In Defense of Gambling with Borrowed Chips, Part III

Still working, as I was yesterday, from the recommendations in my final chapter: I proposed that "we must learn to let the failures fail." As a closely related point, I also said that  this would involve a reform of corporate bankruptcy law. This is worth some emphasis, so I'll quote myself here:

"Well-functioning bankruptcy courts perform the vital role of allowing the assets of a failed enterprise to find new owners -- owners who will be in a better position to find their highest-return use. Unfortunately, the courts at present do not accomplish that function effectively, and this contributes sadly to the too-big-to-fail mentality."

Gravelle takes issue with me here, saying if I understand her that some institutions really are too big to fail, and that government (in association with its central bank) needs the authority to rescue them as necessary if doing otherwise "means disaster for the broader economy, as well it might."

Yet her meaning requires some cross-examination. Does she really mean that some institutions have to be rescued outside of the context of bankruptcy courts, because the latter aren't doing their jobs? Is a bankruptcy filing the sort of "failure" that sometimes cannot be allowed?

 

Certainly in the 1970s there was a widespread opinion that Chrysler was too big to fail. It was too big for its fate to depend upon our existing corporate bankruptcy system. Thus, in 1979, the U.S. Congress passed a loan guarantee act, which President Carter signed into law in January 1980.

Obviously, that act did not cure what ailed the US auto industry. Both Chrysler and Gemeral Motors would have to pass through the bankruptcy system nearly thirty years later, after a generation's worth of stop-gaps, hems, and haws. Would it not have been better done, when it could have been done more quickly, in 1979-80?

Bankruptcy is an important concept here because it is through bankruptcy filings and reorganizations that common-law jurisdictions re-jigger ongoing enterprises in ways that sacrifice the value of the old equity to the owners of debt. Through that process the significance of equity as the residual bearer of risk is acknowledged, and in fact (unless the process ends in liquidation) a new group of claimants become the bearer of that residual risk, the risk of the next failure.

The role of government bail-outs outside of bankruptcy is all too often to short-circuit this healthy process, diluting our core sense of what equity is, of what ownership means in the corporate context.

And ... why? To save the assets involved, so they'll continue to be of productive use? The assets of a Chrysler (or a Lehman) don't disappear when it goes into bankruptcy. Ownership may pass, over time, to the next round of owners of equity. Or (if it is feared that some of the assets are blocks of ice on a summer day -- liable to disappear entirely unless someone inherits them immediately) ownership may pass much more quickly to new owners through an auction arranged by a bankruptcy trustee.

This, after all, is what happened to the more valuable, and 'melting,' assets of Lehman. The British bank Barclays had been unable or unwilling to come to Lehman's rescue in any alternative-to-bankruptcy arrangement, but it did buy up the choice assets almost immedisately after Lehman's actual filing. Whatever was the productive capacity of those assets: that was not lost by virtue of the bankruptcy filing.

Gravelle (following Bernanke's lead in this) says that it is too simplistic to dedicate ourselves to the proposition that failures should be allowed to fail. Her solution, and his, are "regulatory changes" that will limit the moral hazards associated with bail-outs.

At their very best, if we agree to be wildly optimistic in our assessment of the ongoing or likely regulatory changes, what they'll be able to do is give us something akin to a finctioning bankruptcy system -- a way of letting the failures fail, having the equity owners take their loss, and finding someone else to carry on with the valuable assets of the failed enterprise.  Yet that very best is, as it happens, what I proposed. If the "regulatory changes" are not to work through the reforming the bankruptcy system and facilitating its operation, they'll only be (at best) a pale duplicating of a bankruptcy system elsewhere.

And really ... why duplicate? Why not fix up the original?

Or maybe it isn't about productive use of assets. Maybe, (some of you are thinking this now, surely) the real reason the Treasury and central bank need the flexibility for bailing out 2B2Fail firms is to "avert panic." But consider that for a second ... as a matter of mass psychology, do bailouts real calm the waters?



