It has been nearly two years since the beginnings of the current economic crisis.  And while many culprits have been put forth to assume the mantle of blame, the most critical item now on the agenda is the jumpstarting of the U.S. and global economies.

With equity prices down over 50% from their highs and residential/commercial real estate not far behind, asset price deflation is the most visible symptom of today’s economic malaise.  While dismal unemployment statistics certainly play an integral role in consumer confidence and spending, the public is bombarded with daily report cards on the nation’s (world’s) economic health by way of asset price reports, particularly those of equities.

Whether it has been the ubiquitously mentioned Troubled Asset Relief Program (TARP), the Commercial Paper Funding Facility (CPFF), or any other government-led attempt to kickstart the economy, the major flaw in each has been the lack of capital to purchase assets which serve as the backbone for so much of this nation’s daily lending — securitized products.  Knocking down this one pin, the theory goes, will raise asset prices, stimulate consumer and business confidence, and grease the country’s economic gears.

Arguably, a big enough pool of capital aimed squarely at these assets would be sufficient to break the financial logjam and get capital flowing again.  Up to this point, the problem hasn’t been that assets were not cheap enough for investors to buy, but that funding was not available to lend to those who wanted to purchase these assets at current market prices.

Now, the Fed and Treasury have launched the Term Asset-Backed Securites Loan Facility (TALF) to provide as much as $1 trillion in funding for specific, highly-rated asset-backed securities (ABS).  The program certainly has holes — funding will only be available for newly issued securities (not secondary paper), and only for securities rated AAA.

However, as the Fed provides investors with advantageous funding for ABS, prices for these securities should rise, potentially dragging the prices for other similar assets higher as well.  While the TALF is far from a sure thing, its success could represent the knocking down of that one all-important economic pin.

Come on, Rodney!

How many athletes/personalities can you identify in this commercial from the 1980s?  Click here for a list, and contact The Lamb if you recognize others.

“Remember, anyone can do it.  Not everyone will.  The only question is:  Will you?” — Gary Keller, The Millionaire Real Estate Investor

Yesterday, President Obama pledged $75 billion to help alleviate the financial hardships caused by the decreasing value of a single asset class — residential real estate.  The goal is to ameliorate the unfortunate burden of homeowners having to pay monthly mortgage payments that the government says could cause them “financial ruin.”

Among other things, the scheme calls for allocating this $75 billion to as many as 9 million homeowners (less than $139 per family per month, spread over five years – the length of time this program is scheduled to remain in effect).  Call The Lamb naive (he’s been called worse), but does this really do anything to solve the long-term dilemma that home prices remain far above their long-term average of two-and-a-half times median household income?

Quoting a summary of the plan:

“This initiative is intended to reach millions of responsible homeowners who are struggling to afford their mortgage payments because of the current recession, yet cannot sell their homes because prices have fallen so significantly” (emphasis added).

Responsible?  Many of these borrowers purchased an asset, real estate, at a price that was three to four times the amount of their gross annual incomes!  Exacerbating their financial risk (which is now being dispersed to more responsible taxpayers to foot the bill for them), many of these borrowers were leveraged more than the usual four to one (via a 20% down payment).  In fact, some (euphamistically described) “brave” souls even went with the then-ubiquitous (for 2005-2007) no-money-down or negatively amortizing mortgages. 

Responsible, indeed.

Can it really be that surprising to these borrowers that they can no longer afford the payments on that asset?  Several of the bobble heads on CNN and CNBC have posited that banks and other mortgage lenders bear the brunt of the responsibility for homeowners taking on such large debt burdens — if the money wasn’t offered to them, these homeowners would not have borrowed it.

The Lamb calls B.S. here.  That argument is akin to a policy holder blaming a life insurance company for costing him money because he didn’t die in a timely manner!

As long as money is being transferred from the responsible to the irresponsible (or from the economically fortunate to the economically unfortunate, if that is more tasteful), why not give taxpayer money to those that suffered losses in other markets?  Raise your hand if you lost money in the stock market in the past few years.  At least these investments were not nearly as highly levered.  And why stop with equity investments?  How about those that were burned in corporate bonds, commodities, or even art?

