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.

How we got here

 So how did we get to the financial mess we're in?

1. For most of the last 20 years, growth of the U.S. economy has been driven by consumer, rather than industrial, spending.
2. In the last ten years, consumer spending has been amplified by the availability of easy credit, especially for buying homes. Many of these home loans, called Adjustable Rate Mortgages, or ARMs, had a low initial interest rate for three to five years, which then adjusted to a higher rate based on prevailing interest rates at the time. Some loans even had an option called Negative Amortization, where borrowers could pay less than even the monthly interest payment for a period of time; this allowed many people to buy homes that they couldn't afford.
   
3. The easy credit caused a run on housing, which increased prices.
4. The increase in home prices allowed homeowners to take out second mortgages and lines of credit, backed by the increased value of their homes, but without commensurate increases in personal income.
5. Financial institutions packaged these home loans together into securities (Collateralized Debt Obligations, or CDOs) that hid the underlying risk of default by individual homeowners. No one knew what the true underlying risk was, but credit rating agencies gave these securities AAA ratings, the highest possible.
6. Financial institutions bought and sold Credit Default Swaps (CDSes), totally unregulated financial instruments that were intended to provide insurance in the event that the CDOs lost their value. Unlike conventional insurance, in which the insurer is required by law to keep a sufficient financial reserve to cover losses, there was no such requirement for the purchaser of CDSes. Banks could buy CDSes for pennies on the dollar. For example: A bank could purchase a million dollars of protection for a CDO for $50,000, and the seller of the CDS would have no requirement to have any capital reserve to cover losses. If the value of the insured CDO dropped to $500,000, the CDS seller would be in the hole by $450,000, potentially with no reserves to cover the loss. To minimize this risk, CDSes could be insured by other CDSes.
   
7. When marginal homeowners started to default on their mortgages and lines of credit, the value of CDOs plummeted, because no one knew how much they were truly worth. "Mark-to-Market" accounting rules required the financial institutions to value the CDOs at what others were willing to pay for them.
8. The collapse of CDO values caused the fall of Bear Stearns earlier this year, and put banks around the country under pressure. IndyMac Bank in California failed and was taken over by the Federal Government.
   
9. As the values of CDOs declined, the money in Credit Default Swaps was needed to cover these losses, so the CDSes also became all but worthless, leading to the fall of Lehman Brothers and the bailout of AIG by the U.S. Government. In an auction held on October 10th, Lehman's $400 billion worth of CDSes were valued at 8.625 cents to the dollar, meaning that investors who had agreed to insure these CDSes will have to pay out 91.375 cents to the dollar. Where will they come up with that money? Who knows?
10. The collapse of Bear Stearns and IndyMac, along with all the other problems, caused the stock market to drive down the value of shares in banks, brokerage firms and other financial institutions.
    
11. Because of the fear of not having enough value in the CDOs to cover the CDSes (and vice versa,) banks and other financial institutions began hoarding cash, placing it in short-term U.S. Treasury bills, rather than lending it out to businesses, consumers or other banks.
12. Fear of not being able to get their money caused consumers to pull their money out of the riskiest banks, including Washington Mutual and Wachovia. The Federal Government took over Washington Mutual and sold it to J.P. Morgan Chase, and yesterday, Citicorp agreed to walk away from an earlier agreement to acquire Wachovia in favor of a better deal from Wells Fargo.
13. With almost no credit available and housing prices crumbling, consumers cut back their purchases dramatically, and businesses couldn't get financing. Unemployment increased.
14. The decline in the value of shares in financial institutions spread across all sectors of the stock market, and turned into an outright panic as falling prices caused investors to pull their money out, in order to avoid additional losses.
    

And here we are.

GM wants to buy Chrysler???

