THE GREAT AUTO SALVAGE OPERATION OF 2008-9
Bankruptcy, Bailout or Salvage?
Is the American auto industry “too big to fail’? Or is it “too big to rescue”?
The proposed beneficiaries of the next bailout include Chrysler – recently dumped by the Germans after having been temporarily helped by a loan from the US taxpayers – and General Motors.
Wait a minute? What about Ford? Yes, Ford is in the mix, but is not on life support and has economic taproots all over the world. [One of my favorite high school classmates served as Ford’s CFO for many years … in Mexico.]
Ford and the other two US manufacturers were to have been awarded government loans by the Bush administration out of a 25 B package, but this was ostensibly to help the “big three” to comply with environmental regulations. In response to the proposal by congressional democrats to allocate the same amount from the 700 billion dollar bailout package – an idea opposed by the fed – the Bush administration offered to reconfigure the environmental package. Those sidebar discussions are “pending”.
I doubt that the current congress will be able to do anything but shout. The real target of the “help me now!” campaign is the new president and new congress. And it is GM and Chrysler are desperately hoping for the big money – in lieu of declaring bankruptcy.
General Motors is a basket case. In Northeast blue collar circles – on both sides of the northern border, GMC is referred to as “Generous Motors”. The term is used ironically, of course. Several corporate reformers have attempted to take over GMC, out the ruling management, and remake the company.13 February 2006
Ross Perot had tried to repair GMC in the 90’a as have others. Kerkorian eventually gave up. All outsiders have failed.
Here’s the problem: There is something called “corporate culture” and -- like the career diplomats in the State Department -- the new owners come and go, but the old culture prevails. Corporate culture is not changed from within, and not even by a new, inspirational leader, unless and until that leader – more realistically, leadership team – identifies, terminates and replaces the bulk of the old guard. This is why bankruptcy works so well: new beginnings with no strings and no legacy costs.
What are those legacy costs? The translation: under-funded pension obligations. This is why the new kid on the block in the airline industry tends to do so well – brand new airplanes and no pensioners to support is a great boost to any new enterprise. But to the actual workers, legacy costs are sacred retirement promises that they have worked years to redeem.
Taken as a political question, the bailout of GMC and Chrysler is profoundly complicated by simple human concerns - this in a cold hearted business world where too much compassion is seen as an obstacle to rational business decisions – like necessary layoffs and plant closings.
Here is the heart of the “no” argument: What if, as is likely, business failure is inevitable? How many billions of dollars is a two or three year postponement worth?
Salvage Not Rescue
The alternative to a “loan” with a few – mostly symbolic – strings attached is complicated, and possibly beyond the competence of the congress and federal bureaucrats. The auto companies who accept aid should be split into parts, some of which would be stand alone enterprises, supported by seed money and the rest auctioned for scrap. In the mix, all American carmakers need anti-trust exemptions so that parts, technologies and dealerships can be shared – if they choose to do so.
This requires a team of insider-outsiders to manage the restructuring and breaking up of one or two manufacturing empires [I doubt Ford would agree to join.] Here are some of the considerations:
Recall that some product lines are more durable than their owners. Chrysler acquired American Motors that had acquired the Jeep line from Kaiser-Jeep, and so on. Under Lee Iacocca’s brief but restorative leadership, Chrysler flourished in the 1980’s – largely on the strength of the minivan. In 1998, post-Iacocca, Daimler-Benz bought a weakened Chrysler company, but was forced to dump it last year. Yet the Jeep line has survived.
Saturn was GMC’s stand alone “new culture” carmaker, created as an answer to Japanese successes in 1990. By 2001, the brand was flagging because GMC had neglected it. As of this writing, GMC has put new resources into the line, while attempting to reabsorb the whole piece into the GMC culture. Saturn dealerships have closed and sales are weak.
The famous GMC Cadillac line, also lagging in 2000, was reinvigorated with introduction of the CTS type in 2004, aimed at German high end competition. The results were promising, if not spectacular.
The bottom line here is that the market is ruthlessly effective at picking winners, but politicians and bureaucrats are hopelessly ineffective. [I’m no better than either!]
Every car manufacturer’s inventory and resources presents a mixed bag of products and technologies, some better –higher quality, more profitable or both – than others.
