Friday, November 14, 2008

DIP Financing for the Big Three

As MidMark Capital has a few auto suppliers in its portfolio, I have been intimately involved in various aspects of the current mess in Detroit, and have a few thoughts on how it ought to be handled.

Washington is now mulling over how to handle the crisis, and it has quite a few options. With Washington just having just offered up $750 billion to save the financial industry, there seems to be little popular or legislative support for the same thing again. It seems as if a consensus is growing that the government ought to just let the auto companies go bankrupt and come out the other side smaller, nimbler, more efficient, and making better products.

I generally agree, especially as bankruptcy would allow the court to invalidate prohibitively expensive labor agreements with the UAW. Bankruptcy will not be a panacea, however, and Ron Gettelfinger will still have enormous power in determining what the restructured industry looks like. It may take four of five bankruptcies over the next 50 years in order to finally make the US auto industry competitive in a global marketplace. So, let's get started with the first.

However, there are some very serious issues which need to be worked out before any of these companies can file. First, they will need cash to operate while in bankruptcy. In a normal bankruptcy proceeding, a company will receive DIP (Debtor-in-possession) financing from a bank while in bankruptcy.

But DIP financing for the big auto companies would be simply ginormous. There is no clear indication that it would be available anywhere in the marketplace, especially since we are still in the midst of an unprecedented credit meltdown. Where are these companies going to get DIP financing?

Letting any of the big three go into Chapter 7, or liquidation, would be simply disastrous. Plenty of people have written extensively on this issue, so I won't go into it, except to say that there would be job losses in the millions amongst the Big Three and their suppliers. Ultimately, the cost would make any rescue package today seem like small potatoes.

The obvious answer, to me, is the that U.S. government should step in as the source of DIP financing, and then get out of the way as the auto companies declare bankruptcy. That way, we could be assured that the OEMs would have enough liquidity to operate through bankruptcy, but the private markets could work their magic to shrink the companies and enable them to come out the other side as more robust companies.

One other note: the government should also step in temporarily as guarantor on all of the auto companies' payables to its supply base. If those payables (in the many billions) were to go bad, there would be enough bankruptcies among the supply base to make it seem like the OEMs themselves had gone bankrupt.

Saturday, November 8, 2008


Mark my words: Brazil is going down.

I've watched the Brazilian economy with interest ever since I visited two years ago to arrange bank financing for one of our companies down there. I was surprised at the strength of the real, and was told with conviction that the country had developed a strong currency by offering very high interest rates, and therefore foreigners were investing heavily there.

Well, in my modest opinion, that kind of expediency cannot last. Something's got to break.

There was a gathering of world economic leaders in Brazil last week, and Brazil's president Lula was extremely aggressive in taking developed nations to task for creating a worldwide economic meltdown.

I can only imagine that Lula was setting up to blame developed economies for trouble brewing there. I would not be surprised to see the real continue to fall over the next six months, and possibly to see another debt crisis in Brazil in '09.

Friday, November 7, 2008

The Coming Apocalypse

It is the fall of 2008, and the inevitable now seems upon us.

The auto industry is burning rubber, headed straight to insolvency. It may not happen tomorrow, or even the next day, but news sources are reporting that at least two of the big three have less than a year of cash left. GM and Chrysler are in deep trouble. Ford, luckily, seems to have quite a bit of cash, and thus has more time to work things out.

There will be much gnashing of teeth in the Obama administration this winter as it takes the reigns of the world’s largest economy and realizes that the largest sector in that economy is essentially moribund. There will be an almost unquenchable desire on the part of the new administration, and the complicit press, to blame it all on George Bush, who by that time will be riding into the Texas sunset.

This desire willfully ignores 75 years of history.

Those in the know have seen this state of affairs coming since Walter Reuther dramatically increased the scale and power of the UAW in the 1930s and 40s. Put simply, US auto OEMs cannot compete with their existing cost structures. It is that simple. This was a disaster in the making for 75 years. That it took so long is a small miracle.

If you want a graphic illustration of why the industry is going bankrupt, just stare at this timeline of the UAW for a moment. Look at all those accomplishments. All in one place, it is a truly remarkable list of benefits that the UAW has secured for the American worker.

Now, consider that there are something like 700 million Chinese people who are willing – nay, begging – to work for under $1/hour.

In a truly global economy, how could a company possibly pay someone over $40/hour to sit at a press and push a button every five seconds?

It can’t. End of story.

I would bet bundles of money that, in every single one of the contract negotiating sessions which the big three have had with the UAW over the last 75 years – there have probably been hundreds of them – someone from management has looked in the eye of the UAW rep and said something like this: “You know you are going to bankrupt this industry… Maybe not today or next week. And maybe not because of the specific concessions we are granting today… But add them all up, and, bit by bit, you’re stealing the future of this industry by creating an artificially high wage structure.”

Now, in the coming years you will read all sorts of stories which purport to explain why the US auto industry caused its own demise. People will say that Detroit bet too heavily on trucks and SUVs while the world was shifting to smaller cars. This ignores the fact that those trucks and SUVs were enormously profitable to Detroit, while Toyota loses money on every Prius it ships. If the industry had done what these pundits proposed, the day of reckoning would only have come sooner. This argument also ignores the fact that the US OEMs have always had very full product lines, including smaller, fuel efficient cars. For some reason, Americans bought big cars from Americans and small cars from foreigners. It was a problem of the marketplace, not management.

You will also hear that management in Detroit was inept – they could not design their way out of a box. This argument ignores the fact that foreign automakers have something like a $5,000 cost advantage on every car that it builds and sells. The US auto industry sells something like 8 million cars. Multiply those two numbers together, and that’s $40 billion worth of profit for R&D which the US auto industry did not have. It’s a little easier to develop snappy, highly engineered cars when you have a practically unlimited R&D budget compared to your largest competitors. No, Detroit’s management was not the problem.

