Tuesday, October 28, 2008

Automakers Ready Their Begging Bowls

General Motors has asked the U.S. Treasury to provide financial help for its prospective merger with Chrysler. But rather than use taxpayer money to facilitate this merger, the government should be forbidding it. U.S. automakers are not viable businesses, and if they are to survive at all, they should get smaller, not larger.

Congress recently passed legislation providing for a bailout of the U.S. auto industry, but this law should be repealed and the automakers should be told clearly that no federal aid is forthcoming.

There was a time when automakers represented the strength of U.S. manufacturing, but that time is long past. They have failed to adapt to changing market conditions, and should not be preserved for the sake of nostalgia.

In the last 42 months GM has lost $69.74 billion and Ford has lost $22.46 billion. If they can turn things around, I’ll root for them but U.S. taxpayers should not be forced to make that bet. If they cannot save themselves, bankruptcy should take its course.

There is value in the automakers. There are factories, technology, machinery, workers and more. However, that value is not being put to its most productive use. It may be that these productive inputs could be reorganized into several competing automakers. If we allow them to fail, entrepeneurs will do the work needed to pick through the pieces and create value for consumers.

It may also be that the U.S. is simply not suited to make automobiles anymore. That, in itself, is not a bad thing. If we produce those things for which we are suited, we will benefit from trading with those countries that produces autos at lower cost.

If the industry goes under it will take a large chunk of jobs with it, and this is certainly a negative consequence, but the cost of avoiding this job loss exceeds the benefit. The industry clearly cannot afford to pay its labor costs from sales revenue, meaning that money must be diverted from profitable pursuits to keep these people employed.

Jobs are lost every day, and those people find employment elsewhere. This process is important because it is the means by which our society reallocates resources to produce the things that people actually want to consume. There is nothing special about auto industry jobs; they warrant no artificial preservation.

Sunday, October 26, 2008

Which Headline is Worst?

G7 Warns Yen Moves Excessive; Nakagawa Says Japan Ready to Act on Currency

General Motors Said to Ask U.S. Treasury for Aid in Chrysler Merger Talks

Syria Says U.S. Helicopter Attack on Village Near Iraqi Border Kills Eight

Ukraine Gets $16.5 Billion Loan From IMF; Hungary Next in Line

These are 4 of the 9 headlines currently posted on Bloomberg. They are all bad; each, in itself, is enough bad news for a week.
I would like to offer that Japan acting to contain Yen advances is the biggest problem. World governments' interventions have turned a problem into a catastrophe, and will continue to make matters worse.

Look, as well, for Ford and GM to be the next Fannie Mae / Freddie Mac. Why can't we let them die in peace?

Thursday, October 23, 2008

Greenspan Speaks. Why Do People Listen?

Alan Greenspan will tell the House Oversight Committee that "those of us who have looked to the self-interest of lending institutions to protect shareholder's equity (myself especially) are in a state of shocked disbelief."

There are many of us who are not in such a state; in fact, there is no shortage of people who saw this coming. Why then, is anyone listening to this bozo?

As long as those who hold power in this country continue to take advice from the people who got us into this mess, we will not recover. Period.

Monday, October 6, 2008

Why The Free Market Works: Part 1 of Many

One widely unappreciated aspect of true free market capitalism is the limited liability of failures. When a business fails and goes bankrupt, it is not only the owners' liability that is limited, but also society's. We don't have a bankruptcy system to keep individual's from ruining themselves; we have it to keep them from inflicting too much damage on the rest of the economy. If we give someone an infinite credit line, then in theory, that one person can take everything down.

I keep saying this, but I'm more certain every day that it's true: These guys are creating the very problems they claim to be solving.

Reserve ratio thoughts:

A bank's reserve ratio is the percentage of total demand deposits that the bank is capable of paying out now. Basically, reserves are cash in the vault plus some electronic entries at the Federal Reserve which, in theory, could be immediately delivered as cash. The rest of deposits are lent to customers and cannot be accessed by the bank. The Federal Reserve sets the minimum reserve ratio allowed.

The discount rate is the rate at which member banks can borrow from the Federal Reserve.