The interesting questions are these:
Suppose GMC or Chrysler’s entire inventory, vehicles, technologies, factories, dealer networks, the whole package, went on the block in a bankruptcy auction. Some parts would be much more valuable than others. Which ones? Some parts would have only junk value. Which ones?
Here’s an exercise: Pair product line and description:
- Chevrolet Malibu.
- Chevrolet Volt
---A promising innovation.
This is where I decline any the detailed product suggestions, because, after all, I’m less competent than the experts and – unlike our elected leaders - I really do know my limits.
Our problem here is that the patient requires both life support AND surgery.
Bankruptcy is surgery by a blind OR team with blunt instruments. And the market is an expert pathologist looking for salvageable body parts.
I think the democrats are probably right here about the necessity of some significant government aid. I am persuaded that we at least need to spend enough money to provide life support and an incentive for a constructive reorganization.
The problem will be getting the second piece right. Past performance is not encouraging.
So I have just a few recommendations:
[a] If is to be bankruptcy, the government needs to move immediately to extract and rescue the military contract components from the wreckage, even if that means temporary nationalization and a managed sale to competent American interests. And the government needs to be proactively in the game to help facilitate rapid re-growth from the ashes, and the preservation of support services for the large fleet of American made card and trucks.
[b] Assuming a bailout takes place:
>>>> Suspend the anti-trust laws to enable creative restructuring of the entire industry. For example, the survivors may need to reach inter-company sharing arrangements for supply resources, service and dealership networks. Technologies might be shared. Other innovations might run afoul of anti-trust. There is plenty of competition already from Asia and Europe. It’s silly to let anti-trust considerations cramp restructuring planning. I say – Anti rust, not anti trust.
>>>> Mitigate the pension and benefit legacy costs for any new enterprise (for example if a division is launched as a stand alone new company, it should at least have the head start that a post bankruptcy company would have).
>>>> Apply the Colin Powell doctrine to the situation. If you go in, do it with enough resources and with a plan to win, and have your exit strategy ready before you commit.
The patient is dying from a chronic disease due to a misspent middle age. The physicians inside the beltway have no medical training. There is no living will. The grieving family says: DO SOMETHING.
It is well to remember the applicable part of the ancient Hippocratic Oath: Physician - do no harm.
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JAY’S ANATOMY OF
The GREAT KEYNSIAN COLLAPSE of 2008
The reputation of the British economist John Keynes, the seminal thinker whose theories later came to be known as “Keynsian economics” lost much of its value along with the stock market when the sub prime lending crisis poisoned the entire world credit system in the fall of 2008.
But the credit meltdown of 2008 represents the collapse of the flawed political implementation of a basically sound economic theory, the so-called Keynsian economics.
Many post WWII political leaders saw Keynes’ economic theory as permission to write checks that would never have to be paid. Flash forward to the recent crisis. The great credit meltdown of 2008 is a failure of adult supervision – an unsurprising outcome, given the adolescent mindset of the congress and the infantile mindset of the Wall Street speculators. Keynes, himself, would not have been surprised at the collapse.
KEYNES’ CHILDREN ARE MANY
John Maynard Keynes, 1883-1946, was probably the single most influential capitalist-friendly economist of the last 100 years. His principal contribution was the idea that government can and should manipulate the “money supply”. This is done by increasing the money supply to reduce unemployment – the federal government lowers interest rates and runs fiscal deficits; or by reducing the money supply to curb inflation – the feds raise interest rates and run surpluses.
To characterize Keynes’ primary contribution as the notion that governments can and should smooth out the business cycle by manipulating the money supply to stimulate employment is a simplification bordering on caricature. But this condensed version of the Keynsian innovation in economic thinking – using monetary policy to manipulate (ie.e. boost) the private economy – was the core idea that has driven American economic policy for about 40 years.
One flavor or another of Keynesian economics has been championed by social democrats and fiscal conservatives alike. His theories have been credited with saving capitalism from itself and for helping finance liberalism ‘without a tax increase”. Of course, there is a always a cost – inflation is the hidden tax that follows excessive increases in the money supply. Naturally, many administrations and congresses of both partisan persuasions jumped on the Keynes bandwagon, except for that darned “budget surplus” part.
The quaint notion that the books must eventually be balanced still has not gained much traction among the political classes.
