The Failure to Admit Failure

“Don’t just stand there.  Do something!”

“Don’t just do something.  Stand there!”

The first statement above is quintessentially American.  We are biased to action.  Terrorist attack?  Reaction: Go kill people who were tangentially related to the event, making everyone wary of attacking us again others think that we act with unreasonable blind rage.

Major companies on the rocks?  Act now to prevent certain disaster!  I don’t know —  there are administrative remedies in the short-run that can be used to stave off insolvency, without immediately throwing money at the problem — appoint a conservator to get maximum value out of the company for senior bondholders while you wind it down (liquidate).

That’s the way I feel about AIG, GM, Ford (F), etc., companies that I have had a consistently negative view on well before the crisis began.  Why are we rewarding companies that took on way too much debt to finance their operations?  To save jobs?  Uh, nice thought, maybe, but you could do a cramdown in bankruptcy where everyone gets hit.  The senior debtholders would convert their claims to a reduced amount of new equity, and wiping everyone else out.

So when I read about AIG getting new loans from the US government, and reducing the interest rate on all of the debt, I go back to my initial statements regarding the bailouts.  When you make policy rapidly, you make mistakes.  This has been proven true with AIG.  Now, with the automakers, will we compound the mistake?

Let the automakers fail.  It is one of the few things that will might bring the unions to their senses.  The senior debtholders will bring in new management, and the unions, if they survive, will have to reduce their unreasonable demands that are out of sync with what other auto workers make in a competitive market.  Many auto workers would be able to keep their jobs, but at wages more congruent with the value produced.

The Humility of Realism

The above title is a play on a book title from a once-obscure politician who has hit it big, much like Jimmy Carter.  But as Woody Allen said, half of life is just showing up.  By the humility of realism, I am trying to get across the idea that our government should slow down, take a step back, and think hard before acting.  Bring in the same old players experts who are disconnected from the “crisis” and let them consider with seriousness the depths of the problem that we are in.  We are probably facing a second depression.

From my perspective, depressions end when enough of the debt of the nation is paid off or liquidated, so that the financial system can once again issue moderate amounts of credit to high quality borrowers.  But the US Government is presently compounding failure with interest, adding to the total debt of the US by borrowing more, and giving the proceeds to companies that not only are special interests, but have proven that they cannot use it well.

The humility of realism would recognize that the US government cannot borrow its way to prosperity, but must act to conserve, admitting the faults of the past, recognizing that past policy has erred significantly.  I am not holding my breath here, waiting for that to happen.  I expect that the US government will proceed further down its present path, playing favorites with special interests, and continue to apply irrelevant “cures” in the hope that action will end the crisis.

As for me, I am puzzling over what would preserve value for me, and those that I care for in this environment.  That’s not a easy puzzle; in a depression, everything gets whacked.  But as I get more clarity, I will write more.

Links:

• Auto Makers Force Bailout Issue
• U.S. Throws New Lifeline to AIG, Scrapping Original Rescue Deal
• Time to pull the plug on AIG?
• (And, what will we do about the collapse that is coming in much of commercial real estate?  Not a happy scenario for the banks, and ultimately the taxpayers and others who get milked by the US government.)

Comments

[getnick:]

What about the outrageous salarys and bonuses of the executives

2008 Nov 10 12:48 PM

[r0yR:]

What about the failure to proof your copy before posting it?
I think the lined out text is more interesting reading.

2008 Nov 10 12:59 PM

[Judybird:]

Mr. Merkel, would have us reduced to a nation in complete economic depression to satisfy his Ideology. The analogy is that if your on a ship sinking because of a sudden rupture in the hull you simply stand and watch the vessel fill with water and let it sink. And, if you're lucky enough to survive you then try to build a new ship. Most rational minds would try to keep the ship from sinking at all costs in the first place. As for his attitude toward those businesses near failure he's chosen to forget that they are in that situation because of the credit markets collapse brought about by the his own free unregulated market anything goes economic philosophy.

