Monday, 17 November 2008

Macro-Level Trends – The US of GM – The United States of General Malais

As the seniors of national central banks and governments of the world 'look-on', they recognise that much of their own economic tinkering is of second-order importance, magnitude and consequence to the economic restorative actions of the US and China.

As the effective powerhouses of global-effect policy and growth, that much needed restorative confidence will take longer to emerge than politicians, business and the public should like.

America's 'Troubled Asset Relief Programme' (TARP) is presently worth somewhere between $700-950bn, was originally intended to buy-up the veritable ocean of toxic assets that created the now international financial fall-out. But the investigation into identifying and locating the problematic instruments has demonstrated that their immense spread and opacity (of SIVs et al) inhibits the realistic possibility of isolating a virulent viral spread that infected even high-grade instruments.

Hence, given such a scenario, the Federal Reserve wisely recognises that even the near trillion dollar fund could well be but a drop in the monetary ocean, with limited direct effect on global finance, let alone broaching the question of the US's cross-border liability.
TARP was born not from a prescriptive, exacting solution, but from general philosophy and ideology, the execution dependent upon realistic outcomes.

In assessing the big-picture the Fed and Congress recognised that an action to 'chase-down the problem' was in reality a 'guestimate solution', an effort which given the problem's scale would be effectively be fool-hardy and irresponsible. Better to resolve domestic financial dynamics in markets and commerce with a mix of traditional free-market economics and periodic light and heavy interventionism to avoid the encouragement of 'moral hazard' and avoid major societal affliction.

Thus TARP's raison d'etre altered from the 'target strike' of what were hard to identify targets to the damage limitation of the country's central players. From the danger of an idealised yet impotent offensive action, to a well-reasoned domestically welcomed defensive play.
Although criticised from some quarters, it has to date largely been used to re-buoy the heavily 'written-down' balance sheets of those damaged entities that are judged inherently critical to avoid market-melt-down (eg Fannie May, Freddie Mac, AIG) or judged inherently strong (eg Goldman Sachs and Morgan Stanley). That criticism should have been largely quelled by the fact that these institutions have as part of that liquidity injection agreed to undertake diktats and accordant measures that redress their own inherent risk exposure. Actions that conform to Bank Company Holding status regulation such as raised capital to leverage cover ratios (typically its Tier 1 level) which in turn has attracted additional equity from respectable domestic and foreign external sources such as Warren Buffet's Berkshire Hathaway and Mitsubishi UFJ.

As a consequence in the flight for safety under TARP, other exposed financial entities have started to court the US government for funding, and as such the latest (if not surprising) community is in the consumer credit-finance arena. The now permitted action of American Express to convert to Bank Holding Company status will give the credit divisions of major American corporations the precedent to seek similar operational protection given their bank-like characters. Indeed the very size of Detroit car-maker's loan & lease exposures weigh heavily on the parent companies' already strained balance sheets and credit ratings. Today the Big 3 are in an unparalleled danger of bankruptcy caused by unprecedented and untenable circumstantial macro and micro headwinds. Headwinds and multiple counternancies which combined evidently highlight a lack of confidence resulting in GM stock plummeting to a 1943 low. [That market counternance consisting of the escalating cost of corporate default insurance for bond-holders and the retraction of insurance for the the Big 3's suppliers, leading to ever declining falls into new realms of 'junk-grade' territory].

The efforts of GM, Ford and Chrysler to highlight their plight and request Capitol Hill's assistance has been a long-time coming, the necessity now here. But although detractors might state that the 2007 New Energy Bill makes proviso for the Big 3, that split $25bn was and is intended for green technologies, not general operations. That promised money needs to be accessed now and protected for only eco-tech projects to ensure US Auto Inc does indeed have a future on the global stage and can play a role as part of the new eco-economy, a new paradigm being created by Californian players in Silicon Valley and the LA mayor's office and LA Port Authority.

However there is now an undeniable need for the government's assistance to ultimately reach that new future, to as Wilbur Ross states “provide a bridging loan” to 2010. Something much needed given the rapid domestic sales crash (from 17m to 11.5m), an unaligned product mix, proportionately heavy overhead costs, ongoing rounds of redundancy costs and an ever increasing squeeze from competitors for the remaining market share. Competitors, ranging from the Japanese, Koreans and now German's (by way of VW) that have realistically better products and deeper pockets to fight price and incentives wars if such a value-destruction continuum is unfortunately maintained. These factors have, and will, continue to create pain via record monthly cash-burns which quickly deplete cash-at-hand and force the sale of its more liquid short-term assets which themselves are endemically seen as undervalued at present unrepresentative 'forced' levels.

Thus the Big 3 are individually and collectively the proverbial “3 Men in a Boat” to re-appropriate Jerome K Jerome's classic literary piece. Unfortunately, the very term banded about - “bail-out” - indicates remedial action regards a sinking vessel, and although the water-level is well past the plimsoll line and very choppy economic waters have washed onto the deck the US industry's situation should perhaps be best described as being an overburdened, essentially antique age old design, struggling to cross hostile waters with heavy currents at many times its payload and so making no headway. Comparable to the all too traumatic Vietnamese fishing boat exodus story of the 1990s which saw too many people and too much baggage on a boat well past its sea-going range limits. In euphemistic essence today the Captains of GM, Ford and Chrysler are requesting the assistance of the US Coastguard.