Why is real estate being held out above all others as a sacrosanct investment in which people are insulated against loss?  Do we really want a system in which the most leveraged investment opportunity available to most people is insured against loss by other taxpayers?  Is this not the very definition of moral hazard?

Many argue that “you gotta live somewhere.”  Fair enough.  But despite its spelling, RENT is not a four-letter word.  Let’s look at renters for a moment.  Here is a group of people that, for whatever reason, chooses not to purchase a home.  Maybe they can’t afford the down payment (although that certainly was not the issue earlier this decade when a down payment was apparently only for suckers).  Maybe they don’t want to take the risk of fixed monthly payments for thirty years.  It doesn’t really matter why.

What matters is that by not targeting real estate prices as they zoomed skyward for a decade, and then unilaterally attempting to stop their rational descent, government is essentially punishing renters for making what in hindsight was the correct economic decision.  Renters who did not chase irrational (or “unaffordable” if that term is friendlier) prices earlier and could otherwise afford to purchase a home today, are being unfairly kept from doing so by government’s artificial price floor.

“Everyone wants a piece of land.  It’s the only sure investment.  It can never depreciate like a car or a washing machine.  Land will double its value in ten years.  In less than that.  Land is going up every day.” — Sam Shepard, Curse of the Starving Class

As the country (world) remains mired in an economic morass, there are as many opinions as to how to extricate ourselves as there are beggars at the collective government trough.  That said, the two most oft-mentioned problems dragging down the economy are the decline in real estate values (both residential and commercial) and the rotting of so-called “toxic” assets on banks’ balance sheets.

The Lamb has written about the former problem.  He remains adamantly opposed to the unilateral rewriting of mortgage terms, especially the reduction of any principal amounts.  Regarding the latter situation, the consensus view now is that, for better or worse, the FDIC will run a so-called “bad bank” that will purchase these toxic assets from banks.  The banks, with cleaner balance sheets, would then feel more comfortable lending, and this, the thought is, will help jump-start the economy.

As has been noted since the initial days of the government’s Troubled Asset Relief Program (TARP), the primary difficulty with a government asset purchase program is coming up with the “correct” price to pay for these assets.  Paying too low a price will leave the banks undercapitalized and do nothing to solve the problem.  Conversely, paying too high a price would saddle taxpayers with losses and reinforce moral hazard issues.

The Lamb discussed the latter problem back in September when the TARP was first brought into existence.  In a nutshell, The Lamb argued against paying 125 cents for a dollar bill.  So, how does this Bad Bank come up with the “right” price to pay for these assets?  The “right” price being one that is acceptable to the banks selling these assets, but one that also carries it with it taxpayer protection.

No financial institution should be forced to sell assets to Bad Bank that it doesn’t want to sell.  Banks that want to sell assets to Bad Bank should submit the asset and the amount of it that they are interested in selling.  Bad Bank would then bid for assets in a ratio equal to the amount of TARP money the Treasury has already invested in these banks in the form of preferred stock (i.e. — banks that have received the most TARP money would be able to sell the most assets).  This would have the effect of bolstering/protecting the preferred stock positions that the Treasury (taxpayer) has already taken.

In order to achieve transparency and reduce the use and risk of taxpayer funds, all Bad Bank bids should be public.  Additionally, any ready, willing and able third party should be allowed to “top” Bad Bank’s bid for any asset.  This will keep as great a portion of the troubled assets as possible in private hands, minimizing the role of the public sector.

Arriving at Bad Bank’s bid price for assets could be done by any of several proposed methods.  As Treasury Secretary Timothy Geithner detailed in his January 21 hearing in front of the Senate Finance Committee, Bad Bank could:

“Look at how the market is pricing similar assets; use computer model-based estimates from independent firms; and seek the judgment of bank supervisors.  They all have limitations.  I think you need to look at a mix of those types of measures.”

Whichever method or combination of methods is used, they must provide positive convexity (the upside for a given degree up-move in the assets’ values is greater than the downside for the same degree down-move) to Bad Bank, hereafter called Convexity Bank.  All increases in asset values will be retained by Convexity Bank.  However, if after a set period of time (say, three years), a given asset has declined in value (as determined by an auction), the bank that originally sold the asset will then have to issue to Convexity Bank common equity in the amount of 110% of the asset’s decrease in market value.  The same downside protection would not be afforded the hypothetical ”private” buyer mentioned earlier.

