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By Martin Hutchinson
Contributing Editor
Money Morning/The Money Map Report
Financial journalists, most of whom spend more time writing about derivatives than carburetors, have been scathing about the possibility of an auto industry bailout, even though they’ve happily accepted multiple bailouts for the financial sector.
Of course, the reality is that bailouts are likely to do more harm than good in the long run, regardless of what sector they are in. But given the choice, I would rather bail out General Motors Corp. (GM) than Citigroup Inc. (C), because the automaker has a better long-term future.
The financial services industry got far too big during the 1995-2007 bubble. Its growth accelerated in the 1990s on the back of innovative new financing techniques such as derivatives and securitization, as well as a huge expansion in areas such as leveraged buyouts. As a result, its share of United States gross domestic product (GDP) has approximately doubled since the late 1970s.
It is now clear that many of the new financing techniques were misapplied or even spurious. The problem of separating loan origination from credit-risk assumption has become obvious, and so securitization will have a much more limited future.
Of the derivatives, credit default swaps are clearly destabilizing and will be tightly regulated. Many of the new market participants, such as hedge funds and private equity funds, should disappear, since they merely represented conduits through which higher fees could be charged rather than truly innovative investment choices. It is thus likely that the financial services business will revert to close to its previous share of GDP. That would involve a downsizing of its 2007 capacity by 50%.
The automobile industry, on the other hand, has no obvious need to become smaller. With global warming now high on the political agenda, its products need to change radically, employing new technologies that greatly reduce carbon emissions. However, the basic demand for personal transportation has not gone away.
Indeed, it is still expanding rapidly in the growth economies of emerging markets such as China and India. And U.S. urban geography, with its widely spread suburban developments, is wholly incompatible with a sharp drop in automobile usage and would be impossibly expensive to modify except over a very long term.
Why Citi Should Fail
Allowing a large bank such as Citigroup to disappear is probably beneficial. It reduces competition for other major banks, allows medium-sized banks to expand into the space opened up, and provides an appropriate penalty for decades of bad management. Citi was a leader in the Latin American loan crisis of the 1980s; its then-Chairman Walter B. Wriston famously opined that “countries don’t go bust,” a sentiment that has been repeatedly disproved.
Wriston got his succession wrong in 1984, choosing the overaggressive retail banker John Reed (who had pioneered the unsolicited credit card offer in 1978 and lost $100 million – real money back then – in 1980 by doing so) over the capable corporate banker Tom Theobald.
Citi almost went bust in 1991, but was bailed out by Saudi Prince Alwaleed bin Talal. It assembled a financial services conglomerate in 1998 that proved unmanageable, and from 2003-2005 was prevented from making any more acquisitions because of its shaky position.
In short, Citi has been a classically mismanaged behemoth that, in any other industry would, have already collapsed.
Yet, its bailout risks more than $300 billion of taxpayer money, and to no obvious economic benefit.
Meanwhile, General Motors has been damaged by two factors: Misguided government regulation of the automobile industry, and a drastic societal shift away from unionized labor.
CAFÉ Backfires
GM had a 60% share of the U.S. market in the 1950s, and was recognized for large cars that performed distinctly better than their imported competitors and were well suited to U.S. driving conditions. Some expansion of foreign competition was inevitable, as Europe recovered and Japan became a major automobile producer, but GM was particularly hard hit by the Corporate Average Fuel Economy (CAFÉ) legislation. CAFÉ, which mandated fuel economy standards instead of simply raising the gasoline tax, put GM’s large models at a disadvantage to their smaller imported competitors.
However, U.S. automobile companies found a loophole, which is that its standards were limited to automobiles. Vehicles built on a truck chassis were exempt. That gave rise to the sports utility vehicle. Now, higher fuel costs, environmental concerns, and tighter CAFÉ standards have made the SUV an endangered species, but it was a Frankenstein’s monster that only existed because of government meddling.
If GM and the other U.S. automobile manufacturers go out of business, only their foreign competitors will benefit. Furthermore, they have an interdependent network of suppliers, with a total of 3 million employees, which could easily be forced into bankruptcy by the disappearance of their major customers. U.S. automobile manufacturers have important, and in some areas unique technological capabilities, whose loss would severely damage the U.S. economy as a whole.
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The automobile business is unprofitable now, but will eventually return its previous size in the United States, as well as expand worldwide. So, while there is no capacity downsizing needed, capacity restructuring, away from SUVs and towards smaller cars, hybrids and innovative power technologies, is essential.
Ultimately, the right decision would have been to bail out General Motors and allow Citi to go to the wall.
