Tuesday, December 30, 2008

retail bankruptcies

On November 23rd, I wrote:
This is my big worry right now. The US is “over retailed” (i.e., we have far more retail sales capacity than we do sustainable demand). That suggests a lot of retailers will be going out of business. Right now, a lot of them are barely hanging on hoping that a decent fourth quarter (holiday sales) will save them. To do that, they are slowing or stopping altogether payment to suppliers. But as the chart above shows, we know the fourth quarter is going to be disastrous. That will drive a lot of retailers under. And because their suppliers, too, have been barely hanging on and have been strung out by their customers, a lot of them will also go out of business. And no one is going to be getting a line of credit to save them – the credit markets have dried up. In other words, this is more likely the beginning of the bad news, not the end of it.

From yesterday’s
New York Times:

A rash of retailing bankruptcies is expected in the new year, but as the clock winds down on one of the weakest holiday shopping seasons in decades, the fallout has already begun. …

Challenging is hardly the word. This year, retailers including Circuit City, Boscov’s, Sharper Image, Mervyns, Linens ’n Things, Whitehall Jewelers and Steve & Barry’s filed for bankruptcy protection.

And that is very likely the tip of the iceberg. After studying more than 180 companies, AlixPartners, a restructuring firm, estimates that over the next 24 months there will be a fourfold increase in the number of retailers in deep distress — companies that do not have enough working capital or are unable to finance their debt. …

Retailers had one of the worst holiday shopping seasons in decades, with sales falling by double digits in nearly all categories, including apparel, luxury goods, furniture and electronics and appliances, according to SpendingPulse, a report by MasterCard Advisors that estimates retail sales from all forms of payment, including checks and
cash. …

From Bloomberg:

U.S. retailers face a wave of store closings, bankruptcies and takeovers starting next month as holiday sales are shaping up to be the worst in 40 years.

Retailers may close 73,000 stores in the first half of 2009, according to the International Council of Shopping Centers [ICSC]. Talbots Inc. and Sears Holdings Corp. are among chains shuttering underperforming locations.

… Investors will start seeing a wide variety of chains seeking bankruptcy protection in February when they file financial reports, said Burt Flickinger.

“You’ll see department stores, specialty stores, discount stores, grocery stores, drugstores, major chains either multi- regionally or nationally go out,” Flickinger, managing director of Strategic Resource Group, a retail-industry consulting firm in New York, said today in a Bloomberg Radio interview. “There are a number that are real causes for concern.” …

The ICSC predicts, using U.S. Bureau of Labor Statistics data, that 148,000 stores will shut down in 2008. … The total number of retail establishments will decline by
about 3 percent this year, also taking into account locations that were opened, [said ICSC Chief Economist Michael Niemira]. The U.S. had 1.11 million retail locations in 2002.

Another 73,000 locations may shut their doors in the first part of 2009, Niemira said. …

Things are going to be bleak in 2009. Don’t expect any good news for a while – things are going to get a lot worse before they get better.

This is from NYU economist Nouriel Roubini:
So what lies ahead in 2009? Is the worst behind us or ahead of us? To answer these questions, we must understand that a vicious circle of economic contraction and worsening financial conditions is underway.

The United States will certainly experience its worst recession in decades, a deep
and protracted contraction lasting about 24 months through the end of 2009.
Moreover, the entire global economy will contract. There will be recession in the euro zone, the United Kingdom, Continental Europe, Canada, Japan, and the other advanced economies. There is also a risk of a hard landing for emerging-market economies, as trade, financial, and currency links transmit real and financial shocks to them. …

Today's global crisis was triggered by the collapse of the US housing bubble, but it was not caused by it. America's credit excesses were in residential mortgages, commercial mortgages, credit cards, auto loans, and student loans. There was also excess in the securitized products that converted these debts into toxic financial derivatives; in borrowing by local governments; in financing for leveraged buyouts that should never have occurred; in corporate bonds that will now suffer massive losses in a surge of defaults; in the dangerous and unregulated credit default swap market.

Moreover, these pathologies were not confined to the US. There were housing bubbles in many other countries, fueled by excessive cheap lending that did not reflect underlying risks. There was also a commodity bubble and a private equity and hedge funds bubble. Indeed, we now see the demise of the shadow banking system, the complex of non-bank financial institutions that looked like banks as they
borrowed short term and in liquid ways, leveraged a lot, and invested in longer
term and illiquid ways.

As a result, the biggest asset and credit bubble in human history is now going bust, with overall credit losses likely to be close to a staggering $2 trillion. Thus, unless governments rapidly recapitalize financial institutions, the credit crunch will become even more severe as losses mount faster than recapitalization and banks are forced to contract credit and lending.

Equity prices and other risky assets have fallen sharply from their peaks of late 2007, but there are still significant downside risks. An emerging consensus suggests that the prices of many risky assets - including equities - have fallen so much that we are at the bottom and a rapid recovery will occur.

But the worst is still ahead of us. In the next few months, the macroeconomic news and earnings/profits reports from around the world will be much worse than expected, putting further downward pressure on prices of risky assets, because equity analysts are still deluding themselves that the economic contraction will be mild and short.

While the risk of a total systemic financial meltdown has been reduced by the actions of the G-7 and other economies to backstop their financial systems, severe vulnerabilities remain. The credit crunch will get worse; deleveraging will continue, as hedge funds and other leveraged players are forced to sell assets into illiquid and distressed markets, thus causing more price falls and driving more insolvent financial institutions out of business. A few emerging-market economies will certainly enter a full-blown financial crisis.

So 2009 will be a painful year of global recession and further financial stresses, losses, and bankruptcies. Only aggressive, coordinated, and effective policy actions by advanced and emerging-market countries can ensure that the global economy recovers in 2010, rather than entering a more protracted period of economic stagnation.

Happy New Year!

Sunday, December 28, 2008

quote of the day

And for the best recent quote:

A CNN poll earlier this month found that 79% of the American people approve of the job President-elect Obama is doing so far.
"An Obama job approval rating of 79 percent -- that's the sort of rating you see when the public rallies around a leader after a national disaster," said Bill Schneider, CNN's senior political analyst. "To many Americans, the Bush administration was a national disaster."

christmas 2008

christmas in babylon

Over time, I’ve ended up on a few right-wing email distribution lists. (Someone forwards one of my emails to her right-wing brother-in-law and, next thing you know, I’m on his list for life.) If you aren’t lucky enough to share this particular pleasure, it really is amazing the stuff that a lot of Americans are sending to each other. (It’s like they’ve never discovered Snopes.) Their world is a scary place, defended only by angry white American men. This is the 24% that still thinks Bush is doing a great job. (And they really DO!! Makes you wonder what metrics they’re using.)

Anyhow, one of those emails that has been going around over the holidays gives a big HUZZAH to President Bush (yes, amazingly, he IS still president) and The Troops because someone in Iraq has made Christmas an “Official National Holiday.” (Does that mean everyone has the day off? Because, according to the
Brookings Institute, the unemployment rate is “27 to 60%, where curfew not in effect.” Think of it as the Iraqi “Christmas Curfew.”) In a country that is, like, 97% Muslim.

This is the kind of thing that makes my head explode.

Now, I applaud any expression of religious tolerance, regardless of its magnitude or motivation. We can’t have enough of them. But this isn’t a celebration of religious tolerance. The same people applauding this gesture would be freaked out if President Barack Hussein Obama made Ramadan or Kwanzaa a national holiday in the US. Rather, it is a celebration of religious triumphalism. Bush brought Christmas to Babylon, dammit, and if the collateral damage included a few hundred thousand Iraqis, it was a small price. (One email I got actually made reference to this as a manifestation of Bush’s “higher calling.”)

