Dispatches from a Small Business
Posts tagged ‘bailouts’
The answer to all of Obama’s spending in trillion dollar chunks is obvious. All we have to do is make our currency work just like that of Zimbabwe, and we will be fine. We could pay off a trillion dollars with 10 bank notes (I bought just one the other day on eBay for $30 or so).
The problem, of course, is that this is what the Obama administration actually appears to be doing.
After giving tens of billions of dollars of our money to the auto makers, Obama has now figured out what I and many others knew years ago:
Obama, responding to a question during an online town hall meeting, said the current business model for U.S. carmakers was unsustainable and the Big Three would need to change their ways.
From the article, however, it is still clear that Obama has no intention of allowing GM to go into chapter 11, as they should have 6 months ago. There is a good political reason for this — remember what I explained before. Obama is working to equate chapter 11 with the disappearance of the American auto industry, clearly an untrue and facile proposition. Many large companies, from airlines to energy companies to equipment manufacturers, have gone bankrupt over the last several decades and continued operations or at least had their productive assets taken over by other companies. GM’s assets are not just going to go poof.
However, there is a clear set of winners and losers in a bankruptcy — and there is enough case law on it that all the players at GM know it and they know into which category they fall. Those who are lower down the food chain are hoping that putting the restructuring in Obama’s hands rather than those of the bankruptcy process will improve their outcomes. And, to get those higher on the food chain (ie senior debt holders) to accept this they need the government to bring taxpayer money to the table. The whole point of an Obama-led restructuring, then, is not to somehow preserve the US auto industry but to improve the financial position of certain GM stakeholders at the expense of US taxpayers (and probably consumers, and some sort of protectionism is likely to be part of this deal).
But here is the most interesting point that was really hammered into me in reading this article. If you were to rank Obama as to where he stood vis a vis all American adults in terms of his knowledge of business and what it takes for a company to be successful, where would you rank him? I don’t think very many would put him in the top half. In fact, given that he has never, to my knowledge, had any real job in business of any sort (not even a high school job at McDonald’s or something similar), I am not sure I would put him above the 10th percentile. Anyway, put your own number to this question, and then read these quotes from the linked article
The president said he planned to announce decisions on the future of the industry in the coming days.
“But my job is to measure the costs of allowing these auto companies just to collapse versus us figuring out – can they come up with a viable plan?” he said.
White House spokesman Robert Gibbs said Obama will announce his strategy for the auto industry before he leaves for Europe on Tuesday.
Seriously, would you hand over your business or your stock portfolio for Obama to manage? I didn’t think so. It takes years of experience to be able to read a business plan skeptically. And even people who are experienced at it fail a lot.
By the way, for those who suspect that decisions will not be based on actual market realities but satisfaction of pet political goals, you are probably correct:
The president said even as the economy bounces back, Detroit can’t focus on “trying to build more and more SUVs and counting on gas prices being low.”…
Gibbs said Obama still thinks U.S. automakers build cars that Americans want to buy. Both he and the president own Ford Escape hybrids. “It’s a nice car,” Gibbs said. “It really is.”
So, for example, one can assume its likely the Obama strategy for GM success will include lots of hybrids. Of course, the market reality is this:
the slowdown has been particularly brutal for hybrids, which use electricity and gasoline as power sources. They were the industry’s darling just last summer, but sales have collapsed as consumers refuse to pay a premium for a fuel-efficient vehicle now that the average price of a gallon of gasoline nationally has slipped below $2.
“When gas prices came down, the priority of buying a hybrid fell off quite quickly,†said Wes Brown, a partner at Los Angeles-based market research firm Iceology.
I personally believe that a meer restructuring of GM is unlikely to create a turnaround, as I discussed here.
Postscript- It is a bit apples and oranges for me to say that Obama is evaluating business plans here. In fact, he is not. Though he calls them that, if the Chrysler retructuring plan they put on the web is any guide, these are political plans, not business plans. No real business plan, for example, seeking to attract private capital would prioritize the goals “Commitment to Energy Security and Environmental Sustainabilityâ€, “Compliance with Fuel Economy Regulations,†and “Compliance with Emissions Regulations†ahead of “Achieving a Competitive Product Mix and Cost Structure.†In fact, the section about costs and competitive products comes dead last in the Chrysler plan, almost as an afterthought.
Update: This sad story about athletes and their difficulty in managing their money seems relevent. These guys, who have spent their whole life getting really good at one thing, don’t even have the basic financial vocabulary to understand money management, and absolutely no ability to parse a business plan:
It began in the winter of 1991 when he sank $300,000 into the Rock N’ Roll Café, a theme restaurant in New England designed to ride the wave of the Hard Rock Cafe and Planet Hollywood franchises. One of his advisers pitched the idea as “fail-proof, with no downsides,” Ismail recalls. He never recouped his money and has no idea what became of the restaurant.
Lesson learned? If only. After that Ismail squandered a fortune funding not only that inspirational movie but also the music label COZ Records (“The guy was a real good talker,” says Rocket); a cosmetics procedure whereby oxygen was absorbed into the skin (“We were not prepared for the sharks in the beauty industry”); a plan to create nationwide phone-card dispensers (“When I was in college, phone cards were a big deal”); and, recently, three shops dubbed It’s in the Name, where tourists could buy framed calligraphy of names or proverbs of their choice (“The main store opened up in New Orleans, but doggone Hurricane Katrina came two months later”). The shops no longer exist.
You might say Ismail had a run of terrible luck, but the odds were never close to being in his favor. Industry experts estimate that only one in 30 of the highest-caliber private investment deals works out as advertised. “Chronic overallocation into real estate and bad private equity is the Number 1 problem [for athletes] in terms of a financial meltdown,” Butowsky says. “And I’ve never seen more people come to me about raising money for those kinds of deals than athletes.”
