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!

Resolutions

Last year my New Year's Resolutions were straightforward. I have achieved four out of five of them.

1. I promised to take good care of my car. Well, I did, although the "car" involved in that resolution changed through no fault of my own!  An idiot ran a red light in February and ruined my old Toyota.  But it was in great shape right up to that moment, and I've done a fine job thus far with its replacement.

2. Keep up with the insurance on car.  Done. 

3. Venture outside of the borders of the U.S. Oops. Never got that done in 2011.  I did get as far as Bretton Woods, New Hampshire, though. 

4. Make progress toward the publication of another book.  This, I've accomplished. I've accepted the fact that the publication of this book will have to be self-financed, but that is more of an observation on the state of the commercial publishing world today than on the merits of my book. At any rate, I've come to a point where the wording of the corresponding resolution for next year will be unconditional.

5. Keep track of Nassar Saber.  Done.  He is still writing about how he is working on his next book.  Maybe 2012 will be the year it actually comes out.  But I've decided not to include such tracking on my next list.

This year....

1. Get my car ("Doug") through December 2012 in good working order

2. Make an entrepreneurial investment. Shouldn't just talk a good game on the anarcho-cap stuff.

3. Regarding technology: enter the 21st century.  For example, get audio back for my computer. Get Skype capacity for it. Learn how to use -- heck, become comfortable using -- my scanner.

4.  Publish GWBCs and sell at least 1,000 copies.

5. Venture outside the borders of the U.S.

So I don't have to read the book

I don't plan to read Rattner's recent book on the auto industry bailout and restructuring.

I feel a bit guilty about not reading it. On the basis of its topic and the author's point of view thereof, it surely seems like the sort of thing I should read, to help preserve my own econoblogger cred.

Rattner, you'll all remember, was chosen in the opening days of the Obama administration to superintend the federal restructuring of both General Motors and Chrysler, and this book is his account of his work at that task.

Rattner also got himself into some hot water in a pay-to-play scheme involving New York State's pension funds, but I don't imagine that scandal figures prominently in the book, OVERHAUL.

Anyway, to ease the aforesaid pangs of guilt, I've read Malcolm Gladwell's detailed review of OVERHAUL in The New Yorker, as well as Felix Salmon's reply to Gladwell in Salmon's Reuters-sponsored blog.

Okay, those pangs were never very sharp....

Toyota's electronics

I imagine that there are different possible ways of transliterating Japanese characters into the Western alphabet, and that at some point in recent history the "Toyoda" family went one way while the company that shares their name, "Toyota," went the other. Here's what a blogger says, but of course you will take it with the proverbial grain of salt.

At any rate, the testimony of Akio Toyodo, and of other high-ranking Toyota execs, was the center ring of yesterday's Congressional circus. This isn't a policy inquiry: more like a public shaming.

I have to say that, in accord with some of the members of the House committee involved, I have some curiosity as to whether this is a software problem. Toyota seems convinced it is a mechanical matter -- sticky gas pedals and so forth. But there is a lot of software involved in cars nowadays, and in particular there is a lot involved in the act of braking a hybrid.

There is (a) the software that does the pumping for you, making for anti-lock brakes, and (b) the software involved in converting the energy exerted in braking into electrical energy, thus re-charging the batteries, and (c) the software involved in the anti-slip. I suspect it is possible that these systems are interacting in some unexpected way in the few cases that have caused all the furor.

Top Financial Stories 2009

I generally ask myself at this time of year what were the biggest stories of the past twelve months, in business/financial news.

By "stories," I don't mean themes, such as "Doubts about efficacy of SEC regulation" or "US/EU relations." I mean stories, such as one might have seen in a particular newspaper on some specific day. Of course, I choose the ones I do largely because they illustrate an important theme. But the theme itself isn't the story.

Further, I don't rank them, as in a top ten list. For the first couple of years that I did this I simply gave one "top" story from each of the twelve months of the year now ending. Last year was so wild, especially in its second half that I couldn't stick to the one-a-month presentation. I ended up with a list of 18 big stories, two per month starting with July.

This year, for the sake of balance I suppose, I have produced another list of 18 stories, twice a month this time for the first six months, then just one a month from July.

All that understood: Here we go! The list is dominated this year by a meta-theme. We might call it: the triumph of experience over hope.

January. (a) The inauguration of a new President of the United States, and Barack Obama's choice of Timothy Geithner to head Treasury. Geithner's presence in the new administration is not a sign of change, but one of continuity. During most of the Bush years, Geithner was the very visible President of the Federal Reserve Bank of New York.

