Topic: Finance, Banking & Monetary Policy

The Corporate Culture at Government Motors

David Brooks comes in for his share of criticism in these parts, but he has a very astute column today about the ways that government ownership will worsen an already problematic corporate culture at a once-great company:

Fifth, G.M.’s executives and unions now have an incentive to see Washington as a prime revenue center. Already, the union has successfully lobbied to move production centers back from overseas. Already, the company has successfully sought to restrict the import of cars that might compete with G.M. brands. In the years ahead, G.M.’s management will have a strong incentive to spend time in Washington, urging the company’s owner, the federal government, to issue laws to help it against Ford and Honda.

Sixth, the new plan will create an ever-thickening set of relationships between G.M.’s new owners — in government, management and unions. These thickening bonds between public and private bureaucrats will fundamentally alter the corporate culture, and not for the better. Members of Congress are also getting more involved in the company they own, and will have their own quaint impact.

The end result is that G.M. will not become more like successful car companies. It will become less like them.

Marginal Tax on Corporate Profits was 74.2% in the 1st Quarter

From the Bureau of Economic Analysis news release of May 29:

Profits from current production (corporate profits with inventory valuation and capital consumption adjustments) increased $42.6 billion in the first quarter… Taxes on corporate income increased $31.6 billion… [therefore] profits after tax … increased $11.1 billion.

In other words, taxes extracted 74.2% of any added (marginal) corporate earnings, leaving only scraps for stockholder.

Companies that lost money, on the other hand, were often bailed out and/or nationalized.

Why bother even trying to maximize profits or minimize losses?

Tough Words

In the Wall Street Journal, Mary Anastasia O’Grady got Dallas Fed president Richard Fisher to go on the record about current Fed policy. He talks tough about inflation. “Throughout history, what the political class has done is they have turned to the central bank to print their way out of an unfunded liability. We can’t let that happen.”

What is lacking is a plan to match the tough words with tough actions. Only when a tough and resolute U.S. president, Ronald Reagan, was matched with a tough and resolute Fed Chairman, Paul Volcker, did the Fed turn into an effective inflation fighter. There is no such match up now in the face of trillion dollar deficits forecast with no end in sight.

Ms. O’Grady describes Fisher as “the lead inflation worrywart” on the Federal Open Market Committee of the Fed. But Fed officials do not act in a political vacuum, and regional Fed presidents cannot on their own stop the Fed’s printing money in the face of the deficits. That requires leadership at the top from both the Fed chairman and the U.S president.

The Administration’s plan appears to be “to print their way out of an unfunded liability.” Thus far, despite tough words from some quarters, the Fed seems ready to accommodate “the political class.”

“They Don’t Have the Money to Pay Us Back”

When they let their guard down, politians can say the most revealing things.  In today’s Wall Street Journal, representatives of local governments in California attacked Governor Schwarnenegger’s plan to borrow $2 billion from local property tax revenues to cover some of the state’s budget shortfalls.  In response, Don Knabe, chairman of the Los Angeles County Board of Supervisiors said, “They’re hijacking our dollars.  They don’t have the money to pay us back.  It’s a joke.” 

Given that California doesn’t have the money to pay back borrowing from its local government, it’s likely they might not be able to pay back borrowing from private investors either.  To solve this problem, we have the Municipal Bond Insurance Enhancement Act, on which the House Financial Services Committee held a hearing this week.  To encourage investors to buy California’s risky debt, the federal government would cover any losses to the investor.  We’re told that the federal government would charge bond-issuing governments insurance premiums to cover any losses, but the federal government’s history of setting rates based on politics rather than risk (have you looked at the health of the National Flood Insurance Program lately?) guarantees that the taxpayer would likely have to cover billions in losses on any guarantee of California’s debt.

Who’s Going to Buy Your Debt, Mr. President?

The administration’s presumption that America can borrow its way to prosperity has taken a couple of big hits over the last couple days.

First, just as the Third World debt crisis destroyed the belief among international bankers that countries don’t go bankrupt, so is the West’s borrowing binge ending the belief among international investors that the U.S. and other Western nations are safe economic bets.

