Sunday, November 09, 2008
TigerHawk TV: On markets and bailouts
[Bumped]
It is the weekend, so it is time for another edition of TigerHawk TV! In today's episode, I discuss the financial markets in terms even a lefty can understand, and fulminate against bailing out the automobile industry. As always, any and all feeback is most welcome.
Prior episodes of TigerHawk TV can be seen here, or by clicking the link on the right sidebar.
MORE: Other bloggers agree! Do not bail out Big Auto. If you want a successful domestic automobile industry some day, let the current clowns fail.
18 Comments:
By 
, at
Sun Nov 09, 01:23:00 PM:
Pelosi and Reid now want the US to rescue the Big Three auto makers. The mantra is already "If we can bailout the banks, why not the Big Three" ... so it's being played to make Bush and Treasury Secretary Paulson be the fall guys if nothing gets done soon.
The Big Three are an interesting test case of systematic problems in our economy and where our politics may be heading.
Underlying Problem
... There's excess auto-making capacity in the US, and in the world ... but companies like GM can't shrink. GM isn't run to maximize its profit per car, but to maximize its overall revenue. That's because GM has a huge nut to cover ... its employee benefits. It has to pay huge costs for pensions and gold-plated health benefits for workers and retirees. There's more "health care" expense in a Big Three car than there is "steel cost." So, a GM factory in Michigan starts out at a competitive disadvantage to a Toyota factory down South, let alone one in Brazil. A company like Toyota can focus on making models that sell at a profit, rather than needing to push the most metal out the door.
The need for the Big Three to maximize revenue -- not profit -- is driving the overcapacity glut. For awhile, the Big Three solved this problem by ramming millions of SUVs and light trucks through a loophole in federal rules on mileage efficiency.
Other aspects of the Big Three's union contracts add to the problem. The Big Three have had to run "job banks" where they pay idle workers full freight to do nothing ... as they can't fire unionized workers.
Perhaps most shocking of all, is that the UAW cut a deal to allow the Big Three to hire new workers at lower wages than those already in the union. The result is that there are now younger workers who make half what older workers do for doing the exact same job. Imagine being 25 and thinking of starting a family, but you're not quite making enough. The guy right next to you is 50 ... has a house he bought for a fraction of current market ... and he makes twice what you do for doing the exact same thing. It 's the most blatant wage discrimination in the US ... but it's union sanctioned.
Face the Music?
Normally, companies in this kind of pickle can go through Chapter 11 bankruptcy to break their union contracts. The airlines have done this many times over. The Big Three could go through a painful downsizing and move on. The big losers would be the State of Michigan, older Big Three workers and retirees and Cerberus, the private equity firm that now owns Chrysler. It would also blow up our underfunded federal Pension Benefit Guaranty Corporation ... which is another Fannie Mae / Freddie Mac waiting to happen. GM's market cap is now only $2.8B ... a shockingly low number for a company with over $200B in sales ... which means that GM is already effectively bankrupt.
Big Government in Big Business - The Other Alternative
Any government aid extended here will turn into the federal government getting into the auto making business, it's just a question of how fast and on what terms. A loan to a nearly bankrupt company is an equity investment, no matter how you label it. Once it's in for $50B, how does the US ever get out?
This would have a better chance of working if the US nationalized the entire auto industry, and banned foreign auto imports. So long as companies like Toyota have factories down South, and foreigners can export into the US, the Big Three will get their clocked cleaned. Do you think adding a layer of government bureaucracy onto the Big Three will make them nimble market-driven players?
Obama is on record as saying he wants the government to help Detroit to re-tool to make the great cars of the future ... so this is where we're probably headed.
Big government can be very good at doing a few big tasks, often at the cost of everything else. The Soviet Union is a prime example of this. Obama often invokes the US success in going to the moon ... very Kennedy-esque ... but our Moon shot was nothing more than a big military procurement exercise ... it didn't involve the federal government taking over a big part of the economy. We also got lucky ... Grumman pulled off one of the greatest feats in engineering history with the Lunar Module.
Obama's Role
I can't tell if Obama is co-coordinating with Pelosi-Reid on this. If he is, it would fit with his passive-aggressive approach to leadership ... don't say anything specific early, but only speak in platitudes ... have others initiate and commit ... step in later to bayonet the wounded. He's on record as saying he wants to have Detroit make the cars of the future. But isn't Toyota already miles ahead of GM on this with the Prius? With gas now under $3, who would pay thousands more to own a Prius insead of a Camry? Should we favor GM workers in Michigan over Toyota workers in Kentucky? Shouldn't the Big Three be punished for having Congressman Dingell and others block efforts to plug the SUV loophole? Aren't the Big Three corporate criminals for doing so?
