The Dubai Gambit

Although we just wrote about Dubai and its impressive level of debt - not to mention its impressive malinvestment of its resources - the Emirate has made a manoeuvre which we didn't even think of: declaring the debt of Dubai World not backed by government guarantee. From the BBC:

"[Creditors] think Dubai World is part of the government, which is not correct," said finance minister Abdulrahman al-Saleh. "Creditors need to take part of the responsibility for their decision to lend to the companies."

Clever, very clever; it seems to us that Dubai is looking to have its cake and eat it too, after a manner of speaking. They got their theme parks and little islands, and now the investors can go stick it wherever they'd prefer the pain. And if those investors attempt to foreclose on the assets of Dubai World, they just might run into the little problem that said parks and islands are property of the Dubai government, or perhaps the Abu Dhabi government; in other words, foreclosure is not happening, because we really don't think an UAE court would care to strip a sovereign government of its assets. Certainly not for foreigners, and the latest incident with the Swiss banning minarets will likely not help the situation.

A thought arises from the move, which we give the same title as this post: the Dubai Gambit. We'll put it in the general terms for starters. A nation's Government spawns this enterprise (we'll use the U.S. term of Government-Sponsored Enterprise, or GSE, with apologies for such Amero-centrism), and lets it just toddle along, doing its thing. As a GSE, it would seem to investors that the GSE enjoys an implicit Government guarantee; the Government made it, so why wouldn't it keep it going if times were tough? So, investors cheerfully pile into the debt of this GSE, because from their perspective it's just as good of debt as sovereign debt.

But surprise! It doesn't say anything anywhere in the GSE's charter (or what have you) about a Government guarantee. That means the Government, at its fickle discretion, can either help out the GSE in times of trouble, or not. The average investor, being apparently rather dim-witted when it came to reading fine print, was speculating much harder than he or she thought; the money he or she plopped down for the GSE's debt might never come home from the front lines of the Free Market. It's a messy place, we hear, and casualties can be heavy.

Bad times come along, and the GSE gets into some serious trouble. Investors start thinking "Boy, I be sure glad that thar GSE's got some sort of gum'ment guarantee or some such. I's real smaaart," and patiently sit on the deck of their double-wide trailer waiting for the cheque from the Government to make them whole. Grandma Kettle's rocking chair creaks as she loads up the shotgun to take aim at a stray dog; the hole in the roof gets a little bigger; no Government cheque comes in.

That's because the Dubai Gambit was brought into play; the Government decided the GSE was not, in fact, going to enjoy a bailout. In the real world, this would probably happen when such a GSE was in such horrible shape, that the Government would have risked its own credit rating to support the malinvestment of the investors, and the GSE's own malinvestments. GSE debt goes from being 'as good as Government' to 'someone has to do something about this!' overnight, as the bonds go belly-up. Investors are left footing the bill for someone else's good time, and the Government comes out, theoretically, smelling like a rose, at least to the credit markets.

As this meltdown of the GSE is underway, the Government finally steps in, but not in the way the investors were expected. Instead of providing a backstop for the full value of the GSE debt, the Government starts Agency X, with the explicit goal of winding down the GSE's debt. With a pre-packaged bankruptcy agreement - and a sufficiently... agreeable... court system - Agency X gets to cherry-pick the good assets of the GSE, and leave the GSE with all of its liabilities. Investors in the failed GSE would get Agency bonds worth pennies on the dollar of their original GSE debt, and the Government gets to have at least something for its efforts.

We fully expect Dubai to do this manoeuvre, or at least something like it. If it seems far-fetched to you, dear Reader, please consider the shenanigans surrounding the General Motors bankruptcy fiasco in the United States. The 'old' GM went into bankruptcy, gave its few good assets to the 'new' GM (owned by the U.S. Government, the Crown in Right of Canada, and a few other favoured parties), and then left its legacy of toxic waste dumps (or, 'factories,' as they are charmingly misnomered) and other such massive liabilities upone the shoulders of now wiped-out investors; the 'new' GM is in the clear. This, in civilised countries, is typically considered unlawful conveyance, but since the Federal Government was involved, such trivialities were easily brushed aside.

