets. None volunteered in the affirmative.
Yes, even UAW chief Ron Gettelfinger has cheerfully pitched in. In a moment of pure deceit, Gettelfinger alleged that, failing a massive, immediate cash infusion by the government into GM, Ford and Chrysler, at least GM would be forced to file a Chapter 7 bankruptcy.
Gettelfinger's wrong. I checked online, and chapter 7 means, in effect, immediate liquidation. Nobody is suggesting that for GM.
Instead, a Chapter 11 reorganization is the logical alternative. Of course, in this scenario, Gettelfinger knows he's going to have to force his UAW members to swallow massive benefit cuts. And Gettelfinger's days as a powerful union boss will be shortened, as perhaps the largest remaining, old-line unionized sector in America takes a giant step closer to oblivion.
Among the more hilarious moments I saw before dashing off to a business meeting were these:
-Rick Wagoner fumbling for about five minutes, with no clear 'elevator pitch' reply to the question,
'Just how much money do you need? When are you going to run out of money now?'
Wagoner failed miserably to provide a clear, concise grasp of his own company's financial situation. If he were applying for a management job at the company he misleads, and provided such a response in a job interview, I'm sure he'd be rejected forthwith.
-A Democratic Congresswoman noting, while unable to pronounce the name of Cerebrus, and being obviously totally unaware of what it is or that it owns Chrysler, that by bailing the auto company out, Congress was essentially providing public financing to a private equity firm partially-owned by two vociferously free-markt Republican former-office holders; John Snow and Dan Quayle.
When Nardelli generously offered that Cerebrus would surrender 'all upside potential' in Chrysler, in exchange for this public bailout, he was tacitly admitting, as my partner agreed, that Cerebrus sees no hope whatsoever for any profit from its Chrysler deal. Thus, it is willing to surrender 100% of nothing, to get a percentage of the requested $25B 'loan.' A loan which only Wagoner, Mulally and Nardelli may actually believe will ever be repaid.
-Various Democratic Congress members reading from obviously-scripted statements provided to them by auto maker staffs, declaring that all sorts of catastrophe will befall the US if these three companies' awful management teams and too-richly-priced union workers are not given money immediately.
-A very articulate Republican Congressman from North Carolina asking why the three ailing, failing auto makers should be given aid, when, as he noted, picture by picture, so many of their cars are made in Canada, Mexico, and Germany. He then noted that the newly-elected President promised to deny tax credits to US companies which export jobs to other countries. How, then, he asked, could the US Congress, at the same time, give $25B to GM, Ford and Chrysler.
-A Congressman asking which, if any, of the testifying CEOs (and, one presumes, Gettelfinger) flew to Washington on commercial flights, would return on commercial flights, and would sell the company fleet of private jets. None volunteered in the affirmative.
The Mounting Cry Against A GM Rescue
As time passes and the CEOs of GM, Ford and Cerebrus/Chrysler continue to cry for Federal aid, more and more Americans seem to be raising objections.
For example, the Wall Street Journal's weekend edition had a nearly-full page article entitled, "Just Say No to Detroit."
It was a thorough, reasoned analysis of how GM has destroyed nearly $200B in capital over the past decade.
As David Yermack, the article's author, writes,
"Yet one can only imagine how the $465 billion (the once-Big 3's total value destruction) could have been used better- for instance, GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan and Volkswagen."
There is also a growing awareness on the part of average Americans that rescuing GM is really about propping up the UAW via aiding the auto maker. It's dawning on more non-union workers, which means most Americans, that the UAW workers have unparalleled benefits unavailable to most of us.
For example, yesterday's Journal featured an editorial by Michael Levine, a "former airline executive" and "senior lecturer at NYU School of Law," entitled, "Why Bankruptcy Is the Best Option for GM." My business partner noted that the same day's NY Times gave the front page of its business section to reporter Andrew Ross Sorkin for a similarly-themed piece on GM.
Levine's editorial is noteworthy for highlighting an underestimated area of auto maker troubles- dealership networks. I touched on it in this post from July of last year. Levine notes that only in bankruptcy could GM renegotiate its suffocating state-by-state dealership agreements.