Reports the Wall Street Journal:

Britain was warned by Standard & Poor’s Ratings Service that it may lose its coveted triple-A credit rating, triggering a drop in U.K. bonds and sparking global fears about the consequences of massive debts being incurred by the U.S. and other major nations as they try to dig out from the economic crisis.

The announcement quickly sent waves across the Atlantic. Investors initially dumped U.K. bonds and the pound, heading for the relative safety of U.S. Treasurys. But within hours, worries about an onslaught of new U.S. bond sales and the security of America’s own triple-A rating drove down the prices of U.S. Treasurys.

The yield of the benchmark U.S. 10-year bond, which moves in the opposite direction to the price, rose by 0.15 percentage point from Wednesday to 3.355%, its highest level in six months.

The relative gloom about the U.K. and the U.S. was apparent Thursday in the market for credit-default swaps, where investors can buy and sell insurance against sovereign defaults. Five years of insurance on $10 million in U.K. debt jumped to around $81,000 a year, from $72,000 earlier in the day. U.S. debt insurance cost the equivalent of $37,500 — in the same range as France at $38,000, and Germany at $35,000.

A shot across the bow of the American ship of state, some analysts have called it.

But shots also were being fired from another direction:  East Asia.  The Chinese are starting to have doubts about Uncle Sam’s creditworthiness.  Reports the New York Times:

Leaders in both Washington and Beijing have been fretting openly about the mutual dependence — some would say codependence — created by China’s vast holdings of United States bonds. But beyond the talk, the relationship is already changing with surprising speed.

China is growing more picky about which American debt it is willing to finance, and is changing laws to make it easier for Chinese companies to invest abroad the billions of dollars they take in each year by exporting to America. For its part, the United States is becoming relatively less dependent on Chinese financing.

Financial statistics released by both countries in recent days show that China paradoxically stepped up its lending to the American government over the winter even as it virtually stopped putting fresh money into dollars.

This combination is possible because China has been exchanging one dollar-denominated asset for another — selling the debt of government-sponsored enterprises like Fannie Mae and Freddie Mac in a hurry to buy Treasuries. While this has been clear for months, new data shows that China is also trading long-term Treasuries for short-term notes, highlighting Beijing’s concerns that inflation will erode the dollar’s value in the long run as America amasses record debt.

The national debt is over $11 trillion.  This year’s deficit will run nearly $2 trillion.  Next year the deficit is projected to be $1.2 trillion, but it undoubtedly will run more.  The administration projects an extra $10 trillion in red ink over the coming decade.

Fannie Mae and Freddie Mac need more money.  The Pension Benefit Guaranty Corporation is in trouble.  The FDIC will need more cash to clean up failed banks.  The effectively nationalized auto companies will soak up more funds.  Then there’s the more than $70 trillion in unfunded Social Security and Medicare liabilities.

But don’t worry, be happy!

Bailout Nation

The four top business headlines in the Washington Post the other day were:

More Homeowners Getting Aid, but Demand Keeps Rising

AIG Could Repay U.S. in 3 to 5 Years, Chief Tells Congress

Treasury Clarifying Rules for Bailed-Out Firms

Small Auto Suppliers Seek Help in Wake of Giants’ Woes

It’s certainly true, as BBC and other journalists have noted, that the center of American business and finance is now Washington, not New York.  The headlines above (in the paper edition, but some of them can be found here) indicate that all sorts of businesses and individuals are looking to the Obama administration for bailouts and loans and “capital injections.” And one could find similar stories about federal money for states, cities, big insurance companies, and more. Money and credit were once allocated by owners of capital, who stood to gain or lose on the strength of their decisions. Now capital is being allocated by politicians and bureaucrats, who have none of their own money at risk and who may well see their own power enhanced by an economy that remains slow.