Here is a short description of Keynes’ theory, excerpted from the “Concise Encyclopedia of Economics” -- available on the web “Library of Economics and Liberty”:
“Keynes’s General Theory revolutionized the way economists think about economics. It… introduced the notion of aggregate demand as the sum of consumption, investment, and government spending; and … that full employment could be maintained only with the help of government spending…Why shouldn’t government, thought Keynes, fill the shoes of business by investing in public works and hiring the unemployed? The General Theory advocated deficit spending during economic downturns to maintain full employment. … Keynes was a relatively strong advocate of free markets. … [He wrote], ‘There is no objection to be raised against the classical analysis of the manner in which private self-interest will determine what in particular is produced, in what proportions the factors of production will be combined to produce it, and how the value of the final product will be distributed between them.’”
These simplifications (mine and the above) omit the ideological window dressing. There are, after all, both liberal and fiscally conservative iterations of Keynes’ doctrine. They tend to sort out into three camps that provide different answers to the including such not-unimportant questions such as -- “What are we supposed to do with all that newly created money?”
Camp liberal: Spend it directly on the disadvantaged individuals. Camp nationalist conservative: Spend it on employers – government and private-government cooperatives who carry out large projects. Camp libertarian conservative: Lend it freely to business and consumers to stimulate economic activity without picking winners and losers.
How “stimulus” deficits are actually spent has a critically important effect on real world outcomes – economic recovery can be delayed or even aborted if the spending piece isn’t done right. Are the new deficit-financed moneys to be spent on large public projects or on artificially low cost credit to stimulate large private projects? In the latter case, is there any public (i.e., government) control or are we to trust to free market forces? Is either set of projects likely to generate sustained growth? The most common recurring question is this: How much of the deficit moneys should be spent on less productive measures like welfare - in all its various forms? Neo-Keynsian economists use computer models to help answer such questions. Democracies use politics.
In the real world, deficits are spent both wisely and unwisely, both productively and for political expediency, both for future growth and for the alleviation of immediate pain.
And in the real world, Keynes’ theory – especially the part that requires fiscal discipline - has mostly been honored in the breach. In addition to the inevitable political distortions of Keynsian theory, we have also to factor in the “greed innovations” of the finance community – the development of various financial “money gaming” schemes that is poorly understood by the political community, remaining under the radar until a malfunction takes place that is to big to ignore.
Let’s look at the data about the “national debt” (the cumulative total of all prior net deficits, funded by federal borrowing in the form of treasury bills, bond and other credit instruments). The figures I quote below are set out in full in an appendix; they were not corrected by inflation.
ROSS PEROT WAS MORE RIGHT THAN WRONG
In 1929, the national debt was about 17 billion dollars. By the end of WW II in 1946 that number had risen to about 269 billion. In 1950, the number was down to 256 billion, but in 1960 it was 286 billion, and by 1970, after the Vietnam War and Great Society had been deficit funded, it had grown to about 371 billion. When Reagan was inaugurated after the end of the Vietnam War, the Great Society deficits, and the Carter years of attempted fiscal restraint, the national debt had grown to about .9 trillion dollars.
By the end of the Reagan Cold War years, the debt (in 1989) was 2.8 trillion. During Bush I, the deficit increased to about 4 trillion. During the Clinton years from 1992-2000, the deficit increased from 4 trillion to 5.6 trillion.
During the first two years of Bush II’s administration (just before the 9-11 attacks), the deficit grew from 5.6 trillion on September 2000 to 5.8 trillion in September 2001. Then it exploded. From 2003 forward it grew at 1 trillion a year, reaching an estimated 10 trillion on September 30, 2008. The bailout costs will probably drive that number up as new data becomes available.
A chart is available showing the percentage increases in the national debt over the years since FDR. Here it is:
This chart fails to capture the debt explosion engendered by the recent bailout.
But here’s the takeaway point: all administrations since FDR have presided over an increase in the national debt. So much for Keynsian discipline!
The second thing to keep in mind is that our national debt is most meaningfully expressed, not in raw dollars (as the numbers I quoted above) or even in inflation adjusted dollars (a truly alarming exercise) but in terms of the percentage the debt represents of total spending, the current measure of which is GDP (gross domestic product). Here’s that chart:
The national debt, at present, represents about 71% of the gross domestic product. For certain, we’re not paying that down during a severe recession. I will not be surprised the learn, at the end of President Obama’s first term, that the number has gone north, say, to 80 % of the GDP.