While this may seem to be a bad deal for banks, let’s remember two things.  First, banks have argued that current market prices are not reflective of the potential value of these troubled assets due to extreme and unprecedented market conditions.  This would be an opportunity for them to sell at prices above otherwise-available market bids.  If the banks’ assessment of the situation is correct, they will have succeeded in selling these assets at prices above what the current market price would be in the absence of Convexity Bank’s bid.  Second, banks will not be forced to sell any assets they don’t want to, or at prices they don’t want to.  They would be free to take the risk themselves.

Since common shareholders are the ones that will most benefit from the disposal of these bad assets, they are the ones that should bear the risk of the assets’ decline in value via the risk of future share dilution.  This plan solves the problem of clearing troubled assets from banks’ balance sheets while also addressing the trillion dollar question of determining the “right” price for Convexity Bank to pay for the assets in question.  Furthermore, this plan alleviates the major risk of taxpayers subsidizing the bad investment decisions of banks while aiding in protecting the hundreds of billions of dollars that they have already invested via preferred stock.

Last November, The Lamb wrote that Uncle Sam should eschew saving General Motors.  He argued that the attempt would be tantamount to keeping alive a terminal patient, with the suffering borne by the American taxpayer.

Fast forward nearly two months.  While The Lamb’s opinion on rescuing GM hasn’t changed, the status of the company’s finances has.  Last week, GM “received $4 billion in initial rescue loans from the U.S. Treasury to help it avoid collapse.”  Many more billions of dollars in loans and other financial assistance is likely forthcoming.  As the Treasury said last week in explaining its current and future assistance to the auto industry (via Bloomberg.com):

“Treasury may consider, among other things, the importance of the institution to production by, or financing of, the American automotive industry.”  The government will weigh “whether a major disruption of the institution’s operations would likely have a materially adverse effect on employment and thereby produce negative spillover effects on economic performance” or on credit markets.

Well, if that doesn’t telegraph that more aid to General Motors is in the cards, The Lamb doesn’t know what does; add to this a newly-inaugurated President Obama’s likely aversion to having one of the most iconic American companies go toes-up on his watch, and you have the makings of an open-ended rescue program.

Just as in the case of the AIG bailout, which carried an initial $85 billion price tag, Uncle Sam has a nasty habit of throwing good money after old money.  He hates to take a loss, especially one that would receive such loud press coverage.  Rather than lose a few billion of taxpayer dollars, he habitually continues to bolster old investments with new money.  With AIG, for instance, over $67 billion (now a total of $152 billion, if you’re keeping score at home) has thus far been promised to the beleagured insurer to protect/bolster/insure the original $85 billion.

Now recall last month that The Lamb advocated investing money in certain institutions that had received money from Uncle Sam in return for preferred stock.  The idea is that owning senior debt of companies that had issued preferred stock to the government was a good risk/reward trade in that Uncle Sam could not recoup any of his principal unless and until you received yours, as senior debt is ahead of preferred stock in a company’s capital structure.

As The Lamb said then and still fervently believes today, “Uncle Sam is gonna get his money back.  You will, too.”

The loan(s) that Uncle Sam provides GM will, in all likelihood, be senior to any senior debt of GM and will not obviate the risk of GM’s defaulting on its senior debt.  However, The Lamb believes that there is a better than decent chance, similar to that of the AIG situation, that Uncle Sam will be loathe to let a company to which it has lent billions of dollars go bankrupt.

Now, it is certainly possible that there will eventually be a (coerced) debt-for-equity exchange, a shotgun merger, or even a pre-packaged bankruptcy.  Each of these could easily result in a significant haircut for GM bondholders.  However, the recovery value for GM debt is likely to be around 10 cents on the dollar, somewhat mitigating any loss.  GM bonds are unquestionably very risky — both Moody’s and S&P have them rated well into the nether regions of junk status.

However, with all this in mind, one interesting and admittedly very risky investment idea is to purchase relatively short-dated senior debt of General Motors.  Though only for investors with the greatest predilection for pushing the risk/reward envelope, 2-year maturity senior debt of GM currently carries a tantalizing yield-to-maturity of over 100%.  Translation:  if the bonds mature at par (100 cents on the dollar), an investor will quadruple his money over a two-year period, including coupon payments.

