Monday, 31 December 2012

Taking the Taxpayers out of General Motors

Ruggles – 12/26/2012
What many stockholders and taxpayers had feared, had Mitt Romney won the recent Presidential election, is coming true anyway. The taxpayers (U. S. Treasury) are quickly being taken out of their remaining General Motors ownership BEFORE the positive impact of the many new and exciting redesigned GM products to be introduced in the next few months can have the chance to boost retained earnings and share price. Waiting another 18 to 24 months could reduce or eliminate the loss that will be taken on the original taxpayer investment.
Having recently arranged for an $11 billion line of credit, and with about $41 billion in available cash and credit, GM is buying the stock back directly from the U.S. Treasury. At least buying back stock directly from Treasury is probably much better than dumping the stock on the open market, thereby diluting the share value and causing the stock price to drop even further. At least that is this stockholder’s point of view.
“Car Czar” Steve Rattner describes the buy back as “welcome news.” I’m not so sure. He goes on to write in the New York Times:
“For General Motors, the separation will conclusively remove the appellation of “Government Motors,” a stigma that the Company had argued affected the buying decisions of a meaningful segment of consumers.”
The divorce will ultimately also liberate G.M. from a number of government-imposed restrictions, importantly including those relating to executive compensation. These restrictions adversely affected G.M.’s ability to recruit and retain talent. Now, compensation decisions will be made by the company’s board of directors, just as they are in every other public company in America.”
As an observation, once GM rids itself of taxpayer ownership, GM execs can also resume the use of corporate jets. And we know how car business execs hate to fly commercial.
Others might say, GM has traded the appellation of “Government Motors” for another appellation, “The Car Company on which the taxpayers lost billions.” Rattner himself estimates the loss will come in at about $14 billion. Other estimates are higher.
The taxpayers should pay $14 - $20 billion so GM execs can go back to their spendthrift ways, when waiting 18 months or so would have given the stock the opportunity to rebound based on the recovering economy and an almost complete makeover of their product line? Not in my world. While this writer is NOT a professional stock picker, many folks look to Forbes for financial advice. A December 10 article in Forbes recommended “Roll with GM for 2013,” and gave compelling reasons why.
Others investment experts have weighed in on the subject and most have recommended buying GM stock for 2013, despite the attempt from some naysayers to float a rumor predicting a near term bankruptcy from GM. Of course, these columns appeared before the stock buyback announcement. And the naysayers ignored facts, while misinterpreting others, to create their false assertions.

Ex GM CEO Ed Whitacre was shown the door after he claimed in a national television commercial that GM had repaid its government loans. This was word parsing at its worst, as GM had only returned unused loans it didn’t need. The commercial implied, even though it did not specifically state, that GM was no longer in hock to the government and U.S. taxpayers, which was certainly not true. Some might argue that GM is using tax payer money to buy back taxpayer stock, a move similar to the claim that sank Whitacre.

What would another 18 to 24 months hurt? The President won his second term. What can the political pressure be? Why not give the stock the chance to improve? Is GM actually claiming that the cap on compensation is why they have had high velocity executive churn since the restructuring?

Has the government been “heavy handed” in its ownerships of GM, except for the jets and executive compensation? Recalling the previous bailout of Chrysler in the 1980s, Lee Iacocca chafed under the government supervision he had to live with during that era, ESPECIALLY the one that kept his jet grounded. In addition, the Feds were pushing Chrysler to divest itself of its truck division. All it took was for Ronald Reagan to make a crack to Iacocca at a Statue of Liberty restoration event about how Iacocca should be grateful that Carter was in the White House, and not Reagan, when the bailout was approved and signed, and the Chrysler CEO was more than incensed. He took a huge risk and paid the Feds off early, forgoing over $300 million in interest savings to do so. Iacocca put Chrysler at risk from a cash position perspective, even though the gamble ultimately paid off, but he saved the truck division, which has been the largest source of profits for Chrysler since. And he got his jet back and stuck it to Reagan. So is it ego or legitimate business considerations driving this current GM stock buyback move?
More Rattner:
“In a perfect world, I would not be a seller of G.M. stock at this moment. For one thing, the company is still completing the reworking of its sluggish management processes in order to achieve faster and better decisions and lower costs.”
For another, G.M.’s financial problems slowed its development of new products during 2008 and 2009. Now, a passel of shiny new models offering great promise is about to hit showrooms.”
And in my view, G.M. stock remains undervalued, trading at about 7 times its projected 2013 earnings, compared with nearly 13 for the stock market as whole.”
I think the move is driven by GM ego and arrogance, a really bad sign, and is NOT in the best interests of the U.S. taxpayer. This does not change the fact that while the auto sector restructuring was not conceived and executed perfectly, on balance what was accomplished will be considered a feat by economic historians. The cost to have NOT done the restructuring is incalculable, and most certainly many times more costly than a measly $20 billion. Depression or “moral hazard?” That was the choice. And the “perfect can’t be the enemy of the good.” In my mind, this premature stock buyback adds unnecessary tarnish to an otherwise laudatory endeavor.

Friday, 7 December 2012

Honda as Japan's Exemplar

...Make where you sell, and that's not Japan...
For a while the impact on the auto industry of 3/11 – the earthquake and tsunami – and then the Thai flood garnered headlines. Lately the headlines in Japan have been politics, politics, and more politics. First there was the US election and the leadership transition in China – Japan's #2 and #1 trading partners. Then there are the upcoming elections in Japan and Korea. These have embroiled the auto industry, too, because of the attempt of various parties in China and Japan to wave the nationalist flag, with much of the fallout hitting bilateral Japan-China auto trade. All this has pushed more mundane news – the transition of the domestic Japanese auto industry – out of the headlines.
So here are two snippets, both using Honda as a foil, though these are more general issues.
First, there's the story – Alan Ohnsman at Bloomberg – that Honda will become a net exporter from the US. Why? – because they're ceasing Accord production in Japan. Of course Nissan is already bringing in the March from its plant in Thailand; Mitsubishi has also begun imports from there. But the yen is cutting into the attractiveness of production in Japan, while the domestic market is small: make where you sell, and that's not Japan.
Second, Honda has now moved into second place in sales for January-November 2012, with 701K units. Meanwhile Nissan, the one-time national champion, ranks fifth. (In third and fourth are Daihatsu and Suzuki; Toyota dominates with 1.55 million units, over twice Honda's level.)
What though is Honda selling? It turns out their success -- and that of Daihatsu [a Toyota subsidiary] and Suzuki -- is due to the growth of the "kei" (minicar) segment, vehicles with engines 360cc or smaller. In the full-size segment Honda is a distant 4th, more-or-less tied with Mitsubishi (29K vs 27K units) but far behind Nissan and Toyota. Indeed, in that segment Honda remains behind the importers BMW and Mercedes (at 32,000 and 33,000, respectively). But in compact cars they were second only to Toyota, and Honda sold enough "kei" to move them to the #2 position.

Passenger Cars

Grand Total

Now domestic sales – cars, trucks and buses – peaked in 1996 at 7.1 mil units; in 2012, the level will be about 5.4 million units, down almost 25% despite the rebound from the depressed levels of 2011. So no one is doing well, and population aging means a declining number of licensed drivers. Things will not improve. But the mix is becoming bimodal, too. Full-sized cars are fine, quite possibly hitting a new peak of 1.5 million units (triple sales in 1990, during Japan's bubble). The shift is from compact cars to minicars. The former peaked in 1990 at 3.8 million units; 2012 will see sales of 1.6 million units. At the same time, minicars will hit 1.6 million units, up from 0.8 million in 1990. The market is thus split about 1/3rd each, but the shift is one that leaves a less rich product mix.