(b) Financial crisis in Iceland brings street protests, shake-up in government there. Iceland, on the one hand, has long been a free market economy, with taxes lower than those of most other OECD countries. On the other hand, it has maintained a Nordic welfare system, including universal health care and post-secondary education. Whatever may be true of Las Vegas: what happens in Iceland, is widely watched elsewhere.

February. (a) Obama signs the stimulus act, a/k/a the American Recovery and Reinvestment Act (ARRA). The full title seems better to convey the almost cartoonish Keynesianism involved: "An act making supplemental appropriations for job preservation and creation, infrastructure investment, energy efficiency and science, assistance to the unemployed, and State and local fiscal stabilization, for the fiscal year ending September 30, 2009, and for other purposes."

(b) Zimbabwe asks African states for $2 billion in aid -- Mugabe vows to continue brilliant policies. I'll simply offer a link here.

March. (a) Bernie Madoff pleads guilty without a plea deal, claims to have acted alone. Of course, he did not act alone, but by taking the fall and keeping mum on confederates, he appears to have earned some necessary prison cred.

(b) UK Financial Services Authority adopts new rules on derivatives. In London as in Washington, complicated and insufficiently regulated derivatives are widely blamed for the crisis of 2008. That diagnosis is jejune, but is to be expected. The particular derivatives that draw fire in the UK are known as "contracts for difference."

April. (a) Dow Chemical finally closes on its Rohm & Haas deal. The idea of this merger was to craete a "leading specialty chemicals and advanced materials company." Its logic would have been more powerful, and the deal would have gone through smoothly, had the timing been a bit better.

(b) Chrysler files for bankruptcy This is the first of three headline events on our list of 18 that may stand in for a single momentous theme -- the frog-marched restructuring of the US automotive industry in general. And we won't bother listing separately that GM too passed through a bankruptcy court proceeding.

May. (a) China-Brazil oil/loan deal The Brazilian oil company Petrobras finalized a deal with the People's Republic of China. Petrobras got a (US)$10 billion loan and PRC got a long-term supply of 'black gold.' This is a straw in a lot of different winds -- the rise of China to global prominence on the back of its huge dollar reserves is one of them.

(b) Obama announces new CAFE/ emissions standards. This is our second auto industry headline of the year. The program is projected to reduce oil consumption over the period from the 2012 to the 2016 model years by approximately 1.8 billion barrels. (As you probably would expect, dear reader, I think such projections warrant skepticism.)

June. (a)US Supreme Court decides Traveler's Indemnity v. Bailey. Asbestos is one of the big "mass tort" issues that have rocked our civil legal system in recent decades. Travelers thought it had a deal that limited its exposure via a settlement trust established by order of the federal district court in Manhattan back in 1986. Unfortunately for them, state law claims and "collateral attacks" made that trickier than they had expected.

(b) Elections to Euro parliament strengthen the center-right parties. For purposes of the italicized statement, anyway, we may understand the term "right" to mean the group of parties or factions that are suspicious about the role of the Parliament they are joining, either on behalf of separate sovereign nationalisms or on behalf of EU-regulated global commercial concerns or both. The "left," which lost this round, consists of those that see a need for a more activist EU.

From here on we are presenting just one headline per month.

July. Cash-for-clunkers program in the US. This is our final US-auto-industry headline. There was always an ambiguity to the plan. Was it designed chiefly to stimulate the auto industry, or to improve fuel efficiency? The goals aren't obviously in harmony. Still, any critique of its efficacy in one respect could be deflected by pointing to the other.

August. Settlement of US/Swiss Dispute over UBS Confidential Client Information. The relationship between Switzerland and the US seems to have grown closer in a number of respects over the last year.

September. Target Corp. declassifies its board Reform has come to the field of corporate governance, though what over-all impact such reforms may end up having it is hard to say.

October. Ireland votes in favor of Lisbon Treaty, effectively secures the new continent-wide government It is difficult to tell where Europe is headed. The Lisbon Treaty would certainly seem to be a step toward closer political integration. But the European Parliamentary elections, as noted above, were won by parties skeptical thereof, and there are a lot of centrifugal forces at work.

November. What is patentable? SCOTUS hears arguments. My own expectation is as follows: (a) the Justices will uphold the court below in its finding that Bilski's 'process' is really an abstract idea and thus not patentable; and (b) they will work harder than the court did below in order to define what is or isn't an abstract idea.

December. Two crucial bills advance through the Houses of the US Congress -- the health care reforms and the financial-regulatory system overhaul.
It seems very likely that something will be enacted into law in both of these areas sometime early next year. But I could be wrong even about that.