The GM 7.20s of 1-15-2011 are currently (as of Friday) priced at a dollar price of 25.03, according to the bond market’s Financial Industry Regulatory Authority’s (FINRA) pricing service.  This equates to a yield of 100.46%, and is a low enough dollar price that even a 10 cent recovery value brought about by bankruptcy will not completely wipe out the investment.

As a final caveat, before making this or any other investment, The Lamb strongly urges you to repeat Rule #2 at least three times while standing in front of a mirror:  “Know and understand what you own.”

Disclosure:  The Lamb currently has a small amount of the above-mentioned GM 7.20s tucked neatly into a dark little corner of his portfolio.

Prediction #9 — Municipalities will see a surge of bankruptcy filings

Once the sleepy backwater of the financial world, municipal debt is turning into one of the most exciting areas of finance and debt trading — for all the wrong reasons.  Bombarded by what many are calling a perfect financial storm, municipal governments have seen their overly optimistic budget projections shotgun blasted to bits.  

The gunslingers on the most wanted posters include lower income tax revenue, lower property tax revenue, souring investments, and skyrocketing health and benefit costs.  These culprits have been aided and abetted by the unwillingness of government officials to cut services and/or raise taxes out of fear of angering their electorate.

Perhaps the next major government to go toes up will be Jefferson County, Alabama (Vallejo, California defaulted on its debt earlier this year), home of the city of Birmingham, population 600,000+.  It’s been on life support for several years as its construction of a city sewer system has gone wildly over budget and the county has borrowed to make up its cash shortfall.  But now the chickens have come home to roost and there simply isn’t enough money to service the county’s growing debt burden.

Not to be outdone:  the City of Detroit, home to ousted Mayor Kwame Kilpatrick.  According to Fox News.com:

“Kwame Kilpatrick stepped down as the mayor of Detroit [September 4th] after pleading guilty to two counts of obstruction of justice stemming from a sex-and-misconduct scandal that has plagued the Motor City for months.  Kilpatrick also pleaded no contest to assaulting or obstructing a public officer as part of the plea agreement, which ends his role as mayor of the nation’s 11th-largest city.”

Maybe the good mayor got out just in time — Motown is going through fiscal trauma of its own, aided in no small part by the near-collapse of the city’s auto industry.  From the Associated Press:

The mayor of Detroit says the city’s deficit is approaching $300 million and he has ordered all departments to reduce their budgets by 10 percent.  Mayor Ken Cockrel Jr. said in a statement [recently] that new problems are being discovered daily regarding the finances and financial reporting practices of the administration of his predecessor, Kwame Kilpatrick.  He says the discoveries confirm that Kilpatrick “misled Detroiters and misled City Council.”

Perhaps the biggest Damoclean sword hanging over muni finance world is the Golden State of California and its $42 billion budget shortfall for 2009.  With $54 billion in general obligation bonds already outstanding, Standard & Poor’s threatening to cut the state’s debt rating, and a general uneasiness on the part of investors to lend the state any more money, the Barbarian Governor’s choices are limited.

These are but a few of the more publicized examples of fiscally troubled municipalites.  However, the list of state and local governments and their severely exigent fiscal situations will only grow longer as budgeted tax receipts come in woefully short of projections.  With a credit market already leery of lending to stable and solvent borrowers, fiscally strapped municipalities’ chances of reaching 2010 in one financial piece are as bleak as the Motown winter.

Prediction #4 — Toyota Motor Company will buy General Motors

OK, “buy” might not be the most accurate term here.  Perhaps “obtain” will be more apropos.  As GM burns through what will likely amount to tens of billions of dollars of federal government cash/loans/preferred stock proceeds, it will eventually become apparent that GM’s debt load and cost structure are unmanageable. 

Reality will rear its ugly head and all parties (well, maybe not Ron Gettlefinger and the United Auto Workers) will throw up their hands and declare, “enough is enough.”  While plans for a pre-packaged bankruptcy will be tossed around, the Obama Administration will push for a plan that safeguards as many blue collar jobs as possible and helps to maintain a semblance of a U.S. presence in the global auto industry.