Cars Total
2012 - Nov
...mike smitka...

Sunday, 2 December 2012

Understanding the Mortgage Crisis

By David Ruggles
Preface: The following is the culmination of over 4 years of research. At one time I thought the mortgage crisis was due to “an unholy alliance between RW and LW forces. That was before I discovered that during the bubble period only 15% of mortgages and equity lines of credit (ELOCs) were made by Community Reinvestment Act lenders, and of those, only a small percentage were actual CRA loans. Further, according to the Federal Reserve study on the matter, those CRA loans have performed better than the overall mortgage loan market. The “fall back” position of the Republican Party when faced with the actual facts is to say, “There is certainly plenty of blame to go around.” This seems to be an attempt to equally apportion blame to both parties when it is clear that RW ideology is what caused the problem regardless of whether it was practiced by Republicans or the very few Democrats involved, Bill Clinton or Larry Summers, to name a couple.
I know it is RW orthodoxy to believe that Fannie Mae and Freddie Mac played a large role. The two Government Sponsored Enterprises (GSEs) were guilty of excessive lobbying, misstating their balance sheet based in a rather complicated legal case, and excessive executive compensation. But for those who want to know the truth and read further it will become clear that that Fannie and Freddie were victims of what RW ideology unleashed, not perpetrators. Had I seen “The Warning” earlier, I would have come to my conclusion earlier. As it was, I watched hours of Congressional testimony, the most entertaining being when Congress got again Hank Greenburg, retired CEO of AIG in front of them. So I studied AIG and Joe Cassano, head of AIG’s London Financial Products division. Then came, “All the Devils are Here,” by Bethany McLean and Joseph Nocera. I later waded through the highly partisan “Financial Crisis Inquiry Report” published by the panel entrusted to analyze the mortgage crisis. I then got my hands on the Federal Reserve documents issued by the Minneapolis Federal Reserve, link provided.
What Is The Mortgage Crisis? –
In short, the Mortgage Crisis is what is stymying the U.S. economy.
Easy credit by Wall Street lenders and artificially low interest rates fueled a real estate bubble. These lenders had been enabled by an anti-regulatory environment that allowed risky mortgages to be rated as an investment much higher than they deserved. Mortgages had been bundled into complex Mortgage Backed Securities, “insured” by “policies” (Credit Default Swaps) that lacked reserves to pay potential claims, and sold around the world. Because they had been rated AAA by the ratings agencies, these securities were held by traditional depository banks, Fannie Mae and Freddie Mac, pension funds, and other conservative investments vehicles. When the bubble burst, these trillions of dollars in securities became valueless virtually overnight because suddenly no one knew what real estate as worth. The MBSs were no longer backed by the asset values that supported them. Those who held mortgage backed securities couldn’t turn them into cash. In fact, all asset backed securities seized up and the world found itself in a credit crisis. Banks couldn’t lend because their cash was tied up in worthless MBSs and ABSs. The worldwide credit system froze up. The stock market fell like a rock. In the U.S., consumers instantly lost a minimum of 38% of their household net worth and at least 50% of their stock portfolio value. Many around the world lost their pensions, or a portion thereof. Panic set in and a worldwide lack of consumer confidence threw the global economy into deep recession. Tax revenues dropped precipitously. By late 2008 the American economy began shedding jobs at the rate of 800K per month. Governments around the world ran huge deficits as they tried to deal with the drop off in tax revenue at a time when they needed to prop up their economies to keep from slipping into Depression.
While things have improved and consumer confidence is on the rise, millions of Americans have to deal with a damaged credit report and the loss of the household net worth. Even though there is tremendous pent up demand, millions are without jobs or underemployed.
The Community Reinvestment Act (CRA)
The Community Reinvestment Act was passed by Congress and signed by Jimmie Carter in 1977. Its purpose was to ban discrimination in lending and insurance markets. A common practice of the day was “red lining.” Insurance companies and lenders frequently made decisions on whether or not to do grant credit or issue insurance to a consumer based on whether or not they lived inside or outside a “red lined” neighborhood. The CRA is frequently blamed by the Right Wing for causing the mortgage crisis as it did morph over the years into method to “persuade” lenders to include a true cross section of consumers in their loan portfolios. The CRA had no real force of law to accomplish this. There were/are no jail sentences or actual fines involved in the Act. However, lenders who did not meet the target percentage could have their names published on a list, which could impact their being granted charters by regulators to buy other banks and expand their business. This could have consequences to a lender.
HOWEVER, the mortgage crisis was not caused by banks regulated by the CRA. During the mortgage crisis, 85% of all mortgages and Home Equity Lines of Credit (ELOCs) were granted by NON CRA regulated lenders. This information is easily accessible via Google. One needs to understand the distinction between depository banks and investment banks to understand this.
Even depository banks, regulated by the CRA, really had NO PRESSURE on them to make “risky CRA loans.” Why? During the bubble period they often functioned as mortgage brokers. They could “approve” all sorts of risky mortgages, but they had no risk. WHY? Because they had NO REQUIREMENT to hold the paper “in house.” They could get CRA credit and immediately sell the “risky” mortgages upstream to a mortgage backed security assembler (Wall Street Investment Bank) who could include it in one of their mortgage backed securities, which were rated AAA because of the complex formula used to assemble them and the credit default swaps purchased to “insure” the risk.
CRA regulated banks were a non factor in causing the mortgage crisis. Out of the 15% or so of mortgages approved by CRA regulated depository banks during the bubble period, only a small percentage of those were CRA caliber mortgage loans. And they have performed well.
CRA Regulated depository banks WERE impacted by the mortgage crisis and the bubble created by the Wall Street Investment Banks. One day they woke up to realize that the collateral that supported the mortgages they had made and still held didn’t support the money they had outstanding. This is essentially the same thing that happened to Fannie and Freddie. F&F had no real role in creating the bubble that burst. They were prohibited by law from buying the kinds of mortgages Wall Street routinely approved, packaged, and sold. There are a few anecdotes where F&F bought some bad mortgage paper from CRA regulated lenders, one of which is playing out now in the $1 billion law suit filed by F&F against BOA for misrepresentation. The transgressions were actually committed by Countrywide, an infamous NON CRA regulated lender. The lawsuit will be interesting as the purchase of Countrywide by Bank OF America was a true “shotgun marriage” arranged by the Feds. There will most certainly be an accommodation of sort made by Federal regulators.
The situation is further complicated by the fact that certain banks had BOTH CRA regulated and NON CRA regulated operations under their roof. The repeal of Glass Steagall via the Gramm-Leach-Bliley Act took care of this. GLBA was essentially the CitiBank/Travelers Insurance Merger Facilitation Act.
Credit Default Swaps (CDS)
The first CDS was invented by Blythe Masters of JP Morgan in 1989. Masters hadn’t reached the age of 30 at the time, and is a remarkable woman born, raised, and educated in the UK. JP Morgan had extended a $4.8 billion credit line to Exxon. The Exxon Valdez had just run aground. Exxon came to JP Morgan to tap their line of credit. JP Morgan had to oblige. Masters exchanged sold risk on the loan to the European Reconstruction and Development Bank in return for a healthy fee, and the CDS was born. There was no mechanism to make sure the European bank had the means to pay a claim of the size they had just “insured.” Once the rest of Wall Street got wind of this, the free for all was on. Once they figured out how to parlay the mortgage backed security, assembled as a “tranched” collateralized debt obligation and insured with a CDS, they could now get the coveted AAA rating from Moody, S&P, and Fitch, and sell mortgage backed securities around the world. In fact, to be able to offer attractive higher yields, they often needed to buy really risky mortgages that carried higher interest rates.
At one time, F&F used Wall Street to securitize their own mortgages. Wall Street sold the mortgage backed securities “backed with the full faith and credit of the U.S. government” and collected fees for doing so. The process provided an endless supply of capital to support the U.S. housing market. Wall Street appreciated the business they had with F&F but had always been envious of their “big brothers.” Once Wall Street firms became public companies and had been enabled by unregulated credit default swaps, which allowed for the AAA rating, Wall Street became F&F’s biggest competitor. Wall Street routinely approved and purchased mortgages that F&F were prohibited by law from purchasing.
The Commodities and Futures Trading Commission, Brooksley Born, and the Commodities and Futures Modernization Act.
What a mouthful! Of all the events responsible for the mortgage crisis, the blocking of regulation of credit default swaps is the critical piece. During the Clinton administration, Brooksley Born was appointed to the chairmanship of the CFTC (Commodities and Futures Trading Commission). An extremely bright person, she quickly figured out the danger to the global economy associated with un-backed credit default swaps. The inherent danger came as a result of issuers not being required to reserve capital to pay potential claims. Issuers could collect fees for “insuring” others’ risk with no associated cost or reserve. The “Fees” would drop straight to the bottom line, on which huge bonuses would be paid, instead of establishing reserves to pay claims. Worse yet, in the complex world of derivatives trading, players could make bets n other’s “bets.” Really complex hybrid derivatives appeared with securities of mortgages, car loans, credit card debt, and student loans all bundled into the same security and “insured” with an un-backed credit default swap.