Doesn’t this sound like the current administration in microcosm? Does Obama have any better chance with his GM investment?
The Liberty Papers thinks we have become a lawless Banana Republic. George Will is thinking along the same lines, snarkily observing that Sweden, China, and Mexico have all observed in one way or another that the Feds seem to be acting outside the rule of law.
I have opined in the past that what really extended the Great Depression was not any real underlying economic issue, or even vast increases in government spending per se. It was that arbitrariness with which the Roosevelt administration dealt with economic matters. With nutty programs like the Mussolini-inspired National Industrial Recovery Act coming and going, investors and businesses never knew from day to day what the rules of the game would be next year, or even next week.
I fear that this is exactly the climate Obama and Congress are creating today.
As of two months ago, my company was still investing. We were still getting bank credit, particularly for equipment financing, though it took more work than in the past to secure it. We still saw opportunity in our business, and in fact saw increased opportunity in the recession for low-cost recreation options and outsourcing of public recreation facilities.
But today, I am reluctant to make any new investments. Investing $5000 now for $8,000 a year from now normally sounds good, but what happens now that the Feds have more than doubled the money supply? How much will $8,000 really be worth a year from now? What will my taxes be on the increase?** What new costs or liabilities might be retroactively placed on me for making the investment? What happens if beltway pundits start thinking I am making too much money?
All this commotion of government intervention started when Paulson and other Bush appointees started screaming that the banking system was going to shut down and therefore crash the whole economy. As my readers know, I believe to this day that this was all sky-is-falling over-reaction and panic-mongering, and most of the credit crunch resulted from uncertainty about the Treasury and its statements, not due to realities on the ground. However, whatever tightening of credit we might or might not have avoided by government action, it pales in its effect on investment in comparison to the arbitrariness and trillion-dollar-plan-of-the-day that has been the first 60 days of the Obama administration.
** footnote: For those of you who have not lived through high inflation times, taxes and inflation are a deadly combination. That is because the Federal Government, after creating inflation, then taxes each of us on its effects. Here is an example: Invest $5000 now at a fixed 10% a year. Suddenly, inflation goes up to 8% a year. In five years, I now have a bit over $8000. In economic terms I have made a small profit of, since $8000 in five years at 8% inflation is worth $5,445 today.
But the IRS thinks I have made $3000, not just $445, and will tax me on the full $3000. If they take a third, I only have $7000 at the end, or $4,764 in current dollars, meaning that after taxes, I actually lost money.
As has been the case for decades (the gun-to-the-head federal strategy to force 55 mph speed limits and seat belt laws come to mind), the feds are sending money to the states with many strings attached. Apparently, Arizona is running afoul of one of those provisions:
Arizona’s receipt of $1.6 billion in stimulus funding, including more than $300 million already being spent to help keep the state in the black, is at risk because a federal agency says the state is not in compliance with a prohibition against health-care rollbacks.
Arizona could lose the money if the federal determination stands or if state law isn’t changed to eliminate a health-care requalification provision that was the basis of the determination, state officials said Monday.
According to Brewer’s letter, the agency determined that the Arizona Health Care Cost Containment System’s requirement that some enrollees requalify every six months instead of annually violated a stimulus-program prohibition against tightened eligibility standards, methodologies or procedures for a state’s Medicaid program.
There is something supremely irritating about Federal bailouts to states that are tied to restrictions that make it more difficult for states to close their budget shortfalls on their own. It’s almost as if Congress wants to institutionalize dependency on the Feds (where have we seen that before?)
Apparently, in the spirit of the retroactive tax-taking of the AIG deferred compensation payments, the restrictions are retroactive to state actions taken as early as July 1, 2008, meaning that Obama is asking states to roll back legislation that was passed months before he was even elected as a condition of getting the cash.
The actions causing problems for Arizona occurred in September, 2008, and were, according to our governor, the result of legislation passed in June of 2008.
via Paul Kedrosky (click to enlarge)
I guess the disputed $175 million in deferred compensation payments should be on here as well, though the line would be too infinitesimally thin to draw. The CDS stuff gets the attention, but the securities guarantees are the largest flow. Are these guarantees of traded securities, like bonds and equities? If so, it sure is a happy notion for all of us taxpayers with portfolios that are well under water that we are going to send some of our money to help bail out the losses in the Goldman Sachs portfolio.
A couple of questions about AIG:
1. Is there any real legal difference between the contractual commitment by AIG to pay bonuses to employees and their contractual commitment to pay off mortgage bond guarantees to companies like Goldman Sachs? **
2. In a bankruptcy, how senior would contractual promises of deferred compensation to employees be? Everyone comes after the government, of course, but would such claims be more or less senior to, say, commitments to pay counter-parties?
** before claiming one commitment was outrageous and unjustified, one needs to be clear which commitment he is referring to, since both commitments in retrospect seem crazy to me. It is just that one party (ie Goldman Sachs), which has the added advantage of being represented by many of its former employees in the Treasury department, has convinced Congress and the Administration that not paying them carries systemic risk to the economy.
That seems to be the new key to government largess: Carrying systemic risk. It used to be one wanted to be poor or female or black to merit special consideration in the government spending sweepstakes. But nowadays, in our post-racial society, the key is to be the one who can wrap himself in the flag of “systemic risk.” Here is AIG’s entry into the “we have systemic risk, so give us taxpayer money” essay contest.
Referring the Senator Grassley’s statement that AIG executives who are receiving bonuses should “resign or go commit suicide,” David Harsanyi responds:
C’mon. If suicide were a proper penalty for piddling away taxpayer dollars, the National Mall would look just like Jonestown after refreshments.