The federal funds rate is the rate at which banks borrow (overnight) from each other. This rate floats, but the Federal Reserve intervenes in the market, by buying or selling U.S. Treasury securities, to keep it close to a target. When reporters speak of the Fed lowering or raising rates, it is this that they refer to.

A bank executive in the current financial crisis is likely to do one of two things:

1) If the bank is in bad shape, he is going to be risky in a way that doesn't appear too reckless, lobby for federal help, and try to keep the party rolling a few more quarters to squeeze out a few more paychecks. Maybe get lucky in the process and pull the bank out of failure. There is little cost to reckless lending for a bank on the brink of failure.

2) If the bank is in good shape, he tries to ride out the storm, tighten up lending standards (but lend freely to people with secure jobs, really good credit history, etc.), try to increase the deposit base, look for really cheap acquisitions a year or two down the road.

It seems to me that keeping a low discount rate / Fed Funds rate encourages both of these, but reducing the reserve ratio only encourages the first, as the second type is likely to keep increased reserves as a matter of internal policy. This, I believe, is why the actual fed funds rate has been below 2% (the current target) for the past two weeks.

Maybe if we do see Bernanke reduce the reserve ratio, it will signal the end, that he has given up and decided to throw the Hail Mary.

Friday, October 3, 2008

Markets Say Bailout is Bad?

On Sept. 30 Bloomberg reported :

Senate Republican leader Mitch McConnell of Kentucky predicted lawmakers would wrap up work on the plan by the end of this week. A plunge in U.S. markets, partially erased today, makes it clear Congress must act, he said.

``I think the message from the markets yesterday was clear,'' McConnell said.

The "message" from the markets was that the Dow Jones Industrial Average settled that day at 10,365.45 and the S&P 500 settled at 1106.42. We are to believe that the stock market declines were due to Congressional inaction on the bailout. Christopher Dodd pointed out that many House members were having "second thoughts" after seeing the market reaction.

The media weighed in, of course. Most egregiously, David Callaway, editor-in-chief of MarketWatch.com wrote about "How rejecting a $700 billion plan cost us $1 trillion." He tells us that "Congress imperils the investments, deposits, money markets and life savings of millions of Americans, to say nothing of people around the world."

One problem: Now that the Congress has acted the Dow sits at 10,325.38 and the S&P 500 is at 1099.23.

Are our members of Congress really making decisions based on the swings of stock markets? By this logic the bailout is 40 Dow points worse than no bailout, and they should re-convene to repeal the law.

What David Callaway (editor-in-chief of MarketWatch.com, How does this happen?) fails to understand is that there is no real wealth in the stock market. Stocks represent a claim on future payment of dividends. Because those payments are in the future, they are uncertain. Stock market buyers and sellers try to evaluate how much will be paid and so sellers are willing to trade money (which can buy things today) for these future claims. The stock market stores consumption for later.

Furthermore, the stock market is not the only place where future consumption can be stored. One other example is the national debt, which is actually negative future consumption since portions of future earnings of American taxpayers must be used to pay principal and interest on the debt instead of buying goods and services.

The argument can be made that the bailout increases future earnings because it improves the cash position of (a small number of very specific) listed companies. This is true, but it also adds to the national debt in the same amount.

There are also other indirect effects. That is, the bailout diverts $700 billion from productive pursuits to compensate some of those who made bad decisions in the past. This in turn makes future bad decisions more likely as people do not see the full cost of their mistakes. It also means that people with good ideas, or who want to expand existing successful business models, will find it harder to borrow money. All this adds up to an exacerbated recession.

The stock market will fall much further. Neither I nor anyone else will ever be able to say exactly how much of that fall results from the bailout and how much is due to other factors.

Nancy Pelosi: "Will it work? We'll see."

Congress passed the Paul Wellstone Mental Health and Addiction Equity Act of 2007 (also known as the Emergency Economic Stabilization Act of 2008), a bill designed to benefit the 74 senators and 263 representatives who have lost their minds.

McDermott voted no. Life At The Margin takes little solace.

