Senators Feinstein, Boxer & Colleagues:
Please vote "No" on the proposed Auto Industry bailout. This plan will be a disaster for our nation and taxpayers, and will only serve to prolong the destructive practices of the industry.
Rick Waggoner, GM CEO, testified yesterday that GM was losing $5 billion per month. If he received the entire bailout his firm would still run out of money in five months!
The industry needs restructuring, and the only credible path to achieve this is Chapter 11 reorganization. In this forum the companies can reject contracts that are not suited to the long term viability of the industry. This includes leases, supply contracts, and labor contracts, among others. It also gives the companies the opportunity to negotiate with lenders. Finally, it will not reward shareholders, as a bailout might (at least temporarily).
Please review this article in yesterday's NY Times - it is well thought out: http://www.nytimes.com/2008/11/18/business/economy/18sorkin.html?dlbk
I am not a big fan of Mitt Romney the politician, but as a corporate financier he knows a thing or two. Please review his op-ed piece that appeared today: http://www.nytimes.com/2008/11/19/opinion/19romney.html?hp
In lieu of a bailout, government should be ready to provide a "DIP" financing to these companies so that they can meet their operating obligations while in bankruptcy. This can be provided either in the form of a direct loan, or via a guarantee to banks providing these funds.
But funding without fundamental change will only prolong their disastrous strategy of gas guzzling and polluting cars, outdated models, over capacity, and over priced labor (on average $70/hour).
These companies need to be redirected to 50 MPG cars which pollute less and reduce our reliance on foreign oil (a national security issue). Currently hybrids cost over $8,000 more than their traditional counterparts. An effective corollary strategy would be an $8,000 tax credit for buyers of hybrids.
We need to be aware of the failure of other auto industry bailouts. Please review this article about the disastrous results of the bailout of the British industry:
http://www.nytimes.com/2008/11/18/business/economy/18car.html?em
Please vote "NO" on the proposed bailout.
Sincerely,
Michael Bloom
Wednesday, November 19, 2008
Monday, November 17, 2008
Bail-out (AIG), Bail-out (Banks), and more Bail-out (Cars)
OK, so I get to say: "I told you so." Unfortunately.
Our Treasury Secretray handed the largest US banks $250 billion. This was supposed to get the banks back on their feet, and encourage lending. Some background here:
The market crash of 1929 is widely thought to be the cause of the Great Depression. Not so. What caused the depression was a lack of liquidity among the banks - ie they simply stopped lending. This occurred a couple years later. When the banks stopped lending, businesses were unable to finance themselves. Farmer's could not afford to plant. Homes could only be sold to cash buyers. And so businesses and farms failed, people were cast out of work, and their homes, their nest eggs, plunged in value because few people had cash to purchase.
Fed Chairman Bernanke is an economist and historian, specializing in the Great Depression, so he is keenly aware of this. It is at his urging that the Treasury developed a plan to save the banks and encourage lending. Mr. Paulson said explicitly that the intention of the Treasury was to encourage the banks to lend.
So, what has been the effect? Since the infusion, lending has declined. Credit cards are being reduced. Auto loans, traditionally approved over 90% of the time, are at 60% approval and declining. Home equity lines are virtually non-existent. But even more worrying, business/commercial lending is at its lowest levels in a decade, which limits investment in new business initiatives and new technologies.
In short, lending is virtually non-existent.
How could this happen?
Well, when Mr. Paulson "negotiated" the terms of the capital infusion he failed to include one little detail: a requirement to lend! Overlooked this small point, somehow.
Now lets put this in perspective: in virtually every securities offering or bank deal there is a section called "Use of Proceeds." In other words, when bankers/investors provide a company with cash, they like to know what the cash will be used for. Sometimes this is merely a general statement by the company, other times it is an actual and highly specific requirement. But it almost always exists as an explicit statement - the cash will be used for X.
Now if investors who are putting, let say, $1 million in a company know to ask and even require what the money will be used for, how could our Treasury invest $250 billion and not require, or even ask, for the same?