The normal process for bureaucratic allocation of, say, highway funds, does not always work that well. Seriously, you don’t have to convince this libertarian of that. But it is at least intended to try to balance priorities and allocate the funds marginally rationally. Which points out the problem with earmarks — they are overrides by Congress of the normal allocation and prioritization process for political ends. By definition, the projects in earmarks would not have normally been funded by the usual operation of the prioritization process.
Which brings me, oddly enough, to AIG (and to GM). When companies can no longer meet all of their obligations, they generally file for chapter 11 bankruptcy. This is an extremely well-worn process, both in the courts and the business community, that attempts to save as much value as possible and to allocate that value, based on law and a set of rules everyone understands in advance, to the various stakeholders. The folks who are involved in this process are pretty hard-headed folks, less out for revenge and retribution as for maintaining value and capturing as much as possible for whatever group one might represent.
Now Congress and the Administration are getting themselves involved in the bankruptcy process, by trying to avert actual chapter 11 filings by AIG and GM. By doing so, they are effectively overriding the bankruptcy process. Just as with earmarking, they claim this override is for some good of the country. But, just as with earmarking, you can assume it is to benefit some politically-favored group. At GM, the feds are saying that we don’t want employees or the equity holders to take a haircut, as they would in Chapter 11, so we will transfer the loss to taxpayers, and perhaps bondholders (could there be any politically less favored group than taxpayers?). Same at AIG. Is it any surprise that the number one beneficiary of the Pauslon bailout of AIG was Goldman Sachs? The Left thought they smelled a rat when the administrations contracted with ex-Cheney-run Haliburton in Iraq, but no one is going to bat an eye when the Treasury department, populated with ex-Wall Street types, is bailing out all its employees’ old firms?
On the subject de jour, the AIG executive bonuses, many of these were just as guaranteed, contractually, as were payments on AIG policies and bond guarantees. I don’t know how such obligations are treated in chapter 11 (are they treated as more or less senior than other obligations?) but I do know the decision to keep them or ditch them would be made against a goal of maintaining long-term value, and not public witch-hunting.
This is the real problem, even beyond the taxpayer cost, of this new form of Congressional or Administration-led pseudo-bankruptcy: Winners and losers are determined by political power and perceptions of short-term political gain, rather than against a goal of maintaining value and following well understood and predictable rule. This process throws all the old predictable rules and traditions out the window. Investors and folks with contracts used to know just how senior their obligations were in a corporate failure. Now, they have no idea, as their position in the bankruptcy may in the future depend more on how much they donated in the last presidential election, or how good their PR agent is.
Thomas Sowell, via Carpe Diem:
The current political stampede to stop mortgage foreclosures proceeds as if foreclosures are just something that strikes people like a bolt of lightning from the blue– and as if the people facing foreclosures are the only people that matter.
What if the foreclosures are not stopped? Will millions of homes just sit empty? Or will new people move into those homes, now selling for lower prices– prices perhaps more within the means of the new occupants?The same politicians who have been talking about a need for “affordable housing” for years are now suddenly alarmed that home prices are falling. How can housing become more affordable unless prices fall?
The political meaning of “affordable housing” is housing that is made more affordable by politicians intervening to create government subsidies, rent control or other gimmicks for which politicians can take credit. Affordable housing produced by market forces provides no benefit to politicians and has no attraction for them.
In the wake of the housing debacle in California, more people are buying less expensive homes, making bigger down payments, and staying away from “creative” and risky financing (see chart above). It is amazing how fast people learn when they are not insulated from the consequences of their decisions.
If the CEOs of banks that take federal money, including those who took federal money only after Hank Paulsen essentially ordered them, have their salary capped at $500,000, under what principle do we allow universities that request federal funding to pay their own presidents much more money? Is there a rational basis for the distinction, or is it simply that the Democrats do not want to go after one of their most important constituents?
Forget about the university presidents, what about the football coaches? One Hundred Billion dollar banks can’t pay their CEO’s or deal-makers more than $500,000, but state-run football programs can pay their coaches $ 4 million dollars?
Once upon a time, most entrepreneurs organized their business as what is called a C-Corporation. Most of the publicly traded corporations you can think of, from Avon to Zenith, are essentially C-Corporations. Such corporations had any number of advantages, but they had (and still have) one big, big disadvantage. C-Corporations paid federal income taxes at the corporate tax rates. And then, if after-tax profits were dividended to owners, those dividends would be taxed again. This double taxation of earnings is something Congress talks about all the time, but never does much about. And the implicit government tax subsidy for debt over equity does a lot to explain various waves of merger and LBO activity we have seen since the 1980′s.
Now, entrepreneurs were not stupid. No one wants their hard-earned income taxed twice. So, entrepreneurs who owned C-corps would do one of two things. One approach was to have the owner pay himself a large salary, thus reducing corporate income and converting the dividends to more tax-advantaged wages. The other approach was to have the company issue the owner loans rather than dividends. I have seen many closely-held C-corps with huge accumulated corporate loans to their owners, which may only be unwound years or decades later when the company is sold or liquidated and profits can be taken out a lower capital gains rates.
Over the last 20 years or so, a new corporate vehicle called the sub-chapter S or S-corp has become popular. With a few limitations, the S-corp offers all the same liability protections as a C-corp, with a big tax advantage: S-corps are not subject to corporate taxes — corporate profits of the owners flow straight through the corporation to the owners’ 1040 personal returns, eliminating any double taxation (Limited Liability Corps or LLC’s operate roughly the same, but with slightly different rules). For this reason they are also sometimes called pass-through entities.
