Taking stock

This is the end of what has been the worst year of my life. I was out of work for six months, and had to file for bankruptcy last October. I had to euthanize my older cat on Christmas Eve, less than two weeks after we got to Chicago for me to take my new job, and just a week after his 17th birthday. (We had been together since he was four months old.) The good news is that my other cat seems to be healthy, if still a little disoriented by the move from California. I've got a good job with a great company, and I'm working with a wonderful team of people. I'm living in a beautiful condo.

In many ways, this is the start of a new phase in my life. I've come full circle, from going to graduate school in Chicago from 1978 to 1980, to returning 28 years later. I've got a fairly young cat to raise in a new city, with new friends, neighbors and co-workers, and a new area to learn. I'm not sure how relevant this blog is to my new life, since what I'm doing is only tangentally related to what I used to do. Therefore, as we wrap up the holiday season, I'm rethinking what this blog should cover, and whether I should even continue it.

For now, I'm putting the blog on pause, at least until after the first of the year.

I've got a new job!

As some of you know, I've been looking for a new job for almost six months. Last week, I accepted an offer with a large, privately-held company outside Chicago, IL, USA. I'll be starting in mid-December, so I have to find a place to live, move and get settled in over the next two weeks. As a result, I'll be posting on this blog intermittently (if at all) for a while. Thank you for your patience!

Bankruptcy is looking ever more likely for one of the Big 3

The possibility of any kind of large-scale bailout of the U.S. automobile industry has been pushed back to December, according to this article from The Wall Street Journal, and may not happen before the Obama Administration comes into power on January 20th. Earlier today, it looked as though members of the Senate had crafted a compromise plan to use the $25 billion already allocated for the development of fuel-efficient vehicles for the bailout, but both Democrats and Republicans in the House of Representatives rejected the idea. It now appears that the U.S. automakers will have to come to the Congress with business plans that explain how they'll work themselves out of the situation they're now in before they can get the money.

Of the Big 3, GM appears to be the likeliest to fail, and Ford is the strongest, having borrowed a huge amount of money before the credit markets closed down. Chrysler is the hardest one to read, since it's a private company owned by Cerberus Capital Management. Of course, it's not clear that any of them will actually declare bankruptcy; GM's management still shuns the use of the word.

From everything I can see, legislators and their constituents who are opposed to a bailout believe some or all of the following:

• The automakers don't deserve the money because their senior managers are incompetent, or because the union jobs that would be preserved pay so much more than what many other workers make
• The automakers would waste the money
• The automakers will soon be back with demands for more money
• The banking bailout has turned out to be much less effective than originally advertised, so why should be believe that an auto industry bailout would be any different?
  
• The ripple effects of one or more bankruptcies won't be as bad as the companies and their supporters are saying
• The companies can survive bankruptcy, and will emerge stronger and more competitive

What these arguments miss, of course, is that once a company files for bankruptcy, its pension liabilities will be transferred to the Federal Government. The workers that were getting health care from their employers will have to get health care somewhere, and will overload already overburdened emergency rooms and hospitals. The ripple effect is quite real--as I wrote about in an earlier post, I saw it when the U.S. steel industry collapsed in the 1980s. Finally, given the frozen credit market, the risk is extremely high that any Chapter 11 bankruptcy would quickly degenerate into a Chapter 7 liquidation. In this market, who would, or could, acquire the assets of GM, Chrysler or Ford? In a growing market, you could argue that a Japanese, Korean, Chinese, Indian or European company might swoop in and buy them "on the cheap" for a quick foothold in the U.S. market, but we're in a worldwide recession, and everyone is hurting.

So everyone now waits as the Congress and automakers play a dangerous game of "Chicken."

The Truth About Forecasting: Part Two--Obviousness

In the first part of this series, I wrote about the errors that make most forecasts meaningless, and gave examples of how I committed most of them in my very first job. Now, I'd like to tackle the one error that I didn't make at that time, the error of obviousness. A forecast that tells you what you already know isn't a forecast, it's redundant. This example comes from when I was working for Toshiba in the late 1980s. I had a conversation with my boss, Hank Yamamoto, about where the design of laptop computers was going. Keep in mind that the standard at this point was VGA (640 x 480) monochrome LCD displays, with Toshiba and Fujitsu also selling portable computers with monochrome plasma displays. Toshiba was already experimenting with pen computers, and was delivering a small number of them to customers.

Hank pointed out that there were several areas in which laptop design would change over time:

• Processors would get faster
• Displays would move from static to active-matrix thin-film LCDs (better for handling graphics), resolution would improve, and color would become affordable
• Hard drives would get bigger and faster
• Memory would also get bigger and faster
• Battery capacity, and thus run-time, would improve
• Everything would get cheaper

That was 1989, and all of that happened. Everything that Hank said was simply an extrapolation of the components and capabilities of existing laptop computers. He didn't try to forecast what prices would be for each of the components, or for the finished computers, at any given time, but Moore's Law could have provided guidelines for timetables. The same extrapolations can still be made today; the only component that we didn't consider back in 1989 was flash memory, which is now being used to replace hard disk drives.

There were plenty of companies in 1989 that were selling research reports and forecasts that stated essentially the same things that I just listed above, albeit with more charts, graphs and tables. These reports sold for thousands of dollars, and would have told us what we already knew. However, these reports usually added prices, dates and even sales quantities, most of which turned out to be wrong. Companies that bought those reports and relied on their forecasts were in worse shape than those that simply used the component breakdown and extrapolation method. Hank knew that he couldn't forecast prices, dates and sales quantities, but he could forecast the direction of development and its eventual payoff.

In the third and final part of this series, I'll revisit the five sources of error, examine what I consider to be the worst ones, and discuss a few ways to be a better forecaster and consumer of forecasts.

The Truth About Forecasting: Part One--The Five Deadly Errors

I've been reading Nassim Nicholas Taleb's book "The Black Swan," which has gotten a lot of attention recently due to the financial meltdown. I may go into Taleb's core arguments in a future post, but one of his arguments is that forecasting of things that aren't physically based is all but impossible. Here's an example: We've learned how to forecast the weather fairly well, at least in general terms over short periods of time, because we increasingly understand the underlying physics. However, the five-year forecast that was undoubtedly assembled by product planners at GM last year has long since been shredded and recycled. The numbers, even for 2008, were useless because while the forecast might have had some allowance for the impact of $4/gallon gasoline, it certainly didn't allow for the possibility of a financial meltdown and complete collapse of the consumer credit market.