Thinking about Cerberus

Cerberus, the private equity group, bought Chrysler from Daimler in 2007.

I've been thinking of that deal anew in recent weeks with the continued disintegration of the US auto industry.

Here's a fascinating blog entry written by someone else who has obviously also been giving it some thought Robert Farago.

Farago's unnamed source says that he thinks Cerberus was really hoping to merge Chrysler's finance company with GMAC, thereby creating a massive auto lender which it could sell to a big bank. Given that plan, the Cerbereans had to keep the auto company alive in order to preserve the real prize, that finance company.

There is some plausibility to that, and I'm beginning to understand the flaw in some of my own earlier theorizing about the future of the auto industry. I've been focusing on the auto/petroleum connection, or lack thereof. I've long thought it would be natural for Exxon/Mobil to buy an auto company, for the same reason that hot dogs and relish are generally sold by the same vendor. Exxon/Mobil could afford the losses at the showroom, just as Gillette sells its razors for a loss -- it does so because it makes a profit from the stream of blades that the customer who buys the cheap razor is thereafter committed to buy.

I now see that neither analogy really works. The hot-dogs-and-relish combo is only natural because at appropriate events we want to buy them at the same time. We want the hot dog, and just enough of a condiment to go with the dog. But of course if we're buying condiments for use at home, we'll go to a grocery store not a ballpark, and there is no great tendency toward consolidation of the relish and hot dog companies who supply such stores.

The lose-on-razors-to-profit-on-blades trick only works for Gillette because its blades are specially designed to fit its razors. So do those of Schick. Were blades fungible (as if petroleum) that model would break down.

Autos and auto finance is a natural combination for the same reason that hot dogs and relish are. The need is simultaneous. The car dealership is the ball park. I want to get the loan to spread over my new car.

What Farago is suggesting, though, is that Cerberus was banking on a decoupling of auto companies with finance comapnies. A GMAC/ChryslerFin combination would presumably be a company interested in financing anybody's car.

That doesn't seem to have worked out all that well for them.

So what lesson might I draw here? Perhaps that though the times through which we are passing are difficult, they aren't revolutionary. What has been bundled will stay bundled (cars and their finance companies, blades and their razors) and what has been separate (car and petroleum companies) will remain asunder.

Lending out the TARP funds

So ... what should banks do with their TARP funds -- the money Uncle Sam has given them under the bail-out program Congress enacted in September?

Given them to their top executives? Good idea. "Job well done guys, you led your company into so much trouble that the feds had to give you money. Here's your personal chunk!"

Let's assume, just for giggles, that some of it won't simply be divvied up among the honchos in charge as takehome. What should they do with the rest? Lend it out to the buyers of homes or of cars and large appliances? lend it out to businesses and entrepreneurs for start-up ventures or expansions?

Or just sit on it and call it a capital reserve? There has been some sentiment that larger capital reserves are good. If the balance sheet looks better, that fact might increase the confidence of bank counter-parties, hastening a return to normalcy.

Frankly, it seems to me that the argument gives much too much importance to cosmetics.

Banks can only be self-sustaining private corporations, then can only cease to be wards of the state, if they get themselves back in the loan-extending business.

Does this mean government should use its new leverage as the provider of the capital infusion to order them to make loans? Heaven forbid! Japan's policy of directed credit, once seen as part of the "Japan Inc." juggarnaut, is now regarded by almost all who've studied it as a colossal failure. South Korea's efforts at directing credit have likewise amounted to waste and the promotion of stagnation.

So, you might ask: what should be done? If banks aren't lending out the money, and should be lending out the money, then how can they be induced to do so?

IMHO, the down side of the housing cycle simply has to play itself out. There won't be any lending activity in that particular field for awhile. A burnt cat doesn't get right back on the stove.

The automobile market is a different matter. If banks were convinced that there was once again a basis for a sound US auto industry, they would resume lending both to that industry, to its accessories (auto parts and the like), AND to their customers for the purpose of buying their products. So the solution to the question: what to do about the banks? depends in large part upon the answer to the question: what to do about automobiles?

And the answer to that is: consolidation. It appears that in the world market and given locked-in cost considerations such as pension commitments, there is only room for one domestic US automobile manufacturer. The government may have a positive role to play (I seldom type those nine words): enter into negotiations and facilitate a merger of the three battered and torn-up US auto makers. They can, together, constitute ONE decent productive auto maker.

That one in turn will enliven the ancillary industries, and together they'll give the banks some one to whom to make loans again.

