U.S. Government's Latest Conflict of Interest

With the U.S. Federal Government firmly in the automobile manufacturing business, we make the fearless prediction that they will be staying into the business until the Government itself collapses into ruin. When that day may come is anyone's guess, but in the meanwhile the United States is stuck with a Government-owned car company. Prepare for even more waste, even more unreliability, and even more ugly to be found in your next new GM car, dear Reader - if you are fool enough to buy one.

But that is neither here nor there; what we'd like to point out is that the Government is positioning itself for a conflict-of-interest situation. A "cash for clunkers" bill is presently making its way through Congress, and it seems to have a good chance at becoming law. The programme would give up to a $4,500 credit to buyers who trade in their older vehicle (25 years old and newer) for a brand-new vehicle. This will come with the price-tag of $4 billion... just a drop in the bucket, really.

The problem is, the Federal Government owns a couple car companies... and here it goes, putting out a bill to pay people to buy new cars! Instant conflict of interest: the Government would naturally prefer you, dear Reader, buys their cars, not the vastly superior Japanese or European models which might catch your eye. When the "clunkers" programme becomes law, we posit it's only a hop, skip, and a jump to legislation punishing those who purchase cars from the non-Government-owned manufacturers. Such a thing would fall loosely under the "Buy American" nonsense.

As an aside, and despite the concerns raised in this article about the possible bad effects the "clunkers" programme will have on auto repair shops, we suspect the new GM (and probably Chrysler) cars will suck so bad that they'll break some expensive - and functionless - part before the first oil change. Repair shops will have booming business for awhile, swapping out broken parts with faulty replacements.

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At this point, we're officially putting Ford on the death-watch. Sure, the company may be able to limp along for awhile, but at some point Ford too will fail. The Government will be waiting with money in hand to add to its burgeoning car manufacturing empire.

The World's Biggest Board of Directors

Now that GM and Chrysler are de facto (and soon to be de jure) owned by the U.S. Government, the government in the person of the U.S. Senate is taking an interest in the operations of its automobile manufacturing operations. The Senate held hearings on Wednesday 'reviewing' the decision of the two companies to disenfranchise a number of dealerships.

This brings into plain view the inherent problem of government ownership of businesses competing in a private sphere. The government has no mechanism to guide business decisions. Politics is reactive, and that is no way to run a business.

Sound arguments may be put forward for the government operating commercial operations such as a postal service, but then it is set up as a part of the machinery of the state. It may be subject to some political pressures (the placement of post offices, distributions of contracts, and so forth) but this is merely the sort of cronyism one expects from any part of government bureaucracy.

The government could proactively set up a Motor Vehicle Manufacturing Authority and assemble a bureaucracy to run it. We don't advocate such a move but it would be preferable to the current situation: taking over corporations, telling the management that the government isn't going to be involved in the day-to-day affairs of the companies, and then proceeding to second-guess and meddle with management's decisions!

GM: The Next Part of AmeriCar

With Chrysler firmly in the morass of bankruptcy restructuring, GMAC under the financial control of the U.S. Federal Government, and General Motors on course with its own bankruptcy court, we feel confident saying that the foundations of AmeriCar - our pet name for a Soviet-esque national car manufacturer - are almost complete. GM, according to the Obama Administration, will be 60% owned by the Federal Government, effectively making it a national auto-manufacturer. Please do not believe the Administration's promise to 'exit' the car business when GM is "bank on its feet;" that would shrink the size of the United States Government, and would run counter to the trend of increasingly large Government ever since President Andrew Jackson.

At the same time, the TARP programme will likely be made permanent, as expected; it will turn into a revolving loan facility for the Government, to nationalise - oh, pardon, "invest in" - various enterprises throughout the U.S. With various banks itching to pay back their TARP loans, the Government will have money to blow on other ventures. We suggest that Ford start watching its back: it's the last independent American auto-maker, which makes it the last major piece of AmeriCar. After Ford is nationalised, we posit that various car parts manufacturers and service providers will be next on the menu. The Obama Administration has already implied this, as it has put a Federal guarantee on all GM and Chrysler warranties... and one cannot fulfil a warranty without the expensive parts!

Eventually, we expect that GM, Chrysler, Ford, and a slew of parts manufacturers will be eventually consolidated into our concept of "AmeriCar." This will be an abomination of mis-managed, corrupt, resource-wasting 'manufacturing' not seen since the fall of the Soviet Union... and it will end just as badly. Simply put, the Obama Administration is betting the farm on a near-term recovery in the U.S. and world economies. There are problems with this attitude.

