The New Romney on GM

...loan 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...

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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 autosandeconomics.blogspot.com 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).