When Born moved to force issuers of CDSs to reserve capital to pay potential claims, she was met by a daunting opposition force. Brooksley Born lost the ensuing battle. The American taxpayer, voter, citizens and their offspring lost. The “winners” at the time were Wall Street, Alan Greenspan, the Fed Chairman and the economic rock star of the day who was appointed by Ronald Reagan, and the RW ideologues. Of course, Greenspan’s his star has been somewhat tarnished and he has been disavowed by his fellow Ayn Rand sycophants and Austrian Economics School theorists. In fact, he is in ideological exile with George W. Bush. To his credit, he has publicly copped to the errors of his thinking.
Greenspan was, no doubt, sincere in what he did. He led the pack which included people like Phil Gramm, Republican Senator from TX, Arthur Leavitt, Chairman of the SEC at the time, Robert Rubin, Treasury Secretary, Tom DeLay, Republican from TX, and a host of other RW “laissez faire ideologues. They succeeded in the forcing Born out of her job and in blocking her move to force issuers of CDSs to reserve capital to pay potential claims. Since Larry Summers was a part of the “pack,” there WAS a Democrat involved in this, but the entire affair was a result of RW “laissez faire markets self- regulate” ideology. This incident is chronicled in the PBS documentary “The Warning.” Excerpts can be seen at YouTube, including the tearful “mea culpas” of Greenspan and Leavitt. Another documentary on the subject is “Inside Job,” by Charles Ferguson. Featured on this film is Glen Hubbard, currently Mitt Romney’s chief economic advisor. Hubbard has been musing publicly of late on whether or not he would prefer to be Treasury Secretary or wait to be appointed Chairman of the Fed. This is NOT a good guy.
In the middle off all of this, Long Term Capital Management, a highly leveraged hedge fund collapsed and threatened to drag the world’s economy along with it. High risk arbitrage trading including credit default swap speculation, was the culprit.
Greenspan and his crew needed to take time out of their effort to block the CFTC to deal with this. I guess they didn’t learn any lessons from their experience. Indeed, regulation is all about “an ounce of prevention is worth a pound of cure.” Greenspan and his pack of ideologues have cost us dearly. Almost 40% of household net worth is gone and the credit reports of millions of consumers have been badly damaged. Credit is required to buy the kind of high ticket items that create high paying manufacturing jobs. Fortunately, almost $23 Trillion in wealth has been restored through the rebound of the stock market, but the current administration is paying a high political price for the fact that their predecessors damaged the economy so thoroughly.
Also on YouTube is the late Jack Kemp scoffing at the idea that the CRA caused the mortgage crisis.
In 2000, Congress passed the Commodities and Futures Modernization Act. The most important part of this bill was written in at the last minute by RW ideologue Phil Gramm. He inserted language ensuring that credit default swaps would NOT be regulated as insurance “because no insurable risk” exists. Bill Clinton signed the bill, so here is another area where a Democrat could shoulder some blame.
I find the fall back position of the RW after facing the insurmountable mountain of evidence that proves “liberals did NOT force banks to make risky loans,” is to claim, “There is plenty of risk to go around.” While this is technically true, the preponderance of evidence of guilt is clearly on the part of RW ideology. Technically, when I took a leak in the ocean I contributed to the Japanese tsunami.
Barney Frank and Chris Dodd
It is said Barney lied to the American people when he made the statement that “Fannie and Freddie are fine.” As the Chairman of the House Banking Committee Barney is prohibited from making statements that could devastate markets. But then, so are other government officials like the Fed Chairman, the Treasury Secretary, and the President of the United States. These people make the wrong statement and they could be creating a self-fulfilling prophecy. Imagine the Chairman of the House Banking Committee saying, “There is a bubble in the housing market that will burst and render mortgage backed securities valueless?” In minutes, the value of pension funds worldwide takes a dump as economies seize up. Give it a rest. Besides, F&F had little or nothing to do with the making of the bubble and were victims of what Wall Street did, NOT perpetrators. Having said this, it is absolutely true that the quasi-private industry companies (GSEs, Government Sponsored Enterprises) paid huge salaries and bonuses to executives based on incentives provided to them by Congress.
While it is true that their compensation incentives included objectives for low income (CRA) mortgages, every time they were given a new target they were already exceeding it? There was nothing that compelled F&F to buy and hold CRA mortgages. In fact, they sold most of them upstream to Wall Street and bought them or similar mortgages back as mortgage backed securities. Yes, F&F held hundreds of trillions of these toxic assets. AND like the home owner who wakes up one day to find that his house isn’t worth anything near what he/she owes against it, F&F awoke to find that the money they had extended wasn’t supported by the collateral they held, PLUS they were out of cash and couldn’t liquidate assets to generate any. This had nothing to do with Barney Frank or Chris Dodd.
Alan Greenspan
Greenspan was the longest serving Federal Reserve Chairman in history, appointed by Ronald Reagan. Greenspan was Ayn Rand’s favorite and highest profile protégé, and used to be a firm believer that markets would “self-regulate.” Some of his exploits have already been chronicled in this piece. A link to the YouTube video where he admits the error in his previous thinking has been included above. But Greenspan’s Fed played an additional role in creating the mortgage bubble that blew up in our face. After the September 11, 2001 terrorist attacks, Greenspan’s Fed lowered interest rates in an effort to bolster the American economy, which had been shocked by the attacks and was in the doldrums. This was probably a good thing at the time, but the Fed held the rates at record lows for much too long. Once addicted to the low interest punch the Fed was afraid to take the risk of raising rates. After all, so many mortgages were ARMs, and an upward reset could have triggered a chain reaction of defaults and deficiencies. Well, we know what happened. And the current administration inherited an economic mess and the Fed lacked the most helpful tool of all, the one Paul Volcker used to bring recovery to the Reagan era recession, that of lowering interest rates. When they are already at low ebb, there is no place to go. It’s like trying to fix a car with an empty tool box and no parts. 
George W. Bush
According to David Frum, Bush 43’s speech writer, the administration worried about the overheated housing sector but made the conscious decision not to touch it, as it was the single bright spot supporting the economy. We really needed someone with the will power and authority to take away the punch bowl just as the party is getting well underway.
Risky Mortgages and ELOCs
There are many lenders who PREFER to make riskier loans. The key is whether or not the risk is properly priced. In most cases, those who are making riskier loans add in a little extra for themselves so they are more than covered from loss through default and deficiency. Even if liberals DID make lenders make risky loans, which is not the case, the issue would be whether or not the loans were properly priced NOT that they were made in the first place.
Wall Street Goes Public
Not often discussed as a role in the mortgage crisis is the fact that Wall Street investment banks went from being closely held partnerships, where the partners watched each other like hawks, to pubic companies without the same level of motivation to properly manage risk. This occurred about twenty years ago. Complicated Value At Risk (VAR) calculations were developed which failed to account for the impact of a slide by all elements at once. Previously, partners had personal liability and would have never allowed the kind of risk taking which became routine after the partners had cashed out and no longer held the same level of risk. It’s one thing to lose on an investment, and quite another when they throw you out of your house, take your vehicles, and you are forced to call your kids home from college and move in with your in laws. In other words, there are different degrees of being “wiped out.”
Gramm Leach Bliley Act
Passed in 1999 and designed to facilitate the merger of Travelers Insurance and CitiBank into the huge conglomerate it became, it made “Too Big to Fail” a reality. It repealed the Glass Steagall Act of 1933, which was designed to provide regulation that was sorely lacking at the time. Many believe it was the Glass Steagall Act that had prevented more serious economic downturns since the Great Depression. A part of the new Dodd Frank Act, designed to reinstall safeguards that could prevent another serious meltdown like the one we are trying to recover from, is called the Volcker Rule, named for ex Fed Chairman and Obama administration advisor Paul Volcker. The Volcker Rule is currently being blocked by a cadre of RWers. I guess they believe that privatizing profits while socializing risk is a good thing. The electorate needs to know what they are doing and why they are doing it. Unfortunately, this is a well-kept secret.
If everything is not clear to this point, all you need to know is that the 85% of mortgages and ELOCS approved during the bubble period, the mortgages and ELOCS that actually inflated the bubble, were made by NON CRA regulated lenders. And those lenders had NO MANDATE forced on them by anyone. All they had driving them was the profit motive and a group of RW ideologues running interference for them.
Research resources include the PBS documentary “The Warning,” the Oscar winning documentary “Inside Job, “by Charles Ferguson, “Too Big to Fail,” by Andrew Ross Sorkin, “Overhaul,” by Steve Rattner, “All the Devils are Here,” by Joe Nocera and Bethany McLean, “The Big Short, Inside the Doomsday Machine,” by Michael Lewis, “The Financial Crisis Inquiry Report,” by the appointed presidential panel that included Brooksley Born, hours of watching CSPAN, scores of Federal Reserve conferences, supplemented by 40 plus years of experience in the financial sector.

