Monthly Archives: November 2008

How much should you worry about a $7 trillion bailout? Less than you think.

All of the bailout programs the government has announced so far fall into three categories.  Insurance, Investment, and loans.

Because of the nature of what the government is trying to do, there is a good chance that it will lose more in insurance claims than the revenues it realizes for insurance premiums, there’s a good chance that more of the investments will fail than the dividends it will receive, and there’s a good chance that more of the loans will default than the interest payments in receives.

That said, the amount of money that the government is likely to actually have to be paid back by taxpayers is probably in the low hundreds of billions, not the high single digit, possible double digit trillions.

To paraphrase someone a long time ago… “A hundred billion here and a hundred billion there, and pretty soon you’re talking about real money.”  Taking on a tax burden of hundreds of billions of dollars isn’t going to be very much fun.  Everyone is always free to make their own judgment about whether the good that will come from it outweighs the cost or not.  But when you hear people talking about the government spending $7 trillion or $8 trillion on the bailout… remember that the vast, vast, vast majority of that is coming back.

If you’ve been learning about credit default swaps, which are the financial instruments at the core of the mess, you may have heard that the “notional value” of all the Credit Default Swaps out there is in the neighborhood of $70 trillion!  This seems stunning because it is considerably larger than the Global Domestic Product.  While today’s unregulated credit default swaps pose such a gigantic risk for the economy that the worst economic collapse since the 1920’s is because of them… the risk isn’t $70 trillion worth.  CDS are basically insurance policies, so the $70 trillion refers to the amount the insurers would have to pay if every policy had to suddenly be paid out in full.  This would mean that every single bond, for every single company and country in the world got defaulted on in one day.  There is a range of bad and while our CDS problem is bad, it isn’t $70 trillion bad.  That’s similar to our situation with the bailout.  We’re talking about incurring, in all likelihood, a lot of new debt for the taxpayer to pay back… but not $7 trillion worth by any stretch of the imagination.

It seems unlikely, but there is still even a possibility that the government will end up making huge profits from all of these business activities.

Here is a great article that goes into more detail about this and also links to a New York Times chart showing the actual commitments.

Leave a comment

Filed under Politics

Why We Get Drunk on Debt

In the world we know as consumers, debt allows us to buy things now and pay for them later, by basically agreeing to pay a lot more for those things than they actually cost.  In the world of investing, debt magnifies the profits of other investments.

It’s easy to understand how.  If you have an investment in mind that you expect a 10% return from, and you have $100,000 to invest, you expect to make a $10,000 profit.  But if you can borrow another $900,000 at 5%, you can make 10% on your initial $100,000 plus 5% on the $900,000.  You’ll earn 10% but have to pay 5% to the bank as interest.  So your profit will end up being $55,000!

The problem is that debt magnifies profit, but it also magnifies risk.  The 5% interest you owe the bank on the $900,000 has to be paid no matter what, and that comes to $45,000.  So long as your 10% estimate is accurate, life is good.  But if there is a bad year and your rate of return is actually 0%, life is terrible.  Had you only been using your own $100,000 you wouldn’t have made anything but you wouldn’t have lost anything.  But now, because of the money you borrowed, you are actually in the hole $45,000.

When times are good and profits are strong, there tends to be a pervasive tendency for both borrowers and lenders to discount the risk side of this equation.  Since the more money is borrowed, the higher profits will be, investors ask to borrow many, many times over their own actual investment money.  Lenders only make money when they are lending it, so there is also a profit motive for them to dismiss risk as unlikely.

Calamity strikes when borrowers leverage their investments so much that when their investments don’t perform as hoped, they end up unable to pay back their loans.  When this happens systemically, banks get can lose billions and billions of dollars, which limits their ability to lend, which creates a ripple effect through the entire economy.

This is how the stock market crash in 1929 evolved into a series of bank runs and then into the Great Depression.  It is also what has happened to the American economy in 2008, what happened to the Japanese economy in the early 1990’s, and what has led to nearly every major financial bloodletting in modern times, around the entire globe.

