Friday, 21 January 2011

Are gas prices high?

Jim Treece at Automotive News had a neat little column in today's Automotive News ("Gas too high? Aw, stop griping"). I'd played around with data in the past; here are two graphs. One presents the inflation-adjusted price of gasoline, from 1919 through 2010. Prices are up -- but we're coming off of almost 20 years of the lowest gasoline prices in US history. The second adjusts in a different way: GDP per person, using a 2000 hour work-year to ask how many minutes it takes to buy a gallon. I could have used average hourly compensation (but what of retirees?) or average consumption; that would change the details but I don't think it affects the basic picture. And any such method would have its own drawbacks.
Mike Smitka

Another Round with Rattner

I’ve been “stalking Steve Rattner for months now in an effort to get to the nuts and bolts of the auto industry bailout and subsequent restructuring. There are those who have hung the “car czar” moniker on him, and he tries to be flattered by it. But as Rattner explains it, his great great grandfather was a fur trader in Russia and would turn over in his grave at the thought of any of his offspring being referred to as any kind of czar.
I have followed the workings of the Auto Task Force in the news, agonized daily with my dealer friends in the industry, watched hours of CSPAN hearings, attended Rattner’s presentation at a Federal Reserve Conference in Detroit in May 2010 in advance of his book “Overhaul, An Insider's Account of the Obama Administration's Emergency Rescue of the Auto Industry” read the book, wrote a book review on it for a variety of publications, participated in an internet teleconference for press members, and now I have attended his presentation to the International Motor Press (IMPA) in New York City Thursday January 20, 2011.
Any undertaking of the size and magnitude of the auto industry restructuring will have it’s critics, and the government’s revamp of the auto industry is no exception. With any endeavor of this size, mistakes will be made. In my own view, shedding dealers was a mistake. Rattner himself watches the sales progress being made by GM and Chrysler on a regular basis these days for signs of progress. Dealers are the customers of the manufacturer. Shedding customers will not sell more vehicles. The report provided by the Special Investigator of the Troubled Asset Relief Fund agreed and excoriated the Task Force for enabling the dealer terminations. When I asked Rattner about the dealer terminations in May 2010 he said the Task Force tried to make sure all parties involved made sacrifices. The Task Force regarded dealers collectively as a single constituency. As the economy and business climate improve, GM and Chrysler will need additional dealers to maximize market share, or will lose ground to competitors.
Rattner fielded a variety of questions and the occasional speech. When asked about GM’s IPO, he says he believes the government can now afford to be patient and wait to sell their GM stock at a premium as the stock continues to rise. He believes GM’s stock is still a bargain at current value, even compared to Ford. I didn’t ask if he owned stock in any of the auto companies, but in the interest of full disclosure, I own some of both GM and Ford. The taxpayers own about 26% of GM and a larger percentage of GMAC/Ally. Chrysler is still controlled by the U.S. government, although Fiat just increased it’s holdings based on meeting previously established benchmarks.
When asked why “car guys” weren’t part of his Task Force, which was made up of people with no real interest in cars but plenty of real world expertise in business restructuring, Rattner was ready with an answer. He asked everyone to recall when the “car guys” Rick Wagner, CEO of GM, Alan Mullaly, CEO of Ford, and Robert Nardelli, CEO of Chrysler came to Capital Hill to beg for a bailout. They came in separate private jets, for which they were soundly scolded by members of the Congressional committee. Mulally came because he knew that Ford would crater if either GM or Chrysler went down, as it would send a ripple of disaster through the supplier base. Such a disruption would have shut down all North American auto production and would have pushed Ford into bankruptcy as well. The three CEOs testified that for a mere 25 billion dollars, allocated based on company size and need, a disaster could be averted. Also on the auto maker side of the discussion was respected economist for Moody Ratings, Mark Zandi. Zandi took direct issue with the CEOs, stating it would take 75 billion dollars at a minimum, and up to 125 billion dollars. The bailout was ultimately 82 billion dollars, which is being repaid or redeemed rapidly. It is obvious the “car guys” were in complete denial as to their financial condition, even Ford’s Mulally. I have thought from the beginning that Ford was not so much smarter and forward thinking than the other car companies in their move to borrow money while they could, to sustain them in case of a severe downturn. It was more a case of the Ford family wanting to protect the status of their favored status of the stock. The family lives off the dividends of that stock.
Why was Rick Wagoner removed? Wagoner was steeped in GM corporate culture and was in complete denial about the condition of the company and the need for bankruptcy. Finance specialists like Rattner “bet more on the jockey than the horse.” Not knowing how much his company would need to survive was really the straw that sealed his fate. The report GM filed after the Bush administration bridge loan was so deficient there really was no other choice for the Task Force other than to replace Wagoner.
Why was the UAW favored over other constituent group? Rattner says is more a matter of perception than anything else. First, world class car companies need skilled workers to build the vehicles. Bankers and bondholders can’t build cars. In addition, he went through a list of concessions imposed on the UAW. The 320 job classifications previously in place are no more. There is no more “jobs bank,” where the Detroit 3 paid workers to stay home to watch Oprah and drink beer.. The union has agreed to serious wage and work rules cuts. Their heath care fund has been turned into a VEBA. Fortunately it has been funded by stock, laying a lot of risk on the union but looking like it will pay off well based on current stock value. The union pensions had already been funded UNLIKE the pensions of the white collar workers and the executives like Wagoner. GM had decided that it was better to bet their executive’s pensions on GM than on the stock market or other investments. That bet didn’t pay off, but the Task Force included a generous pension replacement for white collar workers. The value of bond holders and stockholders had already been determined by the market. The stock was trading at less than fifty cents at time of bankruptcy declaration, and GM bonds were next to worthless. In fact, many bondholders had bought their holdings at distressed prices and were looking to make a killing. Many held bonds that were “insured” by credit default swaps that would only pay off in the case of a complete default. That group of bondholders WANTED to be wiped out, to the consternation of the legitimate bond holders. Rattner then asks rhetorically, what should they have done different with the UAW given the real world situation they were in?
Rattner is the guy that engineered the nuts and bolts of the restructuring and is clearly relishing the current tide of success of GM and Chrysler. Despite my disagreements with some of the actions of his “Task Force,” his book is must reading for those interested in economics, the auto business, and politics. “Car Guys” probably wouldn’t have terminated dealers, but would they have gotten anything else right?
David Ruggles has spent his working life in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the US & Japan. Ruggles has been a dealer for Mercedes Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Nagano Prefecture Japan. He blogs at and writes regular columns for Ward’s Dealer Business, Auto Finance News, and the Daily Post.