The Administration pinning its hopes, reputation, and trillions of dollars on a quick end to this 'recession' is asking for disaster. The Government seems to be unaware that this economic calamity is something altogether more potent. Nevertheless, we wouldn't be surprised if the Administration indeed orders its pet car manufacturer(s) to produce around 10 million cars a year, but we would like to ask the President from whence he thinks the citizenry will have the money to buy these spiffy new vehicles.

Because this Depression is destroying the citizenry's ability to produce income, the last things they will want to do is spend their dwindling resources on additional un-needed automobiles. If anything, people will: keep their cars longer; own fewer cars (say, one); share cars, either informally or through farsighted corporations like ZipCar; or, totally discard automobiles altogether and use public transportation, bicycles, or their own two legs.

We can't think of any reason why AmeriCar should outlast the Obama Administration; it just doesn't seem feasible to keep up such extraordinary waste on such a colossal scale, but it will probably happen anyway. In all honesty, we are putting the AmeriCar fiasco as one of an increasing number for which President Barack Obama will leave office in disgrace... as well as lay the foundation for a new Franklin Roosevelt to seize the presidency.

P.S. To the Government: in order to have a successful car maker, reference Tesla Motors. Their $100,000+ Roadster has a fifteen-month waiting list.

Synthetic CDO's are Beginning to Bloom

One of our many interests in the unfolding calamity in the financial world are the hell-spawn known as Synthetic Collateralised Debt Obligation, or SCDO. For an indepth refresher on exactly what these monsters are, please read our first post on the nature of SCDOs. We'll include a brief definition here, but we recommend brushing up on your SCDOs... we needed to do so, as well, since they're impressively complicated.

Put simply, SCDOs are issued by American super-huge banks, and are composed of credit default swaps taken out against a list of about 100 or so major companies, called the reference entities. The investors who buy these SCDOs (under the impression that the instruments are 'bonds') become, in effect, a pool of 'names' - the people who pony up the money when insurance needs to be paid out. In this case, the credit default swap is the insurance for the issuing bank against the reference entities going bankrupt. When a small number of the reference entities - about seven or so - go bankrupt, the SCDO is triggered and the investors' money is immediately and irreversibly transferred to the issuing bank.

As an aside, reference entities typically include such fine companies as: AIG, Fannie Mae, Freddie Mac, Bear Stearns, Merrill Lynch, Chrysler, General Motors, et cetera. All are, as we are sure you noticed, not in the best of shape.

When that slew of reference entities bit the dust, we wondered when the SCDOs' 'trigger' would be tripped; which company or companies were going to start the flood of wealth? Ever heard of Syncora Guarantee Inc? According to Asia One, the Pinnacle Series 1 notes out of Morgan Stanley have wiped out every last cent of those who invested in the notes. Pinnacle Series 1 is a SCDOs, and it has been triggered by a Syncora default. The article also reports that Pinnacle Series 2, 3, 4, 5, 6, and 7 are careening toward being triggered.

As the 2007 Depression puts the screws to the world's economy, Morgan Stanley has tasted some of the first blood in the SCDO arena. When General Motors enters bankruptcy, we strongly suspect that many more SCDOs will be triggered, and thus what will likely be the single greatest transfer of wealth in world history will continue. As the action on the SCDO front is heating up, we will be reporting much more regularly on the topic. You can likely expect another update soon after GM enters bankruptcy.

Building the AmeriCar Market

As we wrote previously, we have a pet theory that the U.S. Federal Government is in the process - deliberate or accidental - of forming a national car manufacturer, owned and operated by the Government. With Chrysler in bankruptcy, never to repay the over $7 billion in loans from the Government, we suspect that the process of forming "AmeriCar" is accelerating (if you'll pardon the expression).

However, as anyone who has actually paid attention knows, most American automobiles suck. It's all well and good that the Federal Government might be running its own car company in the future, but who's going to buy the crap that will - almost certainly - be produced? If the Soviet Union is any indication, the national cars will be impressively crappy... except for the members of the Government, of course.

We suspect that the preliminary methods for corralling people looking to buy new cars will be similar to the "cash for clunkers" programme; older autos can be traded in for a rebate on a new vehicle. It wouldn't be difficult to extend that programme to apply only to vehicles purchased from "AmeriCar." Indeed, an even more draconian move - and in keeping with the "Buy American" mantra of the Obama Administration and Congress - would be to restrict the programme to only American-made cars, on both the trade-in and the new auto. Additionally, we wouldn't be surprised to see hefty tariffs on imported vehicles, to further coerce buyers to get "AmeriCar" vehicles.