So bankruptcy is about much more than the old view of filing Chapter 11 as closing a business. In fact, only last night, by business partner noted that the retail chain of Dave & Barry's is now in liquidation. I mentioned, 'oh, yes, they filed chapter 11 this summer.' My partner noted, however, that doing that simply allowed them to reorganize. Now, however, they are actually closing.
Thus, with GM, although its management, the UAW, and even, this morning, on CNBC, government representatives such as Bart Stupak of Michigan would have you equate filing for bankruptcy with being closed for business, that's not true at all. He and another government official alleged that, because so many middle class employees would be affected, the entire country must save them. And that Goldman Sach's average compensation/person was too high to be 'middle class,' so they never should have been given any help whatsoever.
It's also extremely disingenuous for Stupak to keep saying,
'This would be a loan, not a bailout. It'll be paid back.'
Yeah. Right. Bart, nobody but Michiganders believes this. And that's why it won't happen.
A GM bankruptcy, with Federal aid in that context, would allow the firm's management, and/or the government, to tear up existing contracts- including those with unions- and renegotiate them. Perhaps sell the profitable parts, or slim down and then sell the whole package to a better-run auto maker.
But if, as my partner noted, the left-leaning NY Times is running prominent pieces against a loan to GM, or any of the Detroit auto makers, you know broad public sentiment is probably going to be against a Federal rescue of GM prior to its filing Chapter 11. Once in bankruptcy, GM could be extended a debtor-in-possession loan by the Federal government, which, according to bankruptcy law, assumes senior position among all other creditors.
No matter how you try to spin the troubles of GM, Ford and Chrysler, they are too late in the game to be helped now. The UAW is crying that their employers are victims of the financial crisis, and deserve TARP money.
No such luck. Nobody believes that. And, anyway, we all see the self-serving argument by Gettelfinger, the UAW's chief, as trying to preserve the union's ultra-lush compensation and benefits packages.
The senior management of the three companies are trying that tack, as well as arguing over gasoline prices, 'green cars,' and anything else to avoid admitting that the same lousy management that brought them to this point is going to be wasting...er.....investing and spending the tens of billions of dollars of "loans" they now insist must come before January.
So, on a final note, let's ask this question.
If GM, Ford and Chrysler so badly misforecast their cash and liquidity positions as to be running out of money in a month, when, only two months ago, they reported that they were good through June of next year, what does that say about the quality of management which we, as taxpayers, are being asked to rescue?
Wouldn't we all be better off if any Detroit auto maker receiving a loan from the Federal government did so only after filing Chapter 11 and firing its senior management team, so a more effective, capable team could be put in charge as receivers?
For example, the Wall Street Journal's weekend edition had a nearly-full page article entitled, "Just Say No to Detroit."
It was a thorough, reasoned analysis of how GM has destroyed nearly $200B in capital over the past decade.
As David Yermack, the article's author, writes,
"Yet one can only imagine how the $465 billion (the once-Big 3's total value destruction) could have been used better- for instance, GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan and Volkswagen."
There is also a growing awareness on the part of average Americans that rescuing GM is really about propping up the UAW via aiding the auto maker. It's dawning on more non-union workers, which means most Americans, that the UAW workers have unparalleled benefits unavailable to most of us.
For example, yesterday's Journal featured an editorial by Michael Levine, a "former airline executive" and "senior lecturer at NYU School of Law," entitled, "Why Bankruptcy Is the Best Option for GM." My business partner noted that the same day's NY Times gave the front page of its business section to reporter Andrew Ross Sorkin for a similarly-themed piece on GM.
Levine's editorial is noteworthy for highlighting an underestimated area of auto maker troubles- dealership networks. I touched on it in this post from July of last year. Levine notes that only in bankruptcy could GM renegotiate its suffocating state-by-state dealership agreements.
So bankruptcy is about much more than the old view of filing Chapter 11 as closing a business. In fact, only last night, by business partner noted that the retail chain of Dave & Barry's is now in liquidation. I mentioned, 'oh, yes, they filed chapter 11 this summer.' My partner noted, however, that doing that simply allowed them to reorganize. Now, however, they are actually closing.
