Wednesday, October 1, 2008
Now to be clear I don't know that this is the right thing to be doing, especially since credit is what got us and the world economies into this problem in the first place, but based on the current Global market conditions and the significant chance of a Global recession this may be our only way of turning the economy back into a positive direction. The following is a brief overview of the Bailout solution and how it is suppose to help the economy. Again whether it works or not is totally up to how well it is implemented, governed (policed by the Federal Government) and managed.
Where will the $700+ billion go? What exactly will it buy and from whom?
That's the, um, $700 Billion question. Mortgage-backed securities were to be the main target, and banks the main sellers. But Hank Paulson and Ben Bernanke wanted a fund that could buy pretty much anything from anyone.
How, exactly, is this bailout supposed to 'save' credit markets?
Not entirely clear. Paulson and Bernanke described it as a way to jump-start trading in mortgage securities for which there's no market at the moment, thus allowing banks to clean up their balance sheets and get back to lending. But a lot of economists outside government believe that the real problem is that lots and lots of financial institutions are insolvent--their losses, if they actually recognized them, are enough to wipe out their capital reserves. If that's true it would make more sense for taxpayers to give them cash outright, and take a big ownership stake in return (with the idea of selling it off a few years down the road). The Swedish solution, they call it (and longtime readers of this blog know it was being discussed here long before anybody else in the U.S. was talking about it). The version of the bailout plan voted down in the House Monday seemingly would have allowed Treasury to take such action. But it also would have allowed Treasury not to take such action.
How/why is this situation different from investors simply losing their money because of bad judgment about what to invest in? Can I get bailed out when my portfolio tanks?
It's a variant on the old saw (often attributed to J. Paul Getty, although I'm sure somebody must have said something like it before him): "If you owe the bank $100, that's your problem. If you owe the bank $100 million, that's the bank's problem." Leveraged financial institutions (banks, investment banks, hedge funds) make investments with lots of borrowed money, so when their portfolios tank they can quickly get into a situation where they can no longer make good on their debts. When that happens to a single institution, it's no big deal to let it fail. But if it's happening to a lot of them at once, you get the paradox of deleveraging: a downward spiral in which failure begets more failure and retrenchment begets more retrenchment.
Why should Wall Street be bailed out? Won't it just make them all the more eager to engage in risky practices in the future? Are we bailing out the very people who created the problem?
A lot of the people who created the problem have already lost their jobs, but yes, any bailout risks rewarding the profligate and the foolish. But we're getting to the point where financial sector problems are starting to hurt people who didn't profit from the boom. And you can design a bailout that's not so much a bailout as a new start--such as the Swedish solution outlined above.
There's also the approach favored by the late MIT economist Charles Kindleberger, who thought it was the job of governments and central banks to step in and halt panics, but felt they should "always leave it uncertain whether the rescue will arrive in time or at all, so as to instill caution." That seems to be official U.S. government policy at the moment, actually.
If more currently outstanding mortgages default, won't the problem just keep going on and on?
Yes, that's a big part of the concern at Treasury and the Fed. That economic trouble emanating from the financial system will cause even more people to fall behind on their mortgage payments which will lead to even more trouble in the financial system.
Are we all just supposed to trust that mortgage lenders and Wall Street types have 'learned their lesson' and will not continue to exacerbate the problem (or find ways to create new ones)? What safeguards are/will be put in place so that derivatives of the type that got this mess started will not continue to be created or traded?
I think it's fair to assume that mortgage lenders and Wall Street won't make these same mistakes for another generation at least. But they will do their best to figure out new ones to make. And while bubbles and crashes will always be with us, I think a regulatory structure that is far more restrictive of financial innovation is probably a good idea. Do we have that regulatory structure in place now? No.
Is the money going to the wrong people/institutions? Why should the money go to these institutions instead of homeowners or banks who hold the sub-prime mortgages?
A lot of the money would go to banks that hold sub-prime mortgages. Getting it to homeowners is a more complicated proposition. Would you just give the money to people struggling with their mortgages? How much would you give them? For how long?
If these so-called securities are 'mortgage backed' and the mortgages are in default, would the money be better spent just buying up the mortgages themselves instead of the securities? And re-negotiating mortgage rates to make it more likely that homeowners can pay down their mortgages and hold on to their homes?
A number of economists think that buying up the mortgages themselves would make more sense. I think the reason Treasury doesn't want to do it is that it would be a far more time-consuming and labor-intensive process than simply buying securities on the open market. It was easier in the Depression, when banks held whole mortgages on their books, than it is today.
