TED Spread Narrows, But Not Enough

We are making progress, but this spread needs to shrink another 100 basis points to return to where it was before credit markets started to tank in August 2007. With three-month Treasuries yielding close to zero, this remains an elusive target.

Sales of USED Cars Are No Better

With new-car sales dropping dramatically, we are left to wonder if value-conscious consumers are migrating in greater numbers to the used-car market instead. Not so, according to the chart above, which shows that the supply of used cars is outstripping demand. Wholesale used-vehicle prices fell by over 11% just in the two-month period from September 1 to October 31, as unit sales plunged by 16.5% in September and another 19.7% in October (source: Manheim Consulting).

The number of used cars sold annually in the U.S. far exceeds the number of new cars. In 2007 41.4 million used vehicles (passenger cars and light trucks) were sold, triple the number of new vehicles (13.7 million). So weakness in the used-car market is a good indicator of how the average American consumer is struggling. It is expected that in 2008 1.6 million repossessed vehicles will be added to the inventory of used cars for sale.

Defaults on auto loans will likely increase in 2009, as declining used-car prices make it more difficult for distressed borrowers to extricate themselves. For them, the most economic course of action comes to suspending payments and sparring with the repo man.

GM V-P Lutz: "Market Collapse"

U.S. Auto Sales, 1995-2008

Thanks to Alan Greenspan's easy money, American consumers glutted themselves on automobiles over a ten-year period. By 2006 there were 1.2 registered vehicles in the U.S. for every licensed driver. Think about that for a minute. If every licensed driver got in a car and hit the road at the same moment, that would still leave over 40 million cars sitting idle in garages and driveways. Going way out on a limb here, I will suggest that we need no new cars right now. Those parked cars represent at least a three-year supply.

That is not even counting unregistered new and pre-owned inventory on dealer lots, which are plumb full. In fact, finding a place to store new vehicles is getting to be a problem. "We are seeing cargo buildup at ports of entry on both coasts as well as at other inventory points such as factories and rail yards and dealerships," said Christopher Connor of Wallenius Wilhelmsen Logistics. Pretty soon unsold cars will be floating at sea on drifting container ships, alongside the ones with excess crude oil and the barges hauling solid waste to nowhere in particular.

As we exit 2008, we are selling cars in the U.S. at an annualized rate of 10.5 million. Most estimates for 2009 fall in the range of 11-12 million units. Robert Lutz, former product guru at Chrysler and now Vice-President for Global Product Development at General Motors, said in a Fox interview earlier this week that at these run rates, there is "no viability for the domestics, no viability for the Japanese, no viability for the Germans." The $15 billion now being offered by congressional Democrats to the Big Three is merely a "short-term liquidity measure" that "gets us to the next Administration." His characterization of 16.5 to 18 million units as "normal" may be a bit disingenuous. If that is what he thinks is necessary for Detroit's survival, get ready for some bankruptcies.

[update, December 12:]
GM announced today that it will reduce Q1 (2009) production at its North American plants by 250,000 units. The announcement came just ten days after it had projected Q1 volume of 600,000 units, which, if we do the math together, means a revised expectation of 350,000. A year ago GM was producing over 1 million units per quarter and losing money doing it. GM's 8.375 percent bonds due in July 2033 are now trading at 15 cents on the dollar, effectively yielding 57.6 percent--which tells you what bond traders think of GM's long-term prospects.

[update, December 22:]
Toyota announced today that it will lose money for the first time ever in its fiscal year ending March 31. Sales for the year are expected to decline 18% to 7.54 million units worldwide (2.17 million units in the U.S.). Last week Honda said it expected its U.S. car sales for the year to fall 14 per cent to 1.59m units. "When the American car market shrinks to 11m vehicles," points out Koji Endo, industry analyst at Credit Suisse, "no one is going to make money.”

[update, January 15, 2009:]
GM today cut its estimate for 2009 U.S. industrywide auto sales to 10.5 million units, which, if accurate, would be a "disaster," according to consultant John Casesa. “It’s a level of demand that is far below Detroit’s break-even point.” GM needs to submit a viability plan to the U.S. Treasury by March 31--or else give back the $13.4 billion in emergency loans released, not by Congress, but by the Bush Administration.