Jerry Flint

Jerry Flint is a columnist for Forbes, who wrote a wonderful piece there this week called, simply: Quackery.

His subject, General Motors, a company with a long history of "resorting to gimmicks to resolve labor issues or just to get out of a sticky spot."

He gives two cases in point: one from the company's recent past, the other from its VERY recent past (one might say, from its specious present).

1) A few years back, GM decided that it was paying too much money to those of its workers who, in its Delphi subsidiary, made various auto parts: its power trains, its HVAC, etc.

It 'solved' this problem by spinning off the subsidiary -- making Delphi a theoretically separate company. But to avoid trouble with the union for this bit of domestic outsourcing, it had to give Delphi various guarantees. The guarantees have undermined the reason for the spin off, and as Flinto says GM has since given billions to those same workers. The whole notion of a spinoff was a gimmick, a bit of quackery.

2) The present. Late last month, GM settled with the auto workers union after a brief strike. The stickiest issue was health care for retirees.

The solution was the creation of a health care trust, funded by the auto companies but managed by the union. I've discussed this before, and expressed some of the same skepticism that Flinto expresses here, although he is more forceful on the subject than I was: http://cfaille.blogspot.com/2007/09/after-brief-strike.html

Says Flint, "It doesn't reduce any costs. The health care bill would remain the same" and although that eliminates the medical liability from the balance sheet, "What difference will that make if GM fails to make sexier cars?"

Precious little, surely.

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.

Auto Parts, and the Whole Auto, Too

Don't lets all panic. People paying too much attention to biz news lately may feel a bit frazzled, but that means this is a time to look for signs of hope.

There may be such signs, even in the fractured North American auto industry. Here are three:

1. The auto parts company, Dana Corp., which filed for bankruptcy in March 2006, says it plans to exit bankruptcy by the end of this year.

That isn't just an optimistic rosy-tinted sayso, either. Dana's reorganization plan has been picking up some support. The company's bondholders formally approved it earlier this week.

2. Ford Motor Company has set a new land speed record. Its Ford Fusion Hydrogen 999 reached 207.28 miles per hour on the Bonneville Salt Flats. The reports I've seen aren't clear about the date, but it appears to be something of a breakthrough for the fuel cell technology involved.

http://www.autocar.co.uk/News/NewsArticle/Ford-Concepts/227307/

3. GM, too, is making a "green push" and seems ready to show off the results at the upcoming auto show in Frankfurt, Germany.

http://www.autobloggreen.com/2007/08/16/frankfurt-preview-lots-of-debuts-and-a-green-push-for-gm/

So ... think good thoughts!

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.

Ford's Euro-Luxury Brands

Lest we forget ... Ford Motor Co., aspiring to go upscale, bought Swedish car maker Volvo in February 1999. That was no impulse bet, either. Ford paid $6.45 billion. For purposes of comparison, Ford's profits from the preceding year, 1998, had been all of ... $6.57 billion. So the company spent nearly the whole of what it had just made just to get Volvo, such was the appeal of the brand name.

In 2001, still following that same aspiration, it folded Volvo into its newly formed "Premier Automotive Group" with two other Euro-luxury brands, Jaguar and Land Rover.

Scratch that business plan! At least two of those brands are now on the auction block. It expects to get up to $8 billion for the two UK-based operations. This would get it back about 2/3ds of what it lost in 2006.

http://www.ecanadanow.com/news/business/ford-to-sell-jaguar-and-land-rover-20070719.html

It's possible that all of them are actually on the block: there are persistent rumors that FMC is interested in selling Volvo as well -- though the company denies them.

Is this the sound of a company, and an industry, marching bravely toward extinction? Or is it just me? At the minimum the whole 'Premier Group' thing is a failed experiment, now written off. But that experiment was in itself a bit of a last-gasp.

One Million

Toyota recently announced that it's passed the 1 million mark in the sale of hybrid vehicles worldwide.

Such nice big round numbers sometimes have psychological significance, and perhaps this marks a threshold, where the hybrid is no longer an innovation, but a normal part of the auto markets.

Of course, Toyota is no longer alone in bringing them to us, although Detroit still seems rather clumsy in this matter. The real challenge to Toyota in the hybrid end of the market is from another japanese giant, Honda. Here's the URL for an enthusiastic assessment (by a Brit, Steve Nelson) of the latest from Honda.

http://www.yorkpress.co.uk/display.var.1543980.0.0.php

And here's a discussion of the differences between the two Japanese corporation's approaches in this area.

http://www.vicnews.com/portals-code/list.cgi?paper=36&cat=46&id=1021078&more=0

To my tastes, frankly, that second article, from a paper in British Columbia, Canada, sounds a bit too patly partisan, as if the reporter was simply putting his own name to a Honda hand-out. Still, I'm in no position out of my own technological ignorance to argue with it.