As for renegotiating mortgages, a new program goes into effect tomorrow (it was part of the housing bill passed over the summer) that uses up to $300 billion in FHA guarantees to encourage mortgage services to move people out of adjustable-rate sub-prime loans into fixed-rate loans with lower face values. And if Treasury owned a few hundred billion dollars worth of mortgage securities, it could put pressure on servicors to renegotiate loans rather than foreclose on them.
And what about the 90% of homeowners who are paying off their mortgages and dealing in good faith, who have seen their equity significantly lowered by the tanking of the real estate market?
That equity will go down more if banks continue to struggle.
Is there any chance that any of the bailout money will be recouped?
Yes. Mortgage-backed securities are still, you know, backed by mortgages. They're worth something--and in some cases more than what the feds would pay for them.
How/who will determine how much to pay for these securities?
They haven't really figured that out yet. One possibility would be to hire private managers who would get a share of any profits. And there's lots of talks about using various auction methods to price them. But I have yet to hear a really convincing explanation of how this would work.
Will every financial institution that holds mortgage-backed securities be able to sell them to the federal government? Who determines what will be bought and from whom? Will institutions be able to recover losses they have already written off?
In theory anybody could sell to the TARP (troubled asset relief program). The what and from whom would ultimately be up to the discretion of the Treasury Secretary. And if institutions were able to sell securities for more than they valued them at on their balance sheets, sure, they could reverse some losses.
What is to stop speculators from buying up these bastardized securities for pennies on the dollar anticipating enormous profit when the government buys them at higher rates?
The current owners of those securities aren't going to want to sell them for pennies on the dollar if they think the government will come in soon and buy them for dimes. That said, I think Treasury would love it if there were private vulture investors bidding for mortgage assets too.
How is the current real estate crisis different from the RE bust of the early 1990s?1) It's bigger and more national--although it is worst in California, the Southwest, and Florida.
2) It's also (except in, say, Detroit and Cleveland) not the result of external economic factors like Texas in the 1980s or Southern California in the 1990s. It's a crash caused by the twisted dynamics of real estate finance in recent years.
3) The way mortgage-backed securities and related derivatives have acted to concentrate and transmit risk rather than diffuse it has added a whole new element to the crisis.
Who is at fault here? I have increasingly seen fingers pointed at home buyers for buying 'too much' mortgage (i.e. big eyes for big houses), who 'lied' on their mortgage applications about their ability to keep up payments. Surely significant fault lies with the mortgage lenders for approving such loans without due diligence? And greater fault with the creators of the mortgage-based derivatives?
Until 10 years ago, getting approved for a mortgage was a pretty good indication that you could afford to make the payments. So for the most part I really don't blame buyers--they were relying on a time-honored financial rule of thumb that mortgage lenders and their Wall Street backers had suddenly decided to throw out the window. I'd blame the lenders, the scrutineers, the regulators and Congress first, and buyers probably last. Although I'd still blame 'em a little.
Speaking of fault, how logical (much less honorable, but we probably need not go there) was it for Wall Street to over-leverage itself? Or is it just a matter of 'because they could'?
It was logical for individual Wall Streeters because they could reap big rewards from over leveraging and not necessarily suffer from the eventual fallout. It was not logical for Wall Street firms to do so (because it put their survival at stake) but those firms are after all just collections of individuals.
Without the bailout, is it really likely that we will see the end of the world as we know it? And what, exactly would that Apocalypse look like?
Given the existence of the FDIC and the activist stance of the Federal Reserve, it's hard to envision a 1930s-style breakdown in which banks shut their doors and depositors lose all their money. I think the fear is of a situation where lending to both businesses and individuals stops almost completely, which would lead to a pretty sharp downturn. Not nearly as bad the Great Depression, but the worst we've seen since then.
What is the difference between Wall Street and a casino? (Not meant as a joke)
On Wall Street, the dealers get paid a lot more and are often allowed to bet alongside the customers. Oh, and much of the money raised on Wall Street actually goes to productive purposes. Except when markets are in bubble mode.
This is simply a ramble based on what is seen as of today. I guess all this may or will change with time. Ultimately we will need to see what the real Bill looks like when it is passed by the Senate and House of Reps, and yes it will pass regardless of how John Q public feels about this mess. Sit back and hang on 'cause' this is going to be a wild one.
Tuesday, September 30, 2008
The US Auto industry is in shambles, over the last couple of years they have continually lost market share and support of the US car buying public. Well at least that is how I see it, and frankly the facts support this broad assumption.