In fact, a simple rule that no entity of any kind is allowed to borrow more than a certain multiple of their asset base would prevent, arguably, all future financial meltdowns.

Leave a comment

Filed under economy, Politics

Grab a Bucket for Detroit – Part IV

Bailout Reason Three: We Sabotaged The Economy, Not Them
If we are not willing to make laws, then we need to accept that we will be lawless.

Human nature is what it is and, frankly, capitalism is what it is.  Robert Reich cites studies showing that when given the opportunity to make a private decision between a more expensive version of a product made “responsibly” vs. an identical less expensive version made “irresponsibly”, most consumers (not all, but most) will choose the less expensive one.  And when we give our corporate titans the mandate to compete with every tool they can find, within the limits of the law, and then we don’t provide the laws… how can we possibly expect them to do anything other than what we have paid them to do?!

We, as a nation, have elected conservative governments for 28 years.  Yes, 28 straight years.  Remember that NAFTA was finalized and signed under the Clinton administration, which also, by the way, continued the deregulation and union busting momentum from the Reagan and Bush 41 eras unchecked.

Our government didn’t kill off the Glass-Steagall act against our wishes, we elected the people with he ideology who would do that.  Phil Gramm didn’t become a Senator by staging a palace coup.  That beady-eyed, treasonous bastard was elected by our brothers and sisters in Texas… and made powerful by all the conservatives elected by the rest of us.

Who, you ask?  What?  Are we still talking about Detroit?

Yes!

In 2000 Phil Gramm, the man who brought you the devastatingly costly regulatory fiascoes that allowed both the savings and loan debacle and the Enron failure, and his cronies forced a provision into the federal budget package that exempted a financial instrument called a Credit Default Swap from any sort of government oversight or regulation.  I have discussed these elsewhere, and probably will discuss these again soon, and plenty of information is available on them, so I’m not going to go into great detail here.  I will tell you that for as many times as you’ve heard reporters say that they are arcane and complex… they are not.  Some of the math that gets used to figure out how much they are worth is fierce, but you don’t have to even look at the math to understand what they are.  Frankly, Wikipedia has an article you can print out and read during your morning toilet and you’ll have a pretty good understanding of them.

A long time ago, we developed regulations that limited the amount of insurance an insurance company could write based on how much money it had.  We did this because before we did it, insurance companies would write far more insurance than they could ever make good on, and when something happened where they had to, they would end up bankrupt, their investors walked away with years or decades of profits, and the people who had bought insurance all those years walked away with nothing.  Similarly, after the stock market crash of 1929 we put limits on how much stock can be bought “on margin” (with borrowed money).  We also regulated banks the same way as insurance companies in that we limited the amount of debt they could offer based on how much money they had.

We did all these things because we have learned, again and again and again, unfortunately, that if we don’t regulate the amount of debt that companies can take on, they will take on too much.

Public Service Announcement:

See the post “Why We Get Drunk on Debt”

Back to the Bailout Reason Three
We have known for a long, long time that when investors take on too much debt they put not only themselves at risk, but the whole economy.  That’s why we limit how much debt investors can take on.  What Phil Gramm did, however, was to create a corner of the economy that was completely unregulated and hidden from view, and within which people could borrow as much money as they wanted.

People are people, and if you give them the opportunity to earn 30% on their money rather than 10% most of them will do it, even given the risk.  In fact, people who manage companies could be required to do it to maximize their investors returns.  So… they did!  And sure enough, when the housing bubble burst and created a bad day, this mountain of debt rippled back through the investors, to the banks, to the businesses, and it is now rippling through the workers.  Oh!  Did you catch that?  This mountain of debt that the people we elected deliberately allowed to happen is now rippling through the businesses… like Ford, General Motors, and Chrysler.

