Book Review – Riding the Storm Out by John Bougearel

It is end of March, 2009 as I write this and the economic crisis that has gripped the US and the World shows no signs of abetting. Everyone from Wall Street to the Main Street has been transfixed by the drama unfolding in the markets and the rapid and total collapse of the financial system and repeated intrusions by the government in the private enterprise and the ballooning cost to the taxpayers has everyone worried. How did things go so wrong? Why were our institutions so reckless and fragile? The story still continues to unfold. John Bougearel recounts the history and the economic events leading upto the situation we are in today in his recently released book Riding the Storm Out.

There is always a danger in writing a historical narrative when the events are still playing out as there is no benefit of the hind-sight. In this context, John Bougearel does an excellent job of outlining the chronology of economic events that led to the worst recession since Great Depression. The book offers the authors deep insight as he explains how different events, lack of regulatory oversight, and government’s policy mistakes came together in precipitating the economic crisis. Greed and Leverage and inadequate risk control systems were part of the genesis of the economic crisis and as the author points out, the red flags had started appearing long time ago. As long as the music plays, we will continue to dance, in the words of now ex- Citi CEO Chuck Prince!

The author reaches back in history to compare the elements of the current economic crisis to the many economic crises that occurred in the past (including the Great Depression). As he points out, there are many parallels. There are also many learnings from the past crises, that apparently the regulators failed to apply in their response to the current one. I was however, disappointed that the Author did not mention the Japan’s lost decade which was also spawned out of a real-estate bubble and where the banks continue to carry toxic debt on their books for many many years hoping that the values will re-inflate. I think the Japanese deflation probably carries more learnings and messages for the US regulators on what not to do when trying to fix the real-estate and banking sectors in this country.

Overall it is a great book to read, written in a very down to earth style and probably the first book out of the gates to attempt to chronicle the current economic crisis as it is happening. Maybe some will find John’s prediction of hyperinflation and collapse of the US dollar in the future to be alarmist, but I think that these are very realistic outcomes (probably more so now, given the humongo-gargantuan deficits that we now intend to run for the foreseeable future).

The key to understanding how we should react and act in the coming economic climate is to understand what has happened in the history. In that vein, I will definitely recommend my readers to get a copy of this book and read it.

The book can be ordered at the Author’s website. John also writes several financial newsletters that you can order from his website if you are interested. You may also wish to subscribe to John’s Blog at Trading Tips with John Bougearel.

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Posted in Book Reviews.

Tagged with book review, economic crisis.

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By Arohan – March 31, 2009

GM and Chrysler denied additional long term life support- US automotive industry needs a restructuring

What makes the US Automotive industry so complacent that they believe that the government has a duty to bail them out time and time again? Do they think that the fact that they now support millions of employees and retirees gives them the license to take their responsibilities lightly? Do they think that social burden of supporting the unemployed and the retired (if they were to go bankrupt) is larger than the value that they have been destroying in the economy for the last multiple decades by not heeding to their primary call of operating a profitable enterprise?

First we had the spectacle of the CEOs traveling to the nation’s capital in their own separate private jets, to beg for money. Then we were told that the CEOs didn’t really had a clue as to how they will turn the companies around when they were asking for money. No business plan. Nothing! They were then given a few months to work out a business plan and the deadline is here. They still do not have a plausible business plan that has a chance to work. Maybe, they are so big, or maybe, this industry is so critical to the country, that they have a luxury of letting the deadlines pass without having to do the hard work of extracting tough concessions from the Unions and the debt holders. After all, Obama has been spending money left and right, they think, surely he won’t deny them more bailout funds just because they do not know how to run a profitable company!

Wagoner had to go. No one can preside over years and years of shareholder wealth destruction and expect to continue to hold his position. One wonders why the shareholders did not boot him out earlier. So in my opinion, this is the right move on the administration’s part. The problem now is that the Union has dug their heels and is now the biggest obstacle to the survival of the big 3 US auto companies. There is no way the big 3 can return to a long term sustained profitability unless the Unions are busted and the legacy costs are restructured or eliminated. This can only happen through a bankruptcy process, controlled or not. And one of GM or Chrysler or both will ultimately find them self under liquidation if the Union and legacy cost problem is not solved. Ford’s decision to stay out of bailouts was a brilliant move as they calculated that these problems will be addressed for them when one or both of the other big-3 are under bankruptcy process. I assume that this is one of the war game scenario that has played in Ford’s boardrooms many many times now.

Fact of the matter is, when there is too much supply and declining demand, the capacity needs to be reduced. Since these automakers lose money on each car, reducing production is not going to help much unless they make significant moves to eliminate some of the fixed costs. Which means, they either need to shrink very rapidly to survive or we need fewer market players in this sector.

Point to ponder: Ever wonder why the Union (UAW) would not give any more concessions, even risking a closure of one of the auto companies in the process that will surely hurt many of their members?

Answer (as told to me by someone in the know): If they give concessions that affect their entire membership (like wage reductions or benefits reduction), the entire membership is going to be unhappy with the Union leadership and their clout weakens. They would rather have a portion of the membership take all the pain (let’s say if Chrysler or GM goes bankrupt) if there is a chance that the remaining members will stay happy and support the leadership and keep the union going in the future.

The US automotive industry has been dysfunctional for some time and it needs to be simplified and fixed. It is not a question of technology or skills that are hamstringing the big-3. It is just the business model that does not work anymore. If one or more of the big-3 die out, it does not mean that the US automotive industry has reached its end. Most new automotive jobs in US are created by foreign automakers anyway. The void will allow the remaining automakers to become more profitable as supply is brought down, and it will also allow new more nimble and forward thinking auto company to emerge (for example, Tesla). We have seen instances of a mining company like 3M completely transform itself with time, a furniture maker (Nokia) turn into the world’s largest cell phone manufacturer, Corning (glass maker) change its business many many times to keep up with the changing times. It is lamentable that the auto-makers were not able to change with the times given the fact that many of the problems plaguing them (quality, design, etc) have been decades in the making. I for one am glad that the Obama administration has chosen to draw a line now.

Posted in Commentary.

Tagged with automotive industry, big 3, unions.

2 comments

By Arohan – March 30, 2009

Treasury to purchase toxic assets off