Wait, Don't Tell Me: A Vegetarian Stir-Fry?

Copyright 2008 The Financial Times

Wrong answer. Renminbi literally means "people's currency." Until July 2005 the renminbi, issued by the People's Bank of China, was worth about 12 cents American. This was a favorable exchange rate for the Chinese, who have been exporting like crazy to the rest of the world and have amassed a trade surplus with the U.S. that now exceeds a quarter of a trillion dollars annually, not exactly lunch money.

Since 2005 the renminbi has been allowed to float (slowly) against the dollar and has appreciated over 20% in three years (see graph). As far as the Bush Administration is concerned, that trend is our friend because it prices American-made goods more competitively. Chinese authorities, on the other hand, are not wild about it, and this week they seem to be signalling that they have had enough. On Monday the renminbi dropped out of a narrow trading band and fell by 0.73 per cent.

So most Americans are thinking, "Who cares? I don't like stir-fry anyway." They should care. Dubya cares. He's got his Treasury Secretary, Henry Paulson, over in Beijing right now trying to sweet-talk the Chinese into sticking with the "reform process." Truth be told, China is experiencing an economic slowdown just like everyone else, and displaced workers are rioting in the south. Government officials would like to keep the lid on, and a weakening currency is one way to do it.

If speculators (remember them?) smell blood in the water, things could quickly get out of control. A rapid devaluation of the renminbi is in no country's best interests. Among the domino consequences would be devaluations of other Asian currencies as well as protectionist measures in the West. To defend its currency, China would have to start dumping U.S. Treasuries, driving up interest rates and exacerbating our own recession. And if we can no longer borrow from the Chinese, how are we gonna pay for all these bailouts at home?

Let's face it, the Chinese are now calling the shots. They are choking on U.S. debt and do not want the U.S. trying to inflate its way out of the current credit crisis. Zhou Xiaochuan, the Governor of the People's Bank of China, lectured Paulson earlier today. “Over-consumption and a high reliance on credit is the cause of the U.S. financial crisis,” Zhou said. “As the largest and most important economy in the world, the U.S. should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.” Translation: Don't expect us to clean up your mess. No sooner were the words out of his mouth than Zhou hopped on a plane to Washington, D.C., for a Group of Thirty (G-30) meeting, at which incoming Treasury Secretary Timothy Geithner will surely hear the same message.

My fellow Americans, get ready for a lower standard of living in the coming years.

Is Government Intervention Working?

[Prieur du Plessis of Minyanville, commenting on the credit crisis:]
"The TED spread (i.e. 3-month dollar LIBOR less three-month Treasury Bills) is a measure of perceived credit risk in the economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. An increase in the TED spread is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. On the other hand, when the risk of bank defaults is considered to be decreasing, the TED spread narrows. Since the TED spread’s peak of 4.65% on October 10, the measure eased to 1.75%, but has since worsened to 2.10%.... In summary, although some progress has been made as a result of central banks’ liquidity facilities and capital injections, the credit markets are not yet thawing."

Obama Sees What Works, Sticks With It

The best thing George W. Bush ever did as President was to fire his Defense Secretary, Donald Rumsfeld, and to replace him with Robert Gates (above). This is, of course, faint praise, as it simultaneously brings to mind the worst thing that he ever did, which was to hire Rumsfeld in the first place. Dubya compounded that error by sticking with Rumsfeld for the first six years of his Presidency, making it impossible to recover during the last two.

Yet Gates did almost exactly that. Now expected to continue at Defense during the early months of the Obama Administration, Gates is a pragmatist who reminds us how capable and well-trained the American foreign-policy establishment really is. Our diplomats and strategists work best when not bound by an ideology that simplistically maps the world into good vs. evil. "Success," Gates offered in his famous "Soft Power" speech at K-State a year ago, "will be less a matter of imposing one's will and more a function of shaping behavior--of friends, adversaries, and most importantly, the people in between."

