ECONOMIC RANT
Frankfurt am Main, Germany, Saturday, 04 April 2009

All is doom and gloom on the news here. The Bundesrat, parliament’s upper house, has just approved a new law empowering the government to take over a company “if necessary”. It was designed for a huge and influential German mortgage bank that is co-owned by Italians and an America investor, but in the opinion of the Federal Government is too important economically to be allowed to fail, an argument that is becoming fairly common nowadays. The German machinery industry, a key exporter and economic indicator, has seen domestic and foreign order-intake shrink by half within only a few months. Here too, the car industry is in major kaka. All the car companies (Germany has lots of them: e.g. Daimler; Volkswagen; Porsche; BMW; Ford; GM/Opel) are having a tough time and dependent upon fiscal stimulants and begging for taxpayer handouts. Of the majors, GM’s European subsidiary, OPEL (which includes VAUXHALL in the UK), seems to be in the worst shape. It has been milked for years by the parent in Detroit, seems to have been in a semi-permanent depressed state in terms of new car models for years and hasn’t seen a profit since St. Peter was a corporal in the Jewish underground. The Canadian banks seem to be in rather better shape than elsewhere (why is that, do you suppose?). But the banks in Britain and America and possibly Germany, France, Italy and …… (your country’s name here) are basically kaput, and are only being kept afloat because the accountants agree not to make them reflect the real market values of their assets.

I am all in favour of taking over any bank that asks for taxpayer money, i.e., common shares in return for taxpayer bailout. Then you use the public’s votes to kick out the very managers and directors who conceived of and carried out the failed strategies, wipe out the old shareholders who permitted it all in the first place, install new managers (provided you can even find some that aren't tarnished by past excesses and who might have some basic experience in dealing with a down market), and sell off the shares later if and when the stock market recovers. That was the method in the thrifts catastrophe (the Resolution Trust) in the 1980s, until then possibly the biggest post-war financial meltdown in the USA. It paid off and, after a few years, the public actually made a bit of money on the deal. The same happened quite successfully in Sweden.

As it is, in this crisis some institutions are taken over (e.g. Fannie May), some banks were allowed to collapse (Lehman Bros.) and some banks just get money thrown at them with next to no strings in the now obviously vain hope that the recipient financial institutions will start lending again. As one could predict, the banks of course use the funds to repair their balance sheets and thereby protect the bamboozler-executives, the decorative outside board members and the gullible shareholders who together drove the lorry off the cliff in the first place or as chips in making huge trading profits in turbulent currency, commodity or bond markets. This is possible because first Bush and then Obama have hired the same “markets-will-always-regulate-themselves” gunslingers who were hugely instrumental in adjusting public policy to permit the financial crash in the first place (like Larry Summers or Tim Geithner, for example). These guys personally cashed in enormously when they moved from the Clinton White House, where they stick-handled the financial ‘liberalisation” acts through Congress, to head up the NY Fed or Citibank or, whatever. As is customary, they were just being “warehoused” (the slang actually used for politicos with between-administration offices on Wall Street or at large corporation like Dick Cheny’s Halliburton). These bozos get to make a lot of dough until they can find an empty office in D.C.

The banks, curiously enough, are now perhaps trying to do what they should have been doing all these years when they had left off traditional lending nearly altogether, i.e., they are assessing real risk before they lend. This is unfortunately a skill that, institutionally, they have by and large lost. They don’t have the middle-management-level risk evaluators any more. There is in fact no middle-management any more! There are no more local branch managers, for example, who might based on long local experience know who or what is a good or bad local risk. Retail lending, even mortgage lending is now done online using computer formulas. As for corporate lending (i.e., lending to industry), this has over the years become so unprofitable that an S&P-rated company could hardly these days be bothered to call a lending bank for a quote.

With corporate lending in the dumps, the “retail” banks (usually a division of the same bank) nevertheless found a way to bankroll those who could never in the past have been even remotely considered for a loan: you just package the bad loans with some good ones and sell them as collateralised instruments into the investment market. Blue chip or junk, the same approach was used. To remove any doubt and any need to assess risk inside the banks, you got a name rated AAA by S&P (not analysed by the bank, please note), somebody like A.I.G. for example, to endorse the package and pay them a fee for it. The rating agencies went along with all this rather than lose the business. It seems that, in the great name of profit, the rating agencies, the lenders, the directors, the shareholders and the insurance companies decided to ignore the real world and hope that the money would keep rolling in. All of this was built upon a real estate bubble that was built upon cheap money provided by the Federal Reserve. Nobody would or could throw on the brakes. Those who might have done so, were more interested in making money and hoping not to be the second or third to exit the market when the crunch came.