Sunday, 9 January 2011

Book Review of “All the Devils are Here
The Hidden History of the Financial Crisis”

“Hell is empty and all the devils are here” - William Shakespeare - The Tempest

This brilliantly written book should be required reading for any registered voter in the USA. With all the misinformation “out there” about who and/or what caused the financial crisis, it is important to know where to go for answers. This book is “The Source.” The authors are Bethany McLean and Joseph Nocera. McLean was co author of the highly regarded book on the Enron crisis, “The Smartest Guys in the Room.” Nocera is an acclaimed financial writer for the New York Times. The authors’ mission is to tell the story accurately and honestly with no particular political agenda, to explain the complex in a way that can be understood by those not steeped in Wall Street “speak,” and to provide insight into the personalities and characteristics of the major players. The level of research evident in the book indicates to me that the authors were already well connected before they began their research for the book.

Why is the issue of the financial system meltdown important to those who follow the auto industry, and other sectors of the economy? In the late 1970's, consumption represented about 60% of the total economy. 30 years later, consumption was up to about 70%, despite the fact that the income of the middle class had remained stagnant during that time span. How did this occur? The additional consumption funding came from credit fueled primarily by “securitization.” Wall Street’s version of “securitization” had been invented and had grown to 40% of the total credit market by 2008. This expansion of credit fueled economic growth. When the mortgage backed securities market collapsed, it took down the entire securitization market including, credit cards, student loans, commercial loans, auto loans, dealer floor plan, and many other forms of credit. Losing a major portion of available auto credit and funding for dealer floor plan and working capital, pushed already shaky auto manufacturers over the brink, as auto sales slid and dealers dropped like flies. The resulting vicious cycle took the economy downward into recession. The Troubled Asset Relief Program (TARP) was all that stood between the economy and a major depression.