As reported in the New York Times yesterday, GM and Cerberus Capital Management (the private equity company that controls Chrysler and holds a majority share of GMAC) have been negotiating a deal in which GM would acquire Chrysler in return for the share of GMAC that it continues to hold. For GM, it would get GMAC's toxic subprime mortgages and car loans off of its books, and for Cerberus, it would get out of the car business. However, if this deal happens, it's likely to become the poster child for the adage "When two weak companies merge, you get a bigger weak company."

Other than limiting its downside exposure to the financial market, what would GM get out of this? Chrysler's product line is weak, especially passenger cars, and its product pipeline is almost nonexistent. Its strength is in trucks and SUVs, especially Jeep, but both those product areas have been especially hard-hit by gas prices. Chrysler's international position is far weaker than that of either GM or Ford. GM doesn't need Chrysler's dealers--it already has a bloated dealer structure that needs to be pruned. GM would pick up more plants, with more United Auto Workers contracts.

Even two months ago, this deal wouldn't have made sense, and it makes even less now. GM is having so much trouble turning itself around, why would it even consider taking on Chrysler? If there's any long-term logic to this deal, I don't see it.

Panique! The scent of desperation

We've reached the point of full-blown worldwide stock market panic, something not seen for at least 30 years. People are scared, physically scared, and they're selling off stocks at almost any price to be able to hold on to something, rather than lose everything. So many stocks have been driven down below any rational valuation that it should be a great time to buy, except that people are afraid that prices will go still lower.

This is the point where investors have to look at the fundamentals of companies rather than their stock prices to regain their composure. The question is: Will this company go bankrupt? Companies such as Kraft Foods, Johnson & Johnson, Heinz and Procter & Gamble are going to stay around--people need their products in good times or bad. In tech stocks, IBM, Cisco, Microsoft and Apple certainly aren't going away, although their stocks could go lower. On the other hand, I think that Ford and GM are radioactive, because both companies have a significant chance of failure. People will always need cars and trucks, but there are lots of alternatives, many of which are better managed and better prepared to handle market conditions. And, I wouldn't touch any of the financials with a ten-foot pole, no matter how much of a "bargain" they become. There are still far too many unanswered questions about who will live and who will die.

With all that said, I completely understand the panic that investors are feeling. People who are in their 50s and 60s are seeing their retirement funds obliterated, and they may not have enough time before retirement to recover. My parents, both of whom lived through the Great Depression, often told me what happened to them and their families, and I've read extensively about the Depression's causes and effects, but I'm finally beginning to understand.

The most important green investment

Earlier this week, in the second U.S. Presidential Debate, moderator Tom Brokaw asked the candidates whether they favored a "Manhattan Project"-like approach to funding research and development into alternative power, or "letting a thousand flowers bloom" with smaller investments by many different companies and organizations. As usual, neither candidate really answered the question. Tom didn't ask me, but here's my opinion:

In general, I think that having many organizations taking many different approaches to the problem is the best way to go. However, there is one area in which a massive, coordinated R&D project could make an enormous difference, and that is battery technology. Batteries are essential for storing energy from solar cells and wind turbines, as well as powering automobiles and leveling out demands on power plants, yet battery chemistry has advanced very little in the last 20 years. Improvements are needed in:

• Power density--the amount of power that a battery can store in a given mass.
• Recharging time--it needs to take minutes, rather than hours, to recharge the batteries before all-electric cars will be truly practical.
• Safety/toxicity--batteries must be safe to use in a wide range of environmental conditions, and they must be easily recyclable.
• Cost--the cost to get the above three improvements must not be so high as to make the resulting batteries economically impractical for consumer applications.

Batteries are an area where individual groups doing R&D aren't making the progress needed by not just the U.S., but the entire world. That's why I think that this is one area where a coordinated effort, on a national or international level, is needed. The value of bringing the next generation of battery technology to market is greater than any single country's interests.

Wanna buy GM?