The events of 2007-08 would seem to indicate that they do not. After all, in the spring of 2008, the authorities effectively bailed out the counterparties of Bear Stearns by arranging a shotgun marriage between Bear and JPMorgan. That doesn't seem to have had any very soothing consequences. It merely stimulated traders to look for "who's next." They settled on Lehman. So a bailout at one site generally shifts panic to another.

I have not yet encountered any point of view that would make sense out of the 2B2Fail mentality. Indeed, I'm delighted to read where Gravelle complains that "a gold standard ... does not allow flexibility to manage the economy." I'm not an unequivocal advocate of a gold standard, but that contention is surely a big point in its favor for those of us who don't believe an economy should really be "managed." With a gold standard (or any other hard money system)  central bankers cannot conjure money up out of thin air, so bail-outs are much trickier to arrange. That would suggest that there will be fewer of them, and that in many more cases failures will be allowed to fail.
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Still and all, I have not yet gotten to the core of my quarrel with Gravelle, and hers with me. I'm enjoying this so much that, frankly, I've been spinning it out. I do believe that money must be 'hardened' -- and I think that this may involve the repeal of existing U.S. legal tender laws and will surely have to involve the abolition of the Federal Reserve. Both of these ideas leave Gravelle aghast.

We will discuss some final points next week: Thursday and Friday.  See you there!

Cerberus: Woof

I'm thinking about Cerberus this morning, which is what I was also doing back in April when I wrote in an entry to this blog that Cerberus had gotten into the auto industry in a big way apparently "banking on a decoupling of auto companies with finance companies."

It didn't work all that well for them, although such decoupling as there has been, has made it less a disaster than it might have been.

Lots of people are thinking about Cerberus these days given a recent article in the Wall Street Journal, August 29, p. A!. “Investors in hedge funds run by Cerberus Capital management LP, whose audacious multi-million dollar bet on the U.S. auto industry went bust, are bolting for the door, clinching one of the highest-profile falls from grace of a superstar in the investment world.”

In that article, the WSJ said redemption demands had amounted to $5.5 billion, or 71% of assets. [A Sept. 3 correction indicates that the proper amount is $4.77 billion, or 70%. The original figure “incorrectly included additional assets belonging to Cerberus employees."]

Here are a couple of links to stories from happier days for the big multi-headed dog:

One from Paul Kedrosky, and one from TED.

And let's hear it for a guy who just likes an excuse to put up a cool picture of the mythical beast.

Ben Stein Watch: A Golden Oldie

Back to November. Let's watch the boys talk over each other.

Neil Cavuto has just said that the Fed and Treasury would have to commit $2 trillion in order to backstop the financial institutions. He was making a perfectly good point -- that once the government gets into the business of printing money to support institutions it arbitrarily deems "too big to fail," there is no end to it.

Short, of course, of learning to pull the plug and face the consequences.

Ben can't bear to hear that point explained, and his famous monotone voice manages to convey some excitement as he rises to his level best to keep Cavuto from making it.

Along the way. Ben explains as well as anyone yet has why "we need to bail out the auto companies." We need to do so, on his view, because it will be part of a "massive stimulus package." That's it. Amidst all the posturing, that seems to be all of the reasoning here. And it is germane this week, with the latest news of the Chrysler filing.

Neil's only fault here, by the way, is the reference to "Nancy Pelosi" as the one behind the bail-outs. A typical bit of buck passing, as if the guy who was chief executive last autumn had nothing to do with the bill that was drafted in his name largely by the Secretary of the Treasury he had appointed. No, of course, it was all Pelosi's doing.

Neither of the shouters covers himself with glory here. But Ben ... well, this feature of my blog is called the Ben Stein Watch for a reason.

Paradigm Global

I'm rather late to the fair with his story, but let me summarize the facts as the interested portion of the world now knows them, thanks to the estimable work of blogger John Hempton. Then I'll make a brief comment on a possible bit of political fall-out.