“Securitization” was the process that “allowed mortgages to be converted into a “bond” by combining numerous mortgages into one huge financial instrument. First, Wall Street invented “tranching” to divide up the securities into segments, typically three, based on the inherent risk each tranche entailed. This protected the highest risk level tranch from loss by paying off defaults from the lower rated tranches first. The next step was to devise “derivative” contracts to “insure” the risk. Based on derivative “insurance” like credit default swaps, Wall Street was now able to convince regulators that it was not necessary to “reserve capital” as a hedge against default claims. Now, if only they could get these securities rated AAA by rating agencies like Fitch and Moody, Wall Street nirvana could be achieved. Now junk could be sold around the world as high yield AAA rated securities. AAA is the rating equal to the rating of Treasury bills. To say the least, billions of dollars were made, huge bonuses paid, and many innocent people bilked.

Guarantors of risk were not required to have the money to make good if their bets didn’t pay off. Yet, traditional depository banks were still required to reserve capital, as had been the norm ongoing. This rendered traditional banks to be uncompetitive UNLES they sold their own mortgage originations to Wall Street. If a depository bank originated a mortgage, it could sell that mortgage to Wall Street, buy it back as a part of a AAA rated security, and avoid the “capital reserve requirement. Rating agencies like Fitch and Moody were paid by the Wall Street banks whose products they rated.

Junk mortgages could be assembled into a MBS (Mortgaged Backed Security), tranched into 3 segments based on “risk,” “insured” with a Credit Default Swap contract where no capital reservation was required (it was assumed that Wall Street would not take risks not in their own interests), obtain a AAA rating to represent the securities’ safety as the highest grade, which allowed them to be purchased by entities limited to AAA investments by law, like pension funds, and sold around the world . Profits were privatized on Wall Street as huge profits were made and mind boggling bonuses paid to executives. The risk, however, was socialized to U.S. taxpayers.

The U.S. government, in the form of the George W. Bush administration and it’s Treasury Secretary Hank Paulson, was put into the position of allowing the world financial system to collapse or step in with TARP. Fortunately, Congress approved TARP, which despite its imperfections, saved the world from an incomprehensible disaster. After all, it was the U.S. government’s lack of oversight that stood by and let it happen in the first place. Other countries were looking to the Americans as their own economies were severely impacted by the actions of American investment bankers.

Governments are generally expected to protect it’s citizens from avoidable disasters. The Republican Party found this out after the Great Depression. Democrats paid a price after Jimmie Carter. Even President Barack Obama has been blamed by some despite the fact he had nothing to do with the disaster, other than casting some votes while a Senator. Unfortunately, many voters lack the ability to grasp complex issues, and fall prey to simplistic explanations.

In 1979, the Wall Street version of securitization was invented and launched by Merrill Lynch. Government Sponsored Enterprises (GSE) in the form of Fannie Mae, Freddie Mac, etc., had securitized the first mortgages in previous years. The GSEs were given objectives of how many low down payment low income loans they should make at a minimum by Congress. The compensation packages of the executives of the GSEs were predicated on these objectives. Interestingly, the GSEs were already making these types of loans at a much higher rate than the objectives they were given, making huge bonuses a given. Further, the GSEs received credit just for purchasing AAA MBSs containing them from Wall Street. The GSEs thought that was safer than holding the paper themselves. In fact, Wall Street had rendered the GSEs superfluous.

Wall Street was allowed to create a “betting market” on almost anything. The problem was not so much deregulation, but a refusal to regulate at all. During the period of time Wall Street was “rocking and rolling” American home ownership increased only 1.7%. Yes, we have paid a terrible price for such a small increase in the percentage of those who get to experience the American dream. Yes, mortgage originators “approved” huge numbers of loans with little chance of them being paid back. And they did this because they were never going to hold the paper anyway, just as an auto dealer sells auto loans to his/her banks. It was all being sold to Wall Street because they could take the lousy paper, turn in into AAA rated securities, and sell it to anyone. But the real problem was with home refinances and home equity lines of credit.

So who caused the meltdown and who were the players? In 2008, I wrote that the meltdown was caused by an “unholy alignment between liberal and conservative political causes.” This was after watching hours of testimony on CSPAN and studying the subject intensely. After two years of additional study, including watching Hank Paulson, the Bush Treasury Secretary and author of TARP, testify before Congress under oath, I have adjusted my thinking. But my own personal opinion is not important. All of us have to satisfy ourselves. For those who want to believe the meltdown of the financial system was caused by the overly altruistic “holding a gun” on lenders, forcing them to make loans they knew would never be paid back, you will be disappointed. It’s a non issue.