As of the close of trading in the U.S. today, GM's market capitalization (the total value of equity investments in the company) was around $2.7 billion. For now, at least, the market is betting that GM won't recover from its slump. Could GM become an acquisition target for a European or Asian car manufacturer? Renault, Peugeot/Citroen and Fiat have all talked about reentering the U.S. market at one time or another. One of the myriad of Chinese manufacturers could scoop up GM and use it as an entryway into the U.S. market. The problem, however, is GM's enormous obligations to its employees for jobs, pensions and medical insurance. Any acquirer would either have to take on those obligations or figure out a way to get rid of them, such as massively transferring production outside of the U.S. to plants not represented by the United Auto Workers. That's why an acquisition of GM by a competitor, as appealing as it might look on the surface, is probably not in the cards.

I'm back on the air!

Google has reviewed this blog and determined that it's not, in fact, spam. So, I'm back with more blather!

Obama by a landslide

You read it here first...Barack Obama will win the U.S. Presidential election next month in a landslide. John McCain and his handlers are going to try to do anything and everything possible to attack Obama personally, but it's not going to work. Everywhere I go, every news program I watch or listen to, and every newspaper I read, I hear the same thing: People are angry. Their living standards are poorer than they were eight, or even four, years ago. Their retirement savings are in jeopardy. Their homes are worth much less than they paid for them. The student loans that they arranged for their children are being withdrawn, leaving them scrambling to find new lenders.  Businesses can't get financing, so they're laying off workers, cutting back on orders and, in the worst cases, going out of business.

The worst mistake that the Republican party made in decades was when it decided to put all its chips on George W. Bush, even though John McCain was winning primaries and gaining momentum. Had McCain been in the White House in 2000, we almost certainly wouldn't have gone into Iraq, and we might not be in this financial mess. Unfortunately, the John McCain of 2000 isn't running in this election. The John McCain of 2008 is a political opportunist who seems to make critically important decisions on a whim, the most devastating of which, in my opinion, was appointing Sarah Palin to be his Vice-Presidential candidate. Eight years ago, he might have been able to get away with that; given that he would have a 1 in 6 chance of dying in office were he to be elected now, his decision has to be seen as grossly irresponsible, especially given that there were many other female Republicans with far more experience and qualifications to be President.

Given the many problems that this country has, I would much rather have Obama and his team, rather than McCain and his "ready, fire, aim" approach, in charge. I think that the bulk of American voters are coming to the same conclusion.

A new way to sell cars

I never intended this to become a car blog, but I seem to be fixated on the subject right now. Today's New York Times Magazine has a picture of a Think car on the cover (along with Al Gore, Bill Joy, John Doerr, and who I think are Ray Lane and Randy Komisar--I haven't seen either one of them for a long time). The Think is an electric car made in Norway; the cars were once imported into the U.S. by Ford, when all manufacturers had to offer electric cars in California, and if you live in Northern California, you can still see a few parked at Palo Alto's city hall. However, I don't want to talk about the Think in particular, or the article in NYT Magazine about Kleiner Perkins, but rather about how cars are sold.

The current car dealer system in the U.S. is at least 80 years old. It was built in a time when transportation of cars was extraordinarily expensive, so it made sense to warehouse cars at dealerships across the country. Face-to-face selling was the only model that made sense. However, dealers today are going through an economic disaster, thanks to the high cost of credit, which makes keeping cars on the lot much more expensive and makes it much more difficult for individuals to buy the cars. According to a podcast from Autoline a few days ago, the CEO of AutoNation predicts that thousands of dealers will go out of business in the next year, compared to a few hundred in an average year.

We now have a new generation of car manufacturers in the works--companies that are selling high-value electric and hybrid cars to a generation of buyers who grew up with the Internet. The dealer and service model can, and should, change to address these new realities:

• Perhaps the least radical change would be the no-inventory dealer. In this model, the dealer only keeps demonstration models on the lot, and every car ordered comes from either regional depots financed by the manufacturer or directly from the factory.  Dealerships could be much smaller (you could literally have dealerships within shopping malls), and service could be provided at another, much lower-cost, site entirely.
  