Paradigm Global, a fund of funds (i.e. a "feeder fund" for first-order hedge funds) is under the ownership and control of two members of the Vice President's family, his son and brother -- Hunter and James Biden.

Paradigm Global shares office space on Fifth Avenue with a hedge fund, Ponta Negra. They also used the same phone number and marketer.

This matters because on April 27, the SEC obtained a court order to freeze the assets of Ponta Negra, alleging that its founder, Franscesco Rusciano, has been misrepresenting his fund's monthly and yearly performance results.

Specifically, the SEC alleges that Rusciano claimed his fund earned total annual returns of 42.99 percent for 2007, 24.85 percent for 2008, and 6.14 percent for the first two months of 2009, whereas in fact the assets of the fund "suffered substantial trading losses in 2007, had modest profits in 2008, and again sustained losses in 2009."

Hempton, who was on the case before the SEC was (or at least before it told the rest of the world about it) has posted on his blog a marketing document for Porta Negra, that identified Citigroup as its prime broker. Hempton says, "I wrote to citigroup several times – and spoke to senior people in their government relations area and told Citigroup the entire story. I believe that Citigroup did not react appropriately to a fraud committed in their name."


A lawyer for Paradigm, Marc LoPresti, has tried to play down any connection between Paradigm (and the Bidens) on the one hand and Ponta Negra on the other, saying simply "they were subtenants." As to the common marketer, Jeff Schneider, he "did some marketing for Paradigm over the last couple of years [and] introduced us to Ponte Negra, and we had some available office space. That's 100% the extent of the relationship."

Felix Salmon was initially rather skeptical about the significance of any Ponta Negra/Biden link, calling the subtenancy a "rather tenuous" connection. But as you can see here, Salmon is no longer so skeptical, and says he is "looking into" it.

Fall-out?

A Biden family connection with a crooked hedge fund could, at the least, complicate this administration's efforts to make scape goats out of the supposedly unscrupulous hedge funds who refused to keep Chrysler out of bankruptcy by swallowing its losses as their own. That bit of scapegoating is an absurd policy anyway, and it richly deserves to be complicated.

After a brief strike

The United Auto Workers and General Motors reached an agreement Wednesday. The two day strike served like the prospect of a hanging, to focus the attention of both parties.

The gist of the agreement is this: GM wants to get out of the pension-fund management business. The UAW is willing to take over that role, given various agreements designed to smooth the transition.

The parties will create a trust, to be known as the Voluntary Employees' Beneficiary Association, or VEBA, that is expected to shift more than $50 billion worth of retiree health care obligations to the union.

From the point of view of a retiree, or a GM worker who might become a retiree at some point in the next few years, does this move in the provenance of the pension money make the stream of contracted-for payments more secure, less secure, or is it a wash? I'm not sure. It seems to me that the simply shift of the fund responsibility from one administering organization to another matters little. What matters is (a) the money coming in, (b) the money going out, and (c) the skill of the managers who handle it in the meantime.

I doubt much wil change with (c). The UAW will hire the same sort of folks to run VEBA who've beenhandling this money until now - it might even hire literally the same people to a great degree. Nor will (b) change short term. The commitments and demographics are what they are. So everything depends on (a). Will the new GM/UAW deal allow for the infusion of new cash into VEBA?

It seems to me that this is the idea, although the provisions for that infusion are rather indirect.

Wall Street loves the idea. Because it has visions of VEBA's money managers knocking at the doors of the brokerages, shouting, "puh-leeze help us make money. Puh-leez." It also has visions of Ford and newly-re-Americanized Chrysler joining the VEBA money pool too.

Come on in, the water's fine.

Oleg Deripaska

Things are rolling ahead for a deal in which Russian mogul Oleg Deripaska will buy the Canadian auto parts concern Magna International. The European Commission has approved, [why is the EC ruling on a deal involving chiefly Russian and Canadian firms? Ah, the wonders of globalization!], as have Magna's shareholders, and a Canadian court.