So, is it fair to say that their bad management created their problems?  Sure, their bad management exasperated their problems, but they didn’t create this situation.  Phil Gramm created it.  Phil Gramm’s conservative comrades created it.  If you voted for Reagan, Bush 41, Clinton, Bush 43, Phil Gramm, or any of his conservative pals, you created it.  I created it.  Our government didn’t create it despite us, it is us.  This problem is ours.  And as for Toyota and Honda and their enlightened management?  Well, remember, they don’t have the same retirement commitments that our companies have because they don’t, yet, have as many retirees as our companies have.  So yes, their products may be marginally better in some ways, but that isn’t the whole story.  And frankly, 4 years ago every one of the most profitable vehicles on the market was being made by an American company.  And finally, just because the foreign car makers are stronger right now than the American ones doesn’t mean they’re strong.  They may be following right behind.  Should we allow our industry to go away, and our jobs to go away, only to have Japan and South Korea and Germany and France and Italy and Sweden bail out their own car companies?

I don’t think so.  I think we should do whatever we can to save our automotive industry, if there even is anything, we should insist that it make the changes we know it needs to make, and then we should give it a level playing field by replacing free trade with fair trade and fixing the problem that allows young companie to force old companies to screw their retirees and force them onto the shoulders of the taxpayers.

Leave a comment

Filed under economy, Politics

Grab a Bucket for Detroit – Part III

Bailout Reason Two. We Failed Them As Much As They Failed Us.
Our response to the new competition that started in the 1970’s was ill considered at best.  In order to maximize our corporations’ ability to compete, we bet it all on the trifecta of deregulation, union-busting, and free trade.  This created, and is still creating, a global “race to the bottom” in terms of everything we would call “responsibility”.  We move jobs to anywhere in the world where workers are willing to work for less.  OK.  Fair enough.  But we also move jobs anywhere in the world more willing to take advantage of workers and the environment than we are.

Over the decades, and despite the distance we still have to go, America has really, really, significantly cleaned up a lot of industrial mess.  The Great Lakes that were dead by the 1960’s are alive again.  Our air quality still suffers from our cars and reliance on burning fossil fuels, but it is greatly improved even on bad days from what it was several decades ago.  You know all those Superfund sites?  The word Superfund says it all.  Environmental protection has gigantic benefits but it comes at a cost that we all acknowledge.

Our working conditions in this country are among the safest in the world.  They aren’t perfect, and some places may be even be safer, but we have largely stood behind OSHA regulations.  We paint a lot of yellow lines that sometimes seem silly, we wear safety goggles and hairnets in places that don’t seem to always warrant it, and we try our best to make sure lock-out / tag-out procedures are always followed.  When a sugar refinery exploded and killed workers because it didn’t follow safety regulations it was supposed to, we imposed a stiff penalty.  Safe working conditions come at a cost that we all acknowledge.

We also have decided that all children in America should have the opportunity to be educated.  We have decided that all Americans have a right to at least some basic, minimum level of health care coverage (in emergency rooms and clinics if nothing else) and that most working people should have outstanding health care coverage.  When a bad cow gets slaughtered or a pissed on tomato gets served somewhere, all the stops are pulled out to find the problem, eradicate the problem, and try, again, to prevent the problem.  This comes at a cost that we all acknowledge.

Our government hasn’t done these things for us or to us.  In this country, whether you agree with these things or not, we are our government.  We do have the ability to change things through elections and by running for office, our elections do matter, and we always get exactly the government we deserve, and we have opted over the years to have a government that imposes certain costs on our businesses in order to improve our environment, our safety, our quality of life, etc.

Unfortunately, “free” trade undermines all of that.  Any country that is willing to have its people live in industrial filth, that is willing to allow its workers to climb around in huge grinding machines that can be inadvertently turned on at any time, any country that is willing to not educate its children, or not provide even the pitiful level of health care that we provide, or worry about diseased cows in their food supply, or make sure that even the poorest of the poor and remotest of the remote have at least emergency phone service… gains a competitive advantage and our work flows to it.