It is interesting to note something I never hear mentioned when discussing aggregate personal income data, which is that the switch over time from entrepreneurs using the C-corp to the S-corp creates something of a discontinuity in the income data. Thirty years ago, much of the annual corporate earnings, and all of the retained earnings, of business owners would not show up in the IRS personal income data — it shows up as corporate income, but not personal income. Today, nearly all of that corporate income of small business owners shows up as regular income on personal tax returns. Absent any other changes in income trends, business owners as a group will appear to have large increases in taxable income, when in fact economically nothing may have changed save the corporate structures of their businesses.
But the real point I want to make is that all of the retained income and potential investment capital of a small business using S-corps or LLCs (which is nearly everyone nowadays) shows up on the owner’s personal income tax returns. Let’s hypothesize an entrepreneur whose S-corp earns $250,000 in profits after-tax. Let’s say he typically puts $150,000 of that to savings and living expenses, and the other $100,000 is reinvested in the growth and/or productivity of the business. Now let’s look at proposed increases in upper income tax brackets. With these higher proposed rates, the business owner will have less than $250,000 in after tax income. Let’s say it goes down to $220,000. Odds are that the owner will retain his lifestyle (he will as a minimum still have the same size mortgage and school and other payments). The slack, then, comes out of the retained earnings. Essentially, higher taxes result in less investment capital. In fact, we can see an increased tax rate on wealthier entrepreneurs and business owners could easily result in a dollar for dollar reduction in business investment among small businesses, acknowledged to be the place where most all new jobs are created.
I think readers know that I don’t fully accept the Obama administration’s analysis of this recession. However, let’s take them at face value for a moment. They are concerned that savings of average people won’t currently translate into more business investment, as they fear the credit crisis causes banks to hold the savings rather than re-lend it. If this were the case, then it would mean that as a policy, we would want to preferentially route tax savings to entrepreneurs and business owners who invest their own money directly, because their is no intermediary of a bank to interfere with the process. But in fact, this is exactly opposite of what the Obama administration is doing through tax policy, instead taking away the investment capital and retained earnings of entrepreneurs through higher taxes.
This is the European-style corporate state in a nutshell. In Europe, entrepreneurship is made extraordinarily difficult. This is part of the deal that the political elite have with the largest companies in their countries — we will protect you from potential new competitors, we will bail you out when times get tough, and you in turn will support us politicians. One only has to look at the turnover of the top 30 companies in the US since 1970 vs. the top 30 in Germany or France to see this at work. Political turnover is even slower, as an elite group of ministers run the country, almost no matter the party voted in office. The economy as a whole suffers, but for the top 1000 or so men in power, the system works to protect their position, be it in government or in the largest industries.
And now we bring this system to the US. Small business owners and entrepreneurs are punished with higher taxes in order to bail out politically powerful but failing companies like GM or Citicorp. Welcome to America, the new corporate state.
Postscript: A lot of folks erroneously associate corporate states with right-wing governments, and certainly that was the case in Mussolini’s Italy. But the closest brush the US has ever had with such a system (prior to today) was implemented by leftish FDR via the National Industrial Recovery Act, and governments of both left and right have supported the corporate state approach of France and Germany. In Britain, it was the left that built the corporate state and the right, under Thatcher, who tore it down.
Remember that time, after the Enron bankruptcy, when gas trading and transportation came to a halt in the US? Or when air transportation ground to halt after Frontier, ATA, Aloha, Delta, Northwest, United, and US Airways all filed for bankruptcy in a 3 year period? Or when half of California lost power when PG&E went bankrupt? Or when car production came to a halt when parts supplier Delphi went into Chapter 11?
Yeah, neither do I. That’s because we have a system, that works pretty well and is certainly well-rehearsed, for corporate bankruptcies. And the number 1 design consideration of this system, the most important assumption behind the whole process, is that creditors will ultimately get more value if the company continues to operate.
GM has painted a picture that the US automotive industry will come to an end if they have to declare bankruptcy. This is complete BS. As I wrote the other day, this is an effort by management and certain other constituencies (labor, equity holders) to get the government to intervene not because it is better for the country or the industry, but because it promises to advance their interests at the ultimate expense of taxpayers and bondholders. This is a power play. Holders of the senior debt have the power and call the tune in Chapter 11. If management can get Obama and Congress to substitute themselves for a Chapter 11 judge, then management can hold onto their power.
I feel like the press has done little to call BS on this whole argument, and has generally supported the auto company narrative (don’t discount the fact that auto dealers are the #1 advertisers, by far, in local TV stations and newspapers). But I was happy to see this in the WSJ, via Carpe Diem:
GM continues to argue that it couldn’t survive a Chapter 11 proceeding, but the truth is that bankruptcy could boost its ability to survive. As the Obama administration considers its response to GM’s request for more cash, it should be mindful of the advantages of bankruptcy that haven’t been highlighted — certainly not by GM’s management.
GM executives have been saying that in Chapter 11 its network of suppliers would collapse, dragging down the rest of the auto industry with their company. But Chapter 11 has well-established procedures to deal with this concern.
Bankruptcy may be the only way for GM to fully confront its operational problems, deal with its legacy costs, reconfigure its dealer network, and achieve a viable labor agreement.
But one issue that has not been discussed much is that bankruptcy usually leads to a sharp change in management. There are turnaround teams expert at restructuring troubled companies, and they may well be more effective than GM’s current management. It’s no surprise GM’s management isn’t advertising this fact, but taxpayers and the government should know about it.
In the end, the administration needs to keep in mind that vital elements in GM’s restructuring — recapitalizing its large bond debt and keeping what cash it has flowing to key suppliers — are often dealt with successfully by bankruptcy courts. A bankruptcy could save GM — though maybe not its management.
