December 5, 2008
A Hidden Problem in the Economic Crisis: State Protectionism
On of the jobs of the drafters of the Constitution was to stop state protectionism in the Articles of Confederation. States wanted to put tariffs on all goods coming across their borders from other states. The drafters knew that this was economic chaos. State protectionism has never left us. It is just more subtle. States have many, many forms of legislation that favor state industry and producers. State anti-takeover legislation, state protection for local franchises, state protection for local workers, and the list goes on and on. Now state protection for local automobile dealers is in the way of the restructuring of the American automobile industry. The Big Three need to close down dealers and the state legislation makes it very, very expensive to do so. Another example of state protectionism hurting the general welfare.
Lou Jiwei of China Comments: A Must Read for All Pundits
Lou Jiwei is the head of China's sovereign-wealth fund, a fund awash in dollars (over $200 billion) seeking to invest. Our current Secretary of State, Hank Paulson, went to China to encourage China to invest in the United States financial system. Lou Jiwei said no, bluntly. Why? He has "lost confidence" in the United States government due to its lack of consistency in its actions and plans. He will wait. There are two very, very important lessons here. First, the United States government cannot itself bailout out or restart our economy -- the government's goal is to encourage voluntary private investment to come back. This simple point is lost on my colleagues at work, journalists who write about the market, and many, many economists who write editorials. The governments job is to get private investment up and running -- not to be the primary investor itself. The government can solve the problem only if it is not the the sole investor, only if it is a stimulant to the private markets. Second, our government has deterred voluntarily private investment from reentering the markets; its actions are doomed and silly. The most important three means of encouragement - certainty, more certainty, and maximum certainty. Our government is doing the opposite -- backtracking, lurching, and sputtering. Wise people with cash will wait our zany government out -- until it has exhausted itself and admitted defeat-- and becomes predictable -- then they will get in.
December 4, 2008
SEC Posts New Rules for Rating Companies
The Securities and Exchange Commission announced new rules for ratings companies. Some of the rules are designed to limit conflicts of interest --firms cannot rate debt they helped structure, for example -- and some are designed to increase the disclosure of the rating process. Rating firms must randomly disclose a sample of 10% of their credit ratings (with a delay of six months) on issuer-paid ratings and must disclose rating change percentages (upgrade, downgrade and defaults) in each asset class rated. The changes are sensible so sensible that one wonders why they are 40 years overdue.
Big Three Auto Companies' Pleas for a Bailout: A Hook??
The CEOs of our big three domestic automobile companies are back in Congress today, asking for emergency loan funds to stave off bankruptcy. They drove, rather than flew in private jets, in energy efficient cars the 520 miles to Washington. They submitted "viability plans" and they came with fresh union concessions (no more "job bank" payments and delay in payments to a new health care fund). Congress will give them funds -- at issue is whether this Congress or the next one that takes over in early January will do it. Republicans still have the votes to block the funding in this rump Congress.
Several notable features of the "plans" spell trouble.
First, the companies structural changes (selling brands and shutting dealerships) will take time and not produce immediate cash savings.
Second, the new plans show the need for a $9 billion increase in funds over the amount that the Big Three asked for two weeks ago.
Third, their emphasis on "green" cars comes when gas prices have fallen to historic lows and when the sales of green cars are falling substantially worldwide. Moreover, green cars are often subsidized sales -- their price does not cover their costs.
Fourth, labor costs of $75 an hour are not reduced and are too high compared to the labor costs of domestic plants of foreign auto companies ($45 an hour) and other manufacturing in the United States ($31 an hour). Instead of reducing wages the companies, and this is classic, are firing workers and saving the high wages of senior workers who remain. The simple fact is that the company need to reduce hourly wages. Short of wage cuts, my reading of their situation suggests that the most profitable move they could make would be to shut down most all their domestic manufacturing and import cars into the United States from their overseas plants in Brazil, for example.
Fifth, what are they going to do with the cash? Pay down debt? I hope not. Debt holders should be taking haircuts and any bailout money should not be absorbed immediately by debtholders who are otherwise giving interest rate concessions. My reading of their situation suggests that the most profitable move they could make would be to shut down most all their domestic manufacturing and import cars into the United States from their overseas plants in Brazil, for example.
And sixth, and most important perhaps, no one is doing a thorough due diligence on the companies and their plans. When have their normal financials and 37 page plans but, as would happen in a normal acquisition or a normal workout, there is no due diligence being performed by anyone on the companies. Government officials, before any bailout, should check all the company's confidential books and records, just like bank examiners do for banks. Will they? I doubt it.
All this adds up to trouble. The amount requested looks to be a hook for more requests later. Once the initial money is gone, one could conservatively estimate that another $75 billion of successful requests will follow. A popular suggestion is to loan some now and some later with the later money coming only on the condition that benchmarks have been met. Either meet the conditions or take Chapter 11, but the problem is Congress's stomach for Chapter 11 -- it could later rescind the conditions.
Will the government take warrants or other equity with the loans? The bailouts of the banks and AIG came with grants of equity. We are now seeing the AIG and bank bailouts come back to bite us -- "Why bail out Wall Street and not Main Street (with 2.5 million workers)" is the public cry from Michigan.
December 3, 2008
Icahn's investment partnership, an investor in the buyout of Realogy Corp. is suing to prevent the company from refinancing $1.1 billion in debt (a workout). The $1.15 billion in old debt, below, Ichan's will be transformed into $500 million new debt, of which $237 is senior to Ichan's. Not so fast, says Icahn, the move violates my debt covenants. He, in essence, is unwilling to take a hit in the workout. Realogy with threaten bankruptcy as an alternative and the parties with play a game of chicken in a tense negotiation. Ichan will win.
December 2, 2008
Novel Lawsuits Fly
A hedge fund, run by William Frey, has sued Countrywide and its parent, Bank of America, on their agreement with 15 state attorney generals to modify 400,000 mortgages originated and serviced by Countrywide. In the lawsuit the hedge funds states that the settlement is fine but that Countrywide has offered to modify mortgages that it no longer owns - investment trusts own them. The hedge fund, an investor in securities issued by the trusts and backed by the securities, says that Countrywide must repurchase the mortgages in the trusts at par in order to modify them. The outcome of the case will turn on the contractual language in the pooling and servicing agreement between Countrywide and the investment trusts. If the hedge fund prevails, Countrywide will have to pay MBS security holders to modify the mortgages (with government bailout money??) A demand for redress, filed with HUD and awaiting HUD action, alleges that subprime mortgage originators discriminated against minority groups in pushing and selling subprime mortgages. These will be just two of many, many lawsuits that will occupy lawyers for years as a result of the mortgage default crisis.