Saturday, 17 November 2012

...tariffs are 0% on vehicles shipped from Mexico...
Honda is building a full-sized assembly plant (200K units per year) as is Mazda; Nissan is adding a 3rd plant. Part of that is driven by the strength of the yen, at ¥81.3 per US$ on 17 November; the US is the biggest source of profits for the auto industry, so sourcing vehicles for the US market from a non-yen location is important. [The Euro is also strong, to which anyone who has traveled there on a dollar budget can attest. So while VW has operations in Mexico, here I focus on the Japan angle, because I'm teaching a course on the Japanese economy.]
But why Mexico? Logistics costs are high, because most vehicles will likely be exported and because the local supplier base is not as deep as in the US midwest (hence parts must be imported). So while quality is high and wages are competitive, it's not a priori a natural choice.
The answer lies in free trade agreements: Mexico has been more aggressive on that front than the US (and Japan). As a result not only can vehicles be shipped tariff-free to the US–0% from Mexico versus 2.5% on cars and 25% on trucks shipped from Japan. Ditto Europe–tariffs are 0% from Mexico versus 10% on vehicles shipped from the US or Japan. (I have not researched whether Mexico has similar aggreements in Latin America.)
Now Japan could offset some of this were it to negotiate more free trade agreements. (It has one with Mexico.) But that's an awkward process, and has yet to join the biggest pending agreement (TPP, Trans Pacific Partnership). The reason: farmers, whose political clout is disproportionate to their share of the economy, and whose clout over time has led to subsidies and tariffs that allow rice farmers to remain in business despite costs that are multiples of those in other large producers. So removing protection for rice would drive most farmers out of business. In Japan, it's the "3rd rail" of electoral politics.
While we didn't hear anything about the economies of Canada and Mexico, our two biggest strategic partners, in the recent (and unlamented) US political cycle, this movement clearly benefits NAFTA and thus the US. Do higher wages in Mexico harm us? No! And while we might rather have the jobs in the US, we do pick up additional parts business. If we're going to import vehicles – and economies of scale mean that many will still be built in but a single plant globally – then better Mexico or Canada than Japan or Europe!
...mike smitka...

Tuesday, 13 November 2012

Will GM Again Go Bankrupt?