The compromise solution will have four major components.  First, Uncle Sam will extend the payback period for what will have become over $50 billion in loans to GM alone, thereby decreasing the present value of GM’s liability.  Similarly, GM debtholders will reluctantly agree to a major haircut on their bonds, receiving just ten to twenty cents on the dollar.  Third, common equity holders will be virtually wiped out as GM issues new shares to Toyota for less than $1 per share.  Finally, the UAW will (be forced to) accept cuts in its wage structure and, more importantly, a permanent cut in benefits for both retirees and current workers.

Undoubtedly, this will be a bitter pill to swallow for many.  But, it will be seen as the best long-term solution to safeguard both jobs and (what the Administration will call) a cornerstone of the American economy.

Tomorrow:  Prediction #5 — Trade

With apologies to Dire Straits, The Lamb can think of no better description than the title of this post for describing the investment opportunities currently available courtesy of Uncle Sam.  No, he’s not talking about the zero (or negative) yields available from U.S. Treasury Bills.

The Lamb is speaking about some good, old-fashioned, generic corporate bonds.  As a refresher, corporate bonds are simply IOUs from corporations — you lend them money, they agree to pay you back that money on a pre-set date in the future, as well as paying you interest along the way.  Of course, the risk is that the company goes bankrupt, defaults on its promise, and you’re left fighting for recovery value (the amount ultimately received in a bankruptcy proceeding).

As the economy has headed south recently, default rates have crept up and are expected to continue to rise.  And certainly, debt of many financial companies carries with it at least the same amount of risk as non-financial debt.  Or does it?

As mentioned in several earlier posts (Fannie, Freddie, and Sam; John Smiles, Milton Cries, The Lamb Sighs; and Uncle Sam vs. Uncle Sam) the “Bailout Binge” has been in full force for many months now.  The time has come for investors to take advantage of this government insurance/subsidy.  After all, your tax dollars are what’s bolstering these guarantees.  Shouldn’t you be compensated for your generosity?

Let’s take a small step back.  On October 13th, the FDIC (these are the same good people who insure the deposits, with certain restrictions, at most of your local banks) adopted the Temporary Liquidity Guarantee Program (TLGP).  Essentially, this program puts Uncle Sam’s good name behind some newly issued financial debt that matures on or before June 30, 2012.

The TLGP is in addition to Uncle Sam’s buying (again, with your money) preferred stock (which must remain outstanding for a minimum of three years) in these very same financial institutions.  Currently, these investments are (mostly) under water.  But hey, what’s $8 billion or so between friends?

Now, before we get to the good stuff, let’s review what happens in the event that a corporation goes bust and (in the unlikely event) its assets and liabilities are not assumed by another institution.  The first ones to get their money back are secured creditors.  These are the ones that lent money to the company, but only in exchange for receiving an unfettered claim on certain assets of the borrower.  Next (remember this part, this is what we care about) are the debt holders (senior, than junior, etc.).  Then come the preferred stock holders, followed last in line by common stock holders.

The Lamb’s view is this:  Uncle Sam is going to be loathe to let any institution in which it has invested taxpayer money actually NOT pay that money back.  The public relations black eye, not to mention the financial fallout, would be just too great to bear.

However, Uncle Sam would not be first in line to get paid back if a company went toes up.  Before Uncle Sam, as a preferred stock holder, received dime one, the senior debt holders would have to get every single penny of their money back, including accrued interest.

Now freely available for your investing pleasure are the senior debt of the very same financial institutions that have sold preferred stock to Uncle Sam.  For a not-necessarily exhaustive list of these firms, click here.

Many of these institutions have senior debt trading in the market which matures before the preferred stock can be retired.  And, it’s yielding as much as five percentage points or higher than its corresponding TLGP counterparts, some at yields around 10%.  Granted, this debt does not carry the expressed FDIC guarantee behind it.  But do you really think that Uncle Sam, in the unlikely event that one of these banks goes under, will be willing to face Ma and Pa taxpayer and tell them that the hundreds of billions of dollars they spent on preferred stock is not going to be repaid?

Neither does The Lamb.  He recemmends buying the short-term (less than three years) senior debt of companies that have sold preferred stock to Uncle Sam.  Uncle Sam is gonna get his money back.  You will, too.

Disclosure:  The Lamb owns senior (non-TLGP) debt of Merrill Lynch (soon to be Bank of America), Goldman Sachs, Morgan Stanley, and AIG.  He is looking to purchase more.