The Foundations of AmeriCar

The actions of the Obama Administration are becoming evermore difficult to understand rationally. Halfhearted nationalisations were the bread-and-butter of the outgoing Bush Administration, something we remembered that President Obama promised to change. However, these actions (which are painfully similar to that of the Hoover Administration in the 1930's) have not ceased. If anything, we have the suspicion that the situation has become even more problematic.

An excellent demonstration of this is the situation between the Federal Government, and the deathly duo of General Motors and Chrysler. Although the relationship between the three parties is rather wiggy at best, we consider it a de facto nationalisation. Our evidence is simple: President Obama has ousted General Motors' CEO without consulting the dying company's Board of Directors. If GM isn't a nationalised company, we don't know what it is.

The shake-up of the CEO is, in a way, some muscle-flexing. The Obama Administration is perhaps making sure that the car companies know which side their bread is buttered. In a nutshell, the Government has its car manufacturers in hand, mostly. Like the formation of the National Railroad Passenger Corporation (better known as Amtrak), the formation of a national car company is probably in progress.

The next step toward such a company - let's call it AmeriCar - was taken by the Administration today. All new vehicles sold by Chrysler and GM with warranties will have those same warranties guaranteed by the Treasury Department. From whence the money to pay out these warranties shall come is immaterial; the important point lies elsewhere.

Setting aside the questions of moral hazard (20-year/1,000,000-mile warranty, anyone?), the potential implications of this arrangement are deep. If indeed the U.S. Government is to insure these warranties, it must make secure the supply of the parts necessary to keep crappy American automobiles scraping down the road for the duration of the warranty. The logical conclusion to this is that, the companies which make the parts necessary to fulfil those contracts cannot be allowed to go out of business.

Backing the Warranties may allow the Federal Government to nationalise (sotto voce) parts manufacturers for the American car companies. If it does indeed do this, then the foundation for AmeriCar are firmly set. If Amtrak is any indication, the products of this hypothetical car company will be horrifyingly wasteful and unreliable.

Safety First

It's cliché , but the US Economy is the Titanic, and it's hit the iceberg. We wouldn't be so alarmed, except that the captain is trying to fix the tear, when attention should be given to the lifeboats (and to improvise some flotation devices because there aren't enough lifeboats).

It's time to give up on Fannie, Freddie, GM, Chrysler, Citibank, and so on. Of course the government won't give up and precious time and resources are being wasted.

The sad reality is that most Americans couldn't conceive that the system wouldn't keep delivering the good life, and thus they were over-extended and without savings. It's too late to bemoan the fact that the USA doesn't have a proper social safety net, or decent public housing or public transportation. It's sink or swim time.

We advocate swimming of course, but you are going to soon find yourself on your own. To survive, you must sharpen your skills of observation and exploiting discovered opportunities. Amid all the disruption, life will go on. People need things and you can supply some of them, and for that be compensated. It is very simple, really. Just stay sharp and learn to make do.

Good luck!

Bailouts are the Ultimate Corruption

As we had suggested earlier in the month, a token bailout has been given to General Motors and Chrysler. $17.4 bullion may seem like a ton 'o cash, but its chump change for these sieve-like companies. The Big Three have hit the proverbial iceberg; it's only a matter of time until they go propellers-up. Unsurprisingly, six in ten Americans would prefer to see those propellers than have their tax-dollars go towards making more gas-sucking, barely-functional fashion excessories. And who could blame such sentiment?

Even more odious, in our opinion, is the use of TARP (i.e. taxpayer) money to fund bonuses on Wall Street. The complete hypocrisy of, say, AIG's Jay Wintrob getting $3 million in 'retention awards' is mind-numbing. We personally feel so disgusted that we look for the lynch mobs forming, hunting down Wall Street's finest and stringing them up in Central Park... but we instead see complacence. The American public seems content to whine vaguely about things, but do nothing to stop out-of-control lemon socialism.

These bailouts, besides unwise and reckless, are the signs of corruption so deep and pervasive it makes our head spin. For example, Mr. Henry Paulson, Jr. is a former Goldman Sachs CEO. As Secretary of Treasury and manager of TARP, Mr. Paulson has given his former employer $10 billion of unregulated cash. If this isn't a conflict of interest, we don't know what is. Mr. Paulson also helped remove Goldman Sachs from the old net-capital rule; last we checked, before its recent, cynical move to become a bank, this allowed Goldman to leverage their assets-to-capital to around 30:1 - a speculative foray which taxpayers are now expected to clean up the mess from.