Unsurprisingly as the first $350bn of the $700bn TARP monies is alloted to the finance industry recipients, Detroit tries to access these funds directly via the prompted appeals of corporate executives, industry related state governors, dealer groups and employees; aswell as indirectly via application to have their credit divisions taken into the Bank Holding Company model.

However, the reality is that in previous years when US automakers had to undertake operational turnarounds, the economic environment was relatively benign compared to today – the recessionary cycle more 'V' and 'U' shaped (as depicted on a graph) demonstrating quick and short-term pull-up. Today economists worry about a possible 'W' and at worst 'L' shaped eventuality which compares respectively to Japan's recent experiences and the earlier 1920/30s US drag then created by the 'dust-bowl' leading to the 'Great Depression'.

And that is the real concern that Congress and the new incoming President and his aids and advisors must deal with.

Listen to the all too evident and available media commentary from 'talking heads' or 'economic experts on a stick' and one will hear multi-various expectations of the depth and length of the downturn the US, UK and Europe are now well within. The Bull's have been present throughout, simplistically seeing an upturn as input costs reduced and inflation stemmed, however all others things aren't equal and although oil is below $60 per barrel the consumer reality has shifted measurably given the fragility of income and jobs, so whilst $4 gas has disappeared (if no further geo-political problems occur) today's new reality to feel comfortable in automotive consumer psychological is a national drop to under $2 gas – which given oil corporation's margins squeeze, a pull-back in western accessed reserves & refining and OPEC's capacity cuts, is plainly never going to happen. Add the absence of easy consumer credit and the automotive feel-good factor – at least, as known before through conspicuous consumption – has gone for many years to come.

The Bull's will also point to a much reduced interest rate cut, now globally co-ordinated, that encourages investment and consumer spending and a strong US dollar that attracts the repatriation of foreign currency reserves giving liquidity to domestic markets. But those rate cuts were provided as stimulus measures that ultimately proved impotent and meaningless given the major contraction of interbank and commercial lending, and now that the US rate is so so low the Fed has little room for further similar action to revive the economy. Moreover, the lack of commercial credit being restrained due to lack of real liquidity and ever decreasing commercial credit ratings particularly hitting SMEs means that the ordinary, historical levels of investment will very probably not emerge soon, especially since big players like GM and its peers in other sectors are deferring their own capital expenditure and new product programmes as part of their needed efforts to shrink. Hence the results of an ongoing credit squeeze and lack of pull-demand from the biggest commercial entities means effective hiatus if not complete stagnation.

And importantly, that paradoxically strong US dollar constricts the demand for US exports at such high costs to foreign buyers (esp UK and Eurozone) and equally suppresses domestic profits from exports to the US, especially so for Japan, Korea and China.

So as things stand there is a long haul to trek for a very very strangled private enterprise which is the bedrock of the capital economy. Thus leaving the onus to governmental Keynesian pro-activity to provide impetus. But that impetus will not emerge for some time, we are still in the wind-down period that ultimately necessitates a complete restructure of much of Western industry – a restructure that puts industry and commerce onto a new solid footing set by new long-term strategic directions - as typified and led by the energy companies - and often provide for new, higher margin and critically cash-flow orientated, business models.

Undoubtedly, there is a United State of General Malais, but the American public must realise that the world of commerce, and America's position within it, is today a very different place to the 1950s which essentially created the ever marginalised industrial template evidently prevalent today.

However, it is at such times of change that the call of, and for, entrepreneurialism is loudest, and the US - from Senator to 'Joe the Plumber' - need to demonstrate that strength and conviction as new economic foundations are re-built. The US effectively exported capitalism and now must be seen to, along with other national stakeholders (esp China, India, Russian and Brazil) be seen to act in unison to bolster that motivational ideology.

To falter with a retraction to short-termist protectionist policy-making (reminiscent of the now proven damaging Smoot-Hawley tariffs) would highlight the hypocracy of previous empty rhetoric and in the long-term embed a United State of General Malais for far longer than the period presently faced. So President (Elect) Obama will need to sugar-coat the bitter pill to be swallowed,which in turn requires entreprenerialism at its best.

So whilst investment-auto-motives encourages the use of Federal monies to assist GM et al over the short-term, such funds cannot be used simply to extend the life of the 'obese' industry we witness today. Such funds must be used, with formalised agreements to transform the very structure of the industry just as the previous $25bn is directly solely at green R&D and production programmes.

At a time when Daimler's Dieter Zetsche rightly calls for a complete change to automotive vehicle design, so a concurrent call must be made for industry structure and business model design, reaching as far as a disposal of Chrysler to a foreign buyer, a break-up of GMNA divisions, increased domestic & foreign collaboration to obtain efficiencies and access sector propelling technologies that fit within a new era inter-connected US industry framework