Not that companies really needed much cash anyway. For at least a generation, they have not actually been investing in anything much anyway. American industry has been in a “mature phase” for decades and less than expansionary. That means they had lots of cash, enough to either buy in their own shares or make acquisitions. Any expanding was being done by the Japanese, the Europeans and the Koreans or the Chinese, and they frequently had their own banks. All the while, corporate America, now too expensive but forced to compete with Third World workers, was moving production and know-how first to Alabama, then to Mexico and later to China, Thailand and Viet Nam. Corporate Europe started producing in Slovakia and Poland, still advantageous even after their integration into the E.U. in the course of this, companies usually just rolled the cost of a new plant onto an unsuspecting municipality, state or even a Third-World country. A sucker born every minute and three to take him in!

The Wall Street issuing houses (first stand-alone investment banks and, after 1999, frequently nationwide merged lending and investment behemoths) also increasingly made it possible for companies of any credit quality to by-pass loans and go directly to investors through the much cheaper bond or securitised-credit markets. Big corporations in addition also made their outside component suppliers, their trucking, shipping and leasing companies and even their employees provide them with financial resources. This last they did by making them “contribute” to downsizing under the threat of moving the jobs to Shanghai.

With the corporate lending business gone the way of all flesh and the system awash with petrol-dollars and cash-rich corporates, money centre banks and then, later, nearly all banks began dealing in abstract papers like mortgage-backed securities (MBSs), attaching if necessary an insurance-company default-guarantee to mask the fact that many of the securities were basically worse than junk. This was made possible when the Clinton government (Summers, Furmin, Geithner, et alia) introduced the two major banking ‘reforms’ which permitted banks to do lending and issuing under one roof while excluding a lot of specific financial activities from public supervision. “The market will always regulate itself”, was the mantra. Didn’t St. Adam Smith and his main disciple Milton Friedman say it? Of course, large companies and banks, as well as industries and even the economy itself might collapse first, although nobody wanted to talk about that. Lending bankers are traditionally supposed to have their ear in the market and be able to evaluate risks. With an AIG backstop-guarantee, who needed to do that? They have, indeed, essentially forgotten how to do evaluate risk. The top executives seem as incompetent as the car guys. Bankers are perhaps re-learning risk evaluation, but they are now forced to do so during the near-collapse of even blue chip companies and massive layoffs amongst their own staffs. Like consumers themselves, none of the current generation of bank managers has been through a real market downturn.

You don’t have to be an engineer to know when a car is a wreck. Likewise, you don’t have to be a financial wizard to understand that there are not a great number of good lending opportunities around these days. Banks won’t have much money to lend anyway for a couple of years: they are scared and are patching up their balance sheets. They won’t also know how much money they might have available to lend out anyway: will anybody be depositing or lending money to banks in the future? Will the petrol-dollars still be deposited with American banks?

But, assuming for the moment that there will be deposits, would you lend out to anything but perhaps a house-buyer with plenty of equity already and a low-priced object? I don’t think so. Let’s face it, banks are not at this point in history going to lend fresh money to such floating hulks as GM or Chrysler or even their suppliers or dealers or anybody associated with cars - after all the car companies don't really have any products people want or can afford. Potential buyers are the same people who are all maxed out on their credit cards and totally over-leveraged anyway. Anyway, handouts to GM and Chrysler mean that the American workers at Japanese or German subs in North America are unfairly treated; the taxpayer will be subsidising the lame ducks and depressing the prices of the products from healthy companies. At present potential car buyers are all thirty days away from financial insolvency, are threatened with layoffs, will become increasingly trapped far from any new jobs, in their over-priced and un-saleable houses in suburbs without public transport of any sort and the cost of heating oil rising again inexorably over the next few years. They are quite naturally either expecting to be laid off any day now, or are already in line at the unemployment-benefits office. Would you lend even a nickel to them under these circumstances? Of course not! To GM or Chrysler? Of course not!