Back in September, as the bailout of Fannie Mae and Freddie Mac ushered in a new era of federal help for failing companies, I wrote a blog post titled “Bailout Nation.” I didn’t know the half of it; still to come were the AIG bailout, TARP, federal subsidies to banks and automobile companies, and more. But I warned then:

Capitalism is a system of profit and loss. It works because each person and each company, in seeking its own interest, is led “as if by an invisible hand” to supply goods and services that others want. Companies that satisfy consumers prosper. Companies that can’t produce goods that consumers want–like Chrysler, repeatedly–suffer and sometimes go out of business. The failures are often painful. But as Dwight Lee and Richard McKenzie wrote in their book Failure and Progress (or at least in this column based on the book), “Economic failure is to the economy what physical pain is to the body. No one enjoys pain, but without it the body would lack the information needed to maintain its health.” Government subsidies to prevent business failure simply keep pouring money into businesses that are relatively unsuccessful at satisfying consumer desires. They are, among other things, censorship of vitally needed information. Employees, entrepreneurs, and investors need to know where their money and talent are most valuable. Profits and losses are key indicators of that.

Turns out that David Ignatius had warned of a “Bailout Nation” in a column a few months before that:

As every parent knows, the danger of cutting a special break for one child is that all the other children will demand the same thing. “It’s not fair,” goes the inevitable refrain. “You said Susie could eat ice cream and watch TV until midnight, so why can’t I?” The parents start caving, and family discipline is shot.

We’re now in a comparable cycle of bestowing special economic favors on members of the national family who have been hurt by the credit market crisis. “It’s not fair,” argue the housing interests and consumer advocacy groups. “Bear Stearns got a financial bailout, so why shouldn’t we?” And they’re right, by the simplest schoolyard definition of fairness.

So the line grows of people demanding breaks on financial obligations they can’t afford.

Neither of us is very happy about being so prescient. And what no one seems to discuss is, Where is all this bailout money coming from? Much of it is just being created on the balance sheets of the Federal Reserve, which portends rising inflation. Certainly it’s too much to be paid for in taxes, even in the fondest dreams of Barack Obama and Nancy Pelosi.  Is Bernie Madoff advising the Treasury these days?

How much money is it? CNNMoney estimates that the federal government has now committed $10.5 trillion. Christopher Barker at the Motley Fool concludes that ”the combined total of existing, announced, and potential outlays from the Federal Reserve and U.S. government agencies that are directly attributable to the financial crisis will breach $13 trillion!”

This is nuts. Would Paulson and Bernanke have acted differently last April if they’d known where we would be in a year? They’d have known if they’d read David Ignatius’s column. Or if they’d read some history; when governments start handing out money to troubled institutions, there will be no limit to the number of troubled institutions. And in barely a year, you get small auto parts companies coming to Washington saying that if automakers and large suppliers are getting government help, they should too. President Bush and his Treasury secretary started this process, but Obama and the Democrats own it now. Do they have a plan that doesn’t end in inflation and bankruptcy?

Congress “Helps” Credit Card Customers

One of the best laugh lines always has been “I’m from the government and I’m here to help you.”  Certainly that’s true when it comes to consumer protection.

In the name of saving customers from the evil, rapacious credit card companies Congress plans on limiting access to credit.  It also is working to hike costs for people with good credit.

Reports the New York Times:

Now Congress is moving to limit the penalties on riskier borrowers, who have become a prime source of billions of dollars in fee revenue for the industry. And to make up for lost income, the card companies are going after those people with sterling credit.

Banks are expected to look at reviving annual fees, curtailing cash-back and other rewards programs and charging interest immediately on a purchase instead of allowing a grace period of weeks, according to bank officials and trade groups.

“It will be a different business,” said Edward L. Yingling, the chief executive of the American Bankers Association, which has been lobbying Congress for more lenient legislation on behalf of the nation’s biggest banks. “Those that manage their credit well will in some degree subsidize those that have credit problems.”

This makes a lot of sense.  We’re worried about bad debt, bad mortgages, and bad loans.  So Congress is going to penalize people with good credit who carefully manage their financial affairs.  Of course!

It has long been evident that Congress has the reverse Midas touch.  Everything congressmen touch turns to, well, this is a family-oriented blog.  You can fill in the blank.

If Congress wants to help consumers, the best thing it could do is take an extended recess.