Administration Out on a Limb for GM — and for the Rest of Us

Administration Out on a Limb for GM — and for the Rest of Us

April 28, 2009

As Churchill famously said of democracy, the administration’s new plans for General Motors are a dismal idea, except for all of the alternatives. Under the plan, GM has to come up with a detailed strategy by June 1 that plausibly will allow it to survive and so receive nearly $12 billion more from the taxpayers, or file for bankruptcy. By then, the government will have lent GM $27 billion. What’s new in the plan is that the Treasury will swap half of that debt for equity (GM shares). In the end, the government and a healthcare trust managed by the United Auto Workers will hold 89 percent of the auto giant. Unsecured bondholders will own the rest, if they agree to swap their debt for equity too — and even as they complain bitterly, they’ll have little choice, since if they don’t go along, GM goes belly-up and they get nothing.

With the clarity that comes from impending doom, GM is finally taking serious steps to restructure itself — something it could have done a decade ago and avoided all this. Toppled last year by Toyota as the world’s Number One automaker, the former Detroit titan is now headed for much leaner territory. In exchange for the government’s billions and the UAW concessions that have kept it afloat for the past six months, GM has already announced plans to close down Pontiac — Saturn and Hummer will follow soon — shutter nearly 30 percent of its plants and, by the end of 2010, reduce its workforce by one-third and pare its dealership network from 6,200 to 3,600. If all of this works, GM will end up the Number Three automaker operating here and Number Four or Five in the world.

Already weak before the financial crisis and recession hit, GM probably could have stumbled through a normal business downturn without much help. But like a number of other national brands, GM found that it couldn’t survive a protracted financial-market freeze that dried up its credit line and a deep recession that decimated its sales. The risk now is not that GM managers won’t be able to come up with more reasonable plans, especially with their countless advisors from investment banks, consulting firms and the President’s auto task force. Rather, the risk here is that GM won’t be able to produce competitive automobiles that will sell and keep the company in business into 2010 — and the government can’t do anything about GM’s capacity to turn out sellable cars. I suppose that’s the good news here: Larry Summers, Tim Geithner, and Steven Rattner won’t try to tell GM how to run itself. Instead, once they approve GM new plans, we all become passive investors, much like the big pension funds that hold large stakes in hundreds of other companies.

The government also doesn’t know much about running, for example, either an airline or a retail chain, two other industries with huge market leaders near bankruptcy. So, why hadn’t it offered to lend billions to United Airlines or the GAP, and then swap those loans for majority equity positions? What the easy critics of the plan don’t see is that GM is part of a much larger and deeper global network of suppliers and distributors, so like Lehman Brothers and Bear Stearns — and Citigroup and AIG — its sudden failure would have cascading effects. On top of that, there’s the deep recession — and it’s still getting worse, not better — which could dangerously aggravate those cascading effects. In short, an abrupt bankruptcy by one of America’s largest and most iconic companies during the worst recession in 80 years could drive down the economy another big notch, making all of the current problems that much harder to solve.

So, if it costs the Treasury another $12 billion to try to head that off — or another $20 billion down the line — it will be worth it if it protects the rest of us from an even more dismal economy. Now, think about it: If the Bush administration had done that with Bear Stearns more than a year ago and then Lehman Brothers, all of these problems would be a lot more manageable.



Administration Out on a Limb for GM — and for the Rest of Us

April 28, 2009

As Churchill famously said of democracy, the administration’s new plans for General Motors are a dismal idea, except for all of the alternatives. Under the plan, GM has to come up with a detailed strategy by June 1 that plausibly will allow it to survive and so receive nearly $12 billion more from the taxpayers, or file for bankruptcy. By then, the government will have lent GM $27 billion. What’s new in the plan is that the Treasury will swap half of that debt for equity (GM shares). In the end, the government and a healthcare trust managed by the United Auto Workers will hold 89 percent of the auto giant. Unsecured bondholders will own the rest, if they agree to swap their debt for equity too — and even as they complain bitterly, they’ll have little choice, since if they don’t go along, GM goes belly-up and they get nothing.

With the clarity that comes from impending doom, GM is finally taking serious steps to restructure itself — something it could have done a decade ago and avoided all this. Toppled last year by Toyota as the world’s Number One automaker, the former Detroit titan is now headed for much leaner territory. In exchange for the government’s billions and the UAW concessions that have kept it afloat for the past six months, GM has already announced plans to close down Pontiac — Saturn and Hummer will follow soon — shutter nearly 30 percent of its plants and, by the end of 2010, reduce its workforce by one-third and pare its dealership network from 6,200 to 3,600. If all of this works, GM will end up the Number Three automaker operating here and Number Four or Five in the world.