The Case for Citi
Of course, there are important modifiers to this recommendation. In Citi’s case, its interconnection with the financial system as a whole is such that an immediate bankruptcy followed by years-long court proceedings could render many of its counterparties unviable and damage the global economy badly. Hence, an orderly liquidation is needed, with a receiver appointed to wind down Citi’s positions and sell the viable portion of its operations, making good on those obligations incurred by Citi that appear to have systemic importance. Even if the taxpayer made Citi’s counterparts completely whole, however, it would not have been as expensive as the bailout.
As for GM, it has labor costs and pension obligations making it uncompetitive with foreign-owned producers. Those “legacy” costs can most efficiently be removed through a Chapter 11 bankruptcy filing. The pension obligations will then fall on the taxpayer through the Pension Benefits Guaranty Corporation, while the labor contracts can be rewritten in a way that is competitive with the market in which GM operates. If a government subsidy is then needed to cover GM’s operating cash deficit during the recession, and the investment costs of transforming GM into a producer of environmentally friendly automobiles, it should be provided through a post bankruptcy “debtor-in-possession” financing.
There is nothing magic about banking that should allow the industry to be uniquely permitted access to taxpayer money when disaster hits. Only bank customers and the market should be protected. Conversely, the automobile industry plays an important role in the U.S. economy that is unlikely to be significantly downsized. So, there is considerable justification for assistance to GM and Ford Motor Co. (F), which have valuable capabilities and long-term competitiveness, though less for a bailout of the smaller and less industrially valuable Chrysler Corp.
News and Related Story Links:
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Money Morning Special Investigation of the Credit Crisis (Part I):
The Real Reason for the Global Financial Crisis…the Story No One’s Talking About. -
Wikipedia:
Alwaleed bin Talal.
Tags: Martin Hutchinson
The reality is they need to go into bankruptcy and then the gov can get involved. The union labor rates of $70.00 PER HR vs the non-union rates of $27.50 per hr ( Hundia as an example ) and resistance to robotization. The management labor rates are also too high. Thats why pick up trucks cost $55,000 to $60,000 when they should be in the $30,000 range.
There is truely a misconception about the pay of union labor. First $70 per hour? The cost of labor for a vechicle is 8-10% of the price of the car. If you figure in the current hourly wage, health benefits, the pensions of retirees, their health benefits, and the pensions and health benefits of the surviving spouses and divide that by the number of hours worked then you come up with $70 an hour.
An auto worker with 30 years seniority at age 62 receives $1,615 per month. That is not extravagant.
Why hasn't anyone ever figured out the rate of pay for our congressional leaders using this same formula.
Go to the web site below. PLEASE
http://www.youtube.com/watch?v=yjZ8vgvbM1s
I think all these companies whether financial or automotive should go through the bankrupt process, then restructure completely settling their debts and if necessary sell off the rest of the assets if they are not viable entities. Those that survive need to drastically reduce management costs. They want labor to reduce their wages and benefits so management should have to reduce theirs as well. No more private jets, limos and out of control expense accounts. No more options or bonuses unless the company and it's stockholders are showing a profit. No one in management should make 50% more than the middle income of the employees. All raises would be based on performance. No positive performance no raise. If a company has a board of directors at least 51% would have to come from employees and minority stockholders. And before anyone replies with the lame reasoning that no one would want these jobs at those wages your wrong. There are lots of smart, capable people out there who would love the challange of creating a profitable company. The company makes money, they make money. Certainly no one of the caliber of the present day CEO's would want the job, thank God, and no one in their right mind should want to reward incompetence by hiring them back.
Steve McNeill
Mr. Hutchinson,
Excelllent point, but you are too kind. While I believe anyone
who goes to Congress for a bailout should have to grovel and
beg; it's hard to figure out why they are only making manufacturers (auto industry) do so and not the financial institutions. The only thing I can think of is that Congress doesn't understand the financial sector, and Paulson simply scared them into giving the financial organizations loans.
It's very simple to me. The financial organizations are greedy crooks. We are depending on the greedy crooks and incompetent politicians to remedy this problem. The financial institutions don't have any special skills. On the other hand, manufacturers do have special skills, and they produce items of substance. Over the past 10 years, we have sent manufacturing jobs abroad, allowed the financial organizations to run wild and are now berating what manufacturing we have left.
Lastly, all Paulson wants to do is to return to the same market forces that created the problem in the first place. The world has changed, and going back to the past may not be an option.