But make no mistake about it. The cause of religious tolerance has not been advanced by Bush’s war.

From the
Chicago Tribune two days ago:
In Iraq, the priests routinely celebrate mass in nearly empty churches—if they dare open their church doors at all. …

[T]he exodus of the country's ancient Christian minority has not stopped — and indeed appears to be accelerating again.

"They're threatening the Christians so that they'll be scared and will leave," said Yohan Hanna Hermes, 59, an Iraqi from Mosul who arrived in Beirut in mid-December and attended mass the next day for the first time since September. "It's a deliberate campaign to drive the Christians out."

Iraqis who can afford the plane ticket prefer to go to Lebanon because of its large — 40 percent — Christian population. Others make their way to Jordan or most likely
Syria, the main destination for Iraqi refugees. …

[A]s many as 500,000 to 700,000 of the 1.4 million Christians in Iraq … are believed to have fled in the past five years, according to a report last week by the U.S. Commission on International Religious Freedom, an independent body appointed by Congress.

"Five years from now there won't be any Christians left in Iraq. It's happening
quietly but also very quickly," said retired Gen. Michel Kasdano, a researcher
and spokesman at the Chaldean Archbishopric.

In 2006 and 2007, most of the new arrivals [in Lebanon] were from Baghdad, he said. But since the attacks in late October against Christians in Mosul, which forced an estimated 2,000 Christian families to flee to nearby villages, Christians have been arriving from the north, which was previously considered relatively safe."

From those who are coming, we hear the others are packing and making preparations to leave," he said. "It's only a matter of time before they all are gone."

For Ikhlas Aziz, 40, and her husband, truck driver Dawood Kariokos, 50, the decision to leave was more than a year in the making, since Kariokos was twice kidnapped in 2007.

They cite not only the repeated acts of violence and intimidation against Christians
but also a climate of discrimination that makes them feel they are no longer
welcome. …"

All the Christians are terrified all of the time," said Kariokos, as he waited with his wife to register for aid at the archbishopric. "And if I apply for a job they will take the Muslim, not the Christian. Always they prefer the Muslims."

… Christians, who accounted for 4 percent of Iraq's population on the eve of the war, are also disproportionately represented [among refugees], comprising 16 percent of the 1.1 million refugees in Syria and 25 percent of the 50,000 refugees in Lebanon, the UN says.

They also account for a disproportionate number of those being granted asylum overseas.

Of the 16,874 Iraqis resettled in the U.S. since 2006, 48 percent are Christians, according to the U.S. Embassy in Baghdad. Others claim asylum in Western countries such as Sweden and Australia, though not all will be admitted, leaving their future uncertain.

But going back to Iraq isn't an option, said Solaqa Zaya Moshi, 53, who first fled Baghdad for Mosul in 2007. In October he fled Mosul for the surrounding countryside before deciding to leave Iraq altogether, arriving in Lebanon with his wife and son on Dec. 5.

The Iraqi government says some of the Christians who fled Mosul have now returned to their homes, but when Moshi tried to go back to his house just to
pick up some clothes, his former neighbors told him it wasn't safe."

In all Iraq it's black, it's finished for Christians. I can never go back," he said,
crumpling in tears. "We used to have a very good life in Baghdad, and here I am
like a beggar in Lebanon. I've lost everything."

So much for Bush’s “higher calling.”

We don’t have precise numbers for these things, but the percentage of Iraqis that are Christian is around 2% (and declining by the day). In the US, the percentage of the population that is Muslim is probably a bit under 2%. In other words, they are the same order of magnitude.

When the only Muslim member of Congress, Keith Ellison, took the oath of office on a Koran once owned by Thomas Jefferson, the right-wing went apoplectic. (One
pundit said it “undermines American civilization. Insofar as a member of Congress taking an oath to serve America and uphold its values is concerned, America is interested in only one book, the Bible. If you are incapable of taking an oath on that book, don't serve in Congress.”) Imagine how Bill O’Reilly, Sean Hannity and the rest of the “War on Christmas” crowd would react if the US made Eid (the Muslim feast celebrating the end of Ramadan) a national holiday.

Bush, who began his “War of Terror” (as Borat called it) as a “
crusade”, is leaving office with the same cultural nuance intact.

Thursday, December 25, 2008

year in review

From This Modern World:

[click to enlarge]

See Salon archives here.

happy holidays

... from the Daggatt family.

HHDL, Russ, Gemma, McKinlay & Kaya

(Kaya yet again soundly slept through a visit with His Holiness. She was actually lying on the floor behind us in this picture, so Gemma had to Photoshop her in -- we love this picture of her in Rajastani dress from our New Year’s Eve celebration last year in Bombay).

Tuesday, December 23, 2008


“Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.”
Andrew Mellon

Mellon was Herbert Hoover’s Treasury secretary and those were the words attributed to him by Hoover in his memoirs. “It will purge the rottenness out of the system,” Mellon added, and values “will be adjusted, and enterprising people will pick up the wrecks from less competent people.” That neatly summarizes the prevailing conservative approach – the “responsible” policy response – during the depths of the Great Depression. It helped create and sustain the Great Depression.

We now face the greatest economic crisis since the Great Depression. And, again, the Republican response – at least in Congress – is neo-Hooverism. I can’t think of many times in recent years I have agreed with Dick Cheney. But at a meeting of Senate Republicans earlier this month,
he said of the proposed auto industry bailout, "If we don't do this, we will be known as the party of Herbert Hoover forever.”

Efforts by Congress to bail out the auto industry were killed largely by the efforts of three Southern Senators: Senate Republican Leader Mitch McConnell from Kentucky (home to Toyota's biggest auto assembly plant outside Japan); Senator Bob Corker from Tennessee (home to Nissan's North American headquarters); and Senator Richard Shelby from Alabama (home to a range of foreign auto assembly plants). I’m sure these guys are all good Patriots. But do you think they really want the Big Three US auto makers to survive in ANY form?

Channeling Andrew Mellon, Shelby
said, “I believe their best option would be some type of Chapter 11 bankruptcy.” The Senator from Tuscaloosa (the word an elephant most fears to hear from its Italian dentist?), who also opposed the financial bailout, said the Bush administration’s loans to the industry just, “postpones the inevitable”. (I agree with New York Times columnist Gail Collins when she wrote of the bailout plan, “it did pass my own personal quality-control test, which is to find out what Senator Richard Shelby of Alabama thinks and go the other way.”)

Some of my friends had the same response as Shelby, in reaction to
my post supporting an auto industry bailout. Suffice to say there is a palpable undercurrent of hostility toward the US auto industry out there. I’m not going to deny they deserve that hostility, and I’m not going to revisit the whole debate over an auto industry bailout – it now appears the Bush administration has come up with something close to the Congressional plan (under the rather dodgy auspices of the $700 billion Trouble Assets Relief Program – which to date has entailed no acquisition of trouble assets).

I think those who assert that bankruptcy would be the best course for the US auto industry don’t understand the bankruptcy process very well. It can be a years-long process with every major decision requiring court approval. For example, United Airlines entered bankruptcy in December 2002 and finally exited in February 2006. But United was able to get “debtor-in-possession” (DIP) financing. In a typical bankruptcy, some party puts up the money to keep the company operating during bankruptcy and that debtor has first claim on the assets of the company. But DIP financing is not an option for the auto makers given the current state of credit markets. If the auto companies (and we’re talking here GM and Chrysler) entered Chapter 11 now without government backing, they would very quickly find themselves in a Chapter 7 liquidation. The US government is, in effect, the DIP lender of last resort. If the US government is the DIP lender, what’s the value of reorganizing the companies through a years-long adversarial litigation process with lawyers filing mountains of paper on behalf of all the various stakeholders in reaction to every proposed action? A bailout doesn’t mean the companies don’t have to reorganize. The current plan requires that the companies and their various stakeholders come up with viable plans of reorganization by March 31 – a timetable much faster than anything that could be produced through a Chapter 11 proceeding. Even if the plans that emerge only delay the demise of the auto makers by a few years, the bailout funds would be a wise investment to avoid the full hit to the economy at a time when it is teetering on the edge of the abyss.