  
• The more radical option would be online ordering. Virtually every car manufacturer already has a vehicle pricing and configuration system on its website. Consumers could configure and price vehicles, and then submit them to the manufacturer, which would locate cars closest to the customer's specifications in its own inventory. The consumer would have the option of buying a car from inventory, or if nothing close enough is available, ordering a custom-built car. (For very expensive cars, the expectation is that everything would be custom-built.)
  
  My belief is that the manufacturer would be able to provide better financing options than most individual dealers. Once the financing is obtained, the car would be shipped directly to the consumer. Service would be provided by locally-owned and operated service centers.

In the 21st Century, cars don't have to be sold the same way that they were sold in the early 20th century, especially for new manufacturers who don't already have thousands of dealers to placate.  These models could lower costs for everyone and make it easier to bring innovative new cars to market.

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Chevy's got a great new car that you can't buy (unless you're in Europe)

Judging by all the advertising and promotion, you'd think that the only new car in the works from Chevrolet is the Volt, which is supposed to hit the market in 2010. But let's face it--a $40,000 car, which is what the Volt is predicted to cost, is hardly going to be a big seller. The Cruze, on the other hand, will sell like hotcakes. The Cruze is designed to replace the Cobalt (so named for its radioactive qualities) in 2010. Here's a link to Autoblog, with lots of pictures, including what I think is the nicest interior that GM has ever done. The Cruze would be perfect for today's auto market--1.4 liter turbo engine with 40 mpg highway mileage, good looks, etc. So why is Europe getting the Cruze next Spring, while we have to wait until 2010 for it?

Bob Lutz wanted to jumpstart GM's small car development, so he imported the Opel Astra, the best-selling car in Europe, to the U.S. as a Saturn. However, it was overpriced and underpowered, as well as unprofitable, due to its being manufactured in Belgium. The next-generation Astra will be built in the U.S. in 2011, a year after the new Astra hits Europe. (Yes, they'll be building old-model cars, if anyone wants one, for the U.S.) The Cruze was designed in the U.S. and will be built in the Lordstown, Ohio ("Home of the Vega!") plant that currently builds the Cobalt. If the Cruze is going into production next Spring in Europe, there's no reason except poor planning to explain why GM couldn't have launched it into the U.S. at the same time.

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Bad times if you're in the car business

According to Autoblog, for the first time in its history (and, some sources indicate, the first time since the 1980s), every car maker and brand had lower sales in the U.S. last month than in September 2007. Every one. The best performer, Audi, was down only 5.4% year over year, while the worst performer, Hummer, was down 54.8% (no surprise there). In terms of manufacturers, GM fared best, down 15.8% from last year, primarily on the strength of the company's "Employee Pricing for Everyone" program, while Nissan was worst, down 36.8%. Nissan, Ford, Chrysler and Toyota were all down more than 30%, demonstrating that the problem isn't limited to the Big Three.

Other than the GM Employee Pricing program, which helped Chevy, Saturn and GMC in particular, there doesn't seem to be a pattern to explain why one brand did better than another. Some people were still buying luxury cars, Mercedes-Benzes in particular; they were down 16.4%, while Lexus was down 36.1%, and BMW was down 29.5%. Why did Mercedes do so much better? I have no idea. Why was Subaru down only 11.9% while Mazda was down 35.6% and Toyota was down 31.8%? Again, I haven't a clue.

The point is that the car business is terrible right now, whether you're a manufacturer or a dealer. Most industry observers expect more promotions to be announced, and perhaps an extension of GM's Employee Discount program, in the next few days. It's a great time to buy a car, assuming you can get credit (which is one of the big reasons why everyone's sales are down.)

Can we get this deal done, please?