2008 Nov 10 01:02 PM

[Mike Verkuylen:]

About time! I agree that exec's need to be ousted, but the unions have got to go! All other car makers outside of the big three pay approx $38 per man hour to build a car, conversely, UAW run auto companies $69.60 per man hour! The union worker get about $38 but the union gets fat!

Enough, level the playing field! Fire the unions!

Secondly, if people really wanted to get ride of the special interests, they would have made a real change in the election! That didn't happen, we still have the bloated senators and congressmen that make sure the special interests have their backs covered! If you think the union thing is going to change with Obama, just take a look at ACORN and the others that paid/paved his way to office!

JMHO!

2008 Nov 10 01:26 PM

[Roger Knights:]

@r0Yr: The lined-out text was inserted intentionally, in order to explicitly contrast what the author is proposing with the course or intentions that others pursued or are pursuing (lined out). The unlined text obviously wasn't a mere rewording of the lined-out text, but a 100% contradiction of it.

2008 Nov 10 01:45 PM

[Larry G:]

I think it's an interesting article, however, letting everybody get wiped up to the debtholders hasn't been a winning fomula. If you don't believe me just look at what happen when the government wiped out the preferred shareholders in the Freddie/Fannie takeover. Nobody could raise equity money for fear they may get wiped out.

If that wasn't bad enough they let Lehman go under and the counterparty risk caused so many problems that the government had to step in with capital injections to save the system.

Making decisions based on an idealogy is bad decision making. Decisions should be made based on the facts and the risk/reward tradeoffs.

2008 Nov 10 02:27 PM

[jod:]

Theres 10 non-union workers for every 1 union worker in the auto industry. The biggest problem for the Big 3 is the legacy costs for pensions and healthcare All the foriegn car companies in America operate without any legacy costs as well as many tax advantages given to them to locate their assembly lines in competing states. I find it very sad to watch anyone cheer for the Big 3 to go bankrupt. They have always paid our follow Americans well even though the don't have a level playing field in they own country. If the automakers go so do up to 2.5 million jobs. They're the largest manufacturer we have left. Probably 2 million of them will lose there houses and that will pull down the value of the millions of houses around them causing the government around 200 billion dollars to pay out the bonds. The stock market will lose another 25 % essentually costing us all another 2 trillion. Why don't we just take over there pensions, make them issue the government stock equal to the current amount, and toss 20 billon each for treating one of our greatest assets like shit. Total cost around 200 billion much if not all would be recouped when there stock went up. Thats a level playing field. They should be able to do all that in about an hour.

2008 Nov 10 09:32 PM

[jod:]

How would the foriegn automakers be doing if they had to pay out over 10 billion a year to retirees. Gm has 70000 employees and 350000 retires and surviving spouses. 5 to 1 retirees to workers. Sorry about the spelling errors. I was in a hurry and pissed !!!!!!! Stick up for AMERICA


On Nov 10 09:32 PM jod1921 wrote:

> Theres 10 non-union workers for every 1 union worker in the auto
> industry. The biggest problem for the Big 3 is the legacy costs for
> pensions and healthcare All the foriegn car companies in America
> operate without any legacy costs as well as many tax advantages given
> to them to locate their assembly lines in competing states. I find
> it very sad to watch anyone cheer for the Big 3 to go bankrupt. They
> have always paid our follow Americans well even though the don't
> have a level playing field in they own country. If the automakers
> go so do up to 2.5 million jobs. They're the largest manufacturer
> we have left. Probably 2 million of them will lose there houses and
> that will pull down the value of the millions of houses around them
> causing the government around 200 billion dollars to pay out the
> bonds. The stock market will lose another 25 % essentually costing
> us all another 2 trillion. Why don't we just take over there pensions,
> make them issue the government stock equal to the current amount,
> and toss 20 billon each for treating one of our greatest assets like
> shit. Total cost around 200 billion much if not all would be recouped
> when there stock went up. Thats a level playing field. They should
> be able to do all that in about an hour.