The deal is that Deripaska's firm, Russian Machines, will buy US$1.54 billion in Magna's stock. When the smoke clears, OD through Russian Machines and another company he controls, Stronach Trust, will control 70% of the target's voting shares.

Also, the Toronto Stock Exchange has given its approval to the issuance and listing of the new voting shares the arrangement requires.

Why should you care? Recall that this spring, when Daimler was auctioning off its Chrysler division, Magna was a serious bidder. Deripaska was already then in the market for contgrol of Magna. Although Magna didn't get Chrysler, the fact that the Deripaska deal went forward anyway does illustrate a continuing story of great significance, the consolidation of the automotive and related industries.

http://cfaille.blogspot.com/2007/05/rise-of-deripaska.html

Chrysler and its captains

The buyers and sellers first announced the Daimler/Chrysler deal in the middle of May.

It was a merry merry month, but wasn't a done deal -- there were a lot of particulars to arrange before it could close, especially the details of the financing. And the devil turned out to be in the details.

http://money.cnn.com/2007/07/25/news/international/chrysler/index.htm

Bankers announced last month the postponement of a multi-billion dollar syndicated loan integral to the closing. Daimler and Cerberus both said they were confident everything would go through in this, the third, fiscal quarter as planned. But some -- and I count myself among them -- suspected an element of whistling passed the graveyard there. I thought the deal might be in trouble, though I'm happy to say that I didn't go so far out on a limb as to say so, here or elsewhere.

The political climate also turned against private-equity in some quarters, and that stoked fears that either the buyer or the seller might want to cut and run from this highly visible example of the privatization of a formerly public enterprise.

Still ... captain, my captain ... you've brought the ship to port. It could close as early as today.

http://www.iht.com/articles/ap/2007/08/02/business/NA-FIN-US-Chrysler-Cerberus.php

There might be hope for the North American auto industry yet.

Currency and Chrysler

The senior of my two home state Senators, Christopher Dodd, has a bill pending before the U.S. Senate that would in effect declare the People's Republic of China guilty of "currency manipulation," and would demand that it be pressured into allowing convertibility and free float.

http://dodd.senate.gov/index.php?q=node/3690

The idea is this: if the yuan were made convertible and allowed to float freely, traders and investors around the world would want to hold some of their assets in yuan, or yuan-denominated assets, in preference to, say, U.S. dollars. They'd convert, the value of the yuan vis-a-vis the dollar would increase, and that would reduce the corporate advantage of buying Chinese products or raw materials or outsourcing the manufacturing work there. This (Dodd's view implies) would assist U.S. manufacturers and employees.

The new Chrysler/Chery deal is likely to add appeal to this argument. Just as Chrysler itself is "coming home" in a sense, rescued from those darned Germans, it's outsourcing assemblage to China. Like the kid who comes home from college just long enough to drop off his laundry and then is out gallivanting.

I was speaking to an authority on China's economy earlier this week. He said, "The U.S. makes a good many products, but what we make best is a virtue out of necessity." In the Bretton Woods period, 1944 - 1970, fixed exchange rates were the international norm. The value of the US dollar was pegged to gold and the value of other currencies were pegged to the dollar. That situation wasn't sustainable, and Richard Nixon famously "closed the gold window." The move was a raction to a monetary crisis, not the quasi-religious conversion to the ideal of freely-floating currencies!

Yet in the decades since, the necessity (as it was then) of letting the dollar float has become an ideal, and a central pillar of US foreign/economic policy. Everybody's currency should float freely against everybody else's! The notion that China should adhere to something analogous to the old Bretton Woods system, insofar as it can unilaterally instate it, has become a blasphemy, a manipulation.

There is also something delicious about the fact that it's Dodd, given his reputation as one of the last of the unapologetic liberals, who should pick up a Nixonian banner in this way.

Chrysler's deal

On Independence Day 2007, Chrysler – no longer a division of Daimler-Chrysler, and once again a US headquartered operation – announced a deal with a Chinese auto company -- a company that has a name that oddly echoes its own, Chery.