It could be that the Gates appointment was not actually Bush's idea, that he was grafted onto the Administration at the behest of a wise old guard of policymakers who simply could no longer abide rampant incompetence. Dubya has since demonstrated that he still capable of stifling reasoned debate and nuanced judgment; witness the resignation last spring of Admiral William Fallon as the head of U.S. Central Command in the Middle East. Fallon, incidentally, states in a recent Boston Globe interview that the war in Iraq is "essentially over." Perhaps Gates was able to clean up Rumsfeld's mess after all.

Jobs are Going, Going...GONE!

Unemployment is in the eye of the beholder. This chart depicts three views of the unemployment rate in the U.S. over the past fifteen years. The rosiest scenario, naturally, is the line in red (so-called U3), which shows unemployment currently running at a little over 6%. U3, however, does not count workers laid off in the past year who have become too discouraged to look for a new job. Add those workers into the mix, and you get the U-6 calculation (in gray) of almost 12%.

Now, there is another segment of the labor pool, those discouraged workers who have been jobless for more than one year. These the Labor Department simply ignores. Youz guys don't exist. Add them back in, and now you're talking 16% unemployment (blue). With this figure likely surpassing 20% in 2009, get ready for more talk about the Next Depression.

In the River Valley, baseline unemployment has climbed past 8%, and the news is getting worse. The region's biggest employer, the NewPage coated-paper mill in Rumford, has just announced nearly a month of downtime for its #15 machine. Beginning December 8, at least 250 workers will be temporarily laid off--nearly one-fourth of the mill's workforce.

[update, December 5:]
This morning brought the Labor Department's monthly employment report, and the numbers are abysmal. 533,000 jobs were lost in November, the largest monthly slide since 1974; the loss in October was revised from 240,000 to 320,000. The total for 2008 now stands at 1.9 million jobs lost. The "official" unemployment rate (for what it's worth) ticked up from 6.5% in October to 6.7% last month.

Falling off a Cliff

Copyright 2008 The Boston Globe

2008 AL MVP

Red Sox 2B Dustin Pedroia

Hall of Shame

The Magnificent Seven, Wallywood-style. Combined, these CEOs pocketed nearly $1.5 billion over a five-year period while steering their companies to tens of billions in losses and, in some cases, to oblivion. Tens of thousands of employees have lost their jobs. However we revamp our tax code, the rewards to companies should be for jobs created, not for jobs destroyed. Such concentration of wealth as displayed above has throughout human history been a portent of societal stress, often to the breaking point.

When Charts Go Parabolic, Change Is Imminent

The Federal Reserve's balance sheet has more than doubled in the past six weeks, from less than $1 trillion to almost two. Richard Fisher, the president of the Dallas Fed district bank, predicted this morning that another trillion will be added before year's end as the U.S. Treasury cranks out government bonds to pay for the bailout of Wall Street banks. The Fed, in turn, has been swapping Treasuries for mortgage-backed securities and other tainted collateral to try to thaw credit markets.

So let's get this straight. We, the taxpayers, are borrowing money that does not exist to liquefy banks that should be allowed to fail. We pay interest over a long period of time to provide this service. If we try to retire the debt early, we will be paid back in toxic securities. The fallout from all this financial legerdemain will be a devalued dollar, which rewards borrowers and punishes savers. (Watch the price of gold for hints about future inflation.)

Thanks, Congress.

Here Comes the Cavalry

Your paycheck is in the mail, thanks to Monday's roll-out by the Federal Reserve Bank of short-term financing to some of the nation's biggest businesses. The Fed's intervention is illustrated by the spike in the chart above. The issuance of 90-day commercial paper surged ten-fold, with the Fed committing over $60 billion in a single day. The money will help companies meet payrolls and replenish inventories.

"Of all the things the Fed has tried this year," writes Minyanville's Charles Payne, "I believe this is the smartest. Payrolls have to be met, and cash has to flow into coffers if businesses are to forge ahead in a tight credit environment."

Which Is the Party of Big Government?