...there's not a shred of data to support BK Round II...
I've received an email making the rounds claiming General Motors is destined for bankruptcy before the end of Obama II. I've now heard the same pronouncement from several other directions. However, just because someone thinks that government support during GM's bankruptcy process was wrong does not mean it hasn't worked. I won't address any specific claim, in part because none that I have encountered looked at GM's sales data, much less perused their financial reports. It is though appropriate to ask what leads a firm towards bankruptcy, and whether there's evidence GM is heading that way.
Bankruptcy 101:Firms go bankrupt because they run out of cash.
Companies lose money all the time; they may even, temporarily or otherwise, be in a position where they're unable to pay off their creditors. But as long as they can continue to meet payroll and reimburse suppliers and contractors, they can stay in business. For a company to go bankrupt, it must run out of cash. That could be due to chance events that catch firms short, as when the sudden collapse of Lehman undermined liquidity across the financial system. It can happen because a firm, while profitable, expands too fast and has bills come due that it can't pay because its customers have yet to pay. Most often, of course, it's a result of cumulative losses that impair a firm's ability to borrow, and eventually the losses drain it of cash. Once it runs out, it has no option but to file for Chapter 11. It then needs put together a restructuring plan and to find lenders to provide cash in the interim. Failing that, a firm faces dissolution, Chapter 7, when it simply (well, for a large firm not so simply) shuts downs and a trustee then liquidates anything that might have value.
In GM's case it had a core business that appeared sustainable: new car and truck models in the pipeline, factories that were actually high in productivity. It also had fundamentally unprofitable operations, and owed too many people too much money. To survive it thus needed to shut down parts of its operations, and unload debt. But to restart the new company needed cash to pay workers and suppliers. As it happened, the 2008-9 financial crisis meant neither existing bondholders nor investment banks were willing to fight for a piece of the new GM; risk finance wasn't available on any terms. Only the government proved willing and able to provide the substantial working capital – "DIP" financing – GM required. That was what made GM's bankruptcy process unusual: with only one party involved, negotiating a speedy exit from bankruptcy took weeks, not years.
So that leads to one fundamental question: will GM run out of cash in the near term? The answer comes in two parts:
  1. is GM cashflow positive?
  2. does GM have access to (undrawn) credit lines?
Of course GM may face longer term issues that undermine cashflow and render its credit lines inadequate. The natural followup questions are thus:
  1. is GM profitable?
  2. are they doing well in their two largest markets, that is, does their core business seem to be faring well?
  3. are their non-core businesses doing so poorly elsewhere as to threaten corporate viability?
  4. are there other red flags?
First the main points:
  1. is GM cashflow positive?
    Companies go bankrupt not because they lose money but because they run out of cash. That was what happened in Spring 2009 (and was also why GM needed new money – additional loans – to keep operating). GM is no longer running through cash, it is adding to cash. In 2012Q3 it had +$3.1 billion in net cash flow and +$1.2 billion in automotive free cash flow (up from 2011Q3 levels of +$1.8 bil and +$0.3 bil, respectively).
    So there's no evidence that GM has problems. Overall it has $37.5 billion in automotive liquidity, versus global revenue of $37.6 billion. Their balance sheet is healthy – that after all is a basic outcome of a successful bankruptcy.
  2. does GM have access to (undrawn) credit lines?
    GM just negotiated $11 billion of additional credit lines, replacing roughly $5 billion in existing lines. They have access to twice as much liquidity in the event of another recession, and at a lower interest rate (e.g., no longer at "junk bond" rates). Remember, access to liquidity was the key differentiator between Ford and GM in 2009: Ford was pro-active, drawing down all their credit lines and mortgaging everything they owned, down to the Blue Oval, while selling of Volvo, Jaguar, Mazda and anything else that wasn't a core asset, even if it meant receiving bargain-basement prices. GM had fewer such assets, and waited too long and so couldn't draw down their credit lines. GM is determined not to get caught short again.
    Meanwhile, because it did not go through bankruptcy, Ford is still loaded with debt. Its balance sheet is much less healthy than that of GM.
Now to the subsidiary points:
  1. is GM profitable?
    Yes. On an EBIT (earnings before interest and tax) basis GM earned $2.3 billion, up from $2.2 billion in 2011Q3 – despite the ongoing bloodbath among the mass-market producers in Europe. GM earned money in Asia, in Latin America, in North America and on their (presently small) finance operations. Profits were down to $1.8 billion in North America (from $2.2 billion) but remain healthy.
  2. are they doing well in their two largest markets?
    Here the answer is easy: sales are up for all US brands, cars and trucks. GM is no longer a non-player in any segment. In the US market share is stable while fleet sales are down to sensible levels and used car residual values are up. Sales in China are increasing at double-digit rates in a stagnant market. They continue to invest in new capacity and new models, and (given profitability) are able to use China as a vehicle [pun intended] to launch new technologies.
    By the predicted date of bankruptcy (2016) GM will have launched 23 new models and 13 new powertrains. They will remain at the top end in fuel efficiency, something that consumers are slowly starting to realize. Of course, everyone else is launching a plethora of new models. But unlike Chrysler, new model development never came to a standstill.
  3. are they faring so poorly elsewhere as to threaten corporate viability?
    Europe is bad; Opel has lost money for most of the past two decades. Of course overall sales are down roughly 20%, so at the moment everyone else is losing money there, too (except possibly VW); autos remain a high fixed-cost industry. Ford has already shuttered plants; so have various suppliers. At some point GM will decide whether they should remain in the market or exit; so far they have only slated the Bochum plant for closure, though they have cut shifts elsewhere.
  4. what other red flags are there?
    Despite its bankruptcy, GM remains liable for white-collar pensions. (Thank goodness! – that would have left taxpayers with liabilities through the Pension Benefit Guarantee Corporation, yet hurt pensioneers because of the modest cap on PBGC payments. Of course we bear an indirect cost because GM's share price remains lower…) They continue to address legacy costs, in contrast to their lackadaisical approach in the pre-bankruptcy era. In particular, they just consummated a neat deal with Prudential to offer lump-sum payments to (white collar) retirees and thereby remove the drain on cash to pay pensions by turning it into a one-time payment. It's not a full solution, but it does cover 30% of white-collar retirees.
    It also continues to provide healthcare coverage to current employees (but not pre-2009 white-collar retirees). However this does not distinguish GM from any other automotive firm producing in the United States.
    One millstone around GM's neck in 2008 was its financial arm, GMAC, which had gone hand over fist into real estate lending. GMAC however is gone, with those operations moving into what is now Ally Bank. Whether Ally can implement a profitable business model or will remain a dud bank remains to be seen; if it fails, however, that will no longer affect GM. Meanwhile, banks and other financial institutions have re-entered the auto finance business, so that dealers can get "floor plan" (loans to cover their inventory) and car buyers can get loans. GM will over time rebuild an in-house financial arm, to provide a more reliable source of such financing -- GM has a strong incentive to keep lending to dealers, while banks have a history of leaving when times are tough. Of course, that means GM can charge a premium on its loans. But as long as it sticks close to its knitting – no more chasing after real estate or other financial fads – such lending operations will not threaten the rest of GM. In any case, it will take many years for these operations to grow in scale. A decade hence, when current management has retired, we could see a larger GM finance arm get caught up in a bubble. Between its smaller scale and a management determined not to get burned again, there is no risk on that front over the next 5-6 years.
    Finally, I do not know what sort of liabilities might remain if GM closes large portions of Opel. However, because the rest of the world provides healthcare coverage, legacy costs will so large as to threaten the company, in contrast to 2009, when as a group retirees were GM's biggest creditor.
To summarize, there's not a shred of evidence to support BK Round II. GM has a healthy balance sheet and positive cash flow, and strong positives in all markets outside Europe. Potential threats are too small in magnitude to undermine the overall firm. There is absolutely nothing to suggest GM is in danger, now or in the next 3-4 years.
That however does not mean that you should buy GM's stock, as opposed to its cars and tracks! I have no particular insight into whether GM's share price is high or low; an economist doesn't receive a crystal ball when they receive their PhD. Arguing that case requires doing an analysis of whether today's price adequately reflects likely profits over the next several years (if you take a "fundamental" approach) or arguing that market fads will lead to higher demand for its shares (a "psychological" approach, technical or otherwise). I'm not trained in that, and try not to opine one way or the other.
As for me, the 2013 Chevy Malibu remains on my short-list to replace a 1998 Volvo for which my mechanic has issued a "DNR" the moment I'm leaning towards the Ford C-Max hybrid, but my wife has the deciding vote.
...mike smitka...
Acknowledgments: in May 2010 my students (and I!) were treated to a lecture on this issue at Ford's headquarters by CFO Lewis Booth, who he spent 2 hours explaining how Ford itself (barely) avoided bankruptcy. "No cash = Bankruptcy" was central to how he organized that story, which I hope he will write up at some point.
Addendum: Some of this brouhaha apparently stems from a Louis Woodhill Forbes article
"General Motors Is Headed For Bankruptcy -- Again" that focuses on the evaluation of a single model, the Malibu, in Car and Driver. That article does not provide sales data on the Malibu, nor the impression of other car magazines. Having test-driven competitive models over the past couple weeks, the Malibu is by far the quietest and smoothest. Forbes (or rather Car and Driver) criticizes its rear legroom and failure to lead in mpg. If mgp were what sold cars, fine, but canvassing car lots clearly shows that's not dominant in American minds. Others have the headline (such as The Week) but in fact merely describe GM as having challenges, far short of the "bankrupt again" headline.