Hence the trifecta.  First we open up all of the markets, then we bust the unions so that wages can be pushed down to compete with the third world, then we deregulate everything under the sun so that our environment, our safety, our education, our health care, and everything else that we had agreed we are willing to pay for can be competitive with Guatemala, Ecuador, and Bangladesh.

There is another way!

If instead of “free” trade, we made our mantra “fair” trade, and allowed any country that provides greater worker protections, greater environmental protections, greater educational opportunities, greater health care, greater retirement benefits, more vacation, shorter work weeks, higher wages, etc. to charge tariffs to level the playing field, suddenly every country in the world would have an incentive to race to the top instead of the bottom!  The more we protect the environment, the more competitive our products would be in the global market!  Countries that allow corruption to undermine their worker and consumer safety results, or that don’t even bother to try, would find themselves penalized in the global economy instead of rewarded!  Countries that provided their investors with the best, safest, most accurate accounting controls would be rewarded instead of punished.

And we wouldn’t go broke!  Our investors wouldn’t get poor!  They would be fine because all any investor ever needs in order to make a fair profit is a fair and level playing field.  If everybody has to pay to protect workers, if minimizing worker safety can’t be used as a competitive weapon, then investors pass along the cost and they do fine.

Would there be costs?  Of course there would!  We already acknowledged that safety, education, health care, investor protections, etc. do not come free.  The cost of improving our lives in all of these ways will be that we, all of us, globally, will have fewer, more expensive “things”.  Which sucks.  We as consumers will pick up the cost.  But should we be buying toys with lead in them, that was extracted from its ore by power generated by a plant that turns its city black, and is fed by coal mined by a 9 year old?  We have to make the decision to forgo goods that are made that way, or at least to eliminate the inherent cost advantages of that kind of production, because the only alternative is for that power plant to be here and that 9 year old to be ours.

Because we have not yet done that, our companies are competing against competitors that have lower costs, in many cases, because their governments do not take care of their people, their environment, or their investors as well as our government does.  This is not the auto companies fault.  It’s our fault for voting for free-traders instead of fair traders.

Leave a comment

Filed under economy, Politics

Grab a Bucket for Detroit – Part II

Bailout Reason One. Companies Should Not Be Discriminated Against On The Basis Of Age.
Our domestic airline industry provides a great example of the dynamic at work here.  The large, established carriers find themselves very limited in their ability to compete on price because they have been in business a long time, many people have retired from these companies, and the cost of the commitments made to these retirees are enormous.  Southwest has been managed brilliantly, to be sure.  But in their pocket all these years, along with a stellar leadership team, has been the youth of the company.  It is not old enough to have many retirees.  Even though its labor contracts are not so different from the older airlines, it’s cost structure is wildly different because it just hasn’t grown into these costs yet.

We have to come to some kind of decision about how we want to deal with this going forward.  What has been happening so far is that upstart companies without legacy costs compete against established companies with legacy costs, force them into bankruptcy which as often as not allows the companies to renig on the commitments they made to honest people who worked honestly for them for decades and puts astounding costs of partially re-capitalizing plundered pension plans onto taxpayers.

In the case of foreign competition, there is an element of this too.  Toyota, Honda, and many of the European automakers that have set up shop in the US, like SouthWest, even if they have the same exact labor agreements as Detroit has, simply doesn’t have the same level of retirement costs because they don’t have the same number of retirees… yet.

If we want to look at this as a legitimate competitive advantage, and we fully expect that by the time Toyota and Honda have significant retirement costs we’ll just switch to new companies run out of Brazil, South Africa, or Iran and have the Japanese auto makers screw their retirees and our taxpayers the way we’re forcing Detroit to do… then we need to make retirement benefits such as pensions, 401K matching, retiree health benefits, etc. illegal.  If the goal is kill off any company that tries to stand behind them, we at least need to allow people to plan accordingly.