Thus, with GM, although its management, the UAW, and even, this morning, on CNBC, government representatives such as Bart Stupak of Michigan would have you equate filing for bankruptcy with being closed for business, that's not true at all. He and another government official alleged that, because so many middle class employees would be affected, the entire country must save them. And that Goldman Sach's average compensation/person was too high to be 'middle class,' so they never should have been given any help whatsoever.
It's also extremely disingenuous for Stupak to keep saying,
'This would be a loan, not a bailout. It'll be paid back.'
Yeah. Right. Bart, nobody but Michiganders believes this. And that's why it won't happen.
A GM bankruptcy, with Federal aid in that context, would allow the firm's management, and/or the government, to tear up existing contracts- including those with unions- and renegotiate them. Perhaps sell the profitable parts, or slim down and then sell the whole package to a better-run auto maker.
But if, as my partner noted, the left-leaning NY Times is running prominent pieces against a loan to GM, or any of the Detroit auto makers, you know broad public sentiment is probably going to be against a Federal rescue of GM prior to its filing Chapter 11. Once in bankruptcy, GM could be extended a debtor-in-possession loan by the Federal government, which, according to bankruptcy law, assumes senior position among all other creditors.
No matter how you try to spin the troubles of GM, Ford and Chrysler, they are too late in the game to be helped now. The UAW is crying that their employers are victims of the financial crisis, and deserve TARP money.
No such luck. Nobody believes that. And, anyway, we all see the self-serving argument by Gettelfinger, the UAW's chief, as trying to preserve the union's ultra-lush compensation and benefits packages.
The senior management of the three companies are trying that tack, as well as arguing over gasoline prices, 'green cars,' and anything else to avoid admitting that the same lousy management that brought them to this point is going to be wasting...er.....investing and spending the tens of billions of dollars of "loans" they now insist must come before January.
So, on a final note, let's ask this question.
If GM, Ford and Chrysler so badly misforecast their cash and liquidity positions as to be running out of money in a month, when, only two months ago, they reported that they were good through June of next year, what does that say about the quality of management which we, as taxpayers, are being asked to rescue?
Wouldn't we all be better off if any Detroit auto maker receiving a loan from the Federal government did so only after filing Chapter 11 and firing its senior management team, so a more effective, capable team could be put in charge as receivers?
Tuesday, November 18, 2008
Retail Woes Foretell The Recession
Beginning with its November 7 edition, the Wall Street Journal has published a number of articles describing the evolving and steadily increasing weakness in US retailers.
A closer look at the chart, however, and another Journal article, spell more trouble. Yesterday's edition reported on "sharp earnings declines" at Penney's and A&F, as well as "forecasts that fell shy of Wall Street expectations."
The November 7 Journal headline article, "Global Push to Beat Economic Downturn," was accompanied by a picture of an unemployment line in Spain.
In that edition's Marketplace section, the lead piece was entitled, "Retailers Wallow and See Only More Gloom."
The lead in the article stated,
"U.S. retailers reported the worst monthly sales decline in more than three decades, prompting them to resort to steeper discounts and earlier promotions as they try to salvage the coming holiday season.
Sales by department stores and upscale retailers slid 11.7% overall from a year ago, led by a 17% decline at Saks Inc., while J.C. Penney Co's sales fell 13% and Kohl's Corp.'s slid 9%. All three said customers just weren't walking in the door.
Upscale retailer Neiman Marcus said its same-store sales fell a staggering 28% while catalogue and Internet purchases plummeted 23% compared to a year ago.
Once again, the exception to the dire data was Wal-Mart Stores Inc., whose reputation for lower prices has siphoned off shoppers from other retailers. Wal-Mart's sales at stores open at least a year rose 2.4%, well above its prediction of a 1% to 2% gain.
Retailers has been braced for a slow holiday season, and most thought they had planned for the worst by paring back inventories. But since September, sales slowed far more than expected. Retailers now have pinned their hopes on heavy discounting."