This brings me to my own experience as a forecaster over a nearly 30 year career in high tech. It's my belief that most forecasts aren't worth the paper they're printed on, because they're:

• Obvious
  
• Based on false assumptions
  
• Biased to satisfy the audience
  
• Cover too long a time horizon
  
• Don't (and can't) take into consideration massive, but in hindsight predictable, discontinuities such as our current financial mess
  

Here's a case that demonstrates four of the five errors. In 1980, my first job out of business school was at Hewlett-Packard's Corvallis (Oregon) Division. At that time, Corvallis was responsible for HP's calculator product line, but they also had a line of personal computers called Series 80. The Series 80 machines were based on a processor designed by HP and derived from calculators. They were incompatible with any of the other PCs in that still nascent market, so software, hardware, peripherals—everything—had to be designed especially for them.

I was hired to be the Product Manager for Series 80 software, and part of my job was to forecast the potential sales of new software products. Since our software only worked on our computers, we had to start with sales of Series 80 machines, which were a few tens of thousands a month and growing, modestly. I was responsible for an array of software packages, each of which had its own appeal, including a database, a word processor, and even a Series 80 version of VisiCalc, the original spreadsheet. However, our primary market was engineers, the market for most of HP's products at the time. Were we going to branch out and try to reach consumers and businesspeople? That could make a big difference in the potential market size, and if our software was very successful, it could drive sales of computers.

One of my first questions was whether I could go out and poll current and potential customers to find out their receptivity to our new products. That idea was shot down, because we didn't have the budget for primary research. The industry was so new that there weren't any research services that we could subscribe to in order to independently gauge the market potential (and, as we'll see later, their own forecasts were likely to be of dubious value.) That's when I was introduced to the concepts of "WAGs" and "SWAGs" by one of our most experienced product managers.

"WAG" stands for Wild-Assed Guess, and "SWAG" stands for Silly Wild-Assed Guess. Neither WAGs nor SWAGs are entirely guesses, but they're close. When you don't have hard historical information, you have to estimate what percentage of the existing installed base will buy the product and how many new users will also buy, every month and every quarter, for five years. So, you start with a "rule of thumb"—say, 10% of your existing and new PC buyers over time will buy a particular piece of software, with that number going up to 15% in Year 2 and 20% in Year 3. What's your proof? You don't have any, but it sounds reasonable. By using WAGs and SWAGs, I committed the error of basing the forecast on false (or at least dubious) assumptions.

Once I completed the unit sales forecast, I then had to determine what price we should sell each product at. HP had sold software for "personal computers" over the years, but these were massive, specialized desktop computers that sold for many times the price of our Series 80 models. The company's prevailing model for pricing software for these models was to look at the software's manufacturing cost, and then mark it up by a given percentage. (Development costs were part of HP Labs' budget, and were not factored into product costs.) That's where I began with the pricing for Series 80 software, but it became clear in some cases that the software would be too expensive for buyers, and in other cases, the profit margins were simply too high. (Too high? In those days, HP management felt that charging too much for products—based on their costs—was unethical.)

Now I had a units forecast and a revenue forecast. I even used a WAG to estimate price changes over time. But before I could formally present them to management for approval, I had to calculate the overall rate of return on the product—too high, and the forecasts would go back to be redone with lower profit margins; too low, and the product would be scrapped. My first time through, the margins were too low, so I was told to go back and try again. I raised the units forecast over time, but it was unrealistic compared to separate forecasts for hardware sales, so I fiddled with initial prices and changes over time in both prices and market penetration until I got within the company's rate of return guidelines. (It turned out that competitors were selling comparable products for considerably more money, but those margins wouldn't wash within HP Corporate.)

So I had committed my second error, that of biasing the forecast to satisfy the audience. Virtually any connection between the approved forecast and reality was lost in order to meet HP's financial guidelines. But wait, there's more. My forecast had to cover five years. We now know that five years is a very long time in the personal computer business, but it was all new back then. So, I forecasted five years of growth, assuming updated versions of the software over time. What happened was that the next year, 1981, IBM introduced its first PC, which revolutionized the industry and created a new standard, and in 1984 the Apple Macintosh came out, helped in no small part by two PC product managers from HP Corvallis who went to work on the Mac in 1982. The Series 80 product line simply couldn't compete in this new world, and was discontinued altogether in 1984.

With my five-year forecast, I committed errors three and four: First, five years was far too long to forecast, given the rapidly changing nature of the PC industry. Second, there was an "unknown unknown" being developed in Boca Raton, Florida, which made my entire forecast and product plan moot. In hindsight, the flaws of the Series 80 platform made it very vulnerable to competition, but I was too entrenched with the nuts and bolts of getting my products out the door.

In Part Two of this discussion, I'll discuss the problem of obviousness.

A way to save the Big 3: Turn your clocks ahead one year

The cost for bailing out the Big 3 automakers (if they get everything they want) is now $75 billion and rising, yet the problem for the automakers is time as much as it is money. In John McElroy's column in Autoblog, he argues that the contract between the automakers and the United Auto Workers that goes into effect in 2010 will dramatically decrease the automakers' costs by shifting the burden for medical expenses to the UAW. In addition, a two-tier pay scale will be implemented, with new hires getting significantly lower salaries than existing workers. Therefore, a key goal of any government bailout should be to keep the automakers alive until the new contract goes into effect.

If McElroy is right, one way that the U.S. government could help the automakers would be to turn the clock ahead one year, figuratively speaking. Here's the idea: In return for Government financial aid, the contract scheduled to go into effect in 2010 would go into effect one year earlier, on January 1, 2009. The initial cash payments into the UAW's health care funds would be paid by the U.S. Government, not the automakers, in the form of loans to the automakers. (The money would go to the UAW directly from the U.S. Treasury, so that the automakers couldn't divert the money for other uses, just as banks are diverting funds that were supposed to be used for lending to other purposes.) This would save the automakers billions of dollars that they can use to finance their operations. The loans would be repaid by the automakers once they regain profitability.

This plan would give the Big 3 more flexibility to open and close plants as needed to meet customer demand, and it would also give them incentives to implement the kinds of cost-saving platform engineering strategies adopted by the Japanese manufacturers decades ago. With labor costs under better control, and with more flexible production, this plan would do many of the things that bankruptcies would do, with dramatically less "trickle-down" impact.