The is the first-ever deal in which one of the US “big three” has agreed to have a car built in China and then sold here in the U.S. Everything else has been outsourced, but the actual assembly of the cars has hitherto always been done here for sale here.

The cars that Chery builds under this deal will be compacts, sold under the “Dodge” brand, yet assembled in China.

You can look at this deal in any of a number of ways. On the one hand, you might see it as a triumph for Cerberus, the venture-capital investor that bought 80% of Chrysler in May. Cerberus made the deal with Daimler so that it could take Chrysler private (meaning that ordinary folk can't simply call up a broker and buy a piece of Chrysler through a stock exchange now). Perhaps the Chery deal is precisely the sort of move that needs to be made to save Chrysler, and the sort of deal that can't be done in the context of a publicly traded corporation, with the regulations, transparency, and the general games-playing that status can bring.

Or maybe you can look at the deal through a somewhat more jaded pair of glasses. Maybe it'll go down in history as a landmark in the rise of China and the decline of the United States as economic powers. I'll discuss that possible reading further in tomorrow's entry.

Not what I expected

I admit, recent developments in the auto industry have taken me by surprise.

As my faithful readers may remember, my working theory has been that the US domestic auto industry will integrate with -- in effect, in will become an arm of -- the petroleum industry.

The profit margin is with the blades, not with the razor that holds them. The economic significance of the razor is to lock you in to buying the blades that fit it. The economic significance of an automobile, likewise, is to lock you in to buying an endless stream of petroleum. So: why are the two industries not one already?

The reasoning still seems sound, but ... the restructuring of the domestic auto industry has been well underway all spring, and has gone in a very different direction. There's been an auction for Chrysler of late, and none of the oil companies even stepped forward as a bidder.

Why not? The puzzle, for me, is compounded somewhat when I look at their stock buybacks. They've been very aggressive in buying themselves of late. ExxonMobil has spent close to $48 billion over the last two years in buying its own stock. There are lots of reasons why companies do this. They might want to avoid dilution, they may want to discourage a proxy fight or a takeover.

But another reason a company buys its own stock is ... to have it to offer again as part of the price of an acquisition, which may be preferable to a cash-only deal.

BusinessWeek recently quoted an Oppenheimer analyst who said: "ExxonMobil could go tomorrow and buy a company for $100 billion using its own stock."

So, why not Chrysler? It may well be hoping that the big prize yet falls into its lap -- that it can offer those shares in return for control of General Motors, the (domestic) Razor king.

Or my theory about the synergy to be found in such a combination might just be wrong. That's a possibility, too.

The Rise of Deripaska

Daimler-Chrysler, the German-led automobile company that of late has come to regard its US-based Chrysler branch as dead weight, has found a buyer.

Actually, there are now three buyers bidding an at informal auction, but the most likely buyer by far is a Canadian auto parts manufacturer, Magna International.

Take that with a grain of salt, and recall for example that the last time I wrote about Chrysler here (on April 6) the favorite was Kirk Kerkorian and his company, Tracinda Corp. They seem to have faded from discussions over the last five weeks.

But assume for purposes of discussion that Magna does get Chrysler. Their bid is worth approximately $5 billion. Magna doesn't have that kind of money in its petty-cash drawer, and will likely raise some of it by selling some of its own equity. In other words, one question now is: if Magna gets Chrysler, who gets Magna?

Answer: an aluminum kingpin from Russia, Oleg Deripaska.

Deripaska is a fascinating character, who even if he does end up owning a large chunk of the company that in turn owns a controlling interest in Chrysler, won't be able to visit the Michigan offices thereof. He was stripped of his U.S. visa last year as a result of the FBI's view that he is (a) involved with organized crime and (b) was less than truthful when they asked him about it.

If what we want if for Chrysler to become and remain a sustainable, productive, even innovative car company: would the ascent of Deripaska be a good thing or a bad thing? I don't know, and I consider his difficult relations with the FBI to be a rather ambivalent bit of data for the purpose of answering that question.