You don’t think our current economic predicament is perilous? Read my previous post on

In this context, efforts by Southern Republicans (with, of course, the lock-step support of the rest of the Republican Senate caucus) to bring down the UAW (with the US auto makers as collateral damage) seems rather churlish and ill-timed.

Steve Pearlstein in the Washington Post had an
excellent summary of the current state of play of the auto bailout:
Insurance Against an Even Bigger Wreck

By Steven Pearlstein

At any other time, the day that the federal government stepped in to rescue the domestic auto industry would be a turning point in the history of American capitalism. The only reason it is not is that it was immediately preceded by similar rescues of Bear Stearns, Fannie and Freddie, AIG, and Citigroup. It was just another day in Bailout Nation.

Let's be clear on one point, however: The story here is not that Americans have lost their stomach for the kind of "creative destruction" that is generated by open and competitive markets, which sometimes results in the big companies going under and thousands of jobs being lost. We never particularly relished it -- who would? -- but we tolerated it in the past, we are still tolerating it now (Circuit City, Lehman Brothers), and we will undoubtedly tolerate it in the future. Moreover, even when the government steps in to rescue these companies, it invariably involves a serious and painful restructuring that results in the lost of thousands and even tens of thousands of jobs. That's not how you define bailout in French.

The real story here is that our economy has been so weakened by a financial crisis brought on by decades of national profligacy and misallocation of capital that the failure of certain companies threatens to turn a bad recession into a serious depression.

Do we know that for certain? Of course not. But what we do know is that it is a genuine risk, with very bad consequences for virtually every American if it happens and therefore something we need to insure ourselves against. The premium is steep, but it is still a lot less than what a depression would cost. And the only insurer willing to offer the policy is the U.S. Treasury.

Put another way, this isn't a change in policy or principles so much as a temporary change in circumstances. It is to our credit -- and that of the free-marketeers in the Bush administration -- that we have decided to honor another great American tradition and put practicality ahead of rigid ideology.

It is also important to be honest about what's going on here, which is nothing less than a bankruptcy restructuring without the bankruptcy filing. Over the next 90 days, General Motors and Chrysler will meet with their unions and committees of their major unsecured creditors to negotiate how much each of them is going to give up so that viable companies can emerge.

During that time, the government has agreed to provide what in bankruptcy is called debtor-in-possession financing -- a bridge loan to keep the companies going while the restructuring is negotiated. The hope is that at the end of the 90 days, a deal is reached among all the parties and it is possible to make it legally binding on all the stakeholders without resorting to the extraordinary powers of the bankruptcy court. If that is not possible, then the negotiated plan will be run quickly through the bankruptcy process as a "pre-packaged" reorganization.

Since October, it's been obvious that this is the way the story has to end. Unfortunately, everyone was too busy posturing in the hope of delaying the pain and gaining a bit of negotiating advantage. The companies denied that they were running out of money. The union said it had made all the concessions it was going to make. The Michigan congressional delegation kept up the fiction about a "bridge loan" to get the companies through their temporary "liquidity" shortage. Southern Republicans harbored dreams of breaking the United Auto Workers union. And the White House couldn't get past worrying over which pot of money the auto loans came from, as if it made any difference.

If they'd all simply faced reality two months ago, it would have saved us a lot of unnecessary drama.

When all is said and done, the restructuring deal will get done not because anyone will be happy with the result but because it will be better than the alternative -- a messy bankruptcy or liquidation -- for all of the parties. Tens of thousands of jobs will be cut, longtime workers will get pay cuts at year's end, retirees won't get the full health-care coverage they were counting on, hundreds of dealers will be forced to close their doors and creditors will get only a third of their money back. For all of them, including the taxpayers, the consolation prize is that they will own a piece of Chrysler and GM. The government is likely to wind up with about 20 percent of the shares, the union about 25 percent, the unsecured creditors just under half, with maybe 5 percent for dealers. Current shareholders will be lucky if they wind up with
the remaining 5 percent.

The whining coming from the UAW that somehow its members are being singled out for sacrifice is absurd. As creditors (through their retiree health plan), they would be treated better than other unsecured creditors under the framework suggested by the White House. Their other complaint -- that they will be forced to work for market-rate wages and benefits, without an ironclad guarantee of job security -- probably won't elicit much sympathy from other taxpayers who have lower wages, no better job security and just lent $17 billion to keep the companies from going

Nor should the union harbor fantasies that a newly installed Obama administration will protect their wages and benefits to the detriment of all the other parties. For the past several weeks, the White House has been working quietly and collaboratively with the Obama team, and, as the president-elect suggested in his remarks yesterday, there probably isn't much daylight between them. My guess is that the White House, with Obama encouragement, set conditions that were sufficiently tough and sufficiently flexible that Obama will have room to make modest concessions to his union friends and still come out with a credible plan for making the companies viable again.

It’s not by any means certain that, despite this deal, GM and Chrysler will survive. Chrysler, in particular, is up against the ropes. It has no assets to pledge to potential lenders (not that there are any lenders other than the US government lurking in the wings) because all those assets have already been pledged as collateral for the debt used to gain control of the company by the private equity firm, Cerberus Capital. (Who names their company after a vicious multi-headed dog that guards the gates of Hell? On the other hand, I have dealt with Cerberus, and I think their name is appropriately descriptive. Their chairman now is the worthless political hack who previously served as Treasury secretary under Bush, John Snow. As bad as Paulson is, I hate to think where we would be now if Snow was still Treasury secretary. I guess Cerberus gets some credit for taking him off our hands.)

Any deal that doesn’t ultimately result in Cerberus losing all its equity in Chrysler is a bad deal for taxpayers. Cerberus also has a majority stake in GM’s financing arm, GMAC. And they still think they can retain majority control of that entity and Chrysler’s financing arm. From the
Wall Street Journal :

Layered on top of these complex discussions is the fate of GM's former finance unit, GMAC, in which Cerberus holds a majority stake. It also controls Chrysler's Chrysler Financial unit. Part of Cerberus's strategy, say people briefed on the matter, is to protect its majority investments in these two units.

A person familiar with the GM-Chrysler talks said that Cerberus is eager to make concessions in order to arrange a combination of Chrysler's finance arm with that of GM. "That is one of the core goals," this person said. In order to achieve that end, according to this person, Cerberus feels it has to be flexible on the use of its ownership stake in Chrysler.

Chrysler's financing arm warned auto dealers earlier this week it may have to temporarily stop making the loans they use to stock their lots with vehicles. Dealers, concerned Chrysler could seek bankruptcy-court protection, have been withdrawing as much as $60 million a day -- about $1.5 billion so far -- from the fund used to help them finance their inventory, according to a letter reviewed by The Wall Street Journal. The financing units haven't played a big role in the jockeying over an auto-industry rescue. But federal officials are looking at whether any money put toward rescuing the auto companies might go for naught if the government couldn't also save the companies' financing arms, said one person briefed on the talks. "The fincos
were ignored in the congressional debate, but they have requests out as well for
money," and now they and the auto makers are being considered as a package, this
person said.

Chrysler Financial and GMAC are constrained by the tight credit markets. Because they could be classified as banks, they are central to Detroit's argument for receiving government money from the Troubled Asset Relief Program, set up for the financial industry.