Ron Harris
While I can agree, the Auto Industry is essential to the America I know. Why, GM does not sell GMAC to the Cerberus Financial for cash liquididty and possibly some form of Coporate Agreement, to help streamline Hybrid Tech into the American Auto Giant, is beyond me. I cannot help but think what GM could be if they could acquire some regen-braking from Chrysler, coupled with Multi-Displacment Tech and like that, you have a competative product. The entirety of the U.S. Auto World hinges on the UAW making large concessions and the American Taxpayer picking up the pensions left behind. There will be no real winner for at least a decade, but when the dust settles and the companies are free to go about their business, we will see a strong Detroit. Also, we will remain at the top of the manufacturing/engineering hill. Which is a vital component to National Security and Financial Growth.
I stongly disagree with the excuses for failure of GM stated in the article, blaming its demise on government regulations related to emmisions and fuel economy. GM has plenty of fuel efficient models that compare favorably with foreign automobiles. Labor costs are not the culprit either. Many of the foreign brands are built here in North America paying similar wages. The real problem is the mindset that we will buy American cars just because they are built here and look good. Consumers want dependability and durability at a reasonable price, a concept that has totally escaped the big three. GM might look a their cometitors distribution networks as well. They do not have grand showrooms with hundreds of autos on the lots in every small town in North America!
I agree with the comment about GM going bankrupt and then receivng aid as required. I do not agree withe blaming the government for their demise because of Cafe standards imposed on them. It was the decision to circumvent the intent of the standards, by producing passenger vehicles based on truck bodies that got them into this situation.
Ron Harris said it well above. Why do we throw trillions at financial institutions that have no plan on how to survive other than simply going back to the taxpayer well for more as Citi recently did. The auto companies want a loan not a bailout. The GM plan submitted to congress shows them repaying the loans by 2012. And why would anyone suggest that the taxpayers should pay the pensions for GM through the PBGC when the GM pension plans are more than 100% funded right now. Does the PBGC have the money to handle the number of retirees the big three have? I doubt it. How much will that cost the taxpayers. I'll bet it's a lot more than $34 billion. If the big 3 fail, the supplier and dealer community will collapse. The 533,000 jobs lost in November will look like a good month by comparison.
I'll ask the same question here.that my Senator won't give an answer to.
I work in construction.The banks and auto makers used poor judgement and put themselves in this position.
Because of the banks,the construction industry has gone to hell.Who is going to bail us out?
Damn sure won't be any of that trillion dollars I'll have to help pay back.
While I agree with some of the editorial points above, there is an error. The CAFE standards initiated during the Carter years to address the second oil crisis helped, not harmed the car companies. As early as 1973, during the first oil crisis, the Nixon clean air legislation sounded the death knell for pointlessly large vehicles. With gas prices rising and only foreign car manufacturers offering efficient cars, sales of domestic cars suffered. As the big three (and AMC) began to create more efficient vehicles, sale again rose. Since domestic cars better suited American tastes, the fuel economy standards forced the car companies to build what the Public needed (not just what they wanted). The damage was done when oil got cheap again. Reagan abandoned the progressive CAFE fuel economy standards and no progress was made by American auto companies until fuel prices again rose. It was not on their own dime that things changed. In exchange for not forcing the car maker to meet new economy standards, Clinton asked the Big Three to come up with efficient prototypes. Each developed hybrid cars that would have answered the future demand quite well. In fact, the Japanese were so worried about being locked out of the new efficient car market in America, Honda & Toyota rushed to develop their own hybrids. Of course, we lost an important market advantage because of the old line thinking of the Big Three. For the record, the Corporate Average Fuel Economy standard for 1985 was supposed to be 27.5 miles per gallon. Even with small mandated annual improvements, just imagine where we would be today had the progress continued.
Whoever we decide to bail out needs to operate by different rules than they have in the past.
For several months I have been advocating a massive DEBT restructuring that would include the entire world. I simplified how to do this in three steps. First just make a list to include the debtor, debt-holder and a bank to administer it. The second step would be to just create enough FIAT money to pay all the debt and third authorizing the Central Banks of the entire world to make an accounting adjustment crediting the debtor and paying the debt-holder.
Review it here: http://allencharlesreport.blogspot.com/2008/11/worldwide-debt-is-problem_28.html
If done worldwide the currency values among the various currencies would adjust too different values for inflation, I suspect America has the largest total debt of any country in the world so the dollar might weaken in value the most. If the US Dollar does devalue then we would be much more able to compete with the rest of the world.