I just skimmed through Obama’s speech. I am not particularly good at parsing this political stuff, so I won’t. The speech had a lot of the typical politician’s assertions about features of his programs that have no basis in their actual design. For example, he asserts that home bailout money won’t go to the irresponsible, but there is no such design element in his actual plan (homeowners are eligible for bailouts based on various hard-wired value formulas and ratios — there is no step where their motivation for becoming overextended is or even could be assessed, nor any step where the government may exercise discretion).
Anyway, the one overriding sense I got from reading the speech was that I was totally correct when I wrote this:
So you ask, will we get any stimulative effect? I would answer: Just one. Obama and Congress will now shut the hell up trying to panic everyone into battening down the hatches for the worst economy in history, and folks can get a bit of breathing space to look around them and see that business opportunity is still there. This is $800 billion in hush money, a bribe we are paying Obama and Pelosi in the form of passing a lot of their pent up leftish wish list, in return for them taking some ownership interest in real economic health.
Cooler heads are looking at the world economic data, and starting to come to the conclusion, voiced by yours truly a number of times, that the US financial crisis was/is a symptom of a world economic slowdown, not the other way around
Compare the decline in real GDP over the past 4 quarters (from The Economist):
U.S.
-0.2%
France
-1.0
Germany
-1.6
Britain
-1.8
Italy
-2.6
Japan
-4.6
Does it make sense to blame the largest declines in GDP on one country with the smallest decline? If so, then we need some explanation of how some uniquely American “illness has spread†to so many innocent victims.
If the explanation is supposed to be falling U.S. imports, then the worst decline by far would have been in Canada and Mexico (where real GDP was rising even in the third quarter). If the alleged causality is supposed to be because of some undefined links between financial centers, then Italy would not be among the hardest hit.
When it comes to trade, in fact, the shoe is mainly on the other foot: Collapsing foreign economies crushed U.S. exports.
In the second quarter of 2008, U.S. exports accounted for 1.54 percentage points of the 2.83% annualized rise in real GDP. But falling exports subtracted 2.84 percentage points from fourth quarter GDP. Falling exports, not falling consumption, were the biggest single contributor to the overall drop of 3.8%.
After looking at which economies fell first and fastest, it might be more accurate to say that some foreign illness has spread to the U.S. economy than to assert or assume the causality ran only in the opposite direction.
The Chrysler web page for their restructuring plan they presented to the Feds is here. The summary pdf my comments are based on is here. Thoughts:
In the new corporate state, this is what business plans will look like. Because were aren’t selling returns and wise investment of capital, we are selling the care and feeding of political constituencies and pressure groups.
Postscript: OK, I realize I criticized the plan without suggesting what should be in it. Here is what I would demand as an investor: An achnowlegement and discussion of the reasons for past market share slide, and targeted actions to reverse these trends. As Chrysler has said they have been working on this problem for 30+ years, the proposed solutions will need to sound radical, not incremental. Further, they need to stop complaining that below-market rate consumer financing does not exist, and explain how they are going to sell cars at a price that covers their costs as well as a return for shareholders.
Well, while I was gone this week, GM asked the government for another $21.6 billion, on top of the $17.4 billion taxpayers handed them just two months ago. Reading between the lines of GM statements, it is probably not crazy to assume they are burning cash at the rate of $5-$8 billion a month, which means this new infusion would likely get the company only through May or June. This burn rate should not be surprising, as GM was burning $2.5 billion a month before the recession even really started, and they have really done nothing substantial to restructure the company. By throwing the company to Congress to help save its managers and equity holders, the company has subjected its restructuring not to hard-headed bondholder representatives in a bankrupcy, but to the vagaries of the political process:
When the president’s auto task force meets today to begin trying to fix the broken U.S. auto companies, it must balance dozens of competing demands.
Yeah, I am sure that will go well. GM can have its money as long as it puts a factory in West Virginia and names it after Robert Byrd. The bondholders are pissed, as well they should be. The senior debt holders have first claim in a bankruptcy, so another way to look at this political process is that it is the action of all the other constituents of GM (employees, equity holders, managers) who are trying to get Congress to interrupt the typical subordination of interests in a bankruptcy and allow them to get ahead of the senior debt holders in the line for what limited value remains in GM’s shell.
I am tired of Keynsians and their assumptions setting the tone of the economic debate. Here is the question I would ask them:
I understand that you Keynsians think that there are under-employed assets in the country, and that you think the government can redeploy prvate investment capital to more productive use.
Ignoring the individual liberties issues assosiated with this approach, as well as the fact it has never worked in the past, answer me this: How are we going to turn around the economy by forcing capital to flow to the assets, industries, and management teams that have proven themselves to be the least productive?
We send money preferentially to the industry (autos) that has been showing some of the worst returns on capital in the entire country, and in particular to the company (GM) that has performed the worst in the industry. If we really wanted to create auto jobs, wouldn’t we send the money to the company that has historically invested money the most productively? It would be as if venture capitalists were about to complete their 27th round of financing to keep Pets.com afloat. I have been in a company that eventually failed and couldn’t get new financing. At the time we were trying to convince the investors that they should give us just one more round, one more chance to prove the thing out. In retrospect, I am embarrased they funded us as long as they did. They should have pulled the plug way earlier. Investors have a saying “your first loss is your best loss.”
And don’t even get me started on housing. A deader, less productive investment asset can’t possibly be identified. A million bucks spent on a house produces 30 jobs for 6 months. A million bucks spent on a factory expansion produces 30 jobs indefinitely. For years, Democrats have hammered the Republicans over the jobless recovery of this decade, which in fact has shown a fairly unique jobs profile. I wonder how much of this could be traced to the myriad incentives that were put in place to pour our available capital into these dead assets? And now, with the bailout and the new mortgage bailout, the government is investing even more money to prop up the value of these non-productive investments.
