Category: economics

The more I hear, the more I shake my head. The big three auto companies’ problems are not a sudden catastrophe that can actually be avoided. Many people in DC seem to think that with just the right shuffling of money, things could be very different. They say we need to do something in order to “save jobs” and prevent a plunge in the economy. They act as if those are things a maniacal evil genius is cooking up, as if those things are something that might happen for no reason at all…

Folks, those jobs being lost and those companies’ financial troubles aren’t random. They reflect the way things actually are. What the people up in DC are trying to do is to change the underlying reality of things. It ain’t going to happen. Those companies have already failed, those workers that are going to lose their jobs are already not needed. A prosperous economy is not based on jobs being kept alive by government fiat, it is based on people providing goods and services that are wanted by consumers. Consumers have been telling the Detroit automakers what they think for years via car sales. If those companies aren’t giving people what they want (both in product and price of that product) then they aren’t contributing to a prosperous economy, they are a drag on it. WHen those companies go under, or at least scale back, all sorts of resources will be freed up to go towards things that will contribute to our economy. Steel, rubber, labor, etc. will be able to be used much more efficiently.

It’ll take a little time, especially in the case of the labor, but it will get sorted out. The longer we prolong the process, the more pain that will be inflicted. Let things go on their natural path, it’s the only way to allow an economy to be prosperous.

The Senate wasn’t able to come together and pass the auto bailout package. For that, I’m happy. We’ll see if Bush caves and appropriates money, he better not since the legislative body didn’t…

I was a little disappointed that none of the objections to the bill (that I could see) were on general principle. Instead, everyone disagreed on how budgets should be cut at the companies. Some said union contracts need to come down now, some were saying executive compensation needed to come down, there were talks about how much they should guarantee their bonds, etc. Is there anyone out there that believes that the congress and the senate would make good micro managers of any business? All of those things might be needed, but the congress is that last body you want making those decisions. It looks like all of those things will happen in bankruptcy, if we’re lucky…

I have to say that I continue to be amazed that there is legitimate resistance to the auto company bailout. As free as both houses have been with money, I figured that this current thing was a done deal.

As you might imagine, I am no fan of this thing. There is zero chance that any sort of government appointed car czar will have a good impact on those companies… I have no idea of the bailout will squeak through the Senate or not. I hope it doesn’t and it looks like there will be some sort of fight for it at least… I wonder what will have to be thrown in to sweeten the deal enough to bring enough people over to get it passed like the last bailout bill was…

Anyway, here are my predictions. If the bill passes, this will only be the first of several requests for money. Those companies are bleeding money at an amazing rate and the government is going to show them how to be fiscally responsible? It will be good money after bad and the companies will have to completely reorganize anyway.

If the bill doesn’t pass, the companies will have to file for chapter 11 and they will reorganize. They will reduce their capacity, restructure union contracts, and lay off a ton of people. All of these bad things will be blamed on the lack of bailout money and not on the incompetence of management…

It has been pointed out that this is a bit of a “prisoner’s dilemma.” There is a ton of excess car manufacturing capacity worldwide. That excess needs to go away in order to make the industry profitable and competitive. The trouble is that every country wants the other country’s capacity to shrink, so they will bolster their own. The result? All of the car manufacturers do poorly because of the excess capacity. By moving to prop up the industry, the whole thing stays bad. Yet another chapter of massive distortions caused by government. When will they learn?

Yesterday, Paulson said, “…the most important thing we can do to mitigate the housing correction and reduce the number of foreclosures is to increase access to lower cost mortgage lending.”

GAH! Ok, why does he think that lower cost mortgages will be helpful? They were, to a large extent, what brought us to this current mess. I have already talked a bit about the “correction” (see my last post), but let’s think about what a mortgage rate is.

A mortgage rate is the rate of interest someone will charge you so you can borrow money to buy a house. What that rate is is determined by what it costs them to get that money, your likely ability to pay that loan, and the availability of higher rates of return on other lending options. None of those things are created out of thin air, they’re all important The company with the money wants to loan money, that’s how they make money, but they need to charge the right amount in order for it to work. In addition, they have to make sure they don’t lose money, it’s can be a tricky thing.

So along comes the federal government and decides to lower interest rates. Hmm, what can they do? Well, they make it less expensive to get money to lend. That makes the bank more willing to lend to people that have shaky credit, and it makes it more profitable than lending money for other purposes. In addition, the government guarantees risker mortgages through Freddie Mac and Fannie May. The end result? More houses are sold than would be otherwise, and through our friend “Moral Hazard,” more houses are sold to people that can’t really afford them. That drives the cost of houses higher than it should be (supply and demand being what they are) and also causes a large amount of resources to be spent on the building of houses that shouldn’t have (labor in particular). Poof! Instant bubble… Because the feds made this so profitable, various kinds of mortgage derivatives were formed which were then heavily invested in by banks. In short, it’s a huge distortion, it’s something that wouldn’t have happened if things were left to their own devices.

But they weren’t, and now we have what we have. The good news is that the mortgage market is trying to correct itself, the bad news is that Paulson (and a lot of others on capital hill) want to get back to the same level of house buying and construction that started this whole mess. Someone, somewhere has to start thinking, “Well, maybe we should let the market get back to where it would have been if we hadn’t screwed around so much..” I’m not holding my breath. This is how depressions last, by trying to force markets to go uphill…

So the Fed is jumping in with hundreds of billions of dollars to “help” the financial crisis. At what point do we say enough? I see two big problems with these ongoing debt raising shenanigans. First, there is the issue of how the economy is going to react. The whole point of this is that many people do not like the way the economy (of the world) is reacting to the current mess. Paulson actually commented on “… mitigating the correction..” The key word here is correction. The market is trying to get back to a stable point, and that’s going to mean less spending and less credit than we had before. It is quite possible that the market will over correct, after all, there isn’t a single thing that does this correcting, it’s millions of transactions trying to figure out what to do with money. I’ve said it before, but market forces are a lot like water flowing downhill. You can try to divert it, or dam it, but that water will eventually get downhill. If you don’t like what the water is going to hit and divert it, you can be sure it will hit something else, and maybe get around to hitting the original thing anyway. Damming can work for a while, but when it overflows or breaks the dam, watch out! Both the Treasury’s and the Fed’s actions are very blunt attempts to “correct” a very complicated correction. Collateral damage, here we come!

Another big problem is how these actions are continuing and deepening the fall in consumer confidence. Think about it, if people hear the the financial system is collapsing and we need to pull out all of the stops to rescue it every day, do you think they will want to go spend money? Ultimately, people spending money is what makes things happen, but with so much uncertainty, the spending continues to dry up. “But what’s the alternative Isaac? There are big problems..” Yes, there are problems, but I blame people in DC for fanning the flames and making everyone shoulder the load through taxpayer money. I would have preferred that the institutions that screwed up be allowed to fail. That way, the more conservative ones would have been in a position to profit, and that’s the way it should be. Now, we are in a weird situation where the companies that took risks and got burned are being rewarded. With this sort of bailout, what incentive do you have for being conservative with money?

You can think of it as pulling the bandage off quickly. There would be pain, but things would be primed to correct much more quickly and more accurately than this government led fiasco. Yes, it’s a fiasco, the careless and stupid companies that caused this whole mess are being kept alive and at everyone’s expense…