One developing problem in the auto makers' pursuit of government rescue funds is the state of Chrysler's collateral. Unlike GM, which has assets it can pledge or use
as collateral for a federal loan, Cerberus is believed to have pledged all of Chrysler's assets

This is a HUGE part of the story. What does it say that this comes from page C2 of the Journal (the only place I have read about this element of the story). As soon as the auto bailout becomes part of the financial bailout, the rules change. For example, Republican Senators apparently believe that retired auto workers should have their contractual pension and health care benefits cut as part of any bailout of the auto industry. But what do you bet Cerberus comes out smelling like a rose because they are staking out their ground on the financial side of the companies?

(In recent months, GM bonds were trading for as low as 10 cents on the dollar. Since bonds are senior to equity in the capital structure, that means GM equity should be worthless. Their obligations to retired workers are also contractual rights that would be upheld in bankruptcy before current shareholders salvaged anything. But have you been hearing Republican Senators insisting that GM or Chrysler equity holders get wiped out?)

Contractual benefits are on the table when they take the form of pension and health care benefits of retired workers. But when it comes to the accrued bonuses of the executives who brought the global financial system to its knees and entailed a multi-trillion dollar government bailout … well, those are contractual rights that the government is powerless to touch. Recall
this story from the Wall Street Journal almost two months ago:

Financial giants getting injections of federal cash owed their executives more than $40 billion for past years' pay and pensions as of the end of 2007, a Wall Street Journal analysis shows. …

Asked about the Journal's calculation, the Treasury said, "Every bank that accepts
money through the Capital Purchase Program must first agree to the compensation
restrictions passed by Congress just last month -- and every bank that is receiving money has done so."
Turns out those TARP restrictions on compensation only apply to firms from whom the Treasury buys “troubled assets” – which was the original objective of the TARP program but was subsequently abandoned in favor of direct equity infusions and loans. The Bush administration insisted on inserting a sentence in the authorizing legislation at the last minute that had the effect of
gutting those restrictions once the focus of the TARP program shifted. (In any event, they wouldn’t have applied to the accrued bonuses that were the focus of the Journal story.)

$40 billion in bonuses for financial executives go untouched. That would be enough to pay for the auto bailout twice over. Unlike the retired auto workers who gave decades of their labor in return for their relatively modest retirement benefits, what value did these financial executives give to “earn” their bonuses? But show me ONE Republican who has demanded that these bonuses be voided as a condition to the billions of taxpayer dollars flowing into their firms.

If you really want to get outraged, look at this
AP article that details more of the compensation received by the top executives of the bailed out banks.

(Then there was the bank that didn’t get bailed out: Lehman Brothers. Its CEO, Richard Fuld, took home $450 million since 2000. Of that, $100 million was in stock which he lost when Lehman went bankrupt. But by his
own accounting, he still netted $350 million for destroying the 180-year old bank. That’s “pay for performance.”)

And recall
this story, that the major recipients of financial sector bailout funds were on the path to paying out half those funds in dividends to shareholders over the next three years:

U.S. banks getting more than $163 billion from the Treasury Department for new lending are on pace to pay more than half of that sum to their shareholders, with government permission, over the next three years.

The government said it was giving banks more money so they could make more loans. Dollars paid to shareholders don't serve that purpose, but Treasury officials say that suspending quarterly dividend payments would have deterred banks from participating in the voluntary program.

Critics, including economists and members of Congress, question why banks should get government money if they already have enough money to pay dividends -- or conversely, why banks that need government money are still spending so much on dividends.

What, exactly, is the point of a federal bailout of firms that then proceed to pay those funds out to shareholders? Half of $163 billion is over $80 billion. The auto bailout pales by comparison. Are Republican Senators demanding that banks be prohibited from paying out dividends until they repay taxpayers?

The New York Times had a
good article last week on the bonuses received by Wall Street employees for profits that later proved to be ephemeral. The profits weren’t real, but the bonuses were.

As Harold Meyerson
pointed out in the Washington Post, employee compensation is a much higher percentage of total costs (over 60%) in the financial industry than it is in the auto industry (10%). Do you think bankers and traders would be willing to cap their compensation at the level of a non-union worker in Alabama?

Over the past several weeks, it has become clear that the Republican right hates the UAW so much that it would prefer to plunge the nation into a depression rather than craft a bridge loan that doesn't single out the auto industry's unionized workers for punishment. (As manufacturing consultant Michael Wessel pointed out, no Republican demanded that Big Three executives have their pay permanently reduced to the relatively spartan levels of Japanese auto executives' pay.) Today, setting the terms of that loan has become the final task of the Bush presidency, which puts the auto workers in the unenviable position of depending, if not on the kindness of strangers, then on the impartiality of the most partisan president of modern times.

Republicans complain that labor costs at the Big Three are out of line with those at the non-union transplant factories in the South, factories that Southern governors
have subsidized with billions of taxpayer dollars. But the UAW has already agreed to concessions bringing its members' wages to near-Southern levels, and labor costs already comprise less than 10 percent of the cost of a new car. (On Wall Street, employee compensation at the seven largest financial firms in 2007 constituted 60 percent of the firms' expenses, yet reducing overall employee compensation wasn't an issue in the financial bailout.)

My point here is not (necessarily) to demonize Wall Street. We had to put aside moral hazard concerns in order to prevent the global financial system from collapsing. But we certainly didn’t need to do it on terms so generous to the banks. I think the main reason people are showing greater outrage for the auto industry bailout than for the financial industry bail out is that it is easier to understand the problems of the auto industry and the terms of that bailout. But the amounts involved in the auto industry bailout are a rounding error compared with the financial industry bailout (“bailouts”, plural, I should say – there are so many of them, with almost no transparency, that it’s hard to keep track). Just two companies – AIG and Citigroup – have received bailouts totaling almost half a trillion dollars. Just two firms (and AIG isn’t even a bank). If people really understood the deal that Citigroup got, for example, there would be a political revolution.

As I noted previously, if you total all the federal funds being committed to the financial industry, it totals in the trillions. The exact amount is unknowable because of the almost total lack of transparency.

On the other hand, the problems of the auto industry are not limited to the US auto makers. Toyota is almost certainly the best auto maker in the world, with the best technology and the best management practices. But it announced yesterday that this year it would show its
first operating loss in its 80-year history. That represents a swing of almost $30 billion from their earnings of last year. Sales of autos in Japan are expected to hit a 31-year low next year. Toyota announced last week that it is indefinitely delaying plans to manufacture Priuses in Mississippi despite the fact that the plant is 90% complete.

Meanwhile, Chrysler
announced last week that it is shutting down ALL of its US auto plants for at least a month. GM said it was cutting first quarter vehicle production by 250,000, or 30% from a year ago. It is also delaying completion of the engine factory meant to supply its much touted plug-in electric Chevy Volt.

The problems in the economy right now are much greater than those of the auto companies. Those companies have their problems, but their immediate existence is threatened by an economic crisis outside their control. And the consequences of their failure would be a massive “anti-stimulus” measure at a time when the economy can’t afford to take the hit. We need to focus on re-floating the economy and put off until later punishment for perceived economic sins. This is no time to be encouraging “creative destruction.”

Or Neo-Hooverism.


Last week the Federal Reserve made history by lowering its benchmark lending rate to a range of zero to 0.25%. It has now entered the zero interest rate territory (the “zero bound”) that Japan confronted in its own long (and largely unsuccessful) fight against deflation. Of even greater significance, the Fed announced that it would, essentially, print as much money as necessary to unthaw the credit markets and revive the economy.