Update, May 14. Oops. Shows what I know. Over the weekend, Cerberus apparently brought this auction to an end, bidding $2 billion more than had Magna.

http://www.freep.com/apps/pbcs.dll/article?AID=/20070514/BUSINESS01/70514037

Cerberus is everywhere, as I mentioned in March.

http://cfaille.blogspot.com/2007/03/not-conspiracy-theory.html

It continues to creep me out.

Chrysler, Exclusivity, and an Auction

Kirk Kerkorian has put a bid on the table. He wants to buy Chrysler from Daimler-Chrysler, for $4.5 billion. There are lots of conditions attached to that, and the most likely deal-breaker of the bunch is that he wants a two month period during which he and his investment company, Tracinda Corp., will have the exclusive right to examine Chrysler's books.

Two month exclusivity? Daimler doesn't want to 'go steady' yet. Daimler wants to flirt with a number of prospects. Or, in less romantic language: Daimler wants an auction. Other bidders or potential bidders are likely to find their interest piqued by the very public interest Kerkorian has expressed, and Daimler is best off letting them all stand on a level floor for now, which means denying KK his exclusive access.

By the way, one of those other bidders is: Cerberus. More confirmation for my quasi-conspiracy theory of Cerberus, which is simply: that hell-hound is everywhere.

Meanwhile, over at Deal Journal, Dennis Burnham is having some fun translating Kerkorian speak into English. He's posted a two-part series on this, here's the URL for the first of those parts.

http://blogs.wsj.com/deals/2007/04/05/translating-kerkorians-chrysler-letter/

And, if you don't want to read through it but would like a bit of the flavor, you're at the right place already. KK -- trying to boost his own cred, wrote, "Tracinda has been the controlling shareholder of MGM Mirage (originally MGM Grand) for twenty years–having built it into a public company with a market capitalization of nearly $21 billion today." Burnham translates: "Dr. Z, do you like craps? I can hook you up at a nice table."

Yuck yuck.

Not A Conspiracy Theory

Indeed, I don't plan in this post to offer a "theory" of any sort, not even the most tentative of hypotheses.

What I will do, though, is confess that a certain fact pattern creeps me out. And that if I weren't the level-headed fellow that I am, I would probably spin a conspiracy theory around it. It would be something of a novelty too, because this particular pattern has so far escaped the net of most such theorists.

Which brings us at last to the point: Cerberus is everywhere. I don't mean the multi-headed hellhound. http://www.steliart.com/hercules_capture_of_cerberus.htm

I mean the global-investment company associated with former vice president Dan Quayle. Could it be that Quayle wasn't as dumb as we thought in the days when he couldn't moderate a spelling bee properly?

Cerberus is everywhere, just behind the headlines. Refco, once a very prominent commodities futures trading concern, melted down in 2005. The bankruptcy court auctioned off its assets, and Cerberus was in the thick of that.

http://users2.wsj.com/lmda/do/checkLogin?mg=evo-wsj&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB113176036686295540.html%3Fmod%3Drss_whats_news_us_business

The Austrian bank, Bawag -- that country's fourth largest -- runs into trouble (due to its own entanglement with Refco), and Cerberus steps in to pick up the pieces.
http://www.reuters.com/article/idUSL1475757320061214

The logging and paper industries are going through a period of consolidation. Cerberus is in the thick of that.

Finally, only because accumulating more examples would be too easy: Daimler is looking to unload its American operation, Chrysler. It looks for buyers and guess who surfaces? Yes, the hell hound.

http://money.cnn.com/news/newsfeeds/articles/newstex/AFX-0013-14981488.htm

So Cerberus is a large successful company, and Quayle has found himself a job. What is there especially that bothers me? Well ... chiefly that Cerberus seems to be always just behind the headlines, and also that it seems to be always just behind the headlines. It has managed to intrude itself into innumerable high-profile goings on, while staying remarkably low profile itself.

That just makes me go hmmmm.