Copyright 2008 The Boston Globe

Dear Senator Collins

Message just e-mailed to Senator Susan Collins (R-ME):

Please vote AGAINST the bailout bill to be voted on by the Senate this evening. The TARP will add to the mountain of debt being prepared for our kids and grandkids. It will protect entities that deserve to fail. It will saddle the taxpayer with assets that cannot be valued and may be essentially worthless. It will accelerate the process by which the national debt will be monetized, penalizing savers and crushing folks on fixed incomes. The debt needs to be destroyed instead.

Purveyors of panic insist that a bill is necessary to avoid financial armageddon. For the average American, the worst thing that will happen with no TARP is that he will lose his credit card. The other bad outcomes--loss of jobs, mortgage defaults--are baked in already. The bill cannot stop these.

A vote FOR the bill condones a radical power grab by the moneyed elite and condemns the middle class to indentured servitude for generations to come.

TARP in Trouble

Our Salesman-in-Chief is pushing this latest bailout plan hard, but Congressional leaders may not be able to bring along the rank-and-file, who are getting bombarded with messages of outrage from constituents. With the general election just five weeks away, congressmen running for re-election are going to have a hard time ignoring those messages. Voters have short memories, but not that short.

The proposed "Emergency Economic Stabilization Act of 2008" will require an initial outlay of $250 billion (with another $100 billion at the President's immediate disposal) to fund a Troubled Asset Relief Program (TARP). Once the Treasury Secretary burns through that, he has access to another $350 billion unless Congress votes to withhold it. TARP funds will be used to buy impaired securities for future resale, hopefully at higher prices. Only when TARP has sold all its inventory will taxpayers know the true cost of the program.

It's not like Congress actually has the money. One provision of the new bill is to raise the Statutory Limit on the Public Debt (the so-called debt ceiling) to $11.315 trillion. This will make it legal for us to borrow and spend even more. And it's not like the $700 billion of borrowed money is going to be enough, either, with tens of trillions of dollars worth of illiquid assets looking for a home. So what's the point?

According to erstwhile presidential candidate Ron Paul, the mission is "to prevent the liquidation of bad debt and worthless assets at market prices, and instead [to] try to prop up those markets and keep those assets trading at prices far in excess of what any buyer would be willing to pay." In other words, government will be in the price-fixing business, last attempted with little success during the Nixon Administration. Distressed securities for which there are no bids will be marked to maturity. (I call it marked-to-mandate.) Recent regulations requiring mark-to-market accounting by investment firms may be rolled back: "The Securities and Exchange Commission shall have the authority under the securities laws...to suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board."

Recalcitrant lawmakers on Capitol Hill have formed a "Skeptics Caucus" out of concern that the government will overpay for troubled assets. Convening the caucus a week ago, Rep. Brad Sherman (D-Calif.) proclaimed, “this is greatest shift of power to the imperial presidency and the greatest shift of wealth to a still wealthy Wall Street that anyone could imagine.” The Skeptics cannot be reassured by the present bill, which leaves it to Treasury Secretary Hank Paulson to develop TARP guidelines, including "methods for pricing and valuing troubled assets" and "criteria for identifying troubled assets for purchase." The Secretary is furthermore authorized to make "direct purchases" of assets where "use of a market mechanism...is not feasible or appropriate."

The Secretary's new job, thus, is to create a market where none exists and a price structure that fortifies financial-sector balance sheets under severe pressure since marking to Merrill. And he needs to broadcast the results with all the gusto of a carnival barker. "To facilitate market transparency," the bill reads, "the Secretary shall make available to the public, in electronic form, a description, amounts, and pricing of assets acquired under this Act, within 2 business days of purchase, trade, or other disposition." The goal is to alter perception in the marketplace, to entice private bidders back into the pool.

If private capital remains on the sidelines, the Paulson Plan will go up in smoke.

Merrill, Lehman Are Goners

While most of us got to watch football this weekend, government officials and bank executives had to work overtime in the Big Apple to address the ongoing, ongrowing credit crisis. For those folks, seven-day work weeks are now the norm. Their task is to shuffle assets in a way that will assure investors that (a) they know what they're doing and (b) what they're doing will work. If the answer to either question is "no," financial markets will crash.