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By , at
Sun Nov 09, 01:39:00 PM:
By 
Escort81, at
Sun Nov 09, 01:40:00 PM:
One way of thinking about how the Democrats might deal with the U.S. auto industry -- which has had all of the equity on its balance sheet zeroed out -- is that unions will essentially act as trustees in bankruptcy (notwithstanding the apparent conflict of interest). Management will be kicked out, as you suggest, but the unions will emerge -- through an ESOP or otherwise -- basically having a controlling equity interest in whatever companies remain. DIP financing will likely be courtesy of Uncle Sam, and might well be paid back. To the Democrats, it will be about preserving jobs and therefore votes in Michigan, Indiana, Ohio and elsewhere. Pehaps it is socialism, but at least it is localized socialism -- that is, it is one thing for workers to have skin in the game as long as it is their game (and I think the unions should have to put money in up front); someone living three states away working in a different industry shouldn't have to participate in ownership because they are a taxpayer.
The really neat trick will be whether the unions can make it all work after the increased CAFE standards impose yet additional costs on the automakers.
The track record in this country of unions running large scale companies is mixed at best. It did not work out too well for United Airlines some years back when the various airline unions owned nearly all of the equity and controlled it -- and there was still a pilot's strike!
As you have posted many times previously regarding Card Check, the unions are simply too important a constituency to the Democrats for the Obama administration to not preserve some remnant of domestic auto industry so that auto union workers can still work somewhere.
Anon above makes an excellent point regarding PBGC. It behooves the Obama administration to kick that can down the road and not have it blow up on its watch. Letting the unions takeover at least keeps the ball in play for some period of time.
By , at
Sun Nov 09, 02:01:00 PM:
Thank you for the analysis. I certainly need to learn more. My guess is that we will hear the ‘too big to fail” mantra from the new administration. I would like to see the "Face the Music" analysis taken further just to see what the repercussions of failure would really be. That is, what the American public will be asked to “buy”. I don’t think anyone is going to believe that a buyout will suddenly make the US car industry more competitive. It is just prolonging the inevitable (Rasputin would have been proud).
Put in that context, I would then have to ask who is going to buy my company out if it fails and what protection are the rest of the taxpayers going to afford me in terms of my job, pension and health benefits?
a. moral
By , at
Sun Nov 09, 04:36:00 PM:
TH,
Just wanted you to know I think THTV is a neat addition to your site. Please keep it going!
I agree with your editorial.
I also agree that letting them fail, for Democrats, who just won an election, seems impossible. So what should conservatives advocate, letting them all fail?
I say, identify the weakest of the lot and argue to pull the plug on that one. I think that would be either GM or Chrysler.
By , at
Sun Nov 09, 05:37:00 PM:
The auto industry is a test case of how we might handle systemic problems in our economy. Mr Tiger Hawk blames the Big Three's problems on bad management and outmoded dealer networks, and he may be right. I see health care spending and pensions as big factors, which drove the Big Three to bad decisions. To the extent I'm right, what's going on with the Big Three is what we'll all be facing in a few years.
Big Three managers are a lot like our politicians ... they have a bias to mananging for the short-run and to kick inconvenient cans down the road.
The auto industry is a test case for how we might handle systemic problems in our economy over health care costs and pensions. Mr Tiger Hawk blames the Big Three's problems on bad management and outmoded dealer networks, and he may be right ... but I see health care spending and pensions as big factors which drove the Big Three to bad decisions. To the extent I'm right, what's going on with the Big Three is what we'll all be facing with Social Security and Medicare/Medicaid in a few years.
Big Three managers have been a lot like our politicians ... they have a bias to managing for the short-run and to kick inconvenient cans down the road.
Years ago, the UAW played Big Three management to enter into union contracts with high long-term costs, but which didn't hit in the near term. These decisions were made at a time when no one could foresee spiraling health care costs. GAAP accounting at the time didn't require recognition of these long-term liabilities. There was also an understanding that so long as the Big Three all did the same ... and together they dominated the US market, the costs would just get pushed onto the American consumer.
So the Big Three now favor their older workers over their young, and their retirees most of all. They start at a several thousand dollar per car cost disadvantage ... and that's when they're selling cars at maximum volume ... and they're bankrupt.
This foreshadows what will happen to us all, but there won't be anyone to bail us. We'll just have to make hard decisions.
I like the idea of making the Big Three unions the de facto owners. Make them manage health care costs on a budget and encourage them to come up with radical cost-cutting programs. It could be a great experiment and show the way for us all.
If Obama just gives them a $50 billion "loan," we'll just have kicked another can down the road.
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By , at
Sun Nov 09, 06:25:00 PM:
Please explain more about your comments that dealers are protected by state laws. Don't understand this. Can you give some specifics?
By TigerHawk, at
Sun Nov 09, 06:37:00 PM:
Most states have special protective legislation that makes it extremely difficult for an automobile manufacturer to terminate an auto dealer. These protective laws were passed because, well, car dealers had a lot of clout back in the day -- they were often the wealthiest of small businessmen -- and they lobbied to use local law to strip the big manufacturers of leverage against them.
The problem is that many American dealers are not very good. They have been around since the days when Detroit had a lock on the American market, and many of them never understood that consumers increasing regard even manufacturing businesses as founded on good service. Then the Japanese and Europeans came along much later, and were able to establish and train dealers to operate according to modern methods.
By Purple Avenger, at
Sun Nov 09, 06:58:00 PM:
We also got lucky ... Grumman pulled off one of the greatest feats in engineering history with the Lunar Module.