In 2002, Fed chairman Ben Bernanke (before he became Fed chairman) gave a (now famous)
speech on the subject of deflation (it’s worth reading if you are a real economics junkie). Bernanke concluded that the government could always combat deflation simply by printing more money. He made reference to Milton Friedman’s famous “helicopter drop” phrase which evokes the image of a central banker using a helicopter to rain money down upon the economy (giving rise Bernanke’s unfair but prescient nickname, “Helicopter Ben”). As a practical matter, the Fed doesn’t use a helicopter. Rather, as Bernanke noted in his speech, “If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.” If it could get around legal limitations on its ability to directly purchase private assets, the Fed could cut out the Treasury as a middle man and purchase the private financial assets itself to directly inject money into the economy. That is what the Fed is now proposing to do. As the Fed said last week, “The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth.” Those tools include buying “large quantities” of mortgage-related bonds, longer-term Treasury bonds, corporate debt and even consumer loans.

In a little noted (but huge) development, the Fed said it would
lend up to $200 billion to hedge funds to allow them to purchase asset-backed securities comprised of credit card receivables, automobile loans and student loans. This is the first time the Fed has ever lent to private unregulated investment funds. It may also be a disguised attempt to slow down hedge funds redemptions (disguised because it would cause political outrage if the Fed were to overtly bail out hedge funds). I don’t see any other reason why the Fed would lend money (let’s say at 1 or 2%) to hedge funds to allow them to buy consumer debt that generates much higher yields (say, 5 or 6%). Why wouldn’t the Fed just buy the asset-backed securities directly? What value do the hedge funds add?

It is reasonable to assume that they are sweating bullets at the Fed. It has essentially exhausted traditional monetary policy and is stepping in as a substitute for banks and other lenders and acting more like a bank itself. Make no mistake about it; we are now in “helicopter drop” territory.

When nominal interest rates reach zero, the economy risks entering a “
liquidity trap.” In a liquidity trap, financial assets become unattractive and people and firms prefer to hoard cash. In that environment even banks are unwilling to lend, preferring to use any increase in funds to boost their capital, with the result that any increase in liquidity by the central bank gets “trapped” behind unwilling lenders. That is exactly what is happening now and it is a central banker’s worst nightmare.

In the simplest Econ 101 formulation, Total Income = Money times Velocity (i.e., the turnover of money). This is a truism. If Velocity drops faster than the Money supply increases, nominal Income will drop. That can take the form of deflation or a drop in real income or some combination of the two. A “liquidity trap” can be viewed as a precipitous drop in Velocity.

You don’t have to look far for indications that the threat of deflation is real.

The Consumer Price Index fell 1.7 percent in November, the steepest monthly drop since the government began tracking prices in 1947.

In recent weeks, the
yield on three-month Treasury bills actually went negative during a brief period of intra-day trading Investors were willing to pay the government to keep their money safe for a few months. It is the modern equivalent of keeping your money in your mattress. (Warren Buffett quipped: “This should be bullish for Berkshire. With great foresight, I long ago entered the mattress business in a big way through our furniture operation. Now mattresses have become fully competitive as a place to put your money, and sales will soon take off.”)

Even more alarming, however, was the
yield on 30-year Treasury bonds. Yesterday it stood at 2.59%. How fearful do investors have to be to lock up their money for 30 years at 2.6%? There is some significant element of the investor population out there that believes we are in for a Japanese-style deflation (or worse) for at least a couple of decades. I’m not in that camp (yet). But we damned well better be taking that prospect seriously and temporarily put aside political agendas like trying to crush the UAW in favor things like trying to preserve the largest consumers of steel, plastics, glass and electronics in the country (i.e., the US auto industry).

The Commerce Department
reported today that home sales dropped 8.6% in November. And the National Association of Realtors estimated that 45 percent of all home sales in November were so-called “distressed sales,” meaning that the sellers faced foreclosure, or they were forced to sell their home for less than the value of the mortgage. The median home price is now down 21% from its peak in July 2006.

Another indication of deflationary expectations: The price of oil
dropped on Friday to just over $33/barrel (it subsequently rebounded in response to news that OPEC committed to reducing daily oil output by a further 2.2 million/barrels a day – bringing the cuts since September to 4.2 million/barrels a day,or 5% of daily global output). You might recall the price of oil reached a peak of $147/barrel as recently as July. Certainly there was a large speculative element to that July price (excess global liquidity seeking refuge in one last bubble, commodities). But the subsequent decline in the price also reflects real pessimism over the near-term prospects of the “real” economy and its life blood, oil. (Let’s hope President Obama can set us on the path away from dependence on that vile substance.) Someone is expecting a whole lot less economic activity than previously thought.

(One positive aspect of the decline in oil prices: Prospects for the Obama administration to achieve some kind of “Grand Bargain” with Iran – including Iraq, Israel and their nuclear program – are probably as good as they have ever been. At least as good as they were when
Iran proposed just such a Grand Bargain in 2003 only to have the Bush administration fail even to respond to their overture. The Iranian economy is in horrible shape and could benefit from a thawing of relations with the West.)

Fortunately, we have a new president and a new economic team about to arrive that understands the urgency of a major fiscal stimulus. At a news conference last Tuesday, president-elect Obama said, “We are running out of the traditional ammunition that’s used in a recession, which is to lower interest rates. It is critical that the other branches of government step up, and that’s why the economic recovery plan is so essential.” And that plan is growing with every passing week. During the campaign Obama spoke of a two-year fiscal stimulus of $175 billion. As the magnitude of our economic problems set in, that was raised to $600 billion or so. Now Obama’s advisors are talking of a economic recovery plan of $675 to 775 billion, while acknowledging it could go higher. As the New York Times
notes, even Bush’s former top White House economist, Lawrence Lindsay (no liberal), is now urging a $1 trillion stimulus plan. (You might recall Lindsay was forced out of the White House after honestly answering in a Wall Street Journal interview in late 2002 that an Iraq war could end up costing as much as $100 to 200 billion – which wasn’t consistent with the official White House line that we would be greeted with flowers and candy at essentially no cost.)

In his New York Times column yesterday (“
Life Without Bubbles”) Nobel Laureate Paul Krugman (I love writing that) writes of the need for sustained fiscal stimulus:
In short, getting to the point where our economy can thrive without fiscal support may be a difficult, drawn-out process. And as I said, I hope the Obama team understands that.

Right now, with the economy in free fall and everyone terrified of Great Depression 2.0, opponents of a strong federal response are having a hard time finding support. John Boehner, the House Republican leader, has been reduced to using his Web site to seek “credentialed American economists” willing to add their names to a list of
“stimulus spending skeptics.”

But once the economy has perked up a bit, there will be a lot of pressure on the new administration to pull back, to throw away the economy’s crutches. And if the administration gives in to that pressure too soon, the result could be a repeat of the mistake F.D.R. made in 1937 — the year he slashed spending, raised taxes and helped plunge the United States into a serious recession.

The point is that it may take a lot longer than many people think before the U.S. economy is ready to live without bubbles. And until then, the economy is going to need a lot of government help.

Krugman’s essential point is that recovery from the current economic downturn, when it eventually comes, will be qualitatively different than previous recoveries. It will not be fueled by the kind of easy money and debt to which we have grown accustomed.