Last week came the announcement that Fannie Mae and Freddie Mac will be bailed out by U.S. taxpayers. The news this morning is that Merrill Lynch and Lehman Brothers will cease to exist: Merrill is being taken over by Bank of America, while Lehman is filing for Chapter 11 bankruptcy protection to allow more time for liquidating assets. Treasury Secretary Hank Paulson, apparently of the opinion that taxpayers have done their part, is holding firm for a private-sector workout. Meanwhile, the Federal Reserve (privately capitalized, remember) stands ready to lend funds to other troubled firms (think AIG). Trouble is, the Fed's firepower has already been cut in half year-to-date.

Merrill's demise is no surprise, as vultures have been circling since February. What is a surprise is the price that Bank of America is paying: $29 a share, or 70% higher than Merrill's stock price at the close of Friday's trading. (Too high, traders are saying this morning, as BAC is down five in the pre-market.) In a similar move last March, JPMorgan Chase got Bear Stearns at a substantial discount. So why the premium now for Merrill? In all likelihood, the Fed forced the deal. It remains to be seen whether BAC shareholders can be forced to approve the deal.

A stock-market rout is a distinct possibility today, but it is the price that must be paid for future economic recovery. The bad actors in the false prosperity of the past decade must be allowed to fail. Unfortunately, we will all share the pain in the years ahead. As market strategist Mike O'Rourke observes, "The problems will be the reverberation throughout the economy as access to capital becomes even tighter than it already is. It appears that the amount of de-levering the market is about to encounter in coming months will likely outweigh the benefits of last week's GSE program."

[update, Sept. 17--]
With Merrill Lynch saved from bankruptcy, will the firm satisfy Maine's claim to funds invested last year in MainSail II? A check of the Maine Treasurer's website reveals that the issue was resolved three weeks ago. Merrill has agreed to pay back the $20 million.

Latest on Lehman

After yesterday's bloodbath, in which the common stock of Lehman Brothers declined in value by 45% in a single day, company executives feverishly accelerated their quarterly report by a week. Originally scheduled for next Wednesday, third-quarter earnings were released this morning instead. The news was worse than expected: a loss of nearly $4 billion and a mark-to-Merrill write-down of twice that on its inventory of mortgage-backed securities.

Lehman announced several steps to repair its balance sheet. It cut its quarterly dividend from 68 cents to a nickel (should have been done a year ago) and disclosed plans to sell a majority stake in its investment-management business (good luck--the Koreans just walked away from a possible deal). There was also talk of spinning off its commercial real-estate portfolio into a separate, publicly traded company, but that's just a shell game, no value added. All this is to "reposition" the firm, according to the CEO, who must not be comfortable with the current position of prostrate and tire-marked.

The hastily arranged conference call was meant to prop up the stock price, which briefly exceeded $9 a share in the pre-market as short sellers cashed in. An hour into the regular trading session, the stock has settled back to 8, down 85% in the past year. If the Mac'n'Mae takeover by the U.S. Treasury earlier this week is any indication, the shares are on their way to zero. Another bad omen: the yield on Lehman's two-year paper is going through the roof. The firm will be unable to roll over its debt as a stand-alone entity.

[update, Sept. 11, 8:15 a.m.--]
LEH is getting crushed in today's pre-market, trading near 5.

[update, 15 minutes later--]
Make that 4. Sounds like a launch-pad countdown!

[update, Sept. 12, 8:15 a.m.--]
Now trading with a 3 handle.

[update, Sept. 15, 7:00 a.m.--]
Now less than a buck, as the company files for Chapter 11 bankruptcy protection.

A U.K.-based newspaper, The Observer, reported yesterday that Richard Fuld, CEO at Lehman Brothers Holding Inc., is slowly but surely being relieved of his duties. "His credibility is shot," a senior source within Lehman is quoted as saying. I suggested back in March that Dick should have his parachute ready. Fuld bought time in June by allowing his Chief Financial Officer and Chief Operating Officer to be sacked, but that is all it is, a matter of time.