Our economy has had most opportunities to actual produce (manufacture) something removed from it because we just cannot compete with the low wages paid elsewhere. Ths debt REBOOT would do two things, first it would take the pressure off our economy (the rest of the world as well) to allow the economy to restart because of all the NEW Capital coming back into the system. Because our debt (the USA) will cause a much larger adjustment in the US dollar’s value, the Reboot would allow time for American production of items we use every day to return and our dependence on other countries could be reduced. It would happen because we could not afford the more costly imported products and not because of tariffs which the trade agreements will not allow us to do.
NOW I have a Question ?
I was on a forum site reading comments by a bunch of PHDs and read on one post that when we buy goods from China it is always done in US dollars, but when the Central bank of China pays the manufactures it is in the Chinese currency and the Central Bank of China just creates the payment making a credit to the manufacturers bank account. Then the Chinese government or Central Bank takes the US Dollars that they just got for their newly created fiat Chinese money and buys American debt sending the dollars back to the USA. So we buy with our fiat dollars, they create new fiat money and send our money (and the new debt we owe them) back to us to spend again over and over. Does anyone know if this is TRUE?
Allen Charles
[...] Why GM is More [...]
I like you article and think your points are both relevant and
timely. I also think helping the auto industry bridge to the future is smart politics. But I would prefer the help to minimize
taxpayers money as much as posssible while still offering good solutions.
A) The government should provide the troubled auto companies a one year Federal Tax Hoilday. This should greatly increase their cash flow available to retool and manufacture since they could skip making their quarterly tax payments. Consider that ultimately their tax losses will be so great that most of their taxes would be refunded anyway. So why not save the trouble and allow them to beter utilize those dollars to help themselves for the next 12 months.
B) Offer revolving lines of credit, say at 2% interest, to be used to finance the purchase of new cars or trucks that are either: electric or natural gas powered, or get 30 MPG fuel efficiency.
These two proposals along with the already provided $25 Billion by the Bush Administration and approved by Congress is quite substantial and should be adequate without requiring further taxpayer assistance. After all GM for example can sell GMAC or other assets or car lines to manufacturers in other countries. The American taxpayer should not be required to foot the entire bill.
Done this way the soultions can be considered a helping hand not a bailout!
Mr. Hutchinson:
While I agree with your suggestion concerning Citicorp, you are far too easy on GM in your assessment of their woes. Successive CEOs have made abysmal product and financial decisions, signed irrational labor agreements with greedy unions and offered substandard products to the US domestic market.
A trip down memory lane brings back unpleasant memories of Chevy's Corvair, Vega, Citation, Cavalier and the miserable Cobalt. GM also gave us modified gasoline engines sold as diesels, the Cadillac Cimmaron (aka, the Chevy Cavalier), lookalike Buicks, Pontiacs, Oldsmobiles and Chevies in the 1980s courtesy of Roger Smith, and more recently, the Hummer.
GM's financial woes can also be traced to a dealer network that is far too large to support the market share it has, and to the brand proliferation GM has continued despite continued loss of market share. Does it really need Pontiac, Buick, Saturn, GMC, Hummer, Saab, Chevy and Cadillac, when Toyota, Honda and Nissan all manage to do quite well with only two brands?
GM needs to enter a "pre-packaged" Chapter 11 to rid itself of unnecessary dealers, brands, restructure health care and labor agreements and create a much leaner organization.
GM shouldn't receive a dime from Congress, i.e, the taxpayer, until it demonstrates a credible business plan that is a blueprint for profitability, not years of dependency.
One final comment. Rick Wagoner is without doubt one of the worst, if not THE worst, CEOs of all time. Under his watch GM has run up over $50 billion of losses in the past four years, including the writedown of $30+ billion of tax benefits because of an abortive partnership with Renault. Wagoner and his stooges need to be fired, without any golden parachutes, for their incompetence. Unless GM cleans house at the highest levels, and "recovery plan" it presents will be little more than a joke.
BINGO !! Mr. Ronald Smith. You've nailed this dead on with respect to the US consumer shying away from the BIG 3 and opting with the Asian imports. When we're car shopping we typically consider these things: Dependability ratings (consumerreports.org), Fuel Economy, Resale Values and finally the Cost per Mile (CPM) to own our cars. After doing diligent research, ALL GOOD $$ SENSE take us directly to the Asian imports. European and US are all riding on their laurels and just aren't willing to face (nor meet) the demands of we Joe and Suzie SixPacks,, soo – Adios gas guzzling, poor CPM American and European cars that lose 25 to 35% of their value the second we purchase and bring them home to our driveways or garages. When American cars are willing to get tough with their Boards of Directors, cut costs and force the UAW to join in to meet a good CPM,, we American consumers will be more than happy to BUY AMERICAN. We do not need governmental intervention to tell us why we do not buy American cars – we need GM, FORD, Chrysler to get with the times and build cars we're willing to buy.