THERE AIN’T NO SUCH THING AS FREE MONEY
Now here’s the dirty little secret of the credit meltdown. There is no such thing as “real” money. Even gold has primarily a psychological value. A simple thought experiment will suffice: You and you family are wandering in the desert far from help. What would you rather find: a pile of euros, dollars, gold bricks or an oasis with water, fruit, compass and a map?
Early Keynsian monetary theory talked about “controlling” something called “M 1” which meant the primary money supply. M1 was intended to capture all liquid funds. Here’s the Federal Reserve Definition of M 1:
currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions;
traveler's checks of nonbank issuers;
demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and
other checkable deposits (OCDs), consisting of negotiable order of withdrawal (NOW) and automatic transfer service (ATS) accounts at depository institutions, credit union share draft accounts, and demand deposits at thrift institutions. Seasonally adjusted M1 is constructed by summing currency, traveler's checks, demand deposits, and OCDs, each seasonally adjusted separately.
All you need to remember about this technical definition is this: All of M1 is “owned” by a person, company or institution and it is immediately spendable (“liquid”).
The older generation of Keynsian economists naively assumed that “the economy’ can be regulated by manipulating the M 1 part of the money supply. I emphasize part because it turns out that M 1 is a small fraction of the stuff we now actually use as money.
Credit in all its complicated and variegated forms is the new currency of the economy; credit is virtual money. The total amount of this “virtual money” is actually uncounted and, as a practical matter, is uncountable.
Here’s the dirty little secret of the current economic crisis. The virtual money of the credit world hugely overwhelms the real money of the currency economy (as defined broadly by M 1).
How can this be? Money – whether virtual or real – is not a real asset. Real assets are like that oasis. The credit-engendered flood of virtual money represents a vast network of interlocking promises by individuals and institutions who lend virtual money, partly backed by real assets, and promise to repay these loans with virtual money partly backed by real assets. The whole game is leveraged. This means that a lender’s or a borrower’s assets are always potentially smaller than the money being risked in the transaction. Leveraging refers to the “faith ratio”, if you will, between the small cache of assets and the large hoard of virtual money.
We’ve been playing a high stakes poker game for thirty years, and no one held the right cards. The credit meltdown was a perfect storm in the making. It was miraculous that we avoided an accounting as long as we did. But someone eventually called the bluff. And everybody at the table has been bluffing.
KEYNSIAN FISCAL DISCIPLINE: STAGES OF THE DECLINE
The decline from the noble heights of Keynes’ theory to venal practice has played out in four stages.
Phase One: Predictably there was no working political consensus about how to spend deficits and absolutely no discipline about reversing them. Small deficits occurred in the late fifties and early sixties, but the deficit bam was broken when president Lyndon Johnson financed both the Vietnam War and the great society on credit. The Carter hyperinflation was a direct result.
Phase Two: Those ongoing and ever growing national deficits became the “national debt’; and that huge public indebtedness needed to be financed by some mechanism that would postpone any day of reckoning.
Enter the deficit enablers in the form of deficit debt financing instruments, ‘I-O-U’s” by another name, that were outsourced to rapidly growing underdeveloped economies like mainland China. Because these economies were in a “growth-not-consumption” pattern, this stratagem operated to postpone and reckoning. And as a side benefit the measure temporarily insulated the US economy from the huge inflationary pressures that otherwise would have resulted from too much money chasing too few goods and services. Our inflation was held at bay by the vast influx of under-priced goods from our underpaid creditors.
It was a devil’s bargain that traded cheap WalMart goods for high paying American manufacturing jobs.
Phase Three: The US government lost control of the money supply but was unwilling to “fess up”. People at the Fed have known for about 20 years that, in addition to currency in circulation and direct loans to financial institutions by the central bank, a new form of paper money emerged on center stage of the economic drama.
Sometime in the last twenty five years or so, heavily leveraged credit instruments became a new “virtual money” supply. New loans, leveraged at thirty to one against overvalued collateral, became the “new money”.
Private “paper” has eclipsed the “real money”.