Thursday, 25 October 2012

The New Romney on GM guarantees would have given all the gains to Wall Street...
David and I blogged in 2009 and then many times since on the so-called auto bailouts. (Since when is bankruptcy a bailout? -- there were no winners, all lost something.) From the start we noted that the vertical structure of the industry -- suppliers, assemblers, dealers -- was central, because GM's failure would have taken them all down. This is not a trivial issue: suppliers employ between 2 and 3 people for every "automotive" worker, and dealerships employ fully as many as all of manufacturing. In 2009 all were teetering on the edge of bankruptcy. Without normal financial markets that would have meant Chapter 7 dissolution, not Chapter 11 restructuring. And let's not forget that the whole industry is woven together in a complex pattern. Most cars are sold today by dealership groups; your GM dealer is also a Toyota dealer. In the strained market of 2008-9, the failure of one would have led banks to foreclose on the other in a rush for repayment. And the supplier to GM is also a supplier to Toyota and to BMW. They would have no more been able than GM to make cars -- or even get repair parts to keep the service bays of their dealers generating revenue. Even in the Great Depression of the 1930s there was never a complete collapse.
Mitt Romney's father may have once been the CEO of American Motors [for those without long memories, the Jeep portion of the old AMC continues to mint money, and to keep Toledo Ohio afloat], but that doesn't mean the son inherited a deep knowledge of the industry. Mitt is ignorant of (or chooses to ignore) this complex structure,
and to pretend that financial markets could have raised tens of billions of dollars in 2009. I'm sorry, at the time banks were cutting their loan portfolios, and investment banks were worried they might be the next Lehman, and had no ability to employ their tricks to issue debt on that scale.
Romney's current stand however is that we should have guaranteed loans. Never mind that banks were cutting their lending, David and I have beaten that dead horse several times. But let's stop and think about the winners and losers under guarantees. If things didn't go well, we the taxpayers would be out a lot of money (but Wall Street would have collected a few tens of millions in fees, and collected interest on top of that). If things did go well, Wall Street would reap all the gains. After 7 years on the campaign trail, Romney is still unable to put himself in the shoes of the American public.
For all his defects, Hank Paulson and crew (among whom we should count Steve Rattner) worked on behalf of the Amerian taxpayer. They structured deals, from AIG to GM, to see that we would share in the upside. At last reckoning, GM's share price is still too low to put us in the black, but on many of the other deals we're in the money, indeed we're making out like bandits, Wall Street style. As a result, by insisting on an equity stake (and on tacking high interest rates on the loans we made, something that gets overlooked), we may not break even in the aggregate. But we're pretty damn close.
If he's elected, maybe Romney will reorient to thinking on our behalf, and not that of his and his buddies. Over the past 7 years he's failed to make that case.
...mike smitka...
Engines of Change By Ingrassia, Paul (Google Affiliate Ad)Once upon a Car By Vlasic, Bill (Google Affiliate Ad)

Saturday, 13 October 2012

GM and the Upcoming Presidential Election

by David Ruggles
Amid the political turmoil of election season the rescue of the domestic auto industry by the George W. Bush administration and the Obama Administration is certainly a political football. The President and the Democrats have to defend the fact that the “rescue” wasn’t done perfectly, although a debate rages over exactly what those imperfections might be and who is responsible for them. Many Republicans are sticking to their position that the domestic auto industry should have been allowed to liquidate and eventually reform, although that logic doesn’t play well in the key “swing states” Ohio and Michigan. Governor Romney was adamantly against the “bailout” saying “Let Detroit go Bankrupt” and declaring that “a bail out would insure their failure.” Of course, this is all confused by Romney’s attempt in the Republican debates to actually take credit for the rescue saying, “They took my advice.” (His campaign has repeatedly declined comment when asked to clarify their candidate’s position on the issue.)
It also seems to ignore the fact that in the case of liquidation, there would have obviously been a huge cost dropped on the various states for unemployment compensation, a ripple impact through the banking system, chaos in the supplier base, and a disruption of military procurement. The ultimate result could have been a true Depression. Most pragmatic politicians wouldn’t have taken the risk, despite rhetoric to the contrary.
Some of the criticism leveled at supporters of the auto manufacturer rescue is based on the fact that if GM stock were liquidated today, based on its current value which is down a third since its’ IPO date, the taxpayers would sustain a loss in the tens of billions of dollars, which is entirely true. Of course, no one has calculated the cost of NOT doing the rescue, a calculation which would have to be based on speculation and would be subject to considerable argument.
Another issue rarely heard has to do with the billions of dollars of pension liabilities that would have been dropped on the Pension Benefit Guarantee Corporation. While a close estimate of that financial burden is not available, a comparison is. When United Airlines dropped their pension liabilities on the PBGC about 8 years ago as a part of their Chapter 11 bankruptcy, the amount was $6.6 billion. While this is technically an insurance fund, the obligation for pension obligations abrogated by liquidating OEMs and suppliers in the case of an auto industry liquidation would have easily run into the tens of billions of dollars, rendering the fund insolvent. This would have either landed on the back of taxpayers or pension checks would have ceased for many retired Americans. The impact on the psyche of the country and on consumption in the economy can only be imagined.
In the meantime, President Obama and Governor Romney and their political parties have both been banned from GM properties until after the election. There will be no political grandstanding on bailed out automaker facilities! Imagine banning the person who represents one of your largest stockholders, without whom you would not exist.
The two automakers have also refused to furnish vehicles for the national political conventions. It’s a smart move for GM and Chrysler to stay away from politics when possible. After all, they want to sell vehicles to both Republicans and Democrats.
While things are somewhat different for Chrysler now that FIAT has bought out the Federal Government’s stake, are GM executives hedging their bets in case President Obama loses in November? While it hasn’t been talked about a lot, it has occurred to more than a few GM stockholders (myself included) what would happen if Romney is elected and immediately dumps all of the government’s stock in General Motors. This would certainly be devastating for the stock price, but what does Romney have to lose? He could claim to have relieved of GM of its Government Motors moniker, while hurting millions of private stockholders. He could blame the losses on the previous administration, and move on. If reelected, it is a given that President Obama would hold on to the GM stock, selling small amounts at a time to maintain the stock price, while hoping the improving economy would further bolster the value of the taxpayer’s stock.
It is also a given that President Obama’s role in the restructuring in the domestic auto industry gives him a serious advantage in the November election. It is hard to imagine Ohio and Michigan going Republican. And without those two states, the road to the White House becomes a near impossible journey. And if GM shareholders across the country get wind of Romney’s intent to dump the taxpayer’s GM stock at once, it could impact the way people vote in other closely contested states.

