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.

1 comment:

polit2k said...

Background reading on handouts.

In Britain a national election lasts just three weeks and spending by each candidate is strictly capped. Campaigning between elections is not permitted. Accepting so much as a hotel stay from a lobbyist is a resigning offence. As a result, our news is full of the American campaigns to make up for the deficit in newsworthy political conflict locally. I follow the American election, as does most of the world given the potential for good and ill that proceeds from it. Please indulge me in ruminating on one aspect of the Obama candidacy that intrigues me.