Engineering is never involves "luck". If the state of the art is good enough to do something at a given point in time, then it can be done. If its not, then it can't.
Rockwell, Lockheed, and Boeing all had people that could have built a LEM.
By Purple Avenger, at
Sun Nov 09, 07:06:00 PM:
Let me expand on that a bit -- pure "science" often does involve luck. You can stumble upon some effect or behavior that nobody ever considered or everyone thought impossible and never tried.
The basis of the business I'm involved in now has tons of IP and steady advances, but what's really going to make us all billionaires is stumbling onto a completely unexpected behavior from a fairly ordinary material people have been fiddling with for quite a while.
The engineering needed to bring that raw science to market isn't luck like the discovery was though.
By , at
Sun Nov 09, 07:24:00 PM:
Big Three managers have been a lot like our politicians ... they have a bias to managing for the short-run and to kick inconvenient cans down the road.
This is not only a problem of politicians, but of public company management broadly (which, of course, includes the Big Three).
We have a short-term bias in our conception of financial statements. Managers feel a great deal of pressure to feed the current reporting cycle all possible "good news" and minimize problems until they are unavoidable.
Some very interesting work has been done -- at least at an academic level -- in creating financial reporting that factors in more long-term concerns (environmental impacts, etc.).
In my view, it would be very helpful to bring some of these ideas into company valuation on a broad level. (Yes, I appreciate the complexity. But it seems like an essential issue on many levels -- including so-called "incentive comp" which often takes a very short-term view.)
By , at
Sun Nov 09, 07:59:00 PM:
Ouch, TH. You need a makeover. Call Queer Eye for the Straight Guy ASAP.
By TigerHawk, at
Sun Nov 09, 08:15:00 PM:
There is no question that I'm better suited for radio.
By , at
Sun Nov 09, 08:45:00 PM:
I'm not a scientist nor an engineer, so I stand corrected on saying that building the LEM was luck. I just looked it up -- Grumman was noodling on the LEM idea before JFK spoke, and serious LEM proposals were made in 1962. So when JFK spoke it sounds like he had been advised that a moon landing within a decade was indeed feasible and that the plan had already been thought through. In any event, the LEM was a pretty neat piece of engineering.
I go into this because I have doubts that, in proposing his own Moon shots for energy independence, Obama has thought out the economics and science of alternative energies like solar and wind. They don't look to be viable solutions for more than a marginal contribution to the needs of our electric grid any time soon, not with current technology and at current costs. Am I wrong?
If I'm not wrong, Obama may be taking us down a bad dead end. I've tried to figure this out on my own, but can't. I would have thought that this would be a straightforward engineering question, tied to an economic analysis of relative cost per kwh hour, and that someone could explain how solar can support an electric grid at night.
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By Purple Avenger, at
Sun Nov 09, 10:50:00 PM:
They don't look to be viable solutions for more than a marginal contribution to the needs of our electric grid any time soon, not with current technology and at current costs. Am I wrong?
If nuclear isn't a major component of Obie's strategy, he's going to have an epic fail.
There's some stuff the Russians have fiddled with (ex MHD) that shows some promise, but the problem with that is more political than anything else. MHD is clean enough, and can be a great way to get rid of municipal garbage and break down toxic wastes in the plasma it generates, BUT MHD isn't a "big" technology and wouldn't need a lot of federal regulation, and it scales DOWN quite well to the small municipal level. What this means is the feds would have no constitutional basis for taxing it under the commerce clause.
When I look at apparently retarded energy policy decisions, I always look at the taxing structure they'd exist under. If taxing them would be difficult or impossible should they go pervasive, then you won't see the feds involved and they'll do everything possible to stall it.
This is why I don't think plug in electric cars will ever go too far in spite of what politicians say. We have distribution and TAXING infrastructure in place for liquid fuels. The feds will want to tax electricity for cars heavily because they'll need something to replace lost gasoline taxes...but there isn't a residential housing unit in the country equipped with dual metering equipment, and the retrofit cost to install it would be obscene on a nationwide basis, and of course, people will simply cheat and rewire around it themselves. Natural gas cars will face the same dual metering taxation problem.
By , at
Mon Nov 10, 12:41:00 AM:
If nuclear isn't a major component of Obie's strategy, he's going to have an epic fail.
That's what I've concluded.
Obama has been running for as long as I can remember, but we don't have a clear idea of where he stands on something as basic as whether he backs nuclear power or not. You couldn't find the word nuclear on his vaunted website. Who's fault is that?
My bet is that he doesn't back it, because he'd get too much heat from the left and little short-term personal benefit.
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By , at
Mon Nov 10, 02:38:00 PM:
Op-Ed in today's Wall Street Journal: Detroit Auto Makers Need More Than a Bailout
http://online.wsj.com/article/SB122628230122212449.html#
Author was the long-time WSJ Detroit bureau chief.
By Viking Kaj, at
Wed Nov 12, 02:25:00 PM:
Nice cap.
Since Obama now walks on water and Oprah has the 2d mortgage on the Lincoln bedroom, how about we have them try to fix the auto industry?
Test drive the new Ford "Beloved" or "Audacity" today...
Again, seriously nice cap.