Already weak before the financial crisis and recession hit, GM probably could have stumbled through a normal business downturn without much help. But like a number of other national brands, GM found that it couldn’t survive a protracted financial-market freeze that dried up its credit line and a deep recession that decimated its sales. The risk now is not that GM managers won’t be able to come up with more reasonable plans, especially with their countless advisors from investment banks, consulting firms and the President’s auto task force. Rather, the risk here is that GM won’t be able to produce competitive automobiles that will sell and keep the company in business into 2010 — and the government can’t do anything about GM’s capacity to turn out sellable cars. I suppose that’s the good news here: Larry Summers, Tim Geithner, and Steven Rattner won’t try to tell GM how to run itself. Instead, once they approve GM new plans, we all become passive investors, much like the big pension funds that hold large stakes in hundreds of other companies.

The government also doesn’t know much about running, for example, either an airline or a retail chain, two other industries with huge market leaders near bankruptcy. So, why hadn’t it offered to lend billions to United Airlines or the GAP, and then swap those loans for majority equity positions? What the easy critics of the plan don’t see is that GM is part of a much larger and deeper global network of suppliers and distributors, so like Lehman Brothers and Bear Stearns — and Citigroup and AIG — its sudden failure would have cascading effects. On top of that, there’s the deep recession — and it’s still getting worse, not better — which could dangerously aggravate those cascading effects. In short, an abrupt bankruptcy by one of America’s largest and most iconic companies during the worst recession in 80 years could drive down the economy another big notch, making all of the current problems that much harder to solve.

So, if it costs the Treasury another $12 billion to try to head that off — or another $20 billion down the line — it will be worth it if it protects the rest of us from an even more dismal economy. Now, think about it: If the Bush administration had done that with Bear Stearns more than a year ago and then Lehman Brothers, all of these problems would be a lot more manageable.



The Political Challenges We Face To Preserve the Earth

April 22, 2009

It’s Earth Day as I write this, and the challenges to preserve the Earth as we know it are momentous ones. The biggest and most obvious one is climate change, since it involves the most serious threat. Getting Congress to pass a plan that can reduce greenhouse gas emissions sufficiently to be meaningful will be a very tall order. The biggest political hurdle is that meaningful action on the climate will raise an average American household’s energy costs by some $1,500 per-year (2005 $), including the higher prices they will pay for the oil, gas and electricity they use directly and the effects on the prices of everything else a family consumes. And that doesn’t include the costs of retrofitting the heating, cooling and lighting systems of offices, factories, and homes — as the Obama administration is now doing with federal buildings, thanks to the stimulus — or converting to low-carbon fuels thousands of utility plants and the grids they use to distribute the electricity.

The political temptation is to reduce these costs by not imposing genuine limits on greenhouse gases. That’s the tacit strategy of the European cap-and-trade program, which has yet to reduce any emissions, and the unspoken appeal of the new Waxman-Markey bill, which has so many “carbon offsets” that excuse businesses from reducing their emissions, that environmental experts figure it won’t cut greenhouse gases at all by 2020. If the President wants to get this done and do it right, he needs to drive up those prices — that is, put a high price on carbon — while also giving people the means to absorb those increases. The best way to do that is not cap-and-trade at all, but a carbon-based tax that recycles its revenues in the form of tax relief, such as a payroll tax cut.

The higher price on the carbon content of our energy will move people and businesses towards less-carbon intensive fuels and technologies, but that also won’t be enough. We also will have to develop and deploy entirely new, climate-friendly technologies and fuels, because we probably have less time to contain climate change than we thought. In estimating how much time we have, most people focus on the threat from CO2 concentration: Those concentrations currently are about 370 parts-per-million, with the sustainable range for greenhouse gases being somewhere between 450 and 550 parts-per-million. But there are greenhouse gases besides CO2, including methane, nitrous oxide, ozone, and chlorofluorocarbons. When we convert their atmospheric levels to what’s called, “CO2-equivalents,” we’re already at 415 parts-per-million. So, the world is going to need some technological breakthroughs, on top of carbon-based taxes or cap-and-trade programs.

For that, we’ll need more support for basic R&D, which the Obama stimulus and budget got right. The challenge will be to sustain and probably increase this support when the goal of the budget turns with a vengeance from stimulus to deficit reduction. The new-technology requirements for climate change come with other strings as well, such as intellectual property rights. We will have to face down China, India, Brazil and a number of other developing nations, which argue that the only way they can afford to shift to less carbon-based and more energy-efficient ways of running their economies is to bring down the price of new technologies and fuels by providing them little or no patent protections. That might sound reasonable, but for the broad and certain economic finding that weakening those protections will mean producing fewer innovations — and without those innovations, we could well lose the better part of the fight to contain climate changes.