It has been interesting to watch the reaction to Obama’s mortgage-holder bailout. Certainly the plan is expensive, likely largely ineffective, and has terrible long-term impacts on incentives. To my libertarian eyes the plan is awful, but no more awful, and actually less expensive (incredibly!) than other bailouts and legislation pouring out of Washington of late. Like everything else we are seeing, it is a hair-of-the-dog plan: fix government over-promotion of home ownership with more government promotion of home ownership; Fix the fact that individuals are over-leveraged by trying to keep them in their mortgages.
But this issue changes the political map to some extent. The usual rhetoric about milking one group to help another who are “on the outs by no fault of their own” is just stretched past credulity on this one. Sure, there are enough folks who were really tricked or scammed in their mortgages to fill up any length of a news segment with tearful anecdotes. But the 50% of the country that rents or the large percentage of homeowners that didn’t chase around after zero-down house-flipping deals don’t seem to be buying that their tax money is now flowing to innocent victims.
Postscript: I know there is a tendency to leap onto this “fraud” excuse to help assuage one’s ego. Yeah, I wasn’t stupid, I was tricked! Well, I am in some financial tough times, and I will declare it here publicly: It is all my fault. I got overly exuberant in expanding the business, and doubled down on my mistake by agreeing to a large financial commitment based on a bank’s loan commitment letter, rather than an actual loan (a commitment letter that was pretty much worthless as the bank went into FDIC receivership). I have found, by the way, that my banks have been very reasonable about restructuring commitments as long as I come to the table with a plan showing how I intend to pay them back every cent that is theirs (yes, I said it, it is theirs – it is their money) though just with altered terms and timing. The good news is that a ebbing tide reveals a lot of rocks, and the business has been vastly improved by the thorough review and restructuring we have put it through of late.
October 2008 was a failure of nerve. As so often happens, folks who normally support letting failing institutions fail when times are good tend to lose their nerve when the crisis is at hand, and find some way to convince themselves that somehow, this time is unique and different. But it is not. Only later is there remorse. I won’t want to pick on Megan McArdle too much, if for no other reason than she is generally the first person on the planet to admit she is wrong, but you can start to see some of the remorse here:
We’re now making many of the mistakes that Japan did. I know, I know–I supported TARP I. But I did so because at the time, there seemed to be a reasonable possibility that the funds could stop a liquidity crisis from turning into a solvency crisis. But if liquidity crises go on long enough, they become solvency crises, so whatever we had then, we now have a badly crippled banking system. More of the same isn’t going to help.
We need a plan that is going to force the banks to recognize and write down their bad loans, restructure dysfunctional borrowers, shut down the banks that are too far gone, and inject substantial capital into the banks that are strong enough to pull through. But that kind of radical action is scary. And whether they decide to do it by nationalizing bad banks, or by injecting capital into good ones, the political cost is going to be very high. So we get baby steps and vague promises of major leaps forward down the road.
Another political problem is that recapitalizing the banking system involves, in the initial stage, conserving capital (read: cutting credit limits), and writing down bad loans means unpopular actions like restructuring failing companies (read: layoffs) and foreclosing on hopeless borrowers. One of the major arguments against bank nationalization is that a government-owned bank will find it harder, not easier, to do those things. The temptation to keep large employers on life support will be large, and every congressman will have a list of firms in their district that can’t be allowed to go bust.
I have tried to have this and other bailout arguments with a number of folks. This is often a hard conversation, because people have trouble separating in their minds the productive assets of these companies (factories, investments, systems, deposits, trained people) from the institution itself. So when we talk of bankruptcy of, say, GM, they think if GM goes poof, then all those factories and cars go poof.
But that is absurd. Remember the huge gas shortages that resulted from the loss of the Enron gas trading desk and transportation infrastructure when Enron went bust? Yeah, neither do I. That’s because all of Enron’s productive assets flowed through the well understood chapter 11 (or was Enron Chapter 7) process to new owners.
By the way, by management, I mean something broader than just the CEO or the top tier of managers:
A corporation has physical plant (like factories) and workers of various skill levels who have productive potential. These physical and human assets are overlaid with what we generally shortcut as “management†but which includes not just the actual humans currently managing the company but the organization approach, the culture, the management processes, its systems, the traditions, its contracts, its unions, the intellectual property, etc. etc. In fact, by calling all this summed together “managementâ€, we falsely create the impression that it can easily be changed out, by firing the overpaid bums and getting new smarter guys. This is not the case – Just ask Ross Perot. You could fire the top 20 guys at GM and replace them all with the consensus all-brilliant team and I still am not sure they could fix it.
Bankruptcy is a scary term, but here is what makes it beautiful — it takes assets out of the hands of failed management, failed business plans, failed management cultures, etc. and puts those assets in the hands of new owners and managers. These new owners and managers are not guaranteed to be better at managing the assets, but the odds are they will be since the performance bar set by the last management team is by definition so low (ie, they went bankrupt!)
When we interrupt the bankruptcy process and bail out a failing company, we do two things:
Here is the true economic miracle of the 80′s and 90′s: Not Reagan’s tax cuts or Clinton’s economic plan or Alan Greenspan in the Fed. It was the fact that the government, with the American economy sweating under some very difficult conditions (worse than they are today, but you would never know it in the press) and under strong threats from Japan and Europe, basically did … nothing. There was all kinds of pressure to create an American MITI (seriously, it seems like a joke today, but the push was strong). We did not. The American economy was allowed to restructure itself.
This is why our recessions tend to be shorter than those in Japan and Europe. These other economies are generally more of a corporate state, with a major goal of the government to maintain the incumbents in the corporate world. I would argue that the key determinants to recovering from a recession quickly are asset, capital, and labor mobility. Japan has many structural limitations on these, and it dragged their recession out for years. In the name of trying to avoid the problems Japan has faced, we are repeating the exact same mistakes. Every step we have taken so far to deal with the “crisis” have reduced the asset, capital, and labor mobility the economy needs to right itself.