As a parent, one would not reward a child with extra dessert for throwing his dinner against the wall.  As a boss, one would not lavishly remunerate an employee who has negligently cost the company money.  Poor behavior should be punished, or at the very least, not encouraged.

Unfortunately, Uncle Sam continuously insists on not only rewarding, but actually encouraging bad behavior on the part of consumer borrowers.  The Lamb has been a vocal critic of the American Mortgagor as the prime suspect in the current financial impasse.  While others certainly share the mantle of culpability, the American homebuyer stands atop the pedestal of guilt.  His inability/unwillingness to repay debts he assumed voluntarily is at the crux of the current crisis.

So, what should be done?  Well, what should NOT be done is what the Treasury is currently considering.  From The Wall Street Journal:

“The plan, which is in the development stages, would use mortgage giants Fannie Mae and Freddie Mac to bring loan rates down as low as 4.5%, a full percentage point lower than the prevailing rates for 30-year fixed mortgages.”

Let’s see.  Easy credit over the past few years encouraged borrowers to take on more debt than they could afford to pay back.  This led to a wave of defaults, causing lenders to go bankrupt, which threatened to destabilize the financial system.  This led to bailout after bailout, which coincided with historic downdrafts in asset prices in everything from equities to commodities, and from high-yield debt to Triple-A asset-backed securities.

Now that asset prices are beginning to show signs of stabilizing, what should the next step be?  Hmmm… that’s a tough question…  Wait!!!  Why don’t we use artificial means to make credit easy again?  Yes, that’s a great idea!  In fact, let’s just go ahead and use taxpayer money (which, by definition, is money paid by those who acted prudently by NOT borrowing over their heads and are still paying taxes) to encourage even further bad behavior (i.e. — more borrowing).

In fact, that is exactly what is being proposed (again, via The WSJ):

“Under the plan, Treasury would buy securities underpinning loans guaranteed by the two mortgage giants, which are temporarily under the control of the government, as well as those guaranteed by the Federal Housing Administration.”

Already, the New York Fed is planning on purchasing Fannie and Freddie (GSE) debt.  The first purchases are slated for this Friday.  From the New York Fed’s website:

“What is the policy objective of the Federal Reserve’s program to purchase direct obligations of the housing-related GSEs?
The goal of these debt purchases, combined with the purchases of mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac and Ginnie Mae announced on November 25, 2008, is to reduce the cost and increase the availability of credit for the purchase of houses.”

Sounds like giving your kid more messy food to throw against the wall.

General Motors is an iconic American company.  Unfortunately, the time has come to put this company out of its misery.  We must page that infamous doctor from GM’s home state of Michigan, Dr. Jack Kevorkian, and have him euthanize this patient in order to end its suffering.

GM is currently trading at its lowest level since around World War II.  It has lost over 86% of its value in just the past six months.  According to Bloomberg.com, “GM has not posted an annual profit since 2004, and sales in the U.S., its largest market, have declined every year since 1999.”  Analyst Rod Lache of Deutsche Bank yesterday cut his 12-month price target on the stock to zero.  ZERO! 

Via Barrons.com:

On Friday, GM announced a loss of $2.5 Billion, over $4 per share.  This is greater than its current share price of barely over $3!  And according to Barrons.com, “excluding a $4.9 billion gain on union cost-savings and other extraordinary items, GM lost $4.2 billion, or $7.35 a share.”

But don’t take Wall Street’s word on it.  Ask GM itself.  In a regulatory filing yesterday, it said:

Based on our estimated cash requirements through December 31, 2009, we do not expect our operations to generate sufficient cash flow to fund our obligations as they come due, and we do not currently have other traditional sources of liquidity available to fund these obligations.

But valuation is the least of our problems.  Our problems?  Yes.  GM has traveled hat in hand to Washington begging for financial assistance.  Along with Ford and Chrysler, the Big Three have asked for up to $50 billion (so far) in government money (which, lest we forget, is our money) claiming that the automobile industry in integral to the American economy.  They have apparently already found a sympathetic ear in President-Elect Obama. 

From Bloomberg.com:

“Rahm Emanuel, chief of staff to President-elect Barack Obama, said the U.S. auto industry is “essential” to the economy.” 