Since we also need to persuade those same developing countries to cut their emissions, and in some cases by even more than we will have to cut ours, the administration also will have to figure out how to help them pay for it. One way could be joint ventures to develop and sell these new technologies and fuels, by companies from the U.S. or EU on one side, and, on the other, enterprises in China, India, Brazil, Indonesian, Bangladesh, and other large developing nations. A more direct but also more costly approach would be a global fund set up by the advanced countries to defray some of the cost, for example, of China and India building and operating more nuclear, natural gas, and solar-based power plants, instead of the cheaper, coal versions they’re now building. In principle, such a fund would be no different from the $125 billion in funds which we and other advanced economies committed to the IMF at the recent summit, to provide the means needed to stabilize developing economies whose currencies get caught in the riptide of the economic crisis. Selling Congress on that will take all of the President’s skills and a hefty piece of his political capital. Doing it again for climate change will be even harder.

These dynamics all point in the same political direction: Doing our part to contain climate changes will be very costly and consequently very difficult politically. That makes a strong, economic recovery perhaps the single most important thing the Obama administration can do right now to help preserve the Earth. On that front, as on climate change, the administration has a ways to go: Its programs to revive the financial sector and housing are part-way measures that are not likely to produce the results needed. Fortunately, President Obama appears to be that rare politician who learns from his mistakes and is then prepared to shift course. And that could become his most pressing challenge.



How the Housing Crisis Can Change National Attitudes

April 16, 2009

The Great Depression deeply affected the attitudes of the generation that came of age in the 1920s and 1930s. For example, it made the country thriftier and more Democratic. It took two full generations for other social changes to turn us into a society that was more Republican and saved much less — shifts led, as before, by those who came of age in the bleak times of the 1970s. Our current economic upheavals are the most serious since the 1930s, so it’s appropriate to consider how they may affect American attitudes going forward. And the early surveys suggest that those who came of age during this crisis — that’s the millennials born from 1980 to 1995, America’s largest generation by sheer numbers — already embody distinctive attitudes.

One way to glimpse how these tough times may affect our national psychology is to understand the forces that make times so tough. We’ll start today with an aspect close to people’s sense of themselves, their homes, or more generally, housing. We’ve all now lived through an historic housing bubble which, to begin, was very different socially from most bubbles in history: Unlike tulips, the South Seas, the 1920s stock market or other famous bubbles, this one was not primarily the business of speculators and affluent people. Nearly 70 percent of Americans own their houses, including most middle-class people as well as a broad swath of moderate and even low-income families. So, this bubble’s impact is being felt very broadly. That’s no surprise, since we give home purchases such super-sized tax breaks and regulatory subsidies.

The irony is that while we go out of our way to encourage Americans to put their savings in this basket, in the form of home equity, we also encourage them to keep those savings small. First, we provide a large mortgage deduction, which encourages people to buy houses — and to buy way above what they could afford, but for that deduction. That’s one reason why housing prices generally trend upwards. But the way we provide the deduction actually cuts against saving much, since the deduction isn’t for what we “save” by owning our houses — there’s no tax break for the down payment, for example. Instead, it effectively encourages people to save only relatively little, since they get to deduct only the interest on the mortgage loan, which represents what we don’t own or “save.” The natural result is that most people borrow 90 or 95 percent of the value of their house
— just as Bear Stearns and Lehman Brothers did. We also encourage people to keep their “savings” in housing small, by providing tax breaks for them to pull out the equity or “savings” in their houses in the form of tax-preferred refinancing and home equity loans.

The result is that large numbers of people end up saving relatively little by owning their houses — and that’s especially the case when a housing bubble creates an illusion of significant savings. Federal Reserve data show that people’s home equity, or what they “save” through their homeownership, as a share of the value of their homes, has been generally falling for 60 years — which happens to be the time period since we enacted all of the tax preferences for housing. Moreover, since 1985, that share has fallen from nearly 70 percent to 43 percent. Strikingly, this share remained stable during most of the bubble — because as housing prices rose, people withdrew more and more of what they had “saved” as equity. And in the two years since the bubble first burst, home-equity savings has fallen by about one-third, from 60 percent to 43 percent.