Thursday, October 2, 2008

Bailout Goes Through, No Congress Needed

From the FDIC press release (September 28,2008):

"The FDIC has entered into a loss sharing arrangement on a pre-identified pool of loans. Under the agreement, Citigroup Inc. will absorb up to $42 billion of losses on a $312 billion pool of loans. The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk."

Also from the press release:

"Congress created the Federal Deposit Insurance Corporation in 1933 to restore public confidence in the nation's banking system. The FDIC insures deposits at the nation's 8,451 banks and savings associations and it promotes the safety and soundness of these institutions by identifying, monitoring and addressing risks to which they are exposed. The FDIC receives no federal tax dollars – insured financial institutions fund its operations."

I'd like to know more about that pool of loans. This is an additional exposure of the Federal government to $270 billion in losses. If these were the worst assets Wachovia owned, a high percentage of this exposure may be realized. Remember, these guys invented the pick-a-payment loan.

This is not a case of a strong bank taking over a weak bank. This is a weak bank taking over a really weak bank. That $12 billion in preferred stock and warrants is likely to be worth zero in the end.

How long before the FDIC can no longer write "The FDIC receives no federal tax dollars – insured financial institutions fund its operations?"

What Credit Crunch?

"Right now, we can refinance up to 97% of the value of your home, with zero out-of-pocket expenses." -Paramount Equity radio commercial

"We're confident you'll find the perfect low rate at TILA mortgage" -TILA Mortgage radio commercial

My Letter to Jim McDermott

Dear Representative McDermott,

Your trust is misplaced. I urge you to reconsider your vote concerning the use of taxpayer money to buy distressed financial assets.

In your statement of Sept. 29, you wrote: “I voted in favor of H.R. 3997 because I know with certainty that House Speaker Nancy Pelosi and Financial Services Committee Chairman Rep. Barney Frank put the American people first and negotiated a bill that would have taken a first step in restoring the faith and trust of the American people. Doing nothing sends a terrible signal.”

But Rep. Frank and Speaker Pelosi have not put the interests of the American people first. Instead they are complicit in outright theft from the people. The bill gives one man, Henry Paulson, essentially unchecked power to allocate money from the public Treasury as he sees fit. Although there are rhetorical statements in the bill which purport to provide for oversight, the bill does in 110 pages what Paulson’s original proposal did in two.

Furthermore, the bill does nothing to solve the economic troubles we face; it makes them worse. It necessarily diverts at least $700 billion dollars from productive pursuits to failed investments from the past. Paulson’s rhetoric that buying bad assets will free up capital is a distortion. In fact this action restricts capital. We are in a recession. Our economy needs that $700 billion to aid the recovery.

Yet another problem is the likely irreversible nature of this action. The banking sector is set to lose far more than $700 billion. I am certain that a few months down the road, Paulson will want to throw more money at the problem. At that point it will be difficult for Congress to reverse course. In fact, it is perplexing that Congress would consider any plan that this man proposes given that he has been consistently wrong about everything since taking office. To point out just one example, it has now been 14 days since Henry Paulson told us the world would end in a couple of days without action.

The specter of this bill has already caused great damage, as many capable financial professionals have moved to position themselves to benefit from the new law, rather than putting effort into providing solutions. The most obvious case is that of Warren Buffett’s purchase of a large stake in Goldman Sachs.

The financial industry, and American society as a whole, has made a great deal of bad investments which must be flushed out of the system. This process will take work and sacrifice. There is no easy solution. You say that doing nothing sends a terrible signal, but doing something bad is much worse. The Bush Administration has used threats and unjustified predictions of impending doom to foment fear in the American people, and the Congress is panicking and rushing to “do something.”

Don’t “do something.” Do the right thing. Vote no.

Wednesday, October 1, 2008

U.S. Fiscal Deficit is 1,017,071,524,649.92, Total Debt is 10,024,724,896,912.40

That's more than one trillion dollars of taxpayer liability added in the past 12 months. This does not include the bank handout currently under consideration or future Congressional action on the so-called "financial crisis." It does not include the potential liabilities of the FDIC which the U.S. Treasury may be forced to pay on very soon. Don't be surprised if next year's fiscal deficit exceeds 2 trillion dollars. Will the world really lend us this much money? Can the U.S. dollar survive this onslaught?