The piece goes on to cite more gloomy statistics and provide background anecdotes and details which reinforce that there is now a serious cutback by US consumers in spending on clothing, appliances, and the general assortment of goods at the nation's larger retail chains.
Many conclusions may be drawn regarding the US economy's imminent performance, and that of financial markets, based upon these numbers and comments.
First, ironically, Wal-Mart's senior management may actually be better off due to the failure of its failed strategy to move upmarket several years ago. More on that can be found among the "Wal-Mart" labeled posts on this blog. Suffice to say, Wal-Mart's experience demonstrates why companies move in and out of periods of long term, consistently-superior total return performance.
The nearby, Yahoo-sourced price chart for the past year for Kohl's, Wal-Mart, Penney's, Sears, Target and Abercrombie & Fitch, and the S&P500 Index, for comparison, clearly indicates how Wal-Mart has sailed through the current economic difficulties almost unaffected.
The nearby, Yahoo-sourced price chart for the past year for Kohl's, Wal-Mart, Penney's, Sears, Target and Abercrombie & Fitch, and the S&P500 Index, for comparison, clearly indicates how Wal-Mart has sailed through the current economic difficulties almost unaffected.By contrast, three of the retailers included in the chart fall below the S&P500 curve for the past year, with Kohls and Target basically holding even with the index.
This can briefly be interpreted as Wal-Mart's being well-positioned, despite any actual strategic designs the chain may have, whereas Kolhs and Target tend to continually be among the best-managed of retailers.
A closer look at the chart, however, and another Journal article, spell more trouble. Yesterday's edition reported on "sharp earnings declines" at Penney's and A&F, as well as "forecasts that fell shy of Wall Street expectations."
Penney's profit fell 52% quarter-on-year-ago-quarter, with sales down 10% at stores open at least a year.
A&F's profit declined 46%, with a 14% same-store sales decline.
To me, the key phrase 'Wall Street expectations,' signals that analysts and, probably, investors, are not really paying attention to current consumer behavior, and the degree to which it will affect both coming economic growth, and equity market valuations.
Due to the cascading economic effect of last summer's mark-to-market-based financial services crisis, consumers have now begun to lose jobs, home equity wealth, and confidence in the next few years of US economic health.
The retailers, being on the front line of everyday consumer spending that is not necessary, e.g., food, are seeing plummeting sales, traffic, and equity valuations. And the latter is probably not low enough, yet.
Wal-Mart's position as one of the nation's larger food chains has providentially insulated it from the sole vagaries of discretionary consumer spending in this unfolding weak economy.
In retrospect, Brian Wesbury (see labeled posts) has been correct to refrain from calling the US economy 'in recession' as recently as this summer. However, I have little doubt that in January, or perhaps late next month, he will write a Journal editorial confirming that, as of December, the entire country is in a recession.
As my friend B wrote me last year, pertaining to the Democratic presidential candidate's constant drumbeat of assertions that we were in an economic situation that was 'the worst since the Great Depression,' accompanied by countless pundits and media personages, most of whom are not economists, sagely assuring one and all that the US was in a recession as of mid-2007,
'If enough people keep saying we are in a recession, then we'll soon have one.'
Touche, B. That's exactly what happened. Consumer confidence is a fragile thing. Take a financial sector beset by a stupid, narrowly-defined valuation principle, add the subsequent evaporation of several hundred billion dollars of equity value, follow that with consequent declines in lending, job losses, and falling home and personal equity portfolio values, and you will create a recession.
I suspect the retailers' equity price trends are going to continue for at least a few more months. The news and data are there for everyone to see. Retail is clearly weakening, consumer sentiment is not good, and spending is simply going to decline, with discretionary purchasing becoming increasingly hard to stimulate.
That's why, among other reasons, my partner and I continue to expect a declining S&P500 for several more months. The consumer behavior measures tell us that real economic weakness is just beginning, and will probably cause unexpected equity valuation declines.