I come from a family with over a 70 year of history in the industry, starting with the sales of the first Oldsmobile sedans to being the #1 Cadillac dealer in the country to then being one of the first Datsun (Nissan for those to young to remember) dealers in the country. Our family had over 65 dealerships at one point through the east coast, and we had the number one Oldsmobile dealership in the world, selling about 1000 cars per month at the pinnacle of the business. The majority of the dealerships were GM or Chrysler related, with the exception of some trials into the Japanese lines. So I do come to this discussion with some history and love for the US Auto industry, not to mention that I worked for General Motors in the mid-1980's, and my current company does product and advertising market research for the auto industry. Enough about me! Let's get into the meat of this little dissertation!!
The reality is that the industry has grown and change many times over the years but the one fixed factor that had always been in place, year after year, was the strength and leadership of GM and Ford. Whether it is due to arrogance or simply stupidity their leadership and strength has fallen to almost a second tier player with Toyota, Honda, Daimler (Chrysler has been sold), Nissan and VW leading the design and technology future of vehicle development. With Toyota poised to eclipse all but GM in production and far exceeds all of the US players in profitability.
The US management teams will try to blame the issues on labor and the unions; personally I believe this to be "Hog Wash" (I was raised by a Southern Mom & Grandmother). All the other manufacturers have labor cost, union contracts, and they all seem to be doing very well. They all have chosen to build cars here in the US, while the "boys" in Detroit seem to believe that all manufacturing needs to be sent over to China or other low cost labor zones in south Asia. As they say "Reality Sucks", for all the good will that has been pontificated about buy American, the US public will buy what they trust and what they like, and frankly both the Asian and European competitors are designing more appealing vehicles and building a much better product, that appears to suit the demand of US consumer's. Although, there have been some very solid attempts to provide interesting production vehicles to the market: Ford GT, Chevrolet HHR, Chevrolet SSR, Chrysler PT Cruiser, Dodge Viper, etc. all of which are impressive design concepts and styling cues, however they are low volume sellers that never translated their design concepts into any of the large scale production models. Yes they generate a marketing buzzzz, but unless they provide a link to the product line and name plate their marketing effectiveness can be greatly limited or even completely diminished.
A key factor in vehicle sales and market penetration is hardcore MARKETING. For years Detroit was the leader in how to market vehicles, more importantly they were the leader in how to target market a vehicle to the middle-market, the bread & butter of the auto buying market. Somehow they have lost their way in reaching out to their core market. Granted their is a tremendous amount of confusion in the marketplace and more competition than ever, but the US Big Three still can gain the upper hand against the majority of the competition, except Toyota.
The good news is that not all is lost. We are finally beginning to see some very good designs coming from GM (Saturn & Chevy), Ford and Chrysler in their primary large scale production line models, and some creative thinking. Quality is still somewhat of an issue, although significantly better, they still need to take a quantum leap forward. There will be some very difficult cost restructuring actions that must take place, and if they do it properly then they will have a huge cost and distribution advantage over the foreign competition. Although some dealerships will need to disappear in order to ease the competitive pricing & support issues, there is still more than enough sales outlets to dwarf virtually all of the competition (except Toyota).
Unions and suppliers will not be happy, but operational & component purchasing restructuring will be the price they have to pay if they want to survive as partners with Big US manufacturers. Pay must be inline with the Japanese competition, and pricing for parts must be inline with the economies of Toyota and Honda. Manufacturing processes will have to significantly change so that they align more with a modified Asian and European model that allows for lower core production cost while ensuring a very high build quality, using physical labor only in specific areas of the building process. Manufacturers must always remember that they are building product for a very discerning customer that now has many choices not just a few.
Finally, design and marketing must step up to a new level and maintain this pressing level to ensure long-term market success. Companies like Hyundai and Kia have proven that a company, perceived to be poor quality, can bounce back from extreme adversity. That being said it will be a very difficult road to drive. Detroit must continue to use market and product research to help them establish product and marketing direction. Most importantly US manufacturers must figure out the best methods to reach their buyers, not just from an emotional level, which Chevy is doing a good job with their current ad campaign, but also from a reason to purchase (Hyundai is using both emotion and key high quality points to convince people to buy their product). Buyers are a very fickle group, and they make initial buying decisions on what they believe and are made aware of through advertising and positive press.