[update, August 29--]
The Wall Street Journal is reporting that Lehman will lay off between 1,000 and 1,500 employees, or about 6% of its workforce. Other than that, business is good.

Back from Baxter S.P.

If I am alone in the woods, do I hear the trees falling on Wall Street? The quick answer is "hell, no"--which is precisely the point of our annual pilgrimage to South Branch Pond Campground. No TV or radio, no e-mail, no phone calls. Just roll out of our sleeping bags at dawn and climb above treeline in the crisp morning air, far from the madding crowd. Saunter back to the campground in the late afternoon and slow-fry some quesadillas. Maybe go for a paddle after supper to check out the loons at the far end of the pond. Life is simple and sweet.

Still, I know the trees are falling. They were falling before we left and are not yet done falling. While we were gone, Lehman Bros. tried to sell itself to the Asians, who are holding out for a better price. They just might get it. Meanwhile Merrill Lynch, Goldman Sachs, and Deutsche Bank became the latest investment firms to fess up to government regulators. They agreed to buy back auction-rate securities that had been improperly peddled to clients earlier this year. The industry-wide tally has reached $50 billion in buybacks and over half a billion in fines. Finally, Fannie and Freddie came ever closer to issuing super-senior debt to taxpayers like you and me. Even though we don't want it.

From the top of Bald Mountain (there is no trail, so we had to bushwhack) could be seen the winding course of the East Branch of the Penobscot, the riverbanks finely tinged with crimson in an otherwise broad green expanse, the first faint traces of autumn. Much wider and deeper runs the red ink on Wall Street.

Updates: Following the Money

The window is closing on Seth Carey's casino. This morning's Boston Globe is reporting that two North Shore racetracks, Suffolk Downs and Wonderland Greyhound Park, are combining operations, perhaps with the goal of launching "a premium resort-style casino." This is bad news for Rumford lawyer Carey and his envisioned Evergreen Mountain Four Season Resort & Casino in Oxford County. With gaming revenues stalling nationwide, Carey's only chance for a viable enterprise rests on further delay in Massachusetts, where Governor Deval Patrick supports the idea of casino development. Mainers are still waiting for details from the Evergreen campaign regarding exact location and investor support.

Wall Street banks raise money any way they can. Desperate for cash, Merrill Lynch is expected to cut its dividend to shareholders by at least half. This long overdue step would be a first (Merrill has never cut its dividend since it became a public company in 1971) and follows the company's announcement two weeks ago that it sold a tranche of mortgage-backed securities at a huge discount to face value. Meanwhile, Lehman Brothers is selling off a third of its commercial real-estate assets, three-quarters of which are mortgages sure to be be discounted.

But the money keeps going out faster than it comes in. Last week Citigroup and UBS joined Merrill in agreeing to buy back auction-rate securities sold to retail clients earlier this year. Combined price tag: $40 billion (and climbing, as JPMorgan Chase and Morgan Stanley have just settled). For pushing ARS, several of these firms have been fined by government regulators to the total tune of $200 million. And the write-downs for mortgage-backed securities are never-ending. J.P. Morgan revealed in a 10-Q filed Monday with the SEC that its collateralized debt lost $1.5 billion in value just in the past month. That's 75% of the firm's second-quarter profit--gone.

MDOT puts pavings projects on ice. Apparently $105 million does not go as far as it used to. The Maine Department of Transportation originally planned to pave 825 miles of the state's roads in 2008. But with the price of liquid asphalt jumping 150% since January, the Department is going to come up 85 miles short for the money budgeted.

The news has Peru residents patting themselves on the back. In 2007 the Town voted to borrow $400,000 to address a backlog of local road projects. At the time there was no competition for contractors from the state, which had placed a moratorium on paving projects pending the results of a bond referendum. Peru's timing looks even better now that paving costs have skyrocketed, easily justifying the borrowing costs of the ten-year loan from the Maine Bond Bank.