2008 Nov 10 09:43 PM

[jod:]

The government might as well take over the pensions and take the stock in exchange to avoid bankruptcy. When GM goes bankrupt they will be left with the pensions and no stock.


On Nov 10 09:43 PM jod1921 wrote:

> How would the foriegn automakers be doing if they had to pay out
> over 10 billion a year to retirees. Gm has 70000 employees and 350000
> retires and surviving spouses. 5 to 1 retirees to workers. Sorry
> about the spelling errors. I was in a hurry and pissed !!!!!!! Stick
> up for AMERICA

2008 Nov 10 09:50 PM

[investor88:]

Another excellent article by David in my view. Debt is the problem but government is fuelling the fire with more debt. Let it unwind and get a new begining.

How to protect oneself in this storm? Is it buy assets with the motto "cash is trash"? Have to think hard...

2008 Nov 10 10:22 PM

[ferguson:]

The logic here suggests that the basic problem here is not economics. It is a failure that seems to be built into human nature. My mother described it best when I couldn't finish my dinner.

"Your eyes," she said, "are bigger than your stomach."

So, it is. Whether we are on Wall Street or Detroit, we can imagine all sorts of things that we think can be finessed or managed. But, that doesn't necessarily mean they can. When did they stop teaching about human nature, responsibility and ethical behavior in business schools?

Or, more to the point, why did those who had some understanding of these things all get passed over for promotion, while the pure money-changers got promoted ad infinitum?

Simple. Money, money, money. When nothing else matters, serious mistakes will be made.

2008 Nov 11 09:53 AM

[Steve Funk:]

Mr. Merkel is clearly upset about everyone bellying up to the $700B piggy trough. I don't blame him. He should, however, take his own advice that we be thoughtful about doleing out the money.

Since very few analysts or financial reporters have covered the auto industry in the last two decades there are very few experts to talk about this issue. Mr. Merkel's easy answer that "they" (auto industry) simply be allowed to go out of business is a very glib answer that does not begin to address the repercussions of such a catastrophe. First, he assumes that there will be a Chapter 11 bankruptcy, if it comes to that. Who pays the billions per month in negative cash flow while all the issues are sorted out in bankruptcy court? GM is a very large military contractor and still owns large stakes in Hughes (military satellites). If those interests are sold quickly to the highest bidder probably the only ones with cash will be foreign investors. Is it wise to sell large stakes in a top secret military company? Is it legal? The Pension Benefit Guarantee Corp (i.e. taxpayers) will surely wind up supporting (at least partially) the hundreds of thousands of retireees who will be left high and dry. What of the fallout from dozens of very large corporations being crippled or bankrupted (Lear, Johnson Controls, USX, American Axle, Detroit Diesel, you get the idea).

I don't have the answers to these questions and I don't think anyone does. What does irks me is how glib many are about the auto industry going bankrupt. It shows a total lack of understanding of how industrial complex works. That is not surprising since many believe that we can continue to be a strong economy without producing anything. The second thing that never is mentioned in the many articles like Mr. Merkel's is the huge hand that government regulation and Wall Street have had in the demise of the auto industry. Check into the 1957 Supreme Court ruling that forced GM to divest itself of DuPont (it's proprietary paint supplier) and forced resignation of the Board of Directors. Even in the 1980's engineers were being told that it was illegal to talk out of work with a Ford or Chrysler engineer due to anti-trust rulings. In the 1960's and 1970's the government had a huge hand in backing the Union demands for wages and benefits and unemployment benefits that is at least part of the fixed cost problem that the domestic industry is facing. GM has been coerced by government officials into keeping unprofitable plants open because of local economic concerns.

Obviously a book could be written (and many will) on how the auto industry stumbled. To simply blame it on management and unions is beyond short sighted. I can only hope that our brilliant legislators who brought us to this point will not be as cavalier about the choices we face as Mr. Merkel.

2008 Nov 11 03:10 PM