I am and always will be a big fan of the American Auto industry, and truly believe in buying American where it makes since. Unfortunately, US manufacturers have a lot to work on to catch up with the rest of the world, fortunately there is time and skill (I believe) to get this done. It is important to realize that we are now truly living in a world economy, which will continue to be dynamic and robust well into the future. As long as the Big Three can be creative, focused and resourceful there is a very strong chance that they will bounce back and be even stronger than before, positioning themselves to truly be the WORLD leaders in vehicle development and production.
We will continue this discussion looking at the individual company's and their challenges to regain leadership and profitability. I look forward to a fun and robust discussion about this endeavor and many more. Thank you for spending time with me and have a great day.
The Rambling Jester
Tuesday, June 3, 2008
I felt it my duty to help at least some of us understand the morbid reality of where our country stands with respect to alternative fuels and what is truly available as an alternative. I gues it would be about 12 years ago when I had the opportunity to write a small disertation concerning alternative fuels, and what we could use to address the ever burdening need for a energy alternative that would replace fossil fuels. I am sad to say that over a decade later we are no closer to utilizing or developing, within the US, true alternatives to fossil fuel now than we were then. After that sad fact, it should be noted that there have been significant strides in many other countries to address the reliance on fossil fuels and there is hope that we could tag into these programs with little significant effort. Unfortunately, we are also dealing with a US Presidential administration that has significant ties to the oil industry, regardless of their current postering.
Friday, May 16, 2008
Here is a little Reality
So we are clear on the issue we actually have it realtively easy compared to much of the rest of the world. Below is a brief comparison of Gas prices between the US and some of the major European countries.
As you can see it's not all bad. However, it still hurts when you have to consider that we as a country have a true love affair with our cars, and have chosen not to rely on public or alternative transportation. The US is a country that has built a major part of our lives, social character and work around our cars, and it's quickly becoming a reality that most us will need to change or at the least be decreased our use of the car. What hurts worse is filling up compared to filling up only one year ago, OUCH!!!
One more Reality Slap
The US economy works on a 10 - 12 year cycle. The US economy is currently in one of those downturns after very robust number of years. Of course, the issues are compounded by the mortgage banking problem, but this is no worse than the Savings & Loan collapse in the 1970's. Unfortunately, most Americans are feeling the brunt of the downturn in the US economy. Regardless of what our world famus highly paid Chief Economist may say we are in a "Recession". By the time they come around to calling the cycle what it is the US will be back on it's feet. Most will hate to hear this, but we are in just in one of our adjustment cycles, unfortunately demand is still relatively strong and this is supporting price increases. As demand falls prices will also fall. Guess what this is true of fuel prices as well. Fuel prices may not fall back to the $1.25 per gallon price, but they will come down and the economy will bounce back. The US is the single largest economy in the world and yes China will challenge this, but as long as the communist rule China, they will never have the economic growth the US possess, China will never have the economic flexibility to address a continually dynamic global economy.
So Why the High Prices?
The oil companies realize one thing and that is they have to make their money now while they still have the ability to do so. These profits will provide the future flexibility to modify their business and move in a direction that will allow them to be close to or as profitable as they are today. Given that we are still, as a country, at the low end of the pricing range, and that Americans are still buying gas at close to $4.00 per gallon, with only a minor preceived inconvenience, pricing will stay where it is and will rise until the companies see a drop in demand.
There is one component that appears to be going completely unnoticed as we all move towards a true global economy; the automotive manufacturers. There has been a paradyme shift with the US Auto Manufacturers in that they have finally made the shift to view sustainable growth only if they are able to build and deliver cars on a global basis. This means they must standardize manufacturing and designs so that their productline can be sold cohesively across all countries not country specific. This is the only way they can control manufacturing cost and build their business. This ultimately means no more building gas sucking "Land Yachts" and "Giant Trucks" only for the US market, they must build fuel efficient economical vehicle that can and will be marketed and sold globally with only very minor modification. These higher gas prices will force US auto buyers to think about buying the same or similar vehicle as Europeans, Asian and South African buyer, thus providing more profit to the Auto Manufacturer.
So this is our reality. The good old days of cheap gas are effectively over. Now this is not to say that gas will not come down some in the future, but I truly believe that we are looking at a future where the fuel pricing will become more closely tied to the global economy and demand. Pricing will always be a function of supply and demand, and let's face it when someone can control production supply and proportionately align this production with demand, pricing will stay high. So I guess now may be a time for all of us to begin looking at alternative fuels, and give the oil companies something new to look at for future profits, and probably make the enviromentalist a little happier at the same time. Not a bad thing for all of us to think about, but definately will require some dramatic changes. Those are my thoughts for happy begining to the summer.