The Upcoming Fiscal Cliff

By David Ruggles, originally published in Auto Finance News
The upcoming “fiscal cliff,” as it’s known in investment circles, is the proverbial “sword of Damocles” hanging over the head of the world economy. Somewhere, Grover Norquist is smiling, while the global economy hangs in the balance. When the country’s two political parties couldn’t agree on a deficit-reduction package ― which the Republicans held as hostage to approving an increase of the country’s debt ceiling a year ago, according to Senate Minority Leader Mitch McConnell ― the two parties entered into a sort of “death pact” known as sequestration. Both parties agreed to concessions previously deemed unpalatable to force them into an agreement before the end of 2012. The concessions have the potential to bring catastrophic impact to the U.S. economy and, hence, to the global economy.
The yearend date was selected because the November presidential election will have been decided, and Congress will be in lame-duck session. In theory, this should make it easier to reach an agreement, but only if the Republicans agree to some tax increases on upper-bracket earners. Under the sequestration agreement, draconian cuts will be imposed on defense and social programs, and the Bush tax cuts will expire, which would bring about tax increases on all taxpayers, not just the top bracket.
The threat of having all the above happen simultaneously has the business community running scared, and with good reason. The spending cuts alone amount to $1.2 trillion evenly split between defense and non-defense spending. The expiring Bush tax cuts will raise taxation at the exact same time federal government spending is cut. One doesn’t have to believe in Keynesian economics to see the potential for short term disaster if agreement isn’t reached on a better balanced plan so the shock of the scheduled tax increases and spending cuts does not occur at the same time.
As of this writing, all of the consternation has yet to spill over to the stock market, as the Dow continues to reach new heights, having restored around $23 trillion in wealth since the Obama stimulus package passed. Whether those two events are connected is anyone’s guess, but the fact remains that many Americans’ IRAs and 401Ks are in much better shape than they were in the fall of 2008. Almost $50 trillion in accumulated wealth evaporated in a short time between the dramatic reduction in household net worth and the tanking of the stock market when the financial crisis hit. Only about half of that has been restored through the stock market, as the housing sector is still shaky. This explains the weak recovery.
At the same time, the credit scores of many consumers have been maimed, preventing them from buying the type of large-ticket items that add manufacturing jobs. Perhaps the electorate will be convinced that a President Mitt Romney can restore the household net worth and quickly heal maimed credit scores while cutting taxes and the deficit. If the electorate is convinced that he can, we will have a new administration come January 2013.
Simultaneously raising taxes and slashing government spending could stop the recovery in its tracks and trigger another recession. As we get closer to year end, if an agreement is not reached early, an unlikely prospect at best, expect the Dow to retreat, car sales to fall off, unemployment to spike, and the ripple impact to affect the global economy while our politicians play brinksmanship with all of our lives.
There is incredible pent-up demand in our economy. The recent small drop in the unemployment rate and the addition of 114,000 jobs should be cause for optimism. To put this in perspective, the 114,000 jobs added in September marked a 900,000 job turnaround from January 2009. Economists say we should achieve around 350,000 additional jobs each month to be considered in robust recovery.
Fitch Ratings and others predict that should agreement not be reached, the result would be another recession.
So how long will it take to heal credit reports and restore household net worth through consumers paying down debt and home prices escalating? Will sequestration take place, taxes rise, and government spending be drastically reduced? Will politicians play with all of our well beings for the sake of partisan ideology? The uncertainty is just another thing holding back recovery.
David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & 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 Japan. He blogs at and writes regular columns for several publications.

Energy Self-Sufficiency: A Realistic Goal or a Pipe Dream?

By Gal Luft for the International Global Security Network
Western publics seem to believe that energy self-sufficiency is an ideal response to those who attempt to wield the ‘energy weapon’. I argue, however, that no state will be able to achieve full energy independence, let alone avoid future spikes in prices, in an economically globalized world.
The desire for self-sufficiency has always been a common trait of human society. After all, no one likes to be dependent upon others, especially for vital commodities and services. From a geopolitical perspective, this sentiment is arguably at its strongest when it comes to energy. The Arab Oil Embargo, Russia’s gas supply cutoffs to Europe and Venezuela’s and Iran’s threats to use the ‘oil weapon’ have all reinforced importing nations’ urge for energy self-sufficiency. No country is more preoccupied with this than the United States, where for the past four decades achieving energy self-sufficiency has been the mainstay of Washington’s energy policy. The only difference between Republicans and Democrats is that the former emphasize supply side solutions (‘Drill Baby Drill’) whereas the latter call for an ‘oil diet’ that uses less oil through taxation or increased fuel economy standards. The result is that the overwhelming majority of Americans believe that energy self-sufficiency will improve national security, alleviate the debt and budget crisis and yield lower and more stable gasoline prices. This worldview is based on myths and poor understanding of how the modern global energy market actually works. True energy security requires both uninterrupted energy supply and affordable prices. In today’s globalized world, energy self-sufficiency guarantees neither.
Is self-sufficiency really possible?
A nation’s energy basket is usually comprised of several commodities. Coal, natural gas, biomass and uranium are responsible for most nations’ electricity generation while petroleum and its products dominate the transportation sector. Some countries can reach self-sufficiency in one of the two sectors. For example, the United States’ electricity sector is practically self-sufficient. Other countries are not far behind when it comes to electric power: nuclear power generates 78% of France’s electricity, and renewables are responsible for 82% of Brazil’s power. But of the world’s 195 countries, very few are truly self-sufficient. Even energy-rich countries like Russia, Saudi Arabia, Venezuela, Brazil and Canada which are well endowed in hydrocarbons import some of their energy in the form of refined petroleum products due to insufficient refining capacity.
With some effort and investment in new refineries, this dependency can be eliminated, but most countries are not that fortunate. Of the world’s top ten economies, only two, Brazil and Canada, can theoretically reach self-reliance. The rest – China, Japan and Germany to name a few – are poor in resources in relation to their needs and their dependency on energy imports is growing by leaps and bounds. This means that as long as hydrocarbons dominate both our electricity and transportation systems, most nations will never be able to achieve self-sufficiency and will continue to rely on the global energy trading system.
Neither reliable nor affordable
While the pursuit of energy self-sufficiency lends itself to tactical solutions - such as increased domestic production or fuel economy mandates - that may have a positive effect on a nation’s trade balance and the environment, it would not have a profound impact upon the global price of crude and geopolitics. The reason is that oil is a fungible commodity whose price is being determined in the world market on a minute-by-minute basis. A price of a barrel of oil is more or less equal to every consumer, and when the price spikes, it does so for everyone regardless of where their supply comes from. (This is not always the case for natural gas: unless it is traded in the form of LNG, its price is pre-determined in long-term contracts)
In 2008, for example, the United Kingdom was virtually self-sufficient in oil. Yet, in keeping with other import-dependent economies, British motorists were affected by a sharp rise in crude prices that led to protests over the rising cost of petrol. Over the past decade, both US oil production and vehicle fleet fuel efficiency have increased sharply. Consequently, US oil imports have decreased from 60% in 2005 to 42% in 2012. Yet, despite the fact the US is the world’s top oil consumer, none of this had any noticeable impact on the price of crude. On the contrary, the burden of imported oil on the US economy has roughly doubled and the share of oil imports in the overall trade deficit grew from 32 percent in 2005 to 58 percent in 2011.
Both case studies suggest that the move towards greater self-sufficiency does not necessarily lead to cheaper energy prices. All countries, irrespective of whether they are importers or producers, are part of the global energy market. This also casts doubt over the popular assertion that energy self-sufficiency could, in turn, weaken oil-exporting Middle Eastern states that are hostile to the West. OPEC member-states – who control nearly 80 percent of global conventional reserves -- need a certain breakeven oil price in order to keep their economies afloat. Any increase in non-OPEC oil supply or reduction in demand invites a reciprocal cut in production by OPEC aimed at restoring the price to the level OPEC governments would like it to be.
Equally tenuous is the argument that oil exporters can punish or target their clients with effective embargos for geopolitical reasons. Suppose that for some reason, Saudi Arabia decided to cut its oil exports – currently at 1.3 million barrels a day – to the United States. The effect on the US economy would not be more noticeable than the effect on any other economy. The US government has approximately 700 million barrels in its Strategic Petroleum Reserve (SPR), enough to cover for 18 months of lost Saudi supply. But even without tapping the SPR, the US economy would do just fine. Being dependent on oil for 90 percent of its export revenues, Saudi Arabia would have to sell the oil to someone else, say China. Beijing would possibly forgo some of the oil it brings in from Angola, for example, that may eventually find its way to the US market. On the whole (albeit not without some logistical adaptations) market forces would quickly adjust the supply-demand balance in such a way that all importers receive more or less the amount of crude they need. As long as the commodity is fungible no exporter can target a specific importer for more than a few weeks.
A new paradigm is needed
While achieving energy self-sufficiency remains unrealistic, this does not mean that states should sit idly by in the face of the global economy's vulnerability to oil price spikes. High oil prices wreak havoc in the ailing global economy, and the potential for conflict over access to oil seems to be growing as Asia’s thirst for crude grows. But instead of rooting for energy self-sufficiency, the goal should be to diminish the strategic importance of oil. In the book Turning Oil into Salt: Energy Independence through Fuel Choice (2009), the argument is made that oil today has the same strategic importance that salt held for most of human history. As the sole means of food preservation, salt once determined the course of world affairs. Wars were even fought over it. Competing means of food preservation such as canning and refrigeration stripped salt of its strategic status, turning it into “just another commodity” that no longer has geopolitical leverage. Similarly, the strategic importance of oil does not stem from the amount of it we use or import but from its virtual monopoly over transportation fuel. For the most part, automobiles sold throughout the world can run on nothing but petroleum fuels and thus energy commodities from which competitive fuels can be made are effectively barred from competing against oil. Because of this oil is not substitutable, so consumers cannot shift on the fly to competing products when oil prices become too high.
To achieve true and lasting energy security we must replace self-sufficiency with a competitive fuel market paradigm. This can only be done by opening vehicles to fuel competition. Just as the grid is agnostic as to what type of energy was used to generate the electricity it transmits, our cars and trucks as well as our fuel distribution system should be open to a diversified fuel mix. A variety of liquid fuels like ethanol, methanol and butanol can be made from natural gas, coal, biomass and municipal waste. Some, like methanol, are significantly cheaper than gasoline on an energy equivalent basis. Such fuels, in addition to gasoline, can power flexible fuel vehicles (FFV), which cost manufacturers an extra $100 or less to make compared to gasoline-only cars. Electricity can be stored on board automotive batteries and power pure electric vehicles and plug-in hybrid electric vehicles. Natural gas can be used onboard dedicated vehicles (and of course converted into methanol for use on FFVs). Each of those competitors has pros and cons. Some involve a higher premium on the vehicle side, others require costly infrastructure, and some are not cost-competitive except when oil prices are high. However, the uncertainty over future oil prices requires that the transportation sector opens up to these options as a shield against the economic and security challenges posed by a volatile oil market. This, not elusive self-sufficiency, should be our course.
Gal Luft is co-director of the Institute for the Analysis of Global Security (IAGS) and senior adviser to the United States Energy Security Council. He is and co-author of the books Energy Security Challenges for the 21st Century (2009), Turning Oil into Salt (2009), and Petropoly: the Collapse of America's Energy Security Paradigm (forthcoming 2012).