Couple this with a change in federal administration from a market-based approach to governmental intrusion to a political/fiat-based one, and you have a recipe for a milder and, hopefully, shorter rerun of FDR's lost decade of the 1930s, marked by inept and ineffectual governmental interference in economic and capital markets.
Good News At Yahoo- Yang Resigns!
In June of 2007, I wrote this post concerning Terry Semel's departure as Yahoo CEO. At the time, co-founder Jerry Yang assumed Semel's post. I wrote, in that post,
"To me, however, the most likely epitaph for Yahoo is that it remained the used car of the online world for too long, wasting its early, premier position in so many nascent areas. Now, I believe Schumpeterian dynamics have overtaken it, rendering it a largely has-been collection of concepts, technologies and online information offerings. If they haven't managed to collect revenues for most of this by now, thus setting expectations of free services, what makes you think someone else can do better without losing visitors, resulting in continued problems achieving profitable growth and, with it, consistently superior total returns?"
The nearby, two-year price chart of Yahoo's equity, compared with the S&P500 Index for the same timeframe, illustrates how destructive Yang's temporary reign has been for the firm's shareholders.The two curves are basically on top of one another at the point at which Yang succeeded Semel.
As inept and ineffective as Semel had been, Yang was no picnic. From that point in June of 2007, the S&P declined about 40%, since the curves were both slightly positive at the point of Yang's accession.
In that same time period, Yang managed to drive Yahoo's price down about 60%, or an additional 50% greater loss than that of the S&P.
Reading this morning's Wall Street Journal, I was somewhat shocked that the board has only just retained a search firm to replace Yang. And that the value-destroying co-founder isn't actually out the door yet. He won't leave until a replacement is found.
Oh my. Poor shareholders.
What if nobody wants the job?
In this era, it is no longer proper etiquette to parachute into a firm as CEO, sell or dismember it within a year, and then grab a huge payout and ride off into the sunset. And Susan Decker has now been at Yahoo long enough to be part of the problem, not the solution.
As my earlier posts about Yahoo, one of which is linked to the already-linked post mentioned above, noted, the company's basic business concept is now bankrupt. There is no real value left to manage and grow.
If the board were really smart, they'd send Jerry Yang packing right now, have Carl Icahn call Steve Ballmer, and just sell the whole mess.
Shareholders would get something, and no longer risk getting even less as the aging technology-based online firm slowly sinks into irrelevance.
Once a replacement is found, though, s/he will take time to 'add value' by assessing the situation, and more time- and value- will be irreparably be lost.
This may just be a golden opportunity for Yahoo to escape with what little value remains, intact.
Monday, November 17, 2008
Citigroup's Pandit Tries Again
This morning's news was full of stories concerning Citigroup Pandit's 'townhall' meeting and his announcement that the firm is cutting some 25,000 positions, in addition to plans to sell some small units, and previously-announced cuts, all totaling 50,000.
The nearby, Yahoo-sourced chart of the prices of Citigroup's equity and the S&P500 Index for the past five days indicates Pandit's latest attempt to mollify investors didn't work, either.
As a Wall Street Journal Online piece reported this afternoon,
Still, Mr. Pandit cautioned that tough times may lie ahead. "There is still a lot of rebalancing ahead of us," he said. In a memo distributed to employees after the town hall, he noted that "the coming year could be a difficult one for our clients and customers."
About 15,000 Citigroup employees either attended or tuned in for the town hall, which was closed to investors, analysts and reporters. Some had lukewarm reactions.
Since becoming CEO, Mr. Pandit, a former finance professor, has frustrated some executives and directors with his academic style. Some employees said Monday's presentation fit that mold, dwelling on financial issues without doing much to pep up Citigroup's dispirited troops."
Pandit clearly has no clear grasp on the severity of Citigroup's problems. He's been in the job nearly a year, yet look at the firm's performance, as seen in the third Yahoo-sourced chart.
The nearby, Yahoo-sourced chart of the prices of Citigroup's equity and the S&P500 Index for the past five days indicates Pandit's latest attempt to mollify investors didn't work, either.While the S&P declined by about 5% in the past five trading days, Citi sank by 20%.