One other thing that the U.S. Congress could do would be to preempt car dealership franchise laws in the states. These laws require massive payments by car manufacturers to dealerships that they want to close. There's plenty of attrition in the ranks of car dealers today, but it would make much more sense for the car manufacturers to be able to take active control of their distribution strategies. This wouldn't cost the taxpayers a thing, although it would increase unemployment due to the closed dealerships.

The key is not to simply throw money at the problem, but to make business changes that will finally bring the U.S. auto industry into the 21st century.

U.S. banks raise fees to record highs

The economy is tanking, you can't get a loan, your job is in danger (or you've already lost it,) and banks are still afraid of consumers pulling money out of their accounts, so what are the banks doing? According to the Wall Street Journal, U.S. banks are raising their fees to record highs, changing the rules on accounts so that fees are easier to incur, and increasing the minimum balances necessary to avoid fees. One statistic in the article took my breath away: According to Mike Moebs, chief executive of Moebs $ervices Inc., an economic research firm, approximately 90% of banks' consumer-fee income comes from overdraft and insufficient funds charges, and those fees could go as high as $40 per transaction from the current range of $32 to $35.

Overdraft and NSF (insufficient funds) charges are most likely to be incurred by consumers who are already financially strapped, and they can be incurred in ways that a lot of people don't think about. Automatic bill payments are a big one--the amounts are taken out automatically, but if there's not enough in a checking account to cover the withdrawl, and if funds from a savings account or an overdraft line of credit aren't available, the customer gets hit with a big fee. According to the WSJ article, Citibank intends to make money even if you do have funds in a backup account; they're charging some customers a $10 overdraft protection transfer fee for each such transaction.

What I truly don't understand is how the banks can justify these fees. After all, consider credit cards. If you go to a restaurant and you're over the limit on your credit card, the bank simply declines the transaction. There are no additional fees. Why does it cost nothing to decline a credit card transaction and $40 to decline a debit card transaction?

The article suggests that brokerage accounts, online banks and some community banks carry fewer fees, but in general, those institutions service higher-income individuals who are at less risk of incurring the fees in the first place. The major banks are driving customers out of the market, to prepaid debit card services such as Green Dot. For many people, it's become almost impossible to afford a checking account.

Today's unnecessarily frightening headline: "Radioactive Beer Kegs Menace Public"

On Bloomberg.com today, I found a story with the frightening headline "Radioactive Beer Kegs Menace Public, Boost Costs for Recyclers." Could you get drunk and be sterilized at the same time? The answer is no. It turns out that the problem is that nuclear wastes are being dumped into the conventional metal recycling stream, resulting in radioactive metals. In the entire, long article, there's exactly one reference to beer kegs: "Abandoned medical scanners, food processing devices and mining equipment containing radioactive metals such as cesium-137 and cobalt-60 are often picked up by scrap collectors and sold to recyclers, according to the International Atomic Energy Agency, the UN's nuclear arm. De Bruin (Paul de Bruin, radiation safety chief for Jewometaal Stainless Processing BV in Rotterdam) said he sometimes finds such items hidden inside beer kegs and lead pipes to prevent detection." That's it. The headline could have read "Radioactive Lead Pipes Menace Public," and would have been just as accurate.

Should bankruptcy be the price of bailing out GM?

The Wall Street Journal ran an opinion piece this morning on bailing out GM (and potentially Ford and Chrysler/Cerberus as well) that suggests the price that each company should pay in order to get more government money: The board and senior management should be fired, shareholders should lose their remaining equity, and a Government-appointed receiver should take over. The receiver should tear up contracts with labor, suppliers and dealers, shut plants as needed, and do whatever is necessary in order to return the company to profitability.

That's the definition of Chapter 11 Bankruptcy. So, what the writer is saying is that the price of bailing out GM should be bankruptcy. That argument makes sense, but I question whether a receiver can clean up the mess at GM and turn it back into a viable competitor post-bankruptcy. Let's remember that Cerberus Capital brought in a management "dream team" to turn Chrysler around, and now they're desperately trying to sell the company, in whole or in part. Given the current economy, a move into Chapter 11 reorganization is likely to slide into Chapter 7 liquidation, which would be catastrophic for the U.S. economy.

Even without driving GM into Chapter 7, a receivership could cause other unintended consequences. For example, the Big Three manufacturers won an agreement to turn over responsibility for retiree health benefits to the United Auto Workers, starting in 2010. That will save GM $3 billion a year. However, if the trustee eliminates GM's contributions to the UAW's Voluntary Employee Beneficiary Association fund, the fund will no longer be able to support GM's retirees without taking benefits away from Ford's and Chrysler's retirees. Further, GM's costs will decrease, which will put the company in a much better competitive position vs. Ford and Chrysler. That could drive Ford and Cerberus/Chrysler into bankruptcy. We could end up with three car manufacturers in bankruptcy, not just one.

I think that the best solution is one that nurses GM through this recession, keeping the company going until consumer demand picks up, but with major operational concessions on the part of GM's management and the UAW. The company must replace its Board of Directors. GM needs its own Louis Gerstner, and a new team of senior managers who haven't been innundated with GM's groupthink. GM has got to become the world's best manufacturer of automobiles, not just the biggest, but they won't get there with either the management team or Board of Directors currently in place.

The words that GM executives dare not speak

What words? The first one is "Chrysler." In GM's earnings announcement today, the company said that it has decided not to pursue merger talks with an unspecified company at this time, and instead will focus on internal growth. In an interview with Rick Wagoner, GM's CEO, Phil LeBeau of CNBC asked him if the press release was referring to Chrysler, and Wagoner replied that he couldn't say.

The second word is "bankruptcy." LeBeau asked Wagoner if bankruptcy is a possibility, and Wagoner refused to use the word. It feels a little like the old Soviet Union or pre-Capitalist China, where certain words were banned, or their meanings were twisted beyond recognition. It doesn't reflect well on GM's management when they're frightened by words or afraid to acknowledge the truth. If the company truly wants help from the Federal Government, its management has to demonstrate that it won't waste the money, and they've got to start by speaking plainly and truthfully to the Government, press, investors and their employees.

How long with the lessons of our credit bubble last?

