Barbarians Still Control the Gates...

motordavid · #1 11-15-2008, 01:18 PM

Good article by Floyd Norris in Friday's NewYawkTimes...
Worth the read, imo.
BR,mD

High & Low Finance...

Rescues Fail to Quell Arrogance

By FLOYD NORRIS
Published: November 13, 2008

If you are going to hand out rescue packages, it helps to understand how bad the problem is, and to have some grasp of what is needed to fix it.

Now the automakers are in line for handouts, and we can only hope the government will have a better understanding of their problems — and a willingness to force painful changes on the industry — than it did of the financial industry, where the first round of bailouts were made in a process that is looking more and more absurd.

It is not just that the Treasury and the Federal Reserve pushed Congress to pass a bailout plan that has now been abandoned. Nor is it just that the early recipients are already in line for more handouts. It is that the government seems to have written checks with little knowledge of how deep the rot went.

There are lessons to be learned, but they can seem contradictory:

It doesn’t work to be a passive investor when you are handing out bailouts.

On the other hand, the idea that government planners should determine where companies invest their money does not sound so great either.

What is clear is that the Bush administration, in this as in so many other things, will do as it pleases. The bailout legislation contemplated the purchase of bad bank assets. That idea is now abandoned for most institutions. The legislation set up an elaborate oversight mechanism, and required periodic reports. None of that is happening.

Instead, the first round of bailees are back for second helpings.

Before it collapsed, the American International Group was a haughty company that thought it was better than anyone else. It still feels that way.

Instead of sounding chastened as its second bailout was announced this week, the company was bragging about how wonderful its insurance operations are, and denying this was really a bailout at all.

At a minimum, can’t the government announce and enforce a rule that companies that receive more than $100 billion in bailout money must at least admit their brilliance is open to question?

The automakers are next in line. Before the checks are written, the government should confront the question of how this industry can be revived, and force changes to do that.

But it is doubtful that a Democratic Congress will have any appetite for huge layoffs and plant closings, and certainly not for reductions in retiree health benefits. There will be talk of better fuel economy and hybrids, but little in the way of pain for anyone except future taxpayers who will owe the money being thrown around now.

There may be some stringent financial provisions, intended to force the firms to become commercially viable within a few years, but don’t pay too much attention to them. The early recipients didn’t.

It was less than two months ago that the government put up $85 billion for A.I.G. The interest rate was high, and the term of the loan was just two years. The company, under a new chief executive, would have to shape up or close down within 24 months.

That new chief executive, Edward Liddy, now says he saw his first priority as being to negotiate more lenient terms. While he was at it, he asked for more money and for a mechanism to get Uncle Sam to take on the risk of some of his company’s worst assets while letting A.I.G. share in the profits if those assets should prove to be valuable. He got it all.

Then he told the world that this was not really a bailout at all. “The terms of the restructuring are commercial in nature,” he said on a conference call. “All of the facilities being provided by the U.S. government are at market rates.”

Market rates? The government is getting the London interbank offered rate, plus 1 percentage point, while it takes large risks that the bad assets it is taking from A.I.G. will keep losing value. If they do, A.I.G. is under no obligation to repay that loan.

A.I.G. would like us to believe that it is a collection of wonderfully run insurance companies, whose parent company made a mistake or two. That is not exactly accurate. Consider one part of the latest bailout. A.I.G.’s insurance companies — the ones that Mr. Liddy says “remain disciplined” — lent out securities like corporate bonds to other investors, as do most institutional investors. Also, as is common, the A.I.G. companies received cash temporarily to assure that the securities were returned.

The normal procedure is for the company doing the lending to put the money into supersafe overnight investments, since the securities may be returned, and the cash paid back, at any time. That produces a small but certain profit.

A.I.G. had a different idea. Instead of putting the cash into safe investments, it bought mortgage-backed securities, which promised a much better yield. Now those securities have lost a lot of value, and are difficult to sell. A.I.G. needs to have the government provide the cash.

That practice was roughly akin to taking the rent money to the racetrack. At least people who do that seem embarrassed when they ask for handouts.

Now the government will step in to buy those funny pieces of paper. It will put up 96 percent of the cash, but collect only 83 percent of the profits if the securities go up. And the price the government pays will be based on what A.I.G. says they are worth, although the government is looking for a consultant to check those prices.

Another government bailout that is running into problems only weeks after it was announced is the one for Fannie Mae, the government-sponsored mortgage finance company.

At Fannie, the government was not so shy about issuing orders. It told Fannie to borrow less, buy more mortgages, and cut the fees it charges to those who sell mortgages to it, all at a time when losses from existing mortgages were growing. This is akin to a family reacting to a financial crisis by saying it will save more money while increasing spending as income declines. It doesn’t work.

The problem is conflicting government desires. It wants the costs of mortgages to fall, and wants plenty of them to be available. It also wants Fannie to stop growing.

This week Fannie said it may need a new bailout. Are you surprised?

All this reflects the conflicting needs and responsibilities of a government that deems companies to be too important to fail. It wants to keep them going, but also wants them to act in ways that seem good for society, whether that consists of cutting mortgage rates or building fuel-efficient cars. And it does not want to increase economic distress at a time when millions are losing their jobs.

So the tough choices that would normally have to be made by a company in trouble can be postponed, thereby prolonging the pain.

In the meantime, other firms have to compete with wards of the state, on terms that can appear unfair. Competitors say A.I.G. is holding on to customers by cutting premium rates to unreasonable levels. A.I.G. concedes premiums are down, but denies it is leading the cuts. There is a risk that bailed-out carmakers will try to save jobs by cutting car prices to levels even lower than the ones that left them broke.

Bailing out companies turns out to be a lot like making loans. Getting someone to take the money is easy; getting them to pay it back is not.

Floyd Norris’s blog on finance and economics is at nytimes.com/norris.

Wagner · #2 11-15-2008, 01:24 PM

Looks like we need a little Enemy at the Gates.