Although it seems to be learning, the Administration, including the President, still apparently thinks the answer is to get asset values (by which I guess they mean house and share prices) back up to where they were a couple of years ago, and/or to get consumers simply to go back to spending and spending and spending, house speculators to get back into the market, and car companies to push gas-guzzling SUVs out the factory doors. But, simply tinkering with SUV engines is not likely to do the trick, friends, until at least another generation has passed and the terror of these financial days has faded. Will our grandchildren remember that the last decade has been largely built on sand?
On theh other hand, tThose who know how to take advantage of chaotic markets are busy every day online speculating on down-financial markets. Goldman Sachs is reporting huge profits on trading currencies, commodities and bonds. Given the circumstances, it seems like dancing on graves. But, nothing appeals to a trader like turbulence. The rest of us have no means to get into the game and no know-how to avoid a further catastrophe. Those still in work will trim their optional spending where they can (restaurants, miles driven, vacation spending etc.). Those out of work will do that and start plundering their savings (not an option for those whose wages have been pushed to the bottom over recent years and whose savings are essentially nil), look to unemployment benefits (if they exist for them), exploit their 18 credit cards (if not already maxed out) or even turn to charity (which will become increasingly unavailable as charitable giving nosedives). Shrinking down is going to be severely painful. As most people can all too easily do, imagine losing your job whilst you are carrying a mortgage - especially one higher than the market value of your house. You have kids in private schools, your stock portfolio has tanked and, situated far out of town on an “acreage” you own a McMansion that needs to be heated or air-conditioned.

We, ourselves, have been through all this years ago, so we have some experience. It’s not easy, I can assure you. Your income goes down much, much faster than your expenditures. Viewed dispassionately, our sailboat-home could now perhaps be seen as a floating survival capsule: it is paid off and, provided we don’t wreck it and we stick to sailing rather than motoring, we don't really have to spend much to operate it. The cheapest solution is to sail to an inexpensive harbour in a Third-World country and stay there for a while at anchor. Even motor-sailing will not be too expensive for the next couple of years, i.e., until the oil prices get back up to over $100 a barrel (In GM’s rescue proposal to the U.S. Federal Government, they predicted oil will reach $130/barrel by 2012, i.e., only just over two years away). And, how much food can one eat anyway? We are already living like vegetarians, which is a lot cheaper (and healthier) than eating meat or poultry. We also avoid buying processed foods like cheese and cold meats, etc.; we have no refrigerator or freezer on board and can’t really be bothered buying ice for the cool box. We buy all our clothes at thrift shops or in countries where they are inexpensive: at sea or in the tropics you don’t even need clothes. We don’t as a rule do restaurants or marinas. Countries like Germany, the U.S.A. or Canada have rather high-maintenance life-styles, so visiting places like Ecuador (although not perhaps French Polynesia) shelters us a bit from higher living costs, too. Even the NZ currency is quite low at present. If you are interested and you can sell your house, there are great buys for live-aboard boats at present.

Many cruisers, many of them already retired, are dependent for their cruising income upon the performance of their 401Ks or similar vehicles. Our retirement income, on the other hand, is almost entirely my small German pension. We can live on that because we learned to live on even less for a few years after paid work ended and before the pension began. We have already been through the shrinking process that many, many people, both retired and working have painfully yet to undergo.

A state-backed pension should be fairly reliable for the moment. I expect, however, a huge amount of inflation in the years ahead because of the money-printing that is now beginning in earnest – so far mainly in the USA because, without jacking up the risk premium, it can't flog its government bonds to the Chinese, the Saudis and the Venezuelans any more and, if it were indeed possible, such government borrowing would crowd out any corporate issuers who might one day in the future need money for an economic resurgence. Hence the roar of the printing presses. The German pension is indexed, thank goodness. But, if mega-inflation arrives, that might not really help: first, the cost-of-living adjustment is always after the fact and therfore not much help in runaway inflatin; second, pensions and unemployment benefits tend to be finagled politically when the need for them is greatest. The unemployed and other economically-weakened citizens will have been made nearly voiceless, whilst those still in work and paying taxes, or those watching their inherited wealth shrink will object to “helping” the bouches inutiles – the retired, the sick, the unemployed, conveniently forgetting that the retired “paid” in advance for a pension, the sick for healthcare and the unemployed for benefits. Include Social Security in your evening prayers!