U.S. public radio's Marketplace ran a story today about how the sales of luxury goods are struggling, even with consumers that still have the money to buy them. It's become "unseemly" to buy more than you need, even if it means shopping at Target rather than Bloomingdale's or Nordstrom. The big question is whether this is a temporary shift that will reverse when the current recession ends, or whether this is a generational change that will persist for decades. My gut feeling is that it's the latter, but the only evidence that I can offer is what happened during and after the Great Depression.

Financial hardship causes long memories, and the deeper and more prolonged the hardship, the more entrenched the memories become. My parents both lived through the Depression. In the 1960s and 1970s they refused to do business with Mellon Bank, even though it was the largest bank in Western Pennsylvania, because Mellon had foreclosed on so many homes in the Depression and threw so many families out in the street. They paid cash for everything, financed their retail business out of their own pockets and didn't use trade credit.

Fast forward to this decade and the last. Credit was cheap and widely available, and using debt to leverage, or multiply, the amount of cash that an individual or business had was seen as smart. It worked for a while. It got many people who couldn't otherwise afford homes into homes. It convinced supposed "Masters of the Universe" on Wall Street to take on unbelievable risks. But now, the credit bubble has imploded, just as the Japanese asset value bubble imploded in 1990. Japan still hasn't fully recovered from its "bubble economy". How long will it take the U.S. economy to recover?

I think that it wll take long enough that the lessons of dependence on credit will be burned into a generation of consumers and business owners. Consumers will scale back their purchases to focus on items that they need and can afford. Businesses will again focus on cash flow and profitability, rather than growth and leverage. The quality of earnings, rather than their absolute size or growth, will become the most important factor. Personal savings will eventually swing upward as consumers work off their debt burdens.

I'm going through my own version of a credit bubble implosion, one that, frankly, I may not survive. If I do, I will be as changed as my parents were. I am not the man I was a few years or even a few months ago, but yet my lessons pale next to those of families who, through no fault of their own, have lost their homes and have no place to go. There is no longer any such thing as "good credit." Credit is a necessary evil in some cases, but it is an evil, and it should be avoided.

More pain in autos for October

Autoblog's October "By the Numbers" survey is out, and the auto industry in the U.S. slid deeper into recession last month, with all makers except Audi and Mini showing year-over-year losses. GM was the biggest loser, down 45% from October 2007, and every GM brand except Saab was down at least 40%; HUMMER was down more than 60%, and Cadillac, GMC and Saturn were down over 50%. In September, GM was one of the better performers, due to its "Employee Pricing for Everyone" program, but it was discontinued at the end of that month. In addition, GMAC withdrew financing for all but the very best credit risks, which left GM's dealers with far fewer options for customer financing.

Of the major companies, Chrysler was down almost 35%, Ford fell over 30%, Nissan was down 33%, Honda was down over 25% and Toyota was down 23% (even with its annoying "Saved by Zero" ad campaign.) Only BMW was able to stay nearly even with last year, with a 5% year-over-year decline, and that was largely due to a big increase in production capacity and sales for Mini. In total, industry sales dropped 32.3% to approximately 821,000 vehicles (vs. 1.2 million in October 2007,) the lowest monthly count since February 1993, and adjusted for population growth, the worst monthly total since World War II.

Video business news done better

I recently wrote about the problem that most of CNBC's anchors have with understanding that businesses are collections of people making and selling things, not pieces of paper to be bought and sold on Wall Street. Like a lot of people, I get ideas at 2 a.m., and last night, I wrote one down. Here's the elevator pitch:

The idea is a video news service that focuses on the needs of businesspeople, not investors. There would be multiple channels, with each channel focused on a single industry. Some of the potential channels include:

• Automobile
• Health Care
• Retail (possibly multiple channels)
• Agriculture
• Banking
• Insurance

Editors in a central location would assign and screen stories produced by a combination of full-time field editors and stringers (part-time and contract reporters.) Trade publications and newspapers that already cover these industries could participate by contributing stories; in return, they would share in ad revenues and have the right to republish the stories on their websites. Whenever viewers tune in, they would see the latest news report (continuously refreshed) and have access to longer, in-depth reports on a variety of industry-related subjects.

There would be a dual revenue model: Subscription fees (the service would be business, not consumer, oriented) and advertising.

Most importantly, the service would be available exclusively by phone, not PC. That means that mobile service providers, such as Verizon, AT&T, Sprint and T-Mobile would share in the subscription revenues and participate in marketing.

So, who should do this? Possibly CNBC (NBC Universal has all of the pieces to make it happen,) but they probably won't. Fox or Bloomberg would be better candidates, but in both cases, it would require a radical rethinking of their businesses, shifting from investors to business operators. One or more of the major trade publishers, such as Crain, Reed Business, Nielsen or United Business Media, could make it happen. The New York Times or Dow Jones are also possibilities. The point is that there are no technical limitations making this idea impossible, or even terribly difficult to implement.

Read Tom Friedman's column

Before you vote for any candidate in the U.S. Presidential election, read Tom Friedman's column in today's New York Times. Whether you're a liberal, centrist or conservative, it's the best advice I've read in a long time.

You can check out any time you like, but you can never come back

My job search continues, and I've got some prospects outside Northern California, where I currently live. I haven't lived outside of California for 25 years, so I'm just becoming familiar with the real cost of living differences between this state and most of the country. (I've always known that there are big differences, I just never had to deal with them.) Depending on where I'd move, the differences can be enormous: Using CNNMoney.com's Cost of Living calculator, I'd have the same standard of living on a $72,000 salary in Chicago that I'd have on a $100,000 salary in San Jose, CA. In Denver, $68,000 would go as far as $100,000 in San Jose; in Austin, TX, a little over $61,000 would go as far as $100,000 in San Jose. About the only place in the country where I'd have to make more money to maintain the same standard of living is the New York City area.

That's great; my money will go a lot further, almost no matter where I go. But let's flip the situation around, and say that at some point in the future, I want to return to Silicon Valley. I'd have to make as much as 64% more to maintain the same standard of living. It's almost unheard of to get a 64% raise by changing jobs; in fact, many Silicon Valley start-ups actually pay less, and make it up with stock options. That's why the only people who can afford to move to California are recent college graduates already living on low incomes, immigrants that live incredibly frugally, and people who are already wealthy. In just about every other case, your standard of living will drop dramatically when you move to California. So, once you're gone, you're gone.