Somehow Treasury overlooked this. How can that be? Wasn't Henry Paulson the former Chairman of Goldman Sachs, the most active and prestigious investment bank in the land? Didn't they hire Simpson Thacher, one of Wall Street's most prestigious and experienced law firms, to document these deals? Was this just one big Homer Simpson moment? "Doh!"
Apparently, in their zeal to get something, anything, done, Paulson and Simpson forgot to actually negotiate a deal. No wonder it took only, on average, an hour each to get the banks to approve such a transaction - there was nothing to negotiate!
Perhaps Paulson simply trusted his friends from the "Street" to do the right thing. Much as the now discredited Alan Greenspan trusted the "Street" to do the right thing with derivatives and mortgage backed securities. In short, allow the regulated to make their own rules.
This is one of the most colossal screw-ups in the history of our government and of government regulation. No first year banker or lawyer would be allowed to make such an error. Yet the former Chairman of Goldman, our Treasury Secretary, made it. This is a Ripley's Believe It or Not! type story.
And lets add a couple other "Can you believe it" points. One bank that received $25 billion is scheduled to pay employee bonuses of $10.7 billion this year. That's right - it is not misprint. Over 40% of the proceeds of our government's investment will be paid to executives who put the firm in the dire condition of needing the funds. Paulson forgot to negotiate that away as well.
Finally, as David Levine, Professor of Economics at Cal's Haas School of Business emphatically points out, these banks still pay a dividend. In other words, the proceeds of our government's bailout funds will be used to pay investors!
It is estimated that on average the banks may spend approximately 1/2 the bailout proceeds on bonuses and dividends within the next year. Well done Hank Paulson, Wall Street's friend!!!
Paulson did make one smart decision - that was to do a 180 on buying specific securities from banks. This was always a bad idea, and if Treasury's performance on the bank investments is any indication, purchasing securities (a much more complicated venture than investing in preferred shares of banks) would have been a disaster.
What about today's news? Paulson apparently realizes he is in way over his head, and has therefore announced that $350 billion of the $700 billion in bailout proceeds for which he vigorously campaigned Congress will not be spent. He will leave the rest for the Obama administration to decide what to do with starting January 20, 2009. Hopefully our President elect can find someone to lead this effort with more common sense and who is less prone to knee jerk reactions.
Speaking of knee-jerk reactions, the Democrats had to get in on the act as well by today demanding an auto industry bailout with all the same problems of the Wall Street bailout - and then some! The only positive is that at a mere $25 billion it is a much smaller tax payer problem.
Lets enumerate the flaws:
1) UAW workers make as much as $75/hour. That is over $150k per year, largely to push a button at a factory. US auto labor is obscenely overpriced compared to the rest of the world. There are 17 non-union auto factories in the US whose wages do not exceed $50/hour - these factories actually make money. The UAW has stated that they will not accept concessions of any kind, wage or otherwise. Well at least they make the best cars, right?
2) Wrong. Our industry is based on an unlimited supply of $2.00/gallon gasoline with no concern for greenhoue emissions. Hummers, SUVs, mini-vans and trucks are the staple of the American line of cars. Poor mileage, and poor performance, are its hallmark.
3) These companies are hemorrhaging cash. GM alone loses over $1 billion per month! And the rate of loss is accelerating. If GM receives 1/2 of the proposed bailout proceeds, it will lose all of it within 12 months. Between the three car makers, $25 billion provides less than a one year stopgap.
4) Consumers are not buying cars. They want higher MPG cars, but hybrids on average are over $8,000 more expensive than conventional counterparts. Plus, they are still not made in numbers by the US manufacturers: this is a Japanese dominated auto segment.
5) Credit has dried up. Private lenders such as GE capital dominated the auto lending industry, and they have not been given access to the bailout funds. With 40% declines for auto loans, how can consumer purchasing accelerate?
6) Retiree benefits are outrageous, growing, and underfunded.
I think there is no question that the government will provide funds to this industry. It is too far reaching - the jobs of too many voters and the fortunes of too many midwest cities are tied it, as are the jobs at the parts manufacturers who sell to the Big 3. But lets not rush into anything; lets insist upon some requirements for our money.