“Essential” is debatable.  But The Lamb would say that there is certainly no systemic risk to the economy in allowing GM to fail, as was the reason given for bailouts of AIG, Fannie Mae, Freddie Mac, etc.

Would a GM bankruptcy be painful to many people?  Absolutely.  From The New York Times:

About three million American jobs are directly tied to the Detroit automakers, said David Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich.

The handwriting has been on the wall for years.  GM is now burning through over $76 million per day!  Surely, that money can be put to better use.  With automobile sales and the general economy trending downward, giving money to the auto industry now is tantamount to throwing it away by prolonging the inevitable. 

The situation reminds The Lamb of a scene from one of his favorite movies, Rounders.  In it, Mike (played by Matt Damon) asks Joey Knish (John Turturro) for a loan (paraphrased to avoid profanity):

Mike:  [I don't need a lesson from you right now.]  What I need from you is money.  I need whatever money you can give me.

Knish:  See that’s the thing.  This time, there is no money.  If I give you [some], what’s that buy you?  A day?  Nah, if I give it to you, I’m wasting it.

Mike:  (Sarcastically) That’s [just] great.

Knish:  You did it to yourself.

If we simply must give money to the Big Three, how about earmarking it for job training so that workers in the auto industry can learn new job skills and continue to contribute productively to the American economy?  $50 billion for 3 million workers equates to over $16,000 each.  Why do we continue to treat the auto industry as some sacred cow that must not be slaughtered?  Let’s help workers in this industry learn new skills and embark on new careers that will have long-term benefits for them and for the rest of the country.

Today, General Motors is simply a large health-care conglomerate masquerading as a car company.  Its employees, thanks in no small part to the efforts of the United Auto Workers Union, enjoy some of the finest health benefits on the planet.  This unsustainable cost structure is not something that has occurred overnight.  It has been going on for years, with everyone hoping and praying that it would somehow change.  But it hasn’t.  It has grown worse.  Much worse.

In 1952, during his Senate confirmation hearing to be President Eisenhower’s Secretary of Defense, Charles E. Wilson, former head of General Motors, famously stated, “What’s good for General Motors is good for the country.”  This may have been true more than fifty years ago, but it sure as heck ain’t true today.

Note:  This post is in no way meant to endorse, oppose, compliment, or impugn any person or political party.

Monday, January 28th, 2013

President Palin sat alone in the Oval Office wondering if the plan she had developed with her financial S.W.A.T. Team would be enough to extricate the country from its latest economic crisis.  She was barely one week into her first 100 days in office, and things were going from bad to worse.  She thought back to her predecessor and the challenges he faced during his four years in her position.

It was late summer 2009 and the previous year’s credit crisis already seemed like a distant memory.  The 0.125% federal funds rate and enormous federal bailout programs appeared to have stabilized the financial markets.  The Dow had clawed and scratched its way back above the 11,000 mark and there had been a nearly one year absence of major corporate failures. 

However, the easy monetary policy masked a deeper dilemma.  With memories of 2008 still fresh in their minds, financial institutions remained fearful of committing capital for longer-term projects.  As many banks began facing maturities on their debt, rollovers became a looming problem.  The 2008 guarantee of bank debt issuance had failed to lower term funding costs significantly as investors had grown leery of just what that U.S. government guarantee was really worth.

With small and large banks alike experiencing growing funding difficulties, President Obama called on Treasury Secretary Lawrence Summers to find a solution.  Working with Fed Chairman Robert Rubin, who had reluctantly assumed his position after Ben Bernanke had been “asked” to leave by the President, Summers embarked on a bold solution. 

Loathe to face the specter of another large bank failure, the duo ordered (the official stance was “strongly encouraged”) the marriages of the country’s few remaining “super” banks.  Goldman Sachs was sent kicking and screaming into the arms of Citigroup, and Morgan Stanley was reunited with its ex-spouse JP Morgan.  The restriction on any institution holding more than 10% of total U.S. deposits was conveniently repealed.

Unfortunately, this failed to stem the rising tide of consumer bankruptcies.  Credit card debt was now crippling the country.  By late 2010, credit card debt in the United States had skyrocketed from $27 billion in 2007, past the 2009 level of $96 billion (estimated by NBC News), to a staggering $200 billion, as households tapped any possible source to pay for day-to-day living expenses.