Today alone, as the second chart, below, illustrates, Citigroup's stock price fell by more than 5%, while the Index fell roughly 2.6%.
Various pundits opined that Pandit continues to resist calls to breakup Citigroup's non-performing, dysfunctional business collection. Bob Rubin's head has also been called for.
Even Pandit was rumored to be at risk as the board argues over what to do about Citigroup's dire straits.
As a Wall Street Journal Online piece reported this afternoon,""We have spent the last year getting fit, are more streamlined, and are in a strong competitive position to take advantage of future opportunities," Mr. Pandit said, according to his prepared remarks. "We will be the long-term winner in this industry."
Still, Mr. Pandit cautioned that tough times may lie ahead. "There is still a lot of rebalancing ahead of us," he said. In a memo distributed to employees after the town hall, he noted that "the coming year could be a difficult one for our clients and customers."
About 15,000 Citigroup employees either attended or tuned in for the town hall, which was closed to investors, analysts and reporters. Some had lukewarm reactions.
Since becoming CEO, Mr. Pandit, a former finance professor, has frustrated some executives and directors with his academic style. Some employees said Monday's presentation fit that mold, dwelling on financial issues without doing much to pep up Citigroup's dispirited troops."
Pandit clearly has no clear grasp on the severity of Citigroup's problems. He's been in the job nearly a year, yet look at the firm's performance, as seen in the third Yahoo-sourced chart.Citigroup has declined by about 70%, while the S&P has lost a relatively modest, by comparison, 40% over the past twelve months.
Yet Pandit has offered nothing in the way of strategic change at Citigroup. It's entirely possible that, like Rick Wagoner's GM, Pandit's Citigroup won't make it long enough to see those 'future opportunities.'
Perhaps the real problem at Citigroup is so much overhead to stitch together businesses which have little in common, and, for the most part, simply have over-capacity in this new, credit-constrained environment.
Why Mortgage Forgiveness Is Just Loan Loss Recognition In Disguise
As the months have gone by since various politicians, beginning with Hillary Clinton, began calling for either a moratorium on foreclosures and/or interest rate adjustments and forgiveness on some aspects of troubled mortgages, I have given a lot of thought to these suggestions.
Initially, I thought the suggestions of mortgage rate reductions and/or balance adjustments for a period of time, or permanently, to be an unwise intrusion of governmental regulation, a la a 'taking.'
Recently, however, several large banks, including Chase, have unilaterally begun to take these steps. By reducing rates and/or modifying the mortgage loan balances at points in time, these lenders are basically recognizing loan losses in a non-traditional manner.
Rather than classify some mortgages as either defaulted or delinquent, the banks are taking a smaller haircut on a larger base of home loans. Either way, the financial consequence is to reduce the effective rate of interest which accrues as revenue, and potentially write down some loan values.
Last week, my business partner and I were discussing this phenomenon. As we thought about what we, if we owned a bank, would do with a delinquent or defaulted mortgage borrower, it became obvious that foreclosures aren't a good idea in this environment, irrespective of governmental pressure.
With most real estate prices having declined in the past year, and credit availability much worse than it was even three months ago, a foreclosed home has virtually no chance of being purchased at a price that will preclude a significant loss for the mortgage lender.
Instead, if the borrower is still employed and able to pay something, it would behoove a bank to simply treat him/her as either: a temporary renter, with the loan conditions to be reinstated in the near future, making the mortgage loan currently delinquent, or; modify the loan's conditions to equate the borrower's ability to pay with a new interest rate and/or balance, or some combination of the two, and record a loss while the (newly modified) loan remains current and performing, or; modify the loan's conditions to be a combination of the first two, both temporarily suspending the loan payments, then returning to a modified mortgage payment and terms in the near future.
All three options provide some cash flow for the bank, and the ability to avoid foreclosure, evictions, and an overall worsening of the probabilities that the lender can recover looming losses.
Because of the gradual spread of what began as a largely technical issue of requiring securities held by banks, backed by mortgages to be marked to market (rather than allowed to be valued based on their economic potential while partially or wholly performing), eventually, to engulf the entire banking sector in hundreds of billions of dollars of writedowns, resulting in a credit contraction, the environment in which troubled mortgages now exist is much worse than it was last year.