Our investment in the US Auto Industry should be subject to the following:
1) USE OF PROCEEDS: Invest in new car lines that provide 50 miles per gallon.
2) LABOR: UAW must accept concessions, including capping wages at $50/hr, and allowing for labor reductions. If UAW refuses, de-certify the union.
3) CONSUMER FINANCE: Part of the proceeds must be used to fund consumer loans.
4) TAX CREDITS: Consumers who buy cars with 50 MPG get a $8,000 tax credit.
5) RETIREE BENEFITS: Government takes over the unfunded portion of the benefits. Going forward benefits must be funded, at the risk of criminal penalties to auto executives.
6) PRE-PACKAGED BANKRUPTCY: Invest pursuant to a pre-pack bankruptcy which allows the automakers to reject contracts that are no longer relevant to their business going forward.
7) SUSPEND DIVIDENDS: All monies of the automakers should be reinvested in making safer, more fuel efficient autos.
Saving our auto industry is imperative. What is even more important is saving them from themselves.
Our Treasury Secretray handed the largest US banks $250 billion. This was supposed to get the banks back on their feet, and encourage lending. Some background here:
The market crash of 1929 is widely thought to be the cause of the Great Depression. Not so. What caused the depression was a lack of liquidity among the banks - ie they simply stopped lending. This occurred a couple years later. When the banks stopped lending, businesses were unable to finance themselves. Farmer's could not afford to plant. Homes could only be sold to cash buyers. And so businesses and farms failed, people were cast out of work, and their homes, their nest eggs, plunged in value because few people had cash to purchase.
Fed Chairman Bernanke is an economist and historian, specializing in the Great Depression, so he is keenly aware of this. It is at his urging that the Treasury developed a plan to save the banks and encourage lending. Mr. Paulson said explicitly that the intention of the Treasury was to encourage the banks to lend.
So, what has been the effect? Since the infusion, lending has declined. Credit cards are being reduced. Auto loans, traditionally approved over 90% of the time, are at 60% approval and declining. Home equity lines are virtually non-existent. But even more worrying, business/commercial lending is at its lowest levels in a decade, which limits investment in new business initiatives and new technologies.
In short, lending is virtually non-existent.
How could this happen?
Well, when Mr. Paulson "negotiated" the terms of the capital infusion he failed to include one little detail: a requirement to lend! Overlooked this small point, somehow.
Now lets put this in perspective: in virtually every securities offering or bank deal there is a section called "Use of Proceeds." In other words, when bankers/investors provide a company with cash, they like to know what the cash will be used for. Sometimes this is merely a general statement by the company, other times it is an actual and highly specific requirement. But it almost always exists as an explicit statement - the cash will be used for X.
Now if investors who are putting, let say, $1 million in a company know to ask and even require what the money will be used for, how could our Treasury invest $250 billion and not require, or even ask, for the same?
Somehow Treasury overlooked this. How can that be? Wasn't Henry Paulson the former Chairman of Goldman Sachs, the most active and prestigious investment bank in the land? Didn't they hire Simpson Thacher, one of Wall Street's most prestigious and experienced law firms, to document these deals? Was this just one big Homer Simpson moment? "Doh!"
Apparently, in their zeal to get something, anything, done, Paulson and Simpson forgot to actually negotiate a deal. No wonder it took only, on average, an hour each to get the banks to approve such a transaction - there was nothing to negotiate!
Perhaps Paulson simply trusted his friends from the "Street" to do the right thing. Much as the now discredited Alan Greenspan trusted the "Street" to do the right thing with derivatives and mortgage backed securities. In short, allow the regulated to make their own rules.
This is one of the most colossal screw-ups in the history of our government and of government regulation. No first year banker or lawyer would be allowed to make such an error. Yet the former Chairman of Goldman, our Treasury Secretary, made it. This is a Ripley's Believe It or Not! type story.
And lets add a couple other "Can you believe it" points. One bank that received $25 billion is scheduled to pay employee bonuses of $10.7 billion this year. That's right - it is not misprint. Over 40% of the proceeds of our government's investment will be paid to executives who put the firm in the dire condition of needing the funds. Paulson forgot to negotiate that away as well.