Some major “players,” their roles, and some resources are listed as follows:

“All the Devils are Here,” Nocera and Mclean

“On the Brink: Inside the Race to Stop the Collapse of the Global Financial System,” By Henry Paulson”

The last chapter of Bush speech writer David Frum’s recent book: “Comeback: Conservatism That Can Win Again”

“Overhauled” by Steve Rattner

George W. Bush speech on American home ownership from 2002

George W. Bush - consciously worked to prevent anything from slowling the housing juggernaut that was fueling the economy. He also had the guts to stand up to his own party’s ideologues to move to save the economy from destruction by proposing and passing TARP along with his Treasury Secretary. Moved against Congress to bail out GM and Chrysler by using TARP funds after Congress had turned down a bailout package.

Alan Greenspan - a disciple of Ayn Rand, Chairman of the Federal Reserve, fought regulation of derivatives at every turn

Larry Summers - under the Clinton administration was an opponent of regulating derivatives. Teamed with Robert Rubin to squelch Brooksey Born’s bid to regulate derivatives. At the time, Born was Chairperson of the Commodities Futures Trading Commission. As a member of Barack Obama’s administration, Summers was a key player in the bailout of GM and Chrysler, and the direction of many TARP funds.

Robert Rubin - Treasury Secretary under Bill Clinton - worked to quell efforts to regulate derivatives

Brooksey Born - Chairman of the Commodities Futures Trading Commission - moved to regulate derivatives, and was squelched by Rubin and Summers.

J P Morgan - invented the credit default swap by paying the European Bank for Reconstruction and Development to assume it’s risk in their exposure to Exxon, which tapped 4.9 billion of it’s 5 billion dollar credit line after it’s notorious oil spill disaster. It never occurred to anyone to ensure the EBRD had the funds to make good in the case of a default. It turns out it didn’t make any difference. Years later, the were many claims to be paid and only the U.S. taxpayer to pay them.

Moodys, Standard and Poor, and Fitch Rating - Were paid by the same companies who’s products they were supposed to rate. Enabled Wall Street to sell junk as AAA level investments.

The Three Amigos - Lewis Ranieri - Salomon Brothers bond trader - “I wasn’t out to invent the biggest floating craps game of all time, but that’s what happened.” David Maxwell - CEO of Fannie Mae, formed an uneasy alliance with Ranieri and Wall Street. Larry Fink - After creating some of the first mortgage backed securities he later served as a key government advisor.

Blythe Masters - helped invent the credit default swap for J P Morgan

Joe Cassanno - Ran the Financial Products division for American Insurance Group (AIG) - Began selling credit default swaps (CDS) on collateralized debt obligations (CDOs) “Collateral triggers” built into AIG CDSs helped bring the company down.

Phil and Wendy Gramm - As Senator and later as Chairman of the Senate Banking Committee, Phil blocked attempts at regulation at every turn. Wendy Gramm, a PHD economist, was installed as Chairperson of the Commodity Futures Trading Commission (CFTC) by Geroge H W Bush when it’s current Chairman, Mark Brickell, was moving to regulate derivatives. The move stopped the move to regulate in its tracks.

Roland Arnall - Appointed to the post of Ambassador to the Netherlands by George W Bush while his company, Ameriquest, a major sub prime mortgage “lender,” was a leader in blatantly deceptive lending practices. At one point, a group of ex auto business F&I managers operated a consulting company, specializing in showing fledgling mortgage brokers how to falsify and manipulate documents. They went so far as to have a web site devoted to creating phoney pay stubs, tax returns, job letters, etc. In fact, Wall Street wasn’t really concerned about documentation, as they were able to turn lousy mortgages into AAA rated investments under most circumstances.

President Barack Obama - Was duped and gave Arnall a pass during Senate questioning regarding Arnall’s ambassadorship because a mutual friend, Deval Patrick, the current Governor of Massachusetts, sat on the Ameriquest Board of Directors. His administration inherited the economy in a dreadful condition, although without the strong and decisive action of George W Bush, Hank Paulson at Treasury, and Ben Bernanke at the Federal Reserve Bank, things would have been much worse.

These are only a few of the personalities and characters involved. Before a reader allows themselves to be intimidated by the prospect of not understanding everything in the book, please understand that the people perpetrating these evils on the world didn’t fully understand what they were doing themselves. People don’t usually buy books about business for entertainment purposes, but I couldn’t put this one down. It read like a riveting“who dunnit.” Don’t pass up the opportunity!