Sunday, 23 September 2012

Industry Churn: Clout and Overcapacity

New turmoil dominates today's [July's?] news. First, there is the not-quite-yet announced linkup between PSA and GM. Fiat-Chrysler claims to be looking for an alliance partner. So we are seeing a resurrection of the idea that a modern auto manufacturer needs a bigger scale than these already large firms have—call it the mantra of "clout."
A second piece of news is that Subaru (Fuji Heavy Industries) is withdrawing from the "kei" (minicar) segment in Japan, leaving three players, Suzuki, Daihatsu and the faltering Mitsubishi. Meanwhile, there are rumors of plant closings in the EU. This represents another long-standing industry mantra, "overcapacity."
In Japan, the 30-odd manufacturers present in the 1950s shrank to 11 by 1966, with new entry Honda offset by the acquisition of Prince by Nissan. Now in Japan little changed until the 1990s, but since then Toyota took over Hino, Isuzu, Daihatsu and now has exerted control though not full ownership over Subaru (Fuji Heavy). Renault took over Nissan, Volvo took over Nissan Diesel, and Mercedes took over Fuso, the truck portion of Mitsubishi. Honda remains fiercely independent, while Mazda and Mitsubishi failed to turn themselves around in alliances with Ford and Chrysler/Daimler, respectively. Suzuki is presently unwinding an abortive alliance with Volkswagen.
Confusing? Yes! And it's not just Japan. In Europe brands such as Simca disappeared in the 1970s, along with the remnants of other firms; a few have mutated, with Mini shifting to BMW, Land Rover and Jaguar to the Indian firm Tata, and Rover to a Chinese firm. VW has gobbled up a range of makers, from SEAT and Skoda to Audi and Porsche. Of course the US has seen all sorts of drama, too.
But that hasn't necessarily meant fewer players, at the national level. To give one example, Toyota, Honda and Nissan all have plants in the UK, and the number of models expanded. While many words have been spilled on overcapacity at the pan-European level, there's a puzzling disconnect: aren't there also therefore too many brands and models in the market? "Lean" manufacturing and common platforms, and now manufacturing design standards [off the top of my head I'm not sure there's standard jargon] allow firms to make multiple (and sometimes quite different) models in the same plant. There is still however an association between plants and models, or at least size-based market segments.
This is from an old draft that somehow remained "unpublished". For the moment I will leave it merely as an observation that these multiple levels of analysis haven't been integrated, and that the received wisdom is almost surely comprised of mutually inconsistent elements. I've still got some slogging and blogging to go on these topics...
Mike Smitka

Auto Bailout Redux: Warren Buffett was Bush who bailed out GM -- Obama forced it into bankruptcy...
Steve Rattner's blog points out a February 27th CNBS interview with Warren Buffet that affirms what David Ruggles and I have argued from the start on our Autos and Economics blog, and reiterated here: that the alternative to the government provision of DIP financing for an orderly Chapter 11 restructuring of GM and Chrysler (as though bankruptcy is a bailout!) was a catastrophic dissolution via Chapter 7 ("close your doors forever" bankruptcy). As Buffett notes, capital markets weren't functioning, and there were no sources of working capital for firms seeking Chapter 11. Indeed, he himself told one of those firms "no" -- and unlike banks, he was not constrained by liquidity concerns and depleted capital. Rather, everyone was hunkered down, and clearly uninterested in what a priori was a very risky venture.
Now it's not as though the reorganization was perfect; lots of dealers had their franchises yanked, which neither lowered operating costs at GM nor improved their sales. That seems to have resulted from the input of a consultant who had worked for NADA (the National Auto Dealers Association). Of course every dealer wishes for one less competitor, but that's a tension with every franchise system: what's good for the franchisor is not always good for the franchisee. With hindsight there might have been wiggle room on other terms and conditions. But it's hard to fault what was done from a real-time perspective. Indeed, the speed with which the Chapter 11 restructuring was consummated should give creditors in other bankruptcies, who often shell out staggering legal fees for years on end, food for thought. And speed was critical to the revival of GM and Chrysler, and for keeping suppliers and the rest of the domestic auto industry afloat.
Let me close with a personal reflection. We will continue to quibble over the appropriate role of government in our society. We will always find fault, too, because by and large government is engaged in providing services that can't be quantified or for which market prices aren't available -- economists and environmental scientists can construct models to delimit how much less pollution is worth, but that's a far cry from trying to figure out how much a gallon of milk is worth.
Overall, however, I've always been impressed with the service orientation of those in the public sector, from local school teachers (the biggest component of Leviathan, and certainly not in it for the money!) to individuals such as Mr. Rattner (who incurred a pile of legal bills for the privilege of serving). Kudos! -- our society would be poorer without them
Mike Smitka
An essentially identical post is at the US and Economics blog.
My apologies if this shows up at an odd time; I may have forgotten to hit "publish" after writing it, or else went back to edit it without realizing I had to re-publish it.