The human cost of GM's failure

There was an interesting discussion/argument about whether or not to bail out GM on CNBC this morning. There were a number of different elements to the discussion: Cerberus Capital, the company that owns Chrysler and Chrysler Finance, as well as a majority interest in GMAC, is trying to position itself to get financial bailout money from the U.S. Treasury. GM is trying to get additional loans from the U.S. Government in order to close its acquisition of Chrysler. But hovering over both these issues was the bigger question: Should GM be allowed to fail? After all, it's been mismanaged for decades. We live in a capitalistic, free market society where companies have no right to survival, and no company should be "too big to fail."

The only panelist who seemed to have any interest in the impact of such a decision on the lives of people was Phil LeBeau, CNBC's beat reporter covering the auto and airline industries. LeBeau repeatedly stated that GM going under would be tantamount to exploding a nuclear bomb in the U.S. Midwest. He pointed out that not only would all of GM's workers lose their jobs, but the entire infrastructure of Tier 3, 4 and 5 parts suppliers that are largely or completely dependent on GM or its bigger suppliers would also go under, and with them would go their employees' jobs. Many of the retailers who supply these workers with goods and services would soon follow, along with their jobs. The cities and towns that depend on property, sales and income taxes would be stressed to the limit as their tax bases dry up while demand for their services increases. (If anyone would like to get a foretaste of what would happen, I invite them to visit the steel towns of Western Pennsylvania, where I grew up. The model of progressive economic collapse started in the early 1980s as steel mill after steel mill closed. Today, over 20 years after the steel industry failed, very little has improved.)

I was shocked that none of the other panelists even seemed to understand LeBeau's argument--it's not just GM, it's the entire economy of large portions of the Midwest, and peoples' lives, that are at stake. Perhaps it's time for CNBC to have fewer reporters in New York, and more reporters in the field, where the real economy lives.

GM = Genius Management? No.

According to BusinessWeek, GM has delayed the launch of the Chevy Cruze, the car I wrote about previously that's GM's best hope in the U.S. small car market, to 2011. This is the car that GM needs now, could have had next Spring, and instead won't have until 2011, assuming that the company is still in business by then. Instead, they'll put all their resources into the wildly overpriced Chevy Volt, which was always considered to be a "halo" car that was more about image than sales. In other words, exactly the wrong investment when the company needs sales. The next-generation Chevy Malibu, which is one of GM's few successful cars, will also be delayed by six months, into 2013.

Even when you're battening down the hatches, you still have to invest to insure that you've got competitive products to sell. Otherwise, bankruptcy, the word that GM executives dare not utter, makes more sense than the other alternatives. The Chevy Cobalt, GM's current small car flagship in the U.S. market, is already outdated, and keeping in in the market until 2011 as a placeholder while competitors continue to introduce new models isn't a strategy, it's surrender.

Update, October 30th: Hey kids, you know that Cruze that you won't be able to get until 2011? Well, GM is selling it in South Korea right now, as the Daewoo Lacetti Premiere! That's right, South Korea, the market that has hardly any small, fuel-efficient cars, so GM needed to focus all its attention there. I have no idea what they were thinking.

An amazing (and scary) way to see the U.S. Budget

There's an interactive graphic guide to the 2009 U.S. Budget that shows each component of the budget in scale. Take a look at it here. What it points out is that Defense, Social Security, Medicare and Medicaid swamp everything else. Defense is the biggest piece of the pie, but it's not much bigger than Social Security, and the population is getting older. What's also clear is that there's nowhere near enough income to support the spending we've already got, let alone the hundreds of billions of dollars being pumped into the economy to bail out the financial system that hadn't been factored into the original budget.

In praise of efficiency

I've noticed a theme running through a number of my posts, and it has to do with efficiency. Health care in the U.S. is one of the most inefficient industries around, and the automobile industry isn't much better. In health care, we put up with the costs and inefficiencies because everyone is entitled to the highest quality health care. Except, of course, for the 47 million Americans with no health insurance, and the millions of others who get inadequate or substandard care, or who get no care at all even though they're insured, because they have a "pre-existing condition."

Cars are built they way they are because, well, they've always been built that way. Management and the United Auto Workers agreed to contracts over the decades without any serious thought about their long-term costs, because everyone involved was rewarded based on short-term results, not long-term planning. That's why Toyota and Honda can build small cars profitably in the U.S., but the U.S. automakers can't.

Our automakers are sliding toward bankruptcy. Our health care system is bankrupting the U.S. economy. The status quo is no longer acceptable, and we have to change it.

Too many car brands? How about too many models?

Not too long ago, I suggested that Ford, GM and Chrysler should shrink the number of lines of cars each company has (if GM acquires Chrysler, that will cause a bit more shrinkage than I had in mind.) There's another way to look at this problem, and it's model proliferation. I just checked Edmunds.com, and for the 2009 model year, here are the figures:

• 106 Coupes
• 94 Sedans
• 87 Convertibles
• 15 Minivans and Vans
• 25 Wagons
• 81 SUVs
• 26 Light Trucks

That's 434 different models, and it doesn't even include all the variations within models (upgrades with bigger engines, nicer interiors, etc.). Car manufacturers are trying to manage the proliferation of models with platform engineering--a variety of "top hats", or bodies with interiors, riding on top of a smaller number of platforms, or chassis. The problem is that for most manufacturers, there are still too many platforms, top hats and variations. There are even variations in the way cars are put together that increase costs and cause grief on the production line. For example, one top hat design might require that the doors be attached before the interior, while another one requires the opposite. The manufacturer can't run both top hats on the same line, because the assembly station order is different. It's a problem that most manufacturers are addressing, but it took a long time for them to do it.

There has to be a more reasonable and economically sensible position between 434 models with countless variations, and "you can get any color you want, so long as it's black."

The Condo Problem

According to media reports, condominium buildings around the country are running into what can best be described as "checkerboard" foreclosures. First one or two condo owners fall into financial trouble, and fall behind on their payments to the homeowners' association that manages the building. That means that the remaining owners are assessed more money to cover the bills that need to be paid. Those assessments increase the financial strain on other condo owners, so more fall behind, and the problem escalates from late payments to foreclosures.