The credit contraction has, of course, affected business volumes, economic growth, and job losses. Thus, by late 2008, the unforeseen consequences of Congress' narrow-minded insistence, in Sarbanes-Oxley, on 'mark-to-market' valuation turned what was initially an accounting matter into a a policy choice which has amplified accounting valuations to the point where they have reached out and damaged the entire US economy.
A year ago, the failure of a couple of Bear Stearns mutual funds, due to this dry accounting issue, seemed manageable. But in time, as investors understandably began to recoil from any structured finance instrument potentially containing recent, riskier mortgages, mark-to-market rules caused a chain reaction which has resulted in a real credit and economic contraction that is many times worse than it otherwise might have been.
In this new environment of fallen home values, few new mortgage loans, and rising joblessness, banks really have no choice but to work out non-performing home loans, rather than simply begin foreclosing on every defaulted loan and displacing residents, to no better effect for the bank, the residents, or society in general.
Initially, I thought the suggestions of mortgage rate reductions and/or balance adjustments for a period of time, or permanently, to be an unwise intrusion of governmental regulation, a la a 'taking.'
Recently, however, several large banks, including Chase, have unilaterally begun to take these steps. By reducing rates and/or modifying the mortgage loan balances at points in time, these lenders are basically recognizing loan losses in a non-traditional manner.
Rather than classify some mortgages as either defaulted or delinquent, the banks are taking a smaller haircut on a larger base of home loans. Either way, the financial consequence is to reduce the effective rate of interest which accrues as revenue, and potentially write down some loan values.
Last week, my business partner and I were discussing this phenomenon. As we thought about what we, if we owned a bank, would do with a delinquent or defaulted mortgage borrower, it became obvious that foreclosures aren't a good idea in this environment, irrespective of governmental pressure.
With most real estate prices having declined in the past year, and credit availability much worse than it was even three months ago, a foreclosed home has virtually no chance of being purchased at a price that will preclude a significant loss for the mortgage lender.
Instead, if the borrower is still employed and able to pay something, it would behoove a bank to simply treat him/her as either: a temporary renter, with the loan conditions to be reinstated in the near future, making the mortgage loan currently delinquent, or; modify the loan's conditions to equate the borrower's ability to pay with a new interest rate and/or balance, or some combination of the two, and record a loss while the (newly modified) loan remains current and performing, or; modify the loan's conditions to be a combination of the first two, both temporarily suspending the loan payments, then returning to a modified mortgage payment and terms in the near future.
All three options provide some cash flow for the bank, and the ability to avoid foreclosure, evictions, and an overall worsening of the probabilities that the lender can recover looming losses.
Because of the gradual spread of what began as a largely technical issue of requiring securities held by banks, backed by mortgages to be marked to market (rather than allowed to be valued based on their economic potential while partially or wholly performing), eventually, to engulf the entire banking sector in hundreds of billions of dollars of writedowns, resulting in a credit contraction, the environment in which troubled mortgages now exist is much worse than it was last year.
The credit contraction has, of course, affected business volumes, economic growth, and job losses. Thus, by late 2008, the unforeseen consequences of Congress' narrow-minded insistence, in Sarbanes-Oxley, on 'mark-to-market' valuation turned what was initially an accounting matter into a a policy choice which has amplified accounting valuations to the point where they have reached out and damaged the entire US economy.
A year ago, the failure of a couple of Bear Stearns mutual funds, due to this dry accounting issue, seemed manageable. But in time, as investors understandably began to recoil from any structured finance instrument potentially containing recent, riskier mortgages, mark-to-market rules caused a chain reaction which has resulted in a real credit and economic contraction that is many times worse than it otherwise might have been.
In this new environment of fallen home values, few new mortgage loans, and rising joblessness, banks really have no choice but to work out non-performing home loans, rather than simply begin foreclosing on every defaulted loan and displacing residents, to no better effect for the bank, the residents, or society in general.
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