We will be posting on the stimulus bill for months and years, because it will take that long to figure out what was in it. Congressman who voted for it may never know what they actually voted for. Veronique de Rugy takes a first swing at it:
Total spending amounts to $792 billion, with $570 billion in direct spending and $212 billion in tax provisions. These numbers don’t include the massive amount of interest that will accrue on the increased debt. If we include that, the total amount comes to $1.14 trillion.
Supporters of the package describe the legislation as transportation and infrastructure investment, the idea being to use new spending to put America back to work while at the same time fixing decrepit infrastructure. However, only 17 percent of the discretionary spending in this package is for infrastructure items. More worrisome still, the final version lacks any mechanism to ensure that spending will be targeted toward infrastructure projects with high economic returns
De Rugy actually overestimates the infrastructure spending, because she looks at the spending over 10 years. Since the stimulative effect of infrastructure spending in this recession is, at most, limited to 2009-2010 spending, and since the infrastructure spending is more back-end loaded, the percentage is much lower in the first 2 years — something like 6-7% as I calculated here (I will go back through the CBO reports with an update when I get a chance, but Kevin Drum links them here, hilariously saying they “scored well.”
Unfortunately, even this seems to wildly underestimate the true cost of the bill. In creating the bill, Congress increased the general operating funds for zillions of departments and programs (remember, 80+% of the spending is departmental budget increases, not infrastructure construction). However, they show these increasing disappearing after a couple of years. We all know that Democrats consider removing an increase to be “a massive cut” so we can assume that at some point, these budget increases will be extended for eternity. If one makes this more realistic assumption, then the cost of the stimulus bill is over $3 trillion! [update: Carpe Diem demonstrates this with a nice set of graphs]
My other project I am working on is to look at some of the “shovel ready” projects on the mayor’s list here (warning! 600 page pdf!!) in the Phoenix area. My incoming hypothesis is that any project on here either:
I won’t spill the beans yet, but here are a few tastes from the Phoenix area:
Well, it looks as if the “stumulus” bill has passed, and its all over except for the conference committees (which will likely comprimise the House and Senate bills by adding a $100 billion or so).
There is just no way there can be a Keynesian muliplier above 1 for such spending. Even if someone could show me a theoretical example crafted for a particular economic situation with the best of all governments, there is simply no way this real-world government is going to spend the money that well. 500 geniuses with perfect incentives couldn’t do it, and certainly the folks in Congress are not geniuses and have far less-than-perfect incentives.
So you ask, will we get any stimulative effect? I would answer: Just one. Obama and Congress will now shut the hell up trying to panic everyone into battening down the hatches for the worst economy in history, and folks can get a bit of breathing space to look around them and see that business opportunity is still there. This is $800 billion in hush money, a bribe we are paying Obama and Pelosi in the form of passing a lot of their pent up leftish wish list, in return for them taking some ownership interest in real economic health.
Apparently, Obama is trumpeting victory because a company that will recieve a lot of the stimulus money will likely hire more people.
President Barack Obama says Caterpillar’s chief executive has told him the company will rehire some laid-off workers if the stimulus bill passes.
The heavy equipment maker announced more than 22,000 job cuts last month as it scales back production amid the economic slowdown.
Seriously, do proponents of the stimulus really think that we opponents don’t understand that individual projects funded by this new bill will employ people on the project? I guess they do, because I had this very argument last night. So, to clarify my position, I fully understand and comprehend that projects that get additional funding in the new bill will likely employ more people on that project than if they had not been funded by the bill.
The issue is that the $800 billion of “stimulus” comes from somewhere, in this case borrowing paid for by future taxes. At any point in time, there is only so much investment capital out there in the world. So, the real question is not whether Caterpillar will hire more people if the government throws money its way. The real issue is who won’t be hired somewhere else because $800 billion of investment capital that was going to be employed for some private purpose is now going to be spent by the government.
For those who are not confused about this, and want to discuss the multiplier, which is another way of asking how the net gains and losses described above balance, there is a good back and forth here.
One thing this country just seems incapable of considering — it may be that there is simply nothing the government can do to make this recession better. Everyone, from consumers to lenders, find themselves overleveraged and new spending is simply going to go down for a while until everyone feels comfortable with their reserves. The only thing Obama has done so far is, by spreading panic, to increase the size of reserve everyone thinks they need (example here, and my analysis here)
Postscript: Obama’s actions of late are kind of funny. He has been criticized for lacking experience and having only really demonstrated the ability to campaign well. So, when things get tough and he starts to come in for some here-to-fore unprecedented criticism, he runs back to what he does best – campaign.
The post title is a quote from this video on the bailout, which is not a deep analysis of the financial crisis, but spot-on none-the-less. Via the Liberty Papers.
At what point do politicians bear some public accountability for their public statements and the effect those statements have on the economy? I almost want to ask Obama and Pelosi — what is the minimum size of pork-spending bill you will accept so we can just go ahead and pay the money and get you and your cohorts to shut the hell up on trying to convince everyone we are in the Great Depression. Because, to some extent, such statements can be a self-fulfilling prophesy. Seriously, the biggest stimulative effect of passing this stimulus bill will be, almost without doubt, that it will end the felt need for Washington weenies to create an atmosphere of panic.
Now, I suspect that I would have a different observation if I lived in Detroit, but I ask every business owner or manager I meet for the personal evidence they have of economic cataclysm. Is their business down? And in a surprising number of cases, I get the answer that their business is doing OK, but they are cutting back because surely the worst is soon to come, based on everything they see in the media. And do you know what? I have done exactly the same thing. I had one bad month, but since then things have been pretty steady, but I am cutting like crazy anyway, because I can’t ignore the only other information source I have on the economy, which are pronouncements in the media.