Faced with a public outcry and using the 2008 bank bailout as precedent, President Obama ordered Secretary Summers and Chairman Rubin to enact a freeze on all credit card interest charges effective as of December 1st, 2010.  To mollify the credit card companies, the Treasury would begin making the interest payments on all balances as of this date, though at a rate of just 9%.  Though this was below what they were currently slated to earn from consumer balances, the credit card companies acceded to the plan as it dramatically reduced their allowances for bad debts and strengthened their deteriorating balance sheets.

Financial blows continued to batter the global economy.  South American nations, borrowing more and more money in an effort to grow their own economies out of the three year recession, faced spiraling inflation.  Playing their trump card, they threatened an oil embargo against the U.S.  With oil already having soared above $350 per barrel after the June 2011 Israel-Iran War and the American public demanding a reprieve from crippling gas prices, the United States approved low-interest loans to Brazil, Venezuela, and Argentina in exchange for their promise to maintain the flow of oil.

The dire financial straits of consumers and declining property values culminated in much lower tax receipts for municipalities, just when this money was most badly needed.  California, already buckling under huge fiscal strains and unwilling/unable to repeal Proposition 13, in early 2012 became the largest municipal bankruptcy on record, easily eclipsing Orange County in 1994, Alabama’s Jefferson County in 2009, and even the 2011 State of Arizona filing.

In an effort to forestall cascading municipal failures which threatened to paralyze essential state and local services from education to police and fire departments, in the summer of 2012 Congress passed the Municipal Assistance Rescue Program (MARP).  The MARP allowed state and local governments to borrow money interest free from Uncle Sam for up to three years.

However, as the conga line of municipalities lining up to take MARP funds grew, the national debt soared, as did interest rates on everything from U.S. Treasury securities to home mortgages.  Inflation, that scourge not seen since the late 1970s, skyrocketed past 12% and the U.S. Dollar, already battered by the proliferation of government bailouts the past four years, sank like a stone. 

Many banks were now unwilling to make loans in dollars, fearful of the currency’s continued depreciation and unable to effectively hedge themselves in the increasingly illiquid foreign exchange markets.

As summer turned to fall with the economic and financial landscape looking increasingly bleak, the nation elected its first female president — Senator Sarah Palin of Texas.

Sitting in the Oval Office, President Palin greeted newly appointed Fed Chairman Timothy Geithner.  The President wanted reassurance that her campaign pledge of lowering inflation and crippling interest rates could be accomplished.  The Chairman, taking a page from one of his predecessors, Paul Volcker (who had raised the federal funds rate to as high as 20%), reiterated faith in their plan to raise the funds rate from the current 10% all the way to 18%.

In response to the President’s hesitancy to increase rates, Chairman Geithner explained its necessity in wringing inflation out of the system.  The Chairman admitted that he had learned his lessons from the ill-planned bailout binge that he had helped orchestrate and sustain as President of the Federal Reserve Bank of New York during the presidencies of George Bush and Barack Obama.  He said that the country now needed to take its financial medicine, no matter how bad the taste, in order to cure the disease of inflation.

Besides, he elaborated, raising short-term rates might be enough to reverse the outflow of foreign capital that had been occurring for most of the past year.  China and Japan, for example, had sold nearly $1.5 trillion of dollar-denominated debt, mostly U.S. Treasury and Agency securities.  America’s runaway inflation had shaken their faith in its ability to service its debt, now owned predominantly by foreign governments.

If this did not work, Geithner worried, the country might be forced to return to some version of the gold standard, not seen in the United States since President Nixon abandoned it in 1971.

As February turned to March and March to April, the economic climate began to improve.  Data showed that foreign capital was returning to the U.S., taking advantage of higher short-term yields.  As inflation fears abated, fixed-rate mortgage rates dropped precipitously, falling below the psychologically important 10% level.  Even the Dow had closed above the 5,000 mark for the first time since late 2011.

The country was learning (forced?) to live within its means after an arduous period of stagflation.  Long-gone were the days of easy credit and government safety nets.  But a more disciplined and realistic debtor-creditor relationship had emerged, one which held the promise of stable prices and moderate long-term growth.