The Dubai Gambit is, at its core, entirely designed to have the Government - any Government - protect its credit rating at all costs. Dubai seems to be very much conscious of that factor, as why else would the Emirate have explicitly withdrew any implicit Government guarantee? Dubai World et al. is a mess financially, and it would probably bring down the Government if it tried to back the enterprise's debt for its full value. At pennies on the dollar, as it were, Dubai might be able to convince the UAE central bank, or Abu Dhabi, to bankroll a resolution of the fiasco; Dubai keeps its sovereign credit rating, the UAE and Abu Dhabi look like heroes, and investors in Dubai World don't feel quite as raped as they otherwise would have.

The question is, if Dubai makes this Gambit work, and to paraphrase Tom Lehrer, who's next?

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.

Saving Jobs at $385,000 Each

So far, the cost to the US taxpayer of bailing out GM has been 15.4 billion dollars. With that kind of investment, one would think a lot of jobs would be saved. But this is not the case. According to the deal between GM, the UAW, and the government, GM is planning on keeping only 40,000 permanent hourly workers. The cost to the taxpayer is then $385,000 per job.

How long will these jobs last? Given the tremendous over-capacity in the world's automobile industry, GM will be faced with further drastic cutbacks, if not outright closure, in a few more years. Given that most of these jobs are essentially temporary, $385,000 per job is a waste of resources.

It is our opinion if vast sums of money are going to be used to create jobs at public expense, the jobs created should provide long-lasting public goods and services. This is also known as good government. Bailing out GM, a failed company creating private-sector goods unprofitably, is lemon socialism.

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.

Let the Economy Change

Words like 'decline' and 'collapse' are being tossed around with reference to the economy as if the economy were a static entity. Actually, of course, economies are very dynamic - with a continual stream of emerging and declining enterprises and industries. When the economy in the aggregate is growing, the emerging are growing faster than the declining are shrinking. When the declining are shrinking faster than the emerging are growing, the economy in the aggregate is shrinking, as is the case today.

Once upon a time there was a theory that if the declining enterprises were liquidated quickly, it would offer room for the emerging enterprises to grow. Imagine if you will, a forest fire burning out the dead wood.

Nowadays, the declining enterprises are given bailouts, and the forest fire of Depression isn't allowed to burn out the dead wood. If our analogy is accurate, this makes for bad forest management of the sort that led to the great Yellowstone Fire of 1988.

If current government efforts to stymie the Depression are successful, they will only put off a future, greater depression. The economy must change sooner or later to accommodate reality.

We do not know where economic developments will take society, but we opine that the rate of change is too slow. Bad operations like General Motors and AIG must be put down to allow the economy to readjust to the new realities. and the sooner the better.

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!

The Long, Dark Teatime of the Holidays

As we sit at the keyboard, the rest of the Western world kicks back and takes some time off. The news services grind slower than usual; reporters are having a little eggnog with their vodka. This makes us twitchy: some of the greatest political coups d'etat have occurred when the holiday spirit permeates the air...the long, dark teatime of the year. Take the Federal Reserve Act of 1913... it was passed under the cover of darkness, after the majority of Congress had left for their Yuletide cheer. Who knows? As we type, a financial Kristallnacht could be going on without the slightest publicity...

What news we do see, though, is rather grim: retail traffic is down 24% year-over-year; the commercial real estate industry is whining for its bailout; the National Retail Federation wants a three-day jubilee on sales taxes; local banks are getting some hog slop from TARP; GMAC met with the elves at the Federal Reserve and was magically made a bank.

We wonder about GMAC's new status as a bank holding company. This company is, quite simply, a failed arm of a failed company of a failed industry. Not our idea of a good investment of the people's tax-dollars, and surely even the government must realise this. The details, though, are interesting: General Motors has to reduce its holdings in GMAC from 49% to 10%; Cerberus Capital must reduce from 51% to 33%. The 57% difference goes to an unnamed, independent 'trustee.'

This has deep implications: GMAC is now eligible for its share of TARP-feed... but the Fed's terms effectively cut off GM from the benefits of the gravy train. Cerberus won't get much of the money either, since the lion's share is going... somewhere. Hmmm, we wonder where. Were we the betting sort, we might be feeling lucky and put money on a former investment bank with the initials G.S.

But yet, we're heard that things aren't so bad: Turkey's PM is telling us this whole thing is just in our head. This would be funny, if the situation weren't so tragic. To quote Queen Victoria, we are not amused.

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.