Now, an estimated 12 million people are under water with their mortgages. Since they owe more than their houses are worth, the bursting bubble wiped out their life savings. Moreover, the data which show that people’s home equity is still equal to 43 percent of the value of their homes combines two very different groups of people: Nearly half of homeowners own their houses free and clear (mainly older people), while the other half has modest or little equity. And these “savings” are, by definition, fairly illiquid: You can always sell or take out a home equity loan, but the costs are considerable.

All of this could really change American attitudes towards saving. For one thing, the generation that came of age as these developments unfolded, along with everyone who staked their economic futures on ever-rising housing values, is much less likely to see housing as a safe way to save. That attitude correction in itself could provide a long-term drag on rising housing prices. There also are millions of people who counted on bubble-prices to fund their retirements. That’s been especially true of later baby-boomers and early baby-busters, the parents and older siblings of those coming of age in this period. A rude attitude-adjustment is also coming for those who haven’t bothered to save much because they’ve counted on inheriting the elevated value of their parents’ houses.

The bottom line is that Americans once more may find themselves more inclined to save — because now they have to — and less inclined to use housing values to do it. Since stocks don’t seem much more attractive, that could mean more saving in the safest assets, which are Treasury bonds. And that would be just what an administration and government determined to act big, bold and expensively, will need to carry out those plans.



Time to Face the Facts: The Economy Probably Won’t Get Better For Quite a While

April 9, 2009

Brace yourself for a very anxious and stormy time, economically and politically, because there’s little prospect that the U.S. economy will improve for quite some time. The latest to weigh in is the Federal Reserve, whose new private forecast sees no growth in sight for the rest of this year and slow gains at best for 2010. The Fed always speaks cryptically (even among themselves). What it means is that the economy is still in free fall, with our best prospect for hitting bottom coming sometime this summer, and then bouncing around the bottom through the fall and into early winter. Why early winter? The only force out there to stop the decline is the stimulus package, which ought to kick in just about then. The Fed didn’t say so, but their view that any recovery is some time off and will be a modest one reflects the judgment – one I share – that the administration’s fixes for banking and housing aren’t up to the task.

The Fed also didn’t say so, but the outlook for much of the rest of the world at least as gloomy, since so many Asian and European economies depend on Americans to buy what they produce and on U.S. businesses to invest in their countries. That’s not in the cards for some time. Trade is falling at a 20 percent rate here, at 30 percent rates across much of Europe, and at 30 to 40 percent rates in much of Asia. This week, for example, we found out that Americans’ purchases of foreign imports in February were down $62 billion from a year earlier. That translates into tens of thousands of jobs lost in a lot of other countries (and ultimately fewer U.S. exports down the line).

The Fed’s view should be a wake-up call for the administration, which still talks about a “V” shaped business cycle, where our deep decline will be followed by a strong and sharp recovery starting late this year. V-shaped recoveries are powered by unleashing suppressed demand: People cut back until they see the light at the end of the tunnel, and then they buy everything they had put off during the recession – especially houses and other large purchases that require credit. That’s the scenario behind OMB’s risible forecast of more than 3 percent growth next year, followed by two years of more than 4 percent gains.

This misunderstands the very nature of what we’re going through, which is nothing like the other recessions of the last 50 years. This time, the economy’s circulatory system, banking and credit, isn’t working. Even if it were, American households aren’t holding back because their wages are down a bit. They’re being forced to downsize for the long term, because this crisis has wiped out 20 percent of their net worth. It’s even more serious than that, because most Americans used the fast-rising net worth they thought they had over the last decade to support their consumption. Mainly, we withdrew trillions of dollars from the once, fast-rising value of our houses so we could go on vacation, buy new furniture, and send the kids to college. We had to do that, because for the first time in more than a half-century, most people’s wages and incomes stagnated during a “strong” expansion.

The current crisis will pass eventually, even as it takes much longer and exacts much larger costs for tens of millions of people, than any downturn since the 1930s. When it does, the administration and the country will face once again the profound structural problem of the last decade – of most people’s incomes stagnating in the face of strong productivity gains, and relatively little job creation during times of strong GDP growth. Addressing that will require all of the President’s skills, because it won’t change unless we slow down rising health care and energy costs, and educate and train everyone in many of the ways we now use to prepare only the top 20 percent of us.

The irony is that if President Obama can put in place policies for banking and housing that would work better than what his advisors have been willing to put out there so far, the economy could recover decently early next year. Then, he could have the political capital for the rest of his agenda, which is targeted just where it should be, on health care costs, energy, and education and training. But if he doesn’t pull off the recovery, none of the rest will happen — and the Obama years could look a lot like the Bush era.



Is Cap-and-Trade a Dead Policy Walking?