Condos have always seemed to me to be "the property that you never really own." Yes, you own a few rooms, but if you stop paying the homeowners' association's fees, you can lose your property, even if your mortgage and property taxes are paid. If you disagree with the policies of the homeowners' association, tough luck--your options are to sell your condo or shut up. If the homeowners' association does a lousy job of maintenance or landscaping, again, tough luck. What's more, some homeowners' associations actually have veto power on who you can or can't sell your condo to.

I'm as much a fan of high-density living in cities as anyone, but condos are a sign of the American dream of owning your own home run amok. You can have the illusion of owning your own home, but in fact, homeowners' associations are little more than landlords. In some buildings, once enough people abandon condos to foreclosure, we'll see them transform back into what they once were--apartments. And then, the people who were displaced when their apartments were turned into condos and sold to the highest bidder will have the last laugh.

Nissan/Renault wants a piece of Chrysler

According to Autoblog from a story in the Detroit News, Nissan/Renault has offered to purchase 20% of Chrysler from Cerberus. The deal would keep Chrysler intact as a separate entity, but bring more Nissan and Renault products into the U.S. through Chrysler (a version of the Dodge Ram is already scheduled to become the next Nissan Titan, and a Nissan platform is scheduled to become the basis for a new Chrysler small car.)

The problem is that Cerberus apparently doesn't want to get rid of 20% of Chrysler, it wants to get rid of 100%, and neither Nissan nor Renault have the money to buy the company outright. So, unless Cerberus decides that it wants to stay in the car business, it's increasingly looking likely that the deal will be with GM or no one.

Help you with your prescription drugs? Not so much...

I lost my medical insurance at the end of July, and I've been trying to get along without it since then. Luckily, most of my medications are either generics or over-the-counter, so I can take advantage of low-priced prescription drug programs (I use Walgreens's program, but Walmart, Target and others have similar services.) However, two of my medications are still under patent in the U.S. and quite expensive, so rather than take my chances with an Internet drugstore, I decided to investigate the programs that are available from pharmaceutical companies.

It turns out that almost every major company has its own program, but each one has its own limits and requirements. For example, Eli Lilly, the company that's buying ImClone for $6.5 billion, has a program that provides its medications free, but my income would have to be near the poverty line. I can't file for the program alone--my doctor has to fill in a good deal of information--and Lilly requires me to include the front page of my 2007 Federal Income Taxes, along with paystubs or other evidence of my income. (I thought that tax filings were supposed to remain private.) The drugs will be delivered to my doctor, not to me or to my pharmacy, and I have to get them from the doctor. And, by the way, it'll take four weeks for Lilly to process the paperwork, and I'll have to go through the entire process again for each refill.

There's another option, Together Rx Access, which provides a discount of 25% to 40% on one of the two drugs, but doesn't cover the other one at all. After looking at the options, I've decided to go without either medication for now. If we really want to help people who can't afford their prescriptions, the Federal Government should simply make it legal for U.S. citizens to import small quantities of generic versions of expensive drugs from international sources for their own use. I'm sick of hearing drug companies point to their need to be compensated for their R&D expenses, when the major companies are incredibly profitable. In no other industry is there an expectation of compensation for failed research. If Intel goes the wrong direction with a chip design or fabrication technology, it sucks up the loss and moves forward. Are Lilly, Glaxo, or Merck really all that different?

Bring manufacturing home

During the U.S. Presidential primary campaign, John McCain famously told a group of workers in Michigan that the jobs that they lost were not coming back, but that they could be retrained for other jobs: "I've got to give you some straight talk: Some of the jobs that have left the state of Michigan are not coming back," he said. "They are not. And I am sorry to tell you that." What McCain didn't address was what jobs they could be retrained for. Most of the productivity gains registered in the U.S. for the past ten years have come from international outsourcing, not new technology or better-trained workers. In return, real personal income has been dropping since 2003.

We're not going to get the economy back on track until we dramatically increase the amount of manufacturing done in the U.S. The fundamental logic of moving production to China and other countries was that you could get something for nothing, but as always, you get what you pay for. Outsourcing services to India has backfired on companies such as Dell, which has had to introduce a U.S.-based service option in order to keep customers happy. (Dell learned that customers would pay more for good service--who would have thought?) There's just so many corners that you can cut before you've cut one too many--witness the melamine poisoning that first claimed the lives of pets in the U.S., and is now claiming the lives of infants in China. Over time, always aiming for the lowest possible price will result in disaster.

There's talk of a second stimulus package. It needs to have serious measures to encourage manufacturers and service companies to bring jobs back to the U.S. And, lowering the capital gains tax isn't going to do it. It requires a combination of carrots (tax incentives on a per-U.S. based-employee basis) and sticks (duties on goods and services purchased from outside the U.S.) to provide companies with the encouragement to build here rather than buy from there. These incentives and penalties have to be long-term, in order to encourage the capital investments necessary to rebuild the country's manufacturing infrastructure.

I'm as much a believer in free trade as anyone, but the "hollowing out" of the American economy can't continue if we're to maintain a decent standard of living. We can't rely on some future technology or market to come along and bail us out. The question remains: What do we retrain our workers for if there's nothing for them to do?

Fresh meat at the job sites

As I noted in my other blog, I'm looking for a new job, preferably in product management or product marketing. I've got resumes on just about every major job site, and this morning, I decided to update my resume and repost it. Unfortunately, at one of the sites, I uploaded a new resume rather than updating the existing one. Within minutes, I started to receive "spam" job offers. One insurance company sent me three identical requests to interview for a sales job within four minutes. Another firm actually set up an interview date and time for me, for a sales job with an unknown company. I'll probably also get a barrage of emails from franchisers.

If any of them had bothered to actually read my resume, they'd see that I don't have sales experience, but that doesn't seem to matter. These jobs are either commission-based, or they require a cash investment in a business on my part. Job turnover is incredibly high, so there's always demand for "fresh meat." In turn, the people who are sending me emails are being compensated based on the number of interviews they schedule or the number of franchises they sell, so it's quantity, not quality, that they're looking for.

The good news is that the frequency of spam job offers will taper off in a few days. Now if I could only get a serious offer from a real company...

Update, October 20, 2008: As I predicted, when I opened my email this morning, there was an email from another insurance company, a securities company, and a "consulting" company that uses high-pressure tactics to get small businesses to sign up for expensive, and often useless, services. (I also got an email from a franchiser last night, after I published the original post.)