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.

GM Decides What is "Core"

Yesterday, General Motors announced that it's selling Allison Transmissions to a pair of private-equity firms, for about $5.6 billion.

GM's stock price rose for the day, and one can take that as a "yes" vote in the ongoing referendum about corporate policies on Wall Street.

Still,it raises a puzzle. The spinners are portraying this as a case of a company selling off a "non-core" asset to raise some cash so it can better fix what ails its core.

But since when is the manufacture of transmissions non-core? What is the core? The assembly of automotive parts into a whole and their marketing and sale, presumably.

Isn't there something to be said for the view, though, that if the same company makes the transmissions, and then makes the cars, installing its own transmissions, there is an efficiency gain, because that company doesn't need to haggle with itself over transmission prices?

I suppose GM executives might well say, "yes, there is some gain in efficiency there, but the present discounted value of that gain is a good deal less than the $5.6 billion pricetag we've put on it." Maybe. The language of "core" versus "non-core" doesn't illuminate that question, though.

An old story about eating one's seed corn comes to mind, rather.

Do janitors clean out the GM executives' offices at night? Is that service contracted out to a separate operation, or are those janitors employees of GM? If the service isn't contracted out, should it be? The question of the boundaries of a firm, what it makes sense to keep within the hierarchical structure, what it makes sense to outsource, and why, is a complicated one, raised in clear theoretical form by Ronald Coase as long ago as 1937, in a fascinating essay, one that stills stands up to scrutiny today.

Auto Insurance Premiums

Peter Brink, writing in TheStreet.com yesterday, said that auto insurance premiums are falling. Why would that happen? Aren't auto insurance companies greedy bastards? as much so as any other capitalists?

Brink attributes the decline to the fact that vehicles are safer now than they were 10 years ago. http://www.thestreet.com/funds/ratings/10359691.html?puc=googlefi But, we might ask him: so what? If a business can keep selling its product for the same amount of money even though its costs are dropping, why wouldn't/shouldn't it? It's called profit maximization, isn't it?

Yes. For the sake of clarity, we ought to think this through a bit further. Suppose two brothers, Frick and Frack, have founded two insurance companies. Each has specialized in the field he thinks likely to be most lucrative. Frick sells auto insurance. Frack sells flood insurance. Suppose, now that both lines of business prove to be equally profitable. There is no incentive for either to change his business model, because each is doing as well as the other. What might change this nice equilibrium?

A sharp drop in auto claims, due to increasingly safe models of car over ten years, might change it. Frick continues to charge premiums at the price the market will bear. Since he pays out less money, his profit of course increases. This means he's doing better than Frack now. Some of the Fracks in the world will become dissatisfied with this situation, and will move into auto insurance themselves. The increasing competition (in the absence of prohibitive barriers to entry) will lead to lower rates after all.

That's how its been written up in books at least since Alfred Marshall's day. And that is what seems to be underway.

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.

Auto Statistic

According to the U.S. Department of Transportation, there were more than 243 million passenger vehicles registered in the United States as of 3 years ago.

According to the census figures for the same year, 2004, there were just over 293 million people in the nation. At least twenty percent of that population is too young to drive. So there were more cars than there are human beings of driving age. And 13 million more cars than licensed drivers.

These figures testify to the success of the US auto industry over a period of decades in persuading us that everybody needs a car. Also, they've been tremendously successful in persuading us that most of us need a new one. Those aren't the same cars, in this 1:1 ratio to population, year after year. There are always new models, always new gizmos.

Yet, looking at the numbers, I for one can hardly avoid the guess that some of the trouble of the domestic US auto industry is simple saturation.

The Shanghai Auto Show

The Shanghai Auuto Show opens this Sunday, and runs through April 28.

Shanghai is important to carmakers because they realize that the Chinese consumer market has outlived its bicycles. There are lots of Chinese with the money and the desire to buy cars.

The auto show is using the motto, 'Technology and Nature in Harmony.'

General Motors, Toyota, Mercedes-Benz, BMW and Ford will offer their battery-powered and hybrid models in accord with that theme. But its Volkswagen that seems to be going all out presenting a wide range of cars with what it calls "vanguard" technology. It says the gas consumption and emissions from VWs sold in China will decline by more than 20% by 2010.

Let a thousand flowers bloom.

(Did I just quote Mao Zedong?)