April 1, 2009

In his February 24 speech to Congress, President Obama asked members “to send me legislation that places a market-based cap on carbon pollution.” So, yesterday, House Energy and Commerce chair Henry Waxman took the first step by introducing his cap-and-trade plan. Yet sometimes, the political sands shift underneath a policy approach that was once viable, even embraced broadly, and its chances of becoming law ebb away. Until the media and the public make the connection between the policy and the new reality, the approach becomes a dead policy walking. It happened to social security privatization and the flat tax — good riddance to both — and now it appears to be overtaking cap-and-trade.

Cap-and-trade combines a regulatory cap on greenhouse gas emissions with a market-based scheme to trade as financial instruments the “permits” to produce those emissions. For all of cap-and-trade’s initial promise as an answer to climate change, the current financial crisis has made its vulnerabilities painfully clear. The strategy would have the government create trillions of dollars in new, asset-based financial instruments. These emissions-right-backed securities, like their cousins, mortgage-backed securities, also would throw off a host of new derivatives to be profitably traded by the “professionals.” Unsurprisingly, cap-and-trade’s fiercest promoters include Wall Street institutions that see emissions-permit trading as a lucrative new market that could earn them billions in new fees, commissions and, while it lasts, speculative gains. But after Wall Street’s meltdown, the proposition for another round of the financial merry-go-round that produced the worst economic crisis in our lifetimes seems either very naïve or very cynical.

That’s not the only tricky problem facing cap-and-trade. The other part of the policy’s design, the hard cap on emissions, ensures that the prices of the permits will be very volatile. Here’s why. The cap in cap-and-trade is set as a percentage reduction in annual emissions, figured from some baseline. The problem is that no one can forecast with precision how much energy American businesses and households will need from one year to the next, because no one knows how cold the winter will be, or how hot the summer, or how fast the economy will grow a year from now. When energy companies see that demand is going to outpace the forecast, so they will need more permits to keep on selling energy, the price of those permits will rise sharply. It’s not just theory: We use a small-scale cap-and-trade program to reduce the emissions that produce acid rain, and the price of those permits moves up and down an average of more than 40 percent per-year. In the same vein, Europeans adopted their own cap-and-trade system for energy emissions a few years ago, and the price of their permits has moved up or down by an average of 17 percent per-month.

For years, economists have worried that this basic feature of cap-and-trade would produce new volatility in energy prices. They’ve also cautioned that the result would likely be less investment in climate-friendly fuels, since no one would know what the price of their carbon content would be. Now there’s another, equally serious problem: The unavoidable volatility of the prices of emission permits also would attract furious financial speculation, since speculators live off of volatile prices. And we now know the risks that we all run when rampant speculation occurs in financial instruments tied to our economic foundations, such as housing — or energy.

Like the excesses that helped create our current crisis, the financial markets for emissions permits also could well produce serious insider trading and manipulation. That’s because the final purchasers of the permits, large energy companies and utilities, would see shifts in demand for the underlying energy coming before anyone else. This information would create golden opportunities for insider profits and market manipulation; and erecting a “Chinese wall” inside the companies to segregate the production division from the trading division would work no better than it has on Wall Street. That may explain why until its own collapse, Enron was a prominent advocate of cap-and-trade.

The only reason to play another round of Russian roulette with the economy would be if cap-and-trade were the only way to address climate change. Happily, it isn’t: Many economists and some politicians support the major alternative, carbon-based taxes with rebates. This approach would create no new financial instruments to trade and abuse, and produce no additional price volatility, because the price of carbon would be set. It also would be relatively simple to administer and enforce. And it can be designed to recycle its revenues in payroll tax reductions or rebates. In this way, the carbon tax would change the relative price of different forms of energy, based on how much damage they do to the climate, while protecting people from the additional, direct costs of the tax itself. The revenues could also be recycled as a flat payment to each American household, providing relatively more help to low and middle-income families. The policy’s only real weakness is that it has no cap. But the tax rate could be adjusted periodically if actual emissions exceed its goal. And modeling shows that a carbon tax of about $50 per-ton of CO2 would produce slightly larger reductions in emissions than last year’s leading cap-and-trade proposal, the Warner-Lieberman bill.

For years, many politicians and environmental leaders have believed that any kind of tax to deal with climate change would be dead on arrival. That may be changing, especially if the tax is paired up with rebates to take away much of its political sting. More important, the costs and lessons of the financial crisis may effectively swamp the prospects for cap-and-trade. If cap-and-trade has become a dead policy walking, those who care deeply about climate change will find that a carbon tax system has become the last, reasonable policy standing.