Updated update, same day: Now I'm actually starting to get email from lonely singles! I had no idea that CareerBuilder was a singles site!

A simple proposal for health care

In the last Presidential debate, the candidates talked about their health care proposals (or more accurately, why the other guy's proposals were terrible.) Neither candidate was willing to endorse a single-payer system; that seems to be the "third rail" of U.S. health care policy. Yet the private insurance market we've got is working none too well: The U.S. pays by far the most for its health care, both in absolute terms and as a percentage of GDP, compared to other industrialized countries, yet the quality of care that U.S. residents receive is among the poorest of all those countries, and 47 million Americans are without health insurance.

The private market isn't working, but a single-payer system won't fly politically, so let me humbly propose a system that might:

First, the U.S. Government would split the country into four regions, Northeast, Northwest, Southeast and Southwest. The right to sell health insurance would be auctioned off in each region, just as the FCC auctions licenses to use the airwaves. The highest bidder would win the right to be the sole health insurance provider in that region, and the license fees would go to help pay the Government's part of this plan.

The insurance companies would all have to play under the same basic rules: No limitations for pre-existing conditions. No exclusion of conditions. No waiting periods. No one can be turned down. Personal insurance rates would be set based on age and family size. Companies would have the choice of buying their own insurance for employees, subsidizing employees who purchase insurance, or letting employees get insurance on their own. Everyone would have to get insurance from their employers or purchase it themselves.

The Federal Government would provide reinsurance to the insurance companies for catastrophic illnesses, thus eliminating the reason for insurance companies not to cover patients with AIDS, cancer and other life-threatening diseases. The license fees paid by the insurers would go into the reinsurance fund.

With a single insurance company to deal with in each region, administrative costs for health care providers would go down dramatically, which should result in lower costs. The licensed insurance companies would have far more leverage to negotiate prices with health care providers and drug companies.

This system would allow just about everyone to get insurance at affordable rates, and would maintain a multi-payer system. It would lower (or at least stabilize) costs. And, it would force insurers to pay for their participation in the system with license fees. Senators McCain and Obama, you're welcome.

Health care and the free market

I just finished reading a Business Week article about Eli Lilly's acquisition of ImClone Systems for $6.5 billion in cash in order to get ImClone's current cancer drug, Erbitux, and other cancer drugs under development. Cancer drugs hold a unique place for pharmaceutical companies, doctors and patients: They're typically targeted to a single type of cancer, such as lung or breast, there are often no good substitutes, and they're unbelievably expensive. Erbitux costs around $10,000 a month, while Genentech's Avastin costs up to $100,000 a year.

The prices of these drugs are inflated out of all relationship to either their cost to manufacture or develop; drug companies say that these drugs are incredibly expensive because of their development costs, but they rarely point out that they usually include the costs of drugs that never reached the market because they didn't work, were unsafe or couldn't be sold profitably. ImClone can charge $10,000 a month because without the drug, cancer patients die. Some of Europe's national health authorities are pushing back, refusing to pay exorbitant prices for drugs that often extend patients' lives by six months or less. U.S. insurance companies are expected to follow suit.

This is where we reach the fundamental limit of providing health care under a free market system. Patients will pay any price to stay alive, and under supply and demand, drug companies can charge the highest possible price to those patients. The question is whether or not that's in the best interests of society. I don't think that it is. This is a situation where pharmaceutical companies "stick it" to patients, both figuratively and literally. The people who get stuck the hardest are the uninsured, who in the U.S. pay on average 2 1/2 times as much for their medical care as those who have insurance. Even for insured patients, the prices get passed on to insurance companies, and everyone pays in the form of higher rates.

Getting a reasonable rate of return on a drug company's investment is one thing; gouging patients who have no option but to pay or die is unethical and immoral. That's where the wheels fall off.

Cerberus: Using GMAC to get GM to buy Chrysler?

The negotiations between GM and Cerberus Capital for GM to trade its remaining share of GMAC to Cerberus for Chrysler have apparently picked up steam. One big reason is that GMAC is all but shutting off credit to GM's dealers and customers, leading GM to launch a promotion encouraging dealers to finance cars through companies other than GMAC. Some observers believe that Cerberus is trying to "cut off GM's air supply" by withholding credit, and that without that credit, GM could burn through its remaining cash by the end of this year.

GM's Board of Directors was decidedly cool to the Chrysler deal when it was first proposed, so Cerberus may see this as the only way to get the deal done. If Cerberus is so desperate to get rid of Chrysler that it's willing to hold a gun to the head of GM, things at Chrysler must be even worse than the company has revealed so far. However, it's unlikely to work out well for anyone, even for Cerberus. A merger of GM and Chrysler simply makes no sense, especially in this economy, and the $10 billion operating savings that are being quoted haven't been explained by anyone, and have to be seen as vapor. If GM is forced to take Chrysler, it will have a strong incentive to steer future financing to other banks, thus leaving GMAC without an outlet for future business.

I for one hope that cooler heads prevail. One rumor is that Renault could buy Jeep back from Chrysler (Renault sold Jeep to Chrysler years ago as part of its sale of American Motors), so those jobs wouldn't be lost. Some of Chrysler's more modern plants could be sold to other manufacturers. But, a shotgun wedding between GM and Chrysler could result in far more long-term carnage than would result from a straightforward liquidation of Chrysler.

How not to succeed

The freeze-up in the credit market has hit GMAC, GM and Cerberus Capital Management's financial arm, hard. According to Jalopnik, GMAC will only finance car loans at dealer invoice or below for buyers with a FICO score of 700 or above. That means excellent credit; no subprime borrowers, please. Also, restrictions are being placed on loans for longer than 60 months, so buyers won't be able to get lower payments by opting for a longer term. Earlier, Chrysler Finance (also controlled by Cerberus) pulled the plug on lease financing for anyone, including highly-qualified customers.

With all the problems that GM has right now, pulling the plug on financing to all but the most qualified customers won't make things any better.

There won't be a Depression, but there WILL be...