Now, I do not hold any grudges against the UAW. It did what it was designed to do, and it did it well. I honestly believe that every local rep who ever negotiated with management on behalf of a plant’s employees had those very employee’s best interests in mind.

Unfortunately, imputing honorable intentions to 75 years worth of UAW negotiators does not get us out of our current mess. And what a mess indeed.

I am not hopeful.

This is a topic for another post on another day, but essentially I believe that the US economy will be under pressure of some sort – waxing and waning but nevertheless constant – until the average hourly wage for those 700 million Chinese equals the average wage for our own hourly workers.

How long will that take? 100 years? Maybe less? In any event, it’s depressing.

Wednesday, November 5, 2008


It is November 5th, 2008, and Barack Obama was elected the 44th President of the United States last night.

One of my gravest concerns with an Obama presidency has been the Supreme Court. The good news is that Roberts, Alito and Thomas are all quite young. I had to boogie over to Wikipedia to check Scalia's age - he's 70 - but he seems vigorous and I can only hope that he's as healthy as he looks and sounds. Kennedy is 72. Of course, I am less concerned about losing him since he's been so unreliable lately.

I think we're OK until at least 2012. But we've got to win that one.

A Silver Lining

So Obama has won. It will be some time before I've sorted through all of my thoughts about this, but a few comments are in order.

Congratulations to Obama on his victory. He was a masterful politician, and he is to be congratulated. But there are even more important issues I mean to discuss.

First, the election itself is inspiring. We have elected a black man to the highest office in the land. Race is not, by itself, a reason to elect someone to office, but, having done so, we should celebrate the inspirational story it represents. On January 21st, 2009, the most powerful man in the world will be black, and it has happened in the United States.

Conservatives and certain others like Bill Cosby have been fighting a kind of cultural war related to race for quite a long time. The conservative line in this cultural war says that the darkest days of racism are behind us, and now it is up to black people themselves to craft their own success. It has implored black people, particularly in poor, inner city locations, to shape up. Pull up your pants. Learn to speak proper English. Speak it. Value education. Clean up your streets. Invest in your homes. Stay married. Keep your job.

To a certain extent, these exhortations have fallen on deaf ears. OK, says the inner city black man, I could do all of those things, but to what end? Where have I gotten myself? I do all of those things, and then I am still just a poor black man in the inner city with his pants pulled up and a low paying job. My drug dealer friend down the street is driving an $80,000 Mercedes! It doesn't make sense!

The logic is understandable. But the black man, in this case, is constrained by his own perceptions about the limitations of his success. So he never actually pulls up his pants and strives to learn proper English. It's a vicious cycle, and he stays poor.

But, guess what. Now, there's nothing that a black man cannot do. A black man has ascended to the very pinnacle of human achievement. Barack Obama was born to a man whose father was a Kenyan goatherder. He was raised by a single mother. He faced every possible roadblock put in the way of a young man, and he beat back every single one of them, and now he is poised to lead the greatest nation on earth.

Every myth, every lie, every roadblock to the black man's success has now been demolished. And so now that poor black man in the inner city can have faith that his efforts will be rewarded. That the investments he makes will bear fruit. That the education he gives himself will not be a waste of time. Because success is possible. And that is a thing to be celebrated, because the black man's belief in himself is the only thing which will ultimately rid us of racial economic inequality.

A second major benefit of last night's election is that Obama's success will deflate the insidious philosophy of entitlements which animates people like Jesse Jackson, Al Sharpton, Louis Farrakan and others. That philosophy of entitlements for black people rests on the convenient fiction that racism is rampant in this country, and that we need special dispensations to make up for it.

But, if America is nothing but a boiling pot of racist enmity, then how is it possible that we just elected a black man (and a liberal one, to boot) to the highest office in the nation? Al Sharpton will have nowhere to turn. Whatever he says or does, will sound utterly fake, when the man occupying the White House is black. And he knows it.

Well, I've gotten myself all enthused here, but don't be misled. I have grave concerns about an Obama presidency. It is unclear to me which Obama will show up to work on January 21st: the most liberal senator one with radical past associations and beliefs; or the more moderate one which was presented to the American public during the election process. I am hopeful that the latter will be more prevalent in Obama's future dealings, but still scared that the former might pop up his head from time to time and wreak havoc with freedom and the American economy.

But in the meantime, since he will be our new President whatever I do, good luck and Godspeed to President-elect Obama.

Sunday, November 2, 2008

A Modest Proposal

Those of you who have followed this blog know that I don't believe Obama will actually implement the modest proposals he has put forth. I believe that his political philosophy calls for much more intrusive government, and that, ultimately, this will result in much greater taxes, and a massive increase in the scale of the federal government. This is the logical result of his health care proposals, for one, since what he has actually proposed can only be analyzed as a step toward a more comprehensive public health care. It doesn't make sense any other way.

Furthermore, you know that I believe that the full implementation of Obama's political philosophy will result in several adverse consequences: permanently higher unemployment; permanently lower growth rates; diminished innovation and lower choice and freedom generally.

So, I have a modest proposal of my own.

I propose that we keep track of who votes for whom.

Then, when unemployment goes up to the 8-10% range permanently in 4-5 years, those people who voted for Obama will be required to pay some additional sum of taxes into a pool of money which will be used for unemployment insurance.

Also, when, in 7-8 years, we have completed some portion of the switch to public health care, and I must then wait 9-12 months to get some uncomplicated knee surgery (if I get it at all), I propose that everyone who voted for Obama will have to pay extra sums of money into a special tax pool that will be used for people who voted for McCain to get access to health care on an expedited basis.

Seems fair, right? Isn't Obama all about fairness?