Finally, as David Levine, Professor of Economics at Cal's Haas School of Business emphatically points out, these banks still pay a dividend. In other words, the proceeds of our government's bailout funds will be used to pay investors!
It is estimated that on average the banks may spend approximately 1/2 the bailout proceeds on bonuses and dividends within the next year. Well done Hank Paulson, Wall Street's friend!!!
Paulson did make one smart decision - that was to do a 180 on buying specific securities from banks. This was always a bad idea, and if Treasury's performance on the bank investments is any indication, purchasing securities (a much more complicated venture than investing in preferred shares of banks) would have been a disaster.
What about today's news? Paulson apparently realizes he is in way over his head, and has therefore announced that $350 billion of the $700 billion in bailout proceeds for which he vigorously campaigned Congress will not be spent. He will leave the rest for the Obama administration to decide what to do with starting January 20, 2009. Hopefully our President elect can find someone to lead this effort with more common sense and who is less prone to knee jerk reactions.
Speaking of knee-jerk reactions, the Democrats had to get in on the act as well by today demanding an auto industry bailout with all the same problems of the Wall Street bailout - and then some! The only positive is that at a mere $25 billion it is a much smaller tax payer problem.
Lets enumerate the flaws:
1) UAW workers make as much as $75/hour. That is over $150k per year, largely to push a button at a factory. US auto labor is obscenely overpriced compared to the rest of the world. There are 17 non-union auto factories in the US whose wages do not exceed $50/hour - these factories actually make money. The UAW has stated that they will not accept concessions of any kind, wage or otherwise. Well at least they make the best cars, right?
2) Wrong. Our industry is based on an unlimited supply of $2.00/gallon gasoline with no concern for greenhoue emissions. Hummers, SUVs, mini-vans and trucks are the staple of the American line of cars. Poor mileage, and poor performance, are its hallmark.
3) These companies are hemorrhaging cash. GM alone loses over $1 billion per month! And the rate of loss is accelerating. If GM receives 1/2 of the proposed bailout proceeds, it will lose all of it within 12 months. Between the three car makers, $25 billion provides less than a one year stopgap.
4) Consumers are not buying cars. They want higher MPG cars, but hybrids on average are over $8,000 more expensive than conventional counterparts. Plus, they are still not made in numbers by the US manufacturers: this is a Japanese dominated auto segment.
5) Credit has dried up. Private lenders such as GE capital dominated the auto lending industry, and they have not been given access to the bailout funds. With 40% declines for auto loans, how can consumer purchasing accelerate?
6) Retiree benefits are outrageous, growing, and underfunded.
I think there is no question that the government will provide funds to this industry. It is too far reaching - the jobs of too many voters and the fortunes of too many midwest cities are tied it, as are the jobs at the parts manufacturers who sell to the Big 3. But lets not rush into anything; lets insist upon some requirements for our money.
Our investment in the US Auto Industry should be subject to the following:
1) USE OF PROCEEDS: Invest in new car lines that provide 50 miles per gallon.
2) LABOR: UAW must accept concessions, including capping wages at $50/hr, and allowing for labor reductions. If UAW refuses, de-certify the union.
3) CONSUMER FINANCE: Part of the proceeds must be used to fund consumer loans.
4) TAX CREDITS: Consumers who buy cars with 50 MPG get a $8,000 tax credit.
5) RETIREE BENEFITS: Government takes over the unfunded portion of the benefits. Going forward benefits must be funded, at the risk of criminal penalties to auto executives.
6) PRE-PACKAGED BANKRUPTCY: Invest pursuant to a pre-pack bankruptcy which allows the automakers to reject contracts that are no longer relevant to their business going forward.
7) SUSPEND DIVIDENDS: All monies of the automakers should be reinvested in making safer, more fuel efficient autos.
Saving our auto industry is imperative. What is even more important is saving them from themselves.
Sunday, November 2, 2008
A Novel Bail-Out Approach: Buy it All!
In the past I have expressed the fundamental problems with the bailout, namely:
What are we buying?