I strongly believe that public pronouncements of doom, starting last October with Henry Paulson and continuing now to almost daily excess by Obama (today’s statement: the economy is in a “virtual free fall”) have measurably contributed to job losses in this country. Many people who are on the street without a job today can probably trace their unemployment to “just in case” cuts made more in response to government assurances of doom as on actual declines in output.
I can’t prove this, of course, but I will present one pretty good pointer that I might not be totally full of it. With the January jobs report, the recent recession has become one of the five worst since WWII in terms of jobs losses as a percentage of the work force (I know you may, from reading the paper and listening to Obama, think it is the worst, but it is still only the fourth or fifth worst). Let me compare the job losses and the output declines at this point in the recession for these 5 recessions:
As you can see, we have had far more job losses relative to output losses than any major post-war recession. This does not mean that more output losses are not coming, but it means that, perhaps unique to this recession, job losses are preceding rather than following output losses — in other words, job losses are occurring more than in any other recession based on the expectation of output losses, rather than in reaction to them. I wonder who it is that is setting these expectations?
Wow, using panic to achieve political aims and in the process accelerating job losses. And they say we libertarians are heartless!
Data updated by the Minn. Fed here. They actually have job losses through 13 months, but I jused 12 months because there are only quarters for the output numbers.
Update: Via the Washington Times:
Just Friday, Mr. Obama said a report that 600,000 jobs were lost in January meant “it’s getting worse, not getting better. … Although we had a terrible year with respect to jobs last year, the problem is accelerating, not decelerating.” Last week he said, “A failure to act, and act now, will turn crisis into a catastrophe.”
But he isn’t the only Democrat ramping up the rhetoric while talking down the economy. House Speaker Nancy Pelosi of California said last month that our economy “is dark, darker, darkest.” Rep. David R. Obey of Wisconsin said, “This economy is in mortal danger of absolute collapse.” And Sen. Claire McCaskill of Missouri said of the economic-stimulus bill, “If we don’t pass this thing, it’s Armageddon.”
Michael Smith comments over at EconTalk on a comment by one Mark K (via Cafe Hayek)
Mark K wrote:
These jokers on Wall Street, who according to Russ made ‘innovative’ products like credit default swaps, showed us unregulated free market capitalism in all its glory.
The notion that we have an “unregulated free market†is false.
If we had an unregulated free market, the organizations and individuals that made stupid investment decisions — those “jokers on Wall Street” — would now be bankrupt, to be replaced by more competent organizations and managers. Instead, under the current system, they are “bailed out†— at your expense — and allowed to continue operating.
If we had an unregulated free market, the investment rating agencies that rated securities containing subprime loans as “AAA†would be disgraced, bankrupt and out of business — no one on earth would deal with them any longer — they wouldn’t be able to pay people to use their services. Instead, under our current system, not only are all those rating services still in business, the S.E.C. requires that all issuers of investments use those rating agencies.
If we had an unregulated free market, no one would be forcing bankers to make riskier loans than they wish to, as is currently done by legislation such as the Community Reinvestment Act and threats of lawsuits from organizations like ACORN and from the Federal Government‘s Justice Department (Clinton‘s DOJ filed 13 major lawsuits against banks for failure to lend to “minorities“).
If we had an unregulated free market, there would be no central banking entity in charge of a fiat money supply with the ability to:
a) Make vast amounts of credit available at below-market interest rates.
b) Follow such a persistent policy of inflation as to convince virtually everyone in the country that purchasing a house is “a good investmentâ€.
c) Eliminate ( or at least significantly reduce) risk aversion by guaranteeing bankers that they (the Fed) will always be there as “lender of last resortâ€.
d) Condone and make possible a preposterously over-leveraged fractional reserve banking system under which banks currently hold total reserves of only about 4% and are thus extremely vulnerable to any sort of a run or loss of confidence in the bank.
If we had an unregulated free market there would be no quasi-government entities like Fannie and Freddie and the FHA to insure that trillions of dollars of that cheap credit made possible by the Fed was directed into the residential housing market, producing an unsustainable boom in housing construction, which, when it ends, leads inevitably into an economic bust.
If we had an unregulated free market, the Federal Government would not now be contemplating looting the American taxpayers of another trillion dollars or so to pay off various special interests that helped the latest collection of looters get into power.
We don’t have an unregulated free market. We have a “mixed economyâ€, with a few elements of capitalism struggling under the weight of literally thousands of pages of rules and regulations and dozens of government agencies interfering in virtually every aspect of our economic lives.
And under this set-up, it is you, the “little guyâ€, the individual who doesn’t have a powerful lobby in Washington to get the rules bent in your favor — you, who cannot command an audience with Congress to beg for your personal bailout — you, who can do nothing as government uses your funds to save the incompetent and the dishonest from the consequences of their own actions — it is you who gets screwed.
We don’t have an unregulated free market; we have an out-of-control government intent on looting us blind.
Isn’t this exactly the type of government policy that helped promote the housing bubble and in turn led to our current recession?
WASHINGTON (AP) — The Senate voted Wednesday night to give a tax break of up to $15,000 to homebuyers in hopes of revitalizing the housing industry, a victory for Republicans eager to leave their mark on a mammoth economic stimulus bill at the heart of President Barack Obama’s recovery plan.
Republicans: We want to prove we can do stupid, populist sh*t too!
Update: Via TJIC, more hair of the dog:
Fannie Mae, the mortgage-finance company under U.S. government control, will loosen rules for homeowners seeking to lower their loan payments by refinancing.
Fannie Mae will drop some credit-score requirements, reduce income-documentation standards and waive the need for appraisals in some cases…