"Comment by Ronald Smith on 5 December 2008: I stongly disagree with the excuses for failure of GM stated in the article, blaming its demise on government regulations related to emmisions and fuel economy. GM has plenty of fuel efficient models that compare favorably with foreign automobiles. Labor costs are not the culprit either. Many of the foreign brands are built here in North America paying similar wages. The real problem is the mindset that we will buy American cars just because they are built here and look good. Consumers want dependability and durability at a reasonable price, a concept that has totally escaped the big three. GM might look a their cometitors distribution networks as well. They do not have grand showrooms with hundreds of autos on the lots in every small town in North America!"
The government created the Community Re-development Act in 1977, and they used that to encourage home mortages to be given out as an entitlement. The unintended consequences over the last thirty years are obvious.
The government created all the safety and epa regulations that the car companies had to adhere to.
The democratic congress has spent the last two years talking about no drilling, raising taxes on oil companies, raising taxes period.
Management for the financials and the auto industries have not shown much expertise or common sense over the last thirty years either but I think government has been the biggest problem and now they sit in judgement on problems they are mainly responsible for and try to lay the blame on everybody else.
The major problem over the last two months has been the credit freeze up. What happened to the 67 trillion dollar credit default swap (CDS) problem the media including "Money Map" has been pushing the last several months, thats what caused the credit freeze and then pushed the correction into a recession. According to the Depository Trust Clearing Corporation (DTCC) the problem was grossly over estimated, primarily because the data was created by a survey. The survey included info from both buyers and sellers so some info was included twice or even three times or more. The DTCC handled the sale info of Lehman's CDS auction. Their $72 billion turned into a net funds transfer between sellers and buyers of $5.2 which is 7.22% of $72 billion. DTCC says the total CDS contracts as of 10/9/2008 was $34.8 trilllion so if you apply the Lehman net funds transfer of 7.22% the liability is $2.5 trillion. Still a lot of money but a long ways from the media number of $67 trillion. Just like yelling "Fire" in theater, you go to jail for that. Any people in the media want to go to jail for yelling $67 trillion CDS problem?????????
Bailout or no bailout, there will be a lot of jobs lost and the mantra is, "that can't be allowed to happen"! The basic problem in my view is the accumulated "sense of entitlement" that has become all pervasive at all levels of society, from highest levels of management with all their perks and bonuses, even while their companies are losing money! Equally destructive is the adversarial union stance of "we just want our share" that has driven costs to unrealistic levels that can not be sustained.
Restructuring is essential and the only way to accomplish that efficiently is a Chap 11 bankruptcy, replacement of management, downsizing, elimination of redundant models (too many choices) and better quality. What also needs to take place is cessation of the cycle of "government as lender of last resort" where everybody just expects that if they get into trouble, they can dump their problems on the taxpayer. Under our fractional reserve fiat money system the government has to borrow at interest just like the rest of us and then raise our taxes to cover the cost, or just roll the debt over and leave it for our children and grandchildren to pay!
Whatever happened to old fashioned capitalism where there was real competition, you produced a QUALITY product that people wanted at a price they were willing and able to pay, or you went out of business?
Seems too me our whole society has developed the "gimmes" all rights and no responsibilities for bad decisions!
In response to Sydney Lyons's statement of 12/5. You are right Sid. I too work in construction and with us it's "No tickee-no workee" The errors were not made by middle class America, they have common sense, they were made by so called high dollar geniuses in the name of greed. If we had a Congress that ran on common sense and a government, we'd have our Country back again as a functioning unit. Remove the Lawyers from House and Senate and get back to Trumanesque mind set to return to a prudent USA. The more words that are added to a law, the more loop holes created. Keep it simple and direct, thou shalt not, thou shalt, period. Running a company or a country does not have to be complicated unless you make it so because that way no one knows what's going on because of the chaos. Thank You, Mr. Briggs
Anybody figured out why Bank of America took part of TARP and bought stock in Construction Bank of CHINA with our taxpayer money? Not even a US bank. Does rep. Shelby of Alabama not want to bailout auto industry because of the money the State of Alabama has put out for 5 foreign auto manufacturers to set up plants in the state? Seems like he's looking out for Alabama not the United States of America. I think we fought a Civil War over States Rights. Who IS looking out for the Country as a whole instead of their little fiefdoms? Thanks Guys, Mr. B