One of the biggest reasons why the Great Depression starting in 1929 was so deep and so long was that Herbert Hoover's administration first denied that there was any problem, then blamed it on its political opponents, and finally depended on the free market to fix its own problems for far too long. It took a change of administrations, the willingness to try just about anything, and time, to get the economy going again. The Bush Administration might have denied the risks involved with the subprime housing market and Credit Default Swaps for far too long, but whether through luck or plan, Ben Bernanke and Hank Paulson know their history (Bernanke is considered by some to be the world's leading academic expert on the economic history of the Great Depression.) Bernanke and Paulson knew that they had to take action; they couldn't rely on the free market alone to fix the problems.

We're now seeing coordinated international action to address liquidity problems, stabilize the banking system and restore confidence in the equity markets. None of this occurred in the 1920s and 30s. At the end of the day, these efforts may still not work, but there's an excellent chance that we'll avoid a repeat of 1929.

What we'll be left with, however, won't be pretty:

• The recession is likely to stretch into next summer, if not beyond.
• Unemployment will probably reach 8%.
• Even after the recovery begins, credit will remain very hard to get. For businesses, it will be much more expensive. For consumers, who will likely benefit from reduced interest rates and fees that are lowered or eliminated by Federal law, credit will be available to only the most creditworthy borrowers.
• Tight credit will directly impact the sale of high-ticket items, such as homes and cars. Home prices will finally stabilize, but sales will take longer and be more difficult to complete. People will keep their cars longer, and when they buy new cars, much bigger down payments will be required. Car production will have to slow to adjust to the lowered demand, and more dealers will go out of business.
• Restrictions on the interest rates and fees that can be charged to consumers will make credit card issuers much more selective about who they offer cards to, and how much credit they offer. Only the safest borrowers will get cards, and many borrowers with existing cards will see their credit lines decreased or frozen by banks.
• As a result, the credit- and consumer-driven expansion of the economy will come to an end. Business investment will have to pick up the slack.

This is all bad, but it's not a Depression, and the economy will eventually recover. It might actually benefit the stock market, since much of the capital that had been flowing into banks will end up going either into stocks or Treasury bills. And as I've previously written, there are many true bargains in the stock market that are at no risk of bankruptcy.

Credit cards: The next shoe to drop

The U.S. edition of Business Week has a frightening article in this week's issue about how credit card debt defaults are the next big risk for banks. This is something that I wrote about in my other blog almost a month ago. According to Business Week, the total amount of credit card debt outstanding in the U.S. is $950 billion dollars--less than 10% of the money invested in home mortgages, but a huge number nonetheless. According to researchers, at least 20% of that amount is at risk of default. What's worse, $365 billion of the total debt is held in securitized instruments, similar to the Collateralized Debt Obligations (CDOs) that are wreaking havoc on the financial system. That means that as the rate of default increases, the value of the credit card debt-backed securities will plummet, and much of that $365 billion could be at risk. And, if there are Credit Default Swaps held against that $365 billion, seven trillion dollars or more could actually be at risk. There is nothing whatsoever in the financial bailout plan passed in the U.S. Congress to address this problem.

Defaults are going to increase because consumers have been shifting their purchases from second mortgages and lines of credit to credit cards. With home values dropping, mortgages and home equity loans almost impossible to find, and real personal income declining, credit cards are the only option left. Missing a single payment on a single credit card could cause the interest rate on all the cards and balances held by a consumer to jump to 20 to 30%, or even more, increasing payments and the probability of default. And, a law passed last year requiring banks to increase their minimum monthly payments that was intended to help consumers pay off their debts more quickly has instead increased default rates.

As with mortgages, the banks have no one but themselves to blame for this problem. First, they got Congress to abolish usury laws, which removed caps on the amount of interest that they could charge. Next, they gave credit cards to just about everyone, regardless of their credit. The first generation of credit card issuers who targeted risky borrowers, MBNA and Providian, were acquired by Bank of America and Washington Mutual, respectively. Those banks adopted the aggressive tactics of the banks they acquired, and were followed by J.P. Morgan Chase, Capital One and others. Now, Chase owns Washington Mutual. Note that Chase and Bank of America are considered two of the "too big to fail" superbanks.

There are efforts in Congress to limit interest rates and decrease or eliminate some fees, so what are the banks doing? They're increasing interest rates ahead of the new laws, which will increase the number of defaults. Investors are demanding default insurance from the banks, and many are refusing to buy the banks' securitized instruments altogether, which means that more banks will have to keep their defaulted credit card debt on their own books.

This is one reason why I say that there's no such thing as a "safe" bank. Even the ones that have profited from the mortgage implosion may still be at risk from credit card defaults.

Too many brands

When I was a kid, GM had five car brands. They were clearly defined and differentiated. GM's goal was to bring buyers into the fold with Chevrolet, and as they got older and their needs and tastes changed, keep them for the rest of their lives, moving from Chevy to Pontiac to Buick to Oldsmobile to Cadillac ("The Standard of the World".) Ford did the same thing, with Ford leading to Mercury and then to Lincoln, as did Chrysler, starting with Dodge, to Plymouth, Chrysler and then to Imperial. Since then, GM has added Saturn and shut down Oldsmobile, Imperial was first merged into Chrysler and then discontinued altogether, as was Plymouth.

Is Alfred P. Sloan's model, first developed at GM in the early 1920s, the right way to go in the 21st century? In my opinion, it's obsolete--too costly in an industry with worldwide competition. GM could probably do just fine with Chevrolet, Cadillac and possibly Saturn to act as the U.S. brand for Opel-designed cars. At Ford, Mercury is completely redundant, and Lincoln's product line is little more than dressed-up Fords. Drop Mercury and either differentiate the Lincoln product line much more or fold it into Ford. (The new MKS, for example, is based on the Volvo S80/Ford Taurus platform and could become the new Ford flagship, as the LTD once was.) There's tremendous overlap between Dodge and Chrysler, with the Chryslers having somewhat upmarket trim. Only one brand is needed.

By getting rid of multiple brands, the design, engineering and tooling costs involved with creating multiple variations of the same car can be saved. Advertising can be more effective, and costs can be reduced. Dealer networks can be made smaller and more efficient. Product inventories, both at factories and in the field, can be decreased.

The problem isn't limited to U.S. manufacturers. Toyota is rumored to be considering turning the Prius into a separate brand, with several different models. I think that's a mistake. Just as Scion is not attracting the young, hip buyers that Toyota intended, the buyers for a Prius brand aren't going to be significantly different than those who buy Toyotas. Toyota has succeeded handsomely with two brands, Toyota and Lexus. They don't need any more.