If we don’t want to outlaw retirement benefits, then we need to find a way of leveling the playing field.  One step in this direction would be to force all companies to fully fund their retirement programs instead of assuming that funds will magically appear one day.  But that probably isn’t enough.  We probably need to do more, or stop the practice altogether and put the money that would otherwise go into future retirement benefits into current paychecks so that people can make their own savings decisions.

Leave a comment

Filed under economy, Politics

Grab a Bucket For Detroit – Part I

Detroit has irritated me as much as anyone over the years.  I tried my best.  I really did.  I bought a Mercury Topaz, then two Saturns, then an Explorer, then a Villager… and by then I couldn’t take it any more and I bought a Nissan Altima.  I love it more than I have ever loved any car.  And shame on Detroit for allowing my level of satisfaction, after five(!) American cars… to drive me into the waiting arms of the Japanese.  Shame on them!

That said, there are a number of reasons why we should loan our auto companies taxpayer money to use for restructuring, retooling, and survival.  I’ll provide some background in this posting and then individual reasons in the next several on this topic.

Those Who Don’t Understand History Are Doomed To Repeat It.  Here’s Some Now.
There was a time in the American capitalist experiment before global trade became what it was today.  Robert Reich describes the era and the logic to it excellently in his book Supercapitalism.  For reason that was rational at the time, more or less of a balance had been achieved wherein competition was much more managed than our Cold War rhetoric would have had us believe.  In the name of mass production, companies had built and supported many of the government regulatory agencies to make barriers to entry steeper and to deliberately limit competition.  They also, grudgingly, supported the growth of unions.

Mass production required accurate forecasting, and accurate forecasting required stability.  Limited, oligopolistic competition, controlled with the assistance of the government, and a generally docile labor force managed by the unions made that possible.   In this era the middle class was created and it thrived.  The disparity between rich and poor was more narrow than before or since.  There was a lot of wealth to go around.  This came at a cost.  This broadly distributed wealth that enabled the middle class to become what it did came at the expense of investor profits, which rarely exceeded 3% to 5% and also at the expense of innovation which, by its nature, diminished stability rather than increased it.

During this era, which Reich calls “The Almost Golden Age” (acknowledging that minorities and women were, for the most part, not invited to the party), where wages for working people became truly meaningful, the 40 hour work week became the norm, and healthcare and pensions became standard corporate benefits, to the benefit of us all.

This pleasant enough stability came to an end with the massive expansion of the Vietnam War.  In order to keep our troops supplied, we developed the modern shipping container and the ports, ships, rail lines, and trucks to get goods and containers to Asia.  Rather than dead head back, the ships would stop off in Japan, pick up a load of generally poor quality merchandise, and sell it here.  This was the beginning of the global economy and global competition.  By the mid 1970’s competition was happening with or without the regulations that had made everybody so comfortable, so we began shedding them, starting actually in the Carter era.  By Ronald Reagan’s 1980’s, de-regulation was in full swing, corporate downsizing reached a fever pitch, innovation and quality skyrocketed, prices (adjusted for inflation and quality) plummeted, and corporate profits exploded.

In short, we as consumers and we as investors benefited enormously from global competition, but millions of us as workers (including white collar workers, by the way) got creamed as cheaper sources of labor were found elsewhere.  And we as citizens got creamed as control and the benefit of the government shifted away from our interests to those of corporations and lobbyists, as the disparity between rich and poor exploded, as our infrastructure spending crashed, etc.  Huge numbers of our industries vanished overseas… steel, textiles, manufacturing, programming, customer service…

During Reich’s “Almost Golden Age” our industrial giants, as part and parcel of the bargain that made the age what it was, took on substantial commitments to their workers.  In the shape of wages, working conditions and healthcare, corporations took on layers of current costs, and in the shape of pensions and retiree healthcare, they took on layers untold of future costs.  Those few companies and industries that have survived so far are now “burdened” with these legacy costs that stem from a balance of power between investors and workers that has long since been lost.

Leave a comment

Filed under economy, Politics