THE GREAT RECKONING OF 08
In our current crisis, many major lending institutions – on Wall Street and Main Street – were leveraged 30 times value. Part of what is now happening is an attempt to force the leveraging in the virtual money sector back to more conservative levels, say, “only” 10 times value.
During the last 15 years, the scope and scale of the virtual money supply has swamped the real one. This is why outgoing Treasury Secretary Paulson is trying to leverage the bailout moneys entrusted to him. He has no choice. The U S government simply does not have the staggering amount needed to do much more. That larger figure remains a deep secret, but probably exceeds the current national debt by a large multiplier. So there will be failures and this really is a reckoning.
Let’s assume that no major blunders take place – yes, this is a shaky assumption at best because we’ve already dodged at least one bullet. Thankfully Secretary Paulson came to his senses and abandoned the “let’s buy up .6 trillion dollars worth of failed mortgages secured by overvalued property that no one will buy until the price drops another 45%. But go with that assumption for a moment. This recession will last about two years, starting now. At the end of that particular tunnel, the structural problems that led to this mess will probably not have been corrected.
At a minimum, this is what needs to happen:
1. Compartmentalization of risk. There is no risk-free financial utopia in the known universe. Any attempt to create one has the unintended consequence of spreading the consequences of risk so widely that the entire economy is made hostage. When we temper risk by intervening to rescue failing institutions we create a new risk environment. Any failure cascade affecting a particular industry or financial sector can be made a national failure if government commits to do whatever is necessary to stop it. In the lending and investment sector, the compartmentalization approach is fairly straightforward. Financial institutions need to be insulated from each other along function and risk vulnerability lines. Securitized home mortgages can never again be allowed to finance ordinary commercial business enterprises. High risk ventures, driven by the hope of high rewards, need to take place in financial blast shelters; the damage zone from their failures should affect only their investors and immediate employees. Investment banks should not have ordinary civilian depositors. And so on.
2. Privatization of failure. The immense size of the virtual money sector of the economy precludes bailouts of large private business enterprises. We can’t allow banks to fail but we can’t afford to prevent the failure of poorly run retailers and producers. That’s what the bankruptcy laws are for. The bromide, “too big to fail” needs to be replaced with “too big to bail.”
3. New mechanisms of fiscal discipline. I want to introduce the radical idea of enforced fiscal responsibility. For illustration purposes, only: Whether by constitutional amendment, a miraculous change in the beltway culture or some combination of the foregoing and new legislation, all federal programs that purport to create an “entitlement” must identify a revenue stream, then suffer a pro-rata reduction of the entitlement in any subsequent budget year where the revenue falls short. During non-recessionary years, the federal government must not only remain in balance, it must “tithe” (10% of gross federal revenue) to pay down the prior debt.
NOTE-- This is a 10 AM update -- I had accidentally posted a prior speech. This link now contains the one Obama delivered last night. Sorry about any confusion!
And tonight I also want to thank the men and woman who took this journey with me as fellow candidates for president.
At this defining moment for our nation, we should be proud that our party put forth one of the most talented, qualified field of individuals ever to run for office.
I have not just competed with them as rivals, I have learned from them as friends, as public servants, as patriots who love America and are willing to work tirelessly to make this country better.
They are leaders of this party, and leaders that America will turn to for years to come.
I just received a very gracious call from Senator McCain. He fought long and hard in this campaign, and he’s fought even longer and harder for the country he loves. He has endured sacrifices for America that most of us cannot begin to imagine, and we are better off for the service rendered by this brave and selfless leader. I congratulate him and Governor Palin for all they have achieved, and I look forward to working with them to renew this nation’s promise in the months ahead.
Let us resist the temptation to fall back on the same partisanship and pettiness and immaturity that has poisoned our politics for so long. Let us remember that it was a man from this state who first carried the banner of the Republican Party to the White House – a party founded on the values of self-reliance, individual liberty, and national unity. Those are values we all share, and while the Democratic Party has won a great victory tonight, we do so with a measure of humility and determination to heal the divides that have held back our progress. As Lincoln said to a nation far more divided than ours, “We are not enemies, but friends…though passion may have strained it must not break our bonds of affection.” And to those Americans whose support I have yet to earn – I may not have won your vote, but I hear your voices, I need your help, and I will be your President too.