Therein is the rotten core of the affair: public money has been usurped. Money which could have gone towards any number of productive things -- which would have given real, measurable benefits -- instead are going towards rewarding those who created the mess in the first place.

These people -- the bankers, the auto CEOs, Mr. Paulson, et al. -- are so obscenely greedy we feel ill sharing the same nationality. Even though the entire world is in the 2007 Depression, they will still try to milk the system for every last dollar they can get. The callous disregard for the misery and suffering they are helping to create is staggering, but yet it is apparently greeted with cheers and accolades.

Why JP Morgan wants Detroit to Die

The Big Three automakers (Ford, General Motors, Chrysler) are begging for a bailout. Although we haven't seen the CEOs of the companies on bended knee, we assume their pleas are strident and whiney. Nevertheless, we are certain that a token bailout is being rammed through Congress as we clatter away at the keyboard. $15 billion may sound like a lot of money, but it's a drop in the bucket for these behemoths. They are hemorrhaging capital, disbursing money like Ebeneezer Scrooge doesn't.

Despite this, there is no way in Mordor that the Big Three will live to see Christmas 2009. The obvious reasons: they're unprofitable; they're not competitive, either domestically or globally; their cars are crappy, ugly, out-of-date energy hogs that cost too much and are difficult to repair. Please, don't get us started, it will make us rant loudly.

Like we said, however, those were the obvious reasons. But there is something else - a Sword of Damocles - hanging invisibly over Detroit as we type: synthetic collateralised debt obligations (SCDO), which are soon to become massive windfalls to big banks, like JP Morgan. These SCDOs are very complicated, so please bear with us as we use the Business Spectator to explain:

"A synthetic CDO is a collateralised debt obligation that is based on credit default swaps [CDS] rather than physical debt securities... Here’s how it works: a bank will set up a shelf company in Cayman Islands or somewhere with $2 of capital and shareholders other than the bank itself... That allows the so-called special purpose vehicle (SPV) to have “deniability”, as in “it’s nothing to do with us” – an idea the banks would have picked up from the Godfather movies.

The bank then creates a CDS between itself and the SPV. Usually credit default swaps reference a single third party, but for the purpose of the synthetic CDOs, they reference at least 100 companies.

The CDS contracts between the SPV can be $US500 million to $US1 billion, or sometimes more. They have a variety of twists and turns, but it usually goes something like this: if seven of the 100 reference entities default, the SPV has to pay the bank a third of the money; if eight default, it’s two-thirds; and if nine default, the whole amount is repayable...

Finally the SPV is taken along to Moody’s, Standard and Poor’s and Fitch’s and the ratings agencies sprinkle AAA magic dust upon it, and transform it from a pumpkin into a splendid coach.

The bank’s sales people then hit the road to sell this SPV to investors. It’s presented as the bank’s product, and the sales staff pretend that the bank is fully behind it, but of course it’s actually a $2 Cayman Islands company with one or two unknowing charities as shareholders.

It offers a highly-rated, investment-grade, fixed-interest product paying a 1 or 2 per cent premium. Those investors who bother to read the fine print will see that they will lose some or all of their money if seven, eight or nine of a long list of apparently strong global corporations go broke. In 2004-2006 it seemed money for jam. The companies listed would never go broke – it was unthinkable.

Here are some of the companies that are on all of the synthetic CDO reference lists: the three Icelandic banks, Lehman Brothers, Bear Stearns, Freddie Mac, Fannie Mae, American Insurance Group, Ambac, MBIA, Countrywide Financial, Countrywide Home Loans, PMI, General Motors, Ford and a pretty full retinue of US home builders." [emphasis added]

Please, read this article from the Business Spectator. It is an excellent discussion of the swindle that are SCDOs. It is an epic financial bomb with an uncertain fuse, but will certainly go off with the Big Three dead and buried. And that, dear Reader, is why JP Morgan wants Detroit to die. While JP Morgan may or may not have invented SCDOs, they are certainly at the top of the guest list at this reportedly $50 trillion jamboree (yes, dear Reader, that's trillion).

Put simply, there is an unbelievably huge pie out there, somewhere, and JP Morgan is getting hungry. A little thing like the Big Three, or any of the other companies on SCDOs lists, will not stand in the way of their slice.