From whom?
At what price?
Until these are answered Neel Kashkari, Treasury's choice to run the bailout, is sitting on a real big pile of cash while our banking system and economy continue to falter. Kashkari's previous experience was serving six years as a Goldman technology M&A banker, most recently as a Vice President. Six whole years - none of it working with banks or lending. Clearly this makes Neel eminently qualified to handle the bailout.
While Paulson, Bernanke and Kashkari have been sitting around, they have floated the notion of using a dutch auction to acquire assets. This mechanism would allow banks to identify and price assets to be auctioned. The lowest priced assets would be acquired by the Treasury until it had used up its allocation of bailout funds.
This is a nonsensical approach.
Banks would be forced to prioritize what they want to get off their books, at what price, and in what amounts. This sounds good, right? Not really. If banks price their assets too high, they will remain stuck with them as the funds go to other less aggressive banks. If they price them too low they will take a disproportionate hit to capital reserves, and will crowd out other banks who price prudently but need to get assets off their books and the funds from Treasury.
The only way this type of asset sale works is if banks collude. Unfortunately collusion would be illegal.
Another option Treasury has explored is having a third party manage the purchases. Blackrock founder Larry Fink and PIMCO founder Bill Gross have thrown their firms' hats in the ring to handle that assignment, and Gross has gone so far as to suggest that PIMCO would do it for free. Gross and Fink would certainly understand the business better than Kashkari, but might have a slight conflict of interest here, being significant holders of many of these same asset classes.
So, what to do?
Tom Campbell has an idea.
I had the good fortune to meet Mr. Campbell last week and to speak with him at length. Mr. Campbell is so accomplished that he pisses the rest of us off: Harvard law grad and University of Chicago PhD in Economics under Milton Friedman; Stanford Law Professor; Professor of Economics and former Dean of the Haas School of Business at Berkeley; former state Senator; and former four (4) term US Congressman from California. Some other cool gigs too. No pocket protector, no bow tie. Oh, and he is a nice guy. Enough already.
Mr. Campbell (Dr. Campbell? Professor Campbell? Sheesh!) advocates a unique solution to the problem. In Campbell's world, the government decides what assets are most problematic for financial institutions, and buys them all at 53.7% of face value. There is no negotiating, no auction, no determining market value, no deciding whether to accept the price. The government buys them all. From everybody.
This avoids the crowding out of a Dutch auction. It also alleviates the problem of a fixed price purchase, where the only sellers are those who think their assets are worth less than the purchase price. In that system, almost by definition, as a buyer our government would overpay.
In Mr. Campbell's plan, price is not really the point, and the 53.7% price is somewhat arbitrary. It has to be low enough to not unduly reward banks, but high enough to give them some liquidity. And it needs to be fair to everyone - or at least equally unfair to everyone. Finally, the purchases cannot help just a select few firms, they need to be universal.
Mr. Campbell's premise is that for the institutions to get back to work - and their work is financing the investment required to drive our economy forward - the toxic assets (or at least the ones with huge bid-ask spreads) need to come off their books. And it needs to happen now. This is mission critical, and in his view whether the tax payer receives a return on that investment is not at issue.
Certainly many banks would oppose such a plan, arguing that it comprised a "taking" of assets and therefore was unconstitutional. Ah, but Mr. Campbell didn't go to Harvard law for nothing: his research suggests that provided banks are "compensated fairly," a taking is well within the government's rights. Fair needn't be "full value," just fair. Equal treatment, for example, could connote fairness.
Mr. Campbell is not a banker, so he is not intimately familiar with the assets that banks hold, the amounts, or their current market values. But he realizes that the Treasury's process is going too slowly and has inherent flaws. His plan would get us going again quickly. Treasury's Mr. Kashkari could then focus his efforts on exactly what the most problematic assets were, and buy them, rather than on negotiating their purchase with folks far more experienced than he.
Campbell's plan is unique - especially for a long serving Republican politician. It is elegant in its simplicity and scope. And it is fair.
So, Mr. Paulson, what are you waiting for? Lets get Neel working on it!