I've been watching the stock market yo-yo and the liquidity markets freeze up while we wait for the on-again, off-again bailout plan. At this point, tt doesn't matter which party was responsible for the failure--either one could have produced the 12 additional votes that were needed for passage. The U.S. Senate plans to vote tonight on a modified bailout plan that keeps the basics of the plan voted on last Monday, but adds some tax benefits for individuals and small businesses, and raises the maximum per-account level of FDIC insurance from $100,000 to $250,000. Whether these sweeteners are enough to get the 12 additional votes needed in the House, let alone hold onto the votes that the original bill got, remains to be seen.

The lack of safeguards that I complained about in a post on my "Feldman File" blog was addressed in the version of the bill that originally went to the Senate. While I despise what got us to this place--the almost complete disconnection of capital from its underlying risk that's led us to having no idea how much more than a trillion dollars of securitized mortgages and other debts are really worth--we have to act. We've got to make sure that people can still get home, car and student loans, and that businesses can buy inventory, meet their payrolls and keep their doors open.

As I write this, it appears that "the tide is turning" with members of the House who voted against the original bill. Their "call ratio" from constituents is turning in favor of the plan, thus giving them the political cover that they need to vote for the revised bill. However, I won't count on anything until the bill passes both Houses of Congress and is signed into law by the President.

Unaffordable housing from affordable components

Last week in San Jose, California, the West Coast Green 2008 conference was held. As you might expect from the name, it was devoted to green technologies, one of which was green home construction based on used shipping containers. (You can see a picture of the home on exhibit here.) The home shown, built by SG Blocks, costs around $150 per square foot, not including land. Thus, a 1,000 square foot home would cost $150,000. That's not bad by California standards, but according to this article, the recycled shipping containers cost between $2,000 and $3,000 each, and between four and eight of them are needed to build a home (each container has 320 square feet of floor space.) I understand that there's a lot of additional work required to convert a container into a home, but it hardly seems affordable when modular and manufactured homes are available in other parts of the country for $75 a square foot or less.

I don't want to knock the movement toward using recycled shipping containers, but if the resulting homes end up not significantly less expensive than conventional stick-and-frame homes, what's the point?

POV: Critical Condition

Last night, I watched a documentary in PBS's POV series called "Critical Condition". It takes the viewer into the lives of several families, all of which are being systematically destroyed by the lack of medical insurance. One man, a diabetic, has his foot amputated while he still has medical insurance, rather than have surgery that could have saved his foot but that would have had to take place after he lost his insurance. A woman undergoes a chemotherapy regimen for advanced-stage cancer that probably could have been treated more effectively or even cured, had she been able to seek treatment earlier. A man with non-alcohol-related cirrhosis of the liver and Type II diabetes, who could have been treated easily with medications, literally falls apart because he couldn't afford the medicine.

While these stories play out, the film lays out some cold, hard facts about the U.S. medical system. For example, it points out that on average, hospitals charge patients without insurance 2 1/2 times as much as they charge insured patients. It also notes that the U.S. pays more of its GDP than any other industrialized country for medical care, yet over 47 million Americans have no medical insurance.

Every U.S. Senator and Representative should be made (forced, if necessary) to watch this truly heartbreaking documentary. There is absolutely no excuse for there not to be good medical care for all Americans. What's more, as this documentary points out, early intervention would not only have saved lives, it would have saved literally hundreds of thousands of dollars in critical care that was required when manageable conditions became life-threatening. Our medical system costs far too much for the benefits that our citizens are getting, in large part because of this focus on critical interventions rather than preventative care.

If you didn't get a chance to watch it, I encourage you to contact your PBS station and ask them to replay this important documentary. It's available for purchase, but the more people who get to see and talk about it, the better.

A new blog

Since 2005, I've been writing a blog called "The Feldman File" that covers technology topics. Recently, I began posting some articles related to the economy and politics, and my readership sank. When I went back to technology topics, my readership rebounded. Clearly, I needed to stay "on topic" for my readers. However, there's so much going on in the world that frustrates and alarms me that I can't keep my mouth shut. Hence, a new blog, called "Feldman Off Topic", for the things that I can't write about in The Feldman File. I hope that you enjoy it, or at least find some interesting ideas.