In his December
Outlook column, PIMCO’s Bill Gross, the country’s best bond fund manager, makes the same point in the investment context, cautioning that we have to adjust our long-term investment perspective,
“ …for our future economy and its functioning within the context of a delevering as opposed to a levering financial system. Recent Investment Outlooks … have pointed to the necessity to view current changes as not only non-cyclical, but non-secular. They are, in fact, likely to be transgenerational. We will not go back to what we have known and gotten used to. It’s like comparing Newton and Einstein: both were right but their rules governed entirely different domains. We are now morphing towards a world where the government fist is being substituted for the invisible hand, where regulation trumps Wild West capitalism, and where corporate profits are no longer a function of leverage, cheap financing and the rather mindless ability
to make a deal with other people’s money. …

My transgenerational stock market outlook is this: stocks are cheap when valued within the context of a financed-based economy once dominated by leverage, cheap financing, and even lower corporate tax rates. That world, however, is in our past not our future. More regulation, lower leverage, higher taxes, and a lack of entrepreneurial testosterone are what we must get used to – that and a government checkbook that allows for healing, but crowds the private sector into an awkward and less productive corner.
Dow 5,000? We don’t have to go there if current domestic and global policies are focused on asset price support and eventual recapitalization of lending institutions. But 14,000 is a stretch as well. One only has to recognize that roughly 20% of bank capital is now owned by the U.S. government and that a near proportionate share of profits will flow in that direction as well. Better to own corporate bonds than corporate stocks. ..” [emphasis in original]

A few months ago, The Onion ran a headline, “
Recession-Plagued Nation Demands New Bubble to Invest In.” Don’t count on it. We’ll be lucky if we avoid major deflation.

Monday, December 15, 2008

it's time to raise the gas tax

Michael Kinsley states the case better than I could. Everyone is dissing the US auto makers these days because they haven’t been making fuel-efficient vehicles. Well, that is because the price we pay for gasoline has been cheap (the REAL cost has been high – but consumers haven’t been paying the REAL cost, including the harm to the environment and national security). The cheapest oil has EVER been was in 1998, when it averaged $11.91 for the year (around $16 in current dollars). (The average price since World War II – again, adjusted for inflation – has been around $25.) Cheap gas is the market’s way of saying, “Party on, Wayne!” Unlike Europeans, Americans have never been willing to support policies that would keep gas prices high to encourage conservation and the development of alternative fuels. (The price of gas in Europe has generally averaged three or four times the price in the US – with the difference consisting of high gas taxes.) You don’t need a government mandate for the auto companies to make fuel-efficient vehicles – you need high gas prices.

As Kinsley proposes, make it revenue neutral. Every cent of the gas tax offsets payroll taxes. (With all of Bush’s massive tax cuts we couldn’t afford, NONE of it went to reduce payroll taxes – the taxes that really affect working Americans.) Economists are fond of saying, “If you want more of something, subsidize it. If you want less of something, tax it.” We want more jobs and less oil use. So tax oil and reduces taxes on employment.


Thursday, Dec. 11, 2008
Black Gold: It's Time to Raise the Gas Tax
By Michael Kinsley

The only good economic news lately has been the collapse of oil prices. At the beginning of July, just five months ago, the price of a barrel of was more than $140. By the beginning of December, it was down to about $45. That's a drop of more than two-thirds. In the U.S., we consume about 15 million bbl. of crude a day. The saving of $95 per bbl. adds up to more than $500 billion a year. That's big — enough to bail out the auto industry 15 times.

Of course, we've been through this before. The price of oil shoots up; we start using less; reduced demand sends the price down; we start using more; pretty soon it's shooting up again. This time, though, it does feel different. It seems as if Americans have made a real and fundamental commitment to consuming less energy. That is not so much out of idealism as it is the good side, for a change, of our short attention span. When the price of gasoline shot past $4 per gal., it was both shocking and reassuring. Economists had long wondered what price it would take to get our attention. This, at last, was it. Yet $4 gas turned out not to be the end of the world. Although it was devastating for some people — and it surely accelerated our plunge into recession, which is affecting all of us — we adjusted more easily than one would have thought possible. And we kept on adjusting, even as the price of oil plummeted.

Will this change in behavior last? Or will we return to our wastrel ways as we climb out of recession and the reality again sinks in that gas is cheap? The one sure way to prevent this second scenario from happening is not to let gas get cheap again. Yes, this is yet another plea for that hoary notion: a big energy tax. Just five months ago, we were essentially paying a tax of $95 per bbl. That's the difference between what oil cost then and what it costs now. This was a "tax" whereby the revenue went into the pockets of oil producers — about two-thirds of them foreign countries and one-third fellow Americans. Isn't there something better to do with the money?

This idea always comes up and never goes anywhere. That's partly because of our general loathing of taxes and suspicion of Washington and partly because the idea tends to come up when energy prices are rising and people find it hard to believe that it would be good if they rose even more. But a couple of things are different
now. First, we have experienced the high energy prices that people in most of the rest of the world already live with, and we know we can live with them too. Four-dollar gasoline is no longer unthinkable.

Second, this is the perfect moment for the other part of many proposals for an energy tax, which is to give the money back to people by lowering the payroll tax. The payroll tax, or FICA, collects about 15% of your wages or salary — half from you and half from your employer. It is expected to bring in close to a trillion dollars in 2009. Using our windfall from plummeting crude-oil prices alone, we could cut the FICA tax by more than half. Including other forms of energy would bring in even

FICA is, in effect, a tax on job creation. It applies to the very first dollar earned by a minimum-wage worker, but most of it tops out at an annual income of about $100,000 and doesn't apply at all to income from investments. For most Americans holding jobs, FICA now takes a bigger chunk of their income than the income tax itself. And yet it rarely enjoys the tender concern of tax-cutting Republicans, who prefer to concentrate on tax breaks for capital gains. Cutting the FICA tax in half, for workers and for employers, would make it more affordable for employers to hire — or avoid layoffs — while giving everyone who makes less than $100,000 a 7.5% raise to spend and stimulate the economy even further. People making more than $100,000 would get a tax cut too — as big as anyone else's, though a smaller percentage of their incomes.

One argument against all this is that FICA finances Social Security payments, and the connection between money in and money out helps keep Social Security secure.
There's a simple answer: among the many problems we now face, the danger that a
majority in Congress will gang up against Social Security benefits must surely rank low.

It comes down to this: in the terrible storm of economic misery, we suddenly have a half-trillion-dollar windfall. As unemployment heads toward double digits, we can use this found money to encourage people to create jobs, or we can use it to encourage people to use more gasoline. It's a pretty easy choice, don't you think?

Thursday, December 11, 2008

Monday, December 8, 2008


Friday, December 5, 2008

the auto industry

Am I the only person who finds the whole demonization of the US auto industry bizarre?

I am not an advocate for either management or labor or the auto industry generally. But by some estimates the auto industry accounts, directly or indirectly, for one in ten jobs in this country. I don’t know how that is calculated, but it is not improbable. The auto industry is the largest consumer of steel, plastic, glass and electronics in this country. Then there are the tire manufacturers, the machine tool companies, the advertising agencies, the truckers and railroads that deliver the autos, the repairs shops, the … you get the idea. Auto dealers are in every community in the country. Let’s say the one-in-ten estimate is exaggerated twofold. So only one in twenty jobs in this country depends on the auto industry. (The civilian labor force in this country is around 150 million, so that represents 7.5 million jobs.) Of course, not all of those jobs would go away if one or more of the three major US auto companies went under. And some are connected to foreign auto makers. But a collapse of the US auto industry is one of the biggest “anti-stimulus” measures imaginable for the “real” economy. At a time the economy really can’t afford any major shocks. The potential job loss has been estimated at three million. When we are trying to figure out how to intelligently inject a trillion dollars or so of fiscal stimulus into the economy quickly, do we really want to risk the negative multiplier effect of an auto industry collapse?

This is serious business. Has anyone taken note of the increasing use of the term “depression” in recent months?

It was reported today that the economy
lost over 530,000 jobs in November, the 11th consecutive monthly decline and the biggest monthly decline in 34 years. The numbers of jobs lost in September and October were revised upwards by 100,000. So far this year the economy has shed $1.9 million jobs, with most of that coming in the last three months. About half of the job loss has been in manufacturing.