What are we buying?
From whom?
At what price?
Until these are answered Neel Kashkari, Treasury's choice to run the bailout, is sitting on a real big pile of cash while our banking system and economy continue to falter. Kashkari's previous experience was serving six years as a Goldman technology M&A banker, most recently as a Vice President. Six whole years - none of it working with banks or lending. Clearly this makes Neel eminently qualified to handle the bailout.
While Paulson, Bernanke and Kashkari have been sitting around, they have floated the notion of using a dutch auction to acquire assets. This mechanism would allow banks to identify and price assets to be auctioned. The lowest priced assets would be acquired by the Treasury until it had used up its allocation of bailout funds.
This is a nonsensical approach.
Banks would be forced to prioritize what they want to get off their books, at what price, and in what amounts. This sounds good, right? Not really. If banks price their assets too high, they will remain stuck with them as the funds go to other less aggressive banks. If they price them too low they will take a disproportionate hit to capital reserves, and will crowd out other banks who price prudently but need to get assets off their books and the funds from Treasury.
The only way this type of asset sale works is if banks collude. Unfortunately collusion would be illegal.
Another option Treasury has explored is having a third party manage the purchases. Blackrock founder Larry Fink and PIMCO founder Bill Gross have thrown their firms' hats in the ring to handle that assignment, and Gross has gone so far as to suggest that PIMCO would do it for free. Gross and Fink would certainly understand the business better than Kashkari, but might have a slight conflict of interest here, being significant holders of many of these same asset classes.
So, what to do?
Tom Campbell has an idea.
I had the good fortune to meet Mr. Campbell last week and to speak with him at length. Mr. Campbell is so accomplished that he pisses the rest of us off: Harvard law grad and University of Chicago PhD in Economics under Milton Friedman; Stanford Law Professor; Professor of Economics and former Dean of the Haas School of Business at Berkeley; former state Senator; and former four (4) term US Congressman from California. Some other cool gigs too. No pocket protector, no bow tie. Oh, and he is a nice guy. Enough already.
Mr. Campbell (Dr. Campbell? Professor Campbell? Sheesh!) advocates a unique solution to the problem. In Campbell's world, the government decides what assets are most problematic for financial institutions, and buys them all at 53.7% of face value. There is no negotiating, no auction, no determining market value, no deciding whether to accept the price. The government buys them all. From everybody.
This avoids the crowding out of a Dutch auction. It also alleviates the problem of a fixed price purchase, where the only sellers are those who think their assets are worth less than the purchase price. In that system, almost by definition, as a buyer our government would overpay.
In Mr. Campbell's plan, price is not really the point, and the 53.7% price is somewhat arbitrary. It has to be low enough to not unduly reward banks, but high enough to give them some liquidity. And it needs to be fair to everyone - or at least equally unfair to everyone. Finally, the purchases cannot help just a select few firms, they need to be universal.
Mr. Campbell's premise is that for the institutions to get back to work - and their work is financing the investment required to drive our economy forward - the toxic assets (or at least the ones with huge bid-ask spreads) need to come off their books. And it needs to happen now. This is mission critical, and in his view whether the tax payer receives a return on that investment is not at issue.
Certainly many banks would oppose such a plan, arguing that it comprised a "taking" of assets and therefore was unconstitutional. Ah, but Mr. Campbell didn't go to Harvard law for nothing: his research suggests that provided banks are "compensated fairly," a taking is well within the government's rights. Fair needn't be "full value," just fair. Equal treatment, for example, could connote fairness.
Mr. Campbell is not a banker, so he is not intimately familiar with the assets that banks hold, the amounts, or their current market values. But he realizes that the Treasury's process is going too slowly and has inherent flaws. His plan would get us going again quickly. Treasury's Mr. Kashkari could then focus his efforts on exactly what the most problematic assets were, and buy them, rather than on negotiating their purchase with folks far more experienced than he.
Campbell's plan is unique - especially for a long serving Republican politician. It is elegant in its simplicity and scope. And it is fair.
So, Mr. Paulson, what are you waiting for? Lets get Neel working on it!
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