The unemployment rate rose to 6.7%, but that doesn’t include the 420,000 men and women who left the job market during the month (meaning, they are no longer looking for work and are therefore not counted among the unemployed). The measure of employment I prefer is the
employment-population ratio – the percentage of the population that is working. It has now fallen to 61.4%. (It peaked at 64.7% in April 2000.)

Consumer confidence has decreased to the lowest level since that measure has been maintained, and retail sales in November were the weakest they have been in 35 years. Some economists are now predicting that the economy will have declined at a 5% annual rate in the fourth quarter.

There is certainly a rational discussion to be had over the fate of the US auto industry. But that doesn’t seem to be happening. Instead, there is a sort of political “piling on” taking place. The CEOs of the three major US auto makers were politically tone-deal to fly their private jets to Washington for their first appeal for help. But they have shown their contrition and have now all driven the 520 miles from Detroit to DC in hybrid vehicles. And they have all committed to working for essentially no pay in the short term. They have been subjected to ritualistic abuse in front of the TV cameras. Take
this example from the Senate hearing yesterday:

"Did you drive, or did you have a driver?" demanded Richard Shelby (R-Ala.), the ranking Republican on the Senate banking committee, which questioned the lowly threesome. "Did you drive a little and ride a little? And secondly, I guess, are you going to drive back? And, if so, if some of us wanted a ride to Detroit, could we ride with you?"

The chairman, Chris Dodd (D-Conn.), tried to ease the tension with some levity. "Where'd you stay?" he asked. "What did you eat?"

But Shelby was having none of it. "Mr. Chairman wants to make light of this, but I can tell you this," he growled. "Are you planning to drive back?"

Is this what our response to the economic crisis has been reduced to? (It seems Republicans like Shelby only exhibit this kind of anti-corporate populism when union jobs are at stake.) Does anyone really think that the problems of the auto industry would be eased by requiring that the CEOs of the Big Three drive themselves instead of flying whenever they need to travel? (Maybe flying commercial would be a nice compromise between a private jet and driving a car.)

But let’s compare the scorn being shown the auto industry with the treatment of the financial industry.

Take just two companies: AIG and Citigroup. The federal government has already put up more than $150 billion (and counting) to save AIG, because it engaged in such reckless and irresponsible behavior that its demise could bring down the entire global financial system. I’ve lost track of the cost of the Citigroup bailout. Last time I checked, US taxpayers had put up at least $250 billion. Did anyone grill their CEOs over their means of travel to DC? Of course not, because they didn’t even bother to travel to DC. The Treasury Secretary and Fed officials came to them. Have the CEOs of AIG or Citigroup or any of the other financial companies that have received a taxpayer backstop in the trillions of dollars offered to work for $1 a year? Have they been forced to present to Congress in televised hearings their plans for turning around their companies?

We’ve been hearing a lot lately how much unionized workers in the auto industry make. You may have heard figures like $70/hour thrown around. But that is
wildly misleading. Average wages for workers at Chrysler, Ford, and General Motors were just $28 per hour as of 2007. That works out to a little less than $60,000 a year in gross income – hardly outrageous given the nature of the work. It’s a living wage. And that is about the same wage that foreign manufacturers pay their non-unionized workers in the US. So where does the $70/hour figure come from? If you take the cost of all employer-provided benefits for the Big Three – health insurance and pensions – and divide that by the number of hours worked by current workers, you get about $42/hour per employee. Add that to wages – $28/hour – and you get the $70 figure. But it's not as if each active worker is getting health benefits and pensions worth $42/hour. That would come to nearly twice the worker’s wages. Instead, each active worker is getting benefits equal only to a fraction of that – around $10 per hour. You only get the $70/hour figure if you include the cost of benefits for retirees. But those aren’t benefits received by current workers. Why should they be added to the calculation of the cost of those current workers? If you fire the current workers, or reduce their hours, those costs don’t go away. So they are really not part of the hourly cost of current auto workers. Of course, workers need to park their cars. Why not include the cost of the land used for parking lots as part of their hourly cost? And they need heat and electricity in the auto plants in order to work. Why not add that to the cost of the workers? The legacy costs of retirees are an obligation incurred by past management and shareholders, not today’s active workers. Again, I’m not an advocate for the UAW, but figures like this $70/hour estimate are pure propaganda.

But let’s say auto workers are overpaid. So how about this: Let’s say that no one working in any commercial bank or investment bank or insurance company or mortgage company or hedge fund or any other element of the financial industry receiving support from the federal government (in the form of equity infusions, asset purchases, loans or loan guarantees) can receive salary and bonus greater than TEN TIMES the wages of the average United Auto Workers member (and, directly or indirectly, every player in the financial industry is receiving a federal bailout – as we have come to learn, it is all interconnected). That would mean no one in the financial industry could earn more than about $600,000/year, including bonus. UAW workers are supposedly being grossly overpaid and are responsible for the problems of the US auto industry. Certainly TEN TIMES their average wage should be more than generous pay for bankers and traders who have brought the global financial system to the brink of collapse. (In keeping with the demands on the auto executives, bank CEOs would have to forego pay altogether, of course, until taxpayers are made whole).

Treasury Secretary Paulson, not the bankers, is the one who went before Congress to pitch the financial bailout. He warned us that we couldn’t impose limitations on the compensation of financial executives or even ask for equity in return for a taxpayer bailout because the banks might choose not to “participate” in the bailout. The implication was that the bankers would fly their firms and the entire financial system straight into the mountain rather than agree to such indignities. But federal regulators have the power to seize insolvent banks. If they aren’t insolvent, then why bail them out? If they are insolvent, then why is there even a negotiation over what terms they will accept as part of a bailout?

I keep
citing Kevin Phillips and his description of the “financialization” of the US economy. But it really does look like we have come to distain people who actually make things (rather than the more exalted business of moving bits representing money around on computer screens).

Sure, the US auto makers have made some dumb decisions (although I wouldn’t say they are all equal in that regard – Ford has done a better job changing and adapting than the other two). But even that has been exaggerated. They made gas guzzlers because that’s what Americans wanted. The root problem was our love of cheap oil and the policies that have worked to maintain low gas prices at the pump.

Do you know when oil reached it ALL-TIME historic low? The lowest it has EVER been in constant dollars? That would be 1998, when it averaged $11.91 for the year (around $16 in current dollars). (The average price since World War II (again, adjusted for inflation) has been around $25.) Cheap gas is the market’s way of saying, “Party on, Wayne!” Unlike Europeans, Americans have never been willing to support policies that would keep gas prices high to encourage conservation and the development of alternative fuels. (The price of gas in Europe has generally averaged three or four times the price in the US – with the difference consisting of high taxes.) The auto companies can be blamed for opposing higher fuel efficiency standards. But our love of gas guzzlers and the cheap gasoline that makes them possible is hardly their fault alone.

As I
noted previously, it was reported on Tuesday that auto sales in the US fell more than 37% last month to their lowest level in 26 years. And it wasn’t just US auto makers. Chrysler did the worst, with a 47% sales decline. But Nissan did worse than GM – declining 42% vs. GM’s 41% fall. US sales declined more at Toyota (-33.9%) and Honda (-31.6%) than they did at Ford (-30.6%). Tell me what industry in this country (especially one with high fixed costs) could sustain a sales decline of 37%?

And of all models sold in the US guess which one had the biggest sales decline in November. Check it out:

So, it’s not like making all hybrids would have spared Detroit its current ills.

The New York Times in an
editorial today said that the CEOs of the Big Three should all resign. I have not been impressed with GM’s CEO, Richard Wagoner, but I know so little about him that my impression is meaningless. I don’t know much more about Chrysler’s CEO, Robert Nardelli (although he has a reputation for being autocratic and he was drummed out of Home Depot after receiving $240 million in compensation for mediocre performance). But I do know Ford’s Alan Mulally. I had extensive dealings with him when he was president of Boeing’s Defense and Space Group and I was quite impressed with him (Boeing would have been a lot better off had they made him CEO earlier this decade instead of Phil Condit and Harry Stonecipher, both of whom in my opinion were disasters). Mulally only came to Ford in September of 2006 and he has done a pretty good job. Ford is definitely in the best shape of the Big Three. Indeed, Mulally has said Ford could probably survive without federal help, but would like a line of credit just in case. (Why, then, is Ford supporting his rivals in their bailout request? Because if they go down, so will a lot of suppliers and that could result in a chain of events that takes Ford down, too.)

So what’s the answer? Certainly bankruptcy would be a disaster. To survive bankruptcy the auto makers would need debtor-in-possession financing which isn’t available in the capital markets these days. The only place that money is coming from is the US government. If the capital markets were functioning properly, maybe bankruptcy would be an option. But it isn’t now. The companies need to be reorganized, but that should take place outside bankruptcy. If we actually had a functioning president at the moment he would appoint a special presidential representative to act as a receiver of sorts who could negotiate with all the parties (including Congress) to restructure the Big Three. The result would be essentially a pre-packaged bankruptcy but would take the form of an act of Congress. But since we are still a couple of months away from having a president, Congress must act on its own and provide the companies enough money to survive until Obama can deal with it – enough to get through the first quarter of ’09. Is there a risk some of that money will be wasted? Sure. But whatever inefficiency would be entailed in a bailout would certainly be less than the inefficiency entailed in a collapse of the US auto industry.

The three companies each have their own problems. Ford’s are probably managable – its problems are primarily the problems of the economy generally and the risk that the entire ecosystem of the auto industry collapses. Chrysler is probably toast and needs to be sold off, merged or wound down. GM is the toughest problem. Its market capitalization is currently around
$2.5 billion. At that price, the US government should probably just nationalize it for the time being. (Dan Neil of the Los Angeles Times proposes just that.) That doesn’t solve its problems. But at least it would protect the interests of taxpayers.

Republicans, in particular, seem to be reverting to a kind of neo-Hooverism – “just let them all fail – it’s the free market at work, ridding the system of inefficiencies.” But how inefficient is it to have millions of people out of work? Under current conditions can we really predict the consequences of a collapse of the auto industry? The economy doesn’t need free-market shock therapy at the moment.

Wednesday, December 3, 2008


[from Matt Wuerker at Politico]

Certainly, markets that efficiently allocate capital are an important element of modern capitalism. But as Kevin Phillips notes in his book
Bad Money, when finance overtakes manufacturing and trade as the dominant sector of a nation’s economy that is generally a leading indicator of economic decline. And in our country in the last decade the financial industry has become essentially a casino. In 2004, major investment banks were allowed to leverage up to 30x or even 40x (which means that a decline in asset values of 3 or 4% can wipe out a firm’s entire capital). And with the repeal in 1999 of the Depression-era Glass-Steagall separation of commercial banking (which enjoys federal deposit guarantees but is also subject to heavy regulation) and investment banking (where bankers are much more free to gamble with their money), gambling on the casino side can bring down the whole business or even the entire industry, requiring a taxpayer rescue.

Hedge funds are almost entirely unregulated. (Indeed, that is pretty much what distinguishes a “hedge fund” – its relative lack of regulation and transparency. It really has nothing to do with “hedging” per se. The term “hedge fund” really just defines a compensation structure not an asset class.) Their number has gone from around 600 in 1990 to almost 10,000 at their peak in recent years. Much of the selling pressure on markets now is hedge funds unwinding their bets. In theory, all this gambling increases the liquidity of markets and reduces inefficiencies and instability. In practice, it has increased instability and drained hundreds of billions of dollars out of the economy with no net gain for society as a whole. The financial industry has become, in effect, a massive tax on the overall economy. And that was even before it all imploded and required trillions of dollars of taxpayer money to prevent it from bringing down the “real” economy.

The incentive structure creates a strong bias for investment banks and fund managers to take inordinate risks. For example, Richard Fuld, the former CEO of Lehman Brothers, received $480 million between 2000 and 2008 for behavior that resulted in the demise of the 158 year old firm. Lehman Brothers goes under and helps spark a global financial crisis, but Fuld keeps his $480 million. Even in retrospect, from his own personal standpoint, Fuld engaged in perfectly rational risk-management behavior. (Last week, the Wall Street Journal had an
interesting piece on the pay discrepancies between Japanese securities firms and the American firms they are taking over. For example, Nomura took over the Asian and European operations of Lehman. For the year ended March 31, the top 13 Nomura executives took home a total of $13 million. Quite a contrast with Fuld’s pay.)

Market stability is a public good and therefore the public has a strong interest in its maintenance. The collective behavior of individual market participants will not produce the optimal (or even minimum necessary) level of market stability. That is why regulation is required. It is heartening to see that Obama’s incoming Treasury Secretary understands this:

“[The] ‘public good’ dimension of financial stability means that while the whole economy benefits from a more stable financial system, each individual institution would prefer that others incur the costs associated with its provision. As a result, firms may collectively underinsure against the risk of failure.”

Timothy Geithner
Sept. 15, 2006

The latest issue of Portfolio magazine has a great piece (“The End”) by Michael Lewis (author of Liars Poker, The New New Thing, Moneyball, etc.), presumably an excerpt from his new book, Panic (everything Lewis writes is great). Here is a bit of it (but go ahead and read the whole piece):

When I sat down to write my account of the experience [working for Salomon Brothers – now part of Citigroup – in the ‘80’s] in 1989—Liar’s Poker, it was called—it was in the spirit of a young man who thought he was getting out while the getting was good. I was merely scribbling down a message on my way out and stuffing it into a bottle for those who would pass through these parts in the far distant future.

Unless some insider got all of this down on paper, I figured, no future human would believe that it happened.

I thought I was writing a period piece about the 1980s in America. Not for a moment did I suspect that the financial 1980s would last two full decades longer or that the difference in degree between Wall Street and ordinary life would swell into a difference in kind. I expected readers of the future to be outraged that back in 1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid $3.1 million; I expected them to gape in horror when I reported that one of our traders, Howie Rubin, had moved to Merrill Lynch, where he lost $250 million; I assumed they’d be shocked to learn that a Wall Street C.E.O. had only the vaguest idea of the risks his traders were running. What I didn’t expect was that any future reader would look on my experience and say, “How quaint.”

… John Gutfreund did violence to the Wall Street social order—and got himself dubbed the King of Wall Street—when he turned Salomon Brothers from a private partnership into Wall Street’s first public corporation. He ignored the outrage of Salomon’s retired partners. (“I was disgusted by his materialism,” William Salomon, the son of the firm’s founder, who had made Gutfreund C.E.O. only after he’d promised never to sell the firm, had told me.) He lifted a giant middle finger at the moral disapproval of his fellow Wall Street C.E.O.’s. And he seized the day. He and the other partners not only made a quick killing; they transferred the ultimate financial risk from themselves to their shareholders. It didn’t, in the end, make a great deal of sense for the shareholders. (A share of Salomon Brothers purchased when I arrived on the trading floor, in 1986, at a then market price of $42, would be
worth 2.26 shares of Citigroup today—market value: $27. [Note: $16.50 today])
But it made fantastic sense for the investment bankers.

From that moment, though, the Wall Street firm became a black box. The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished. The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith.

No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.’s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.’s to be sold to its customers. The hoped-for short-term gain would not have justified the long-term hit.

No partnership, for that matter, would have hired me or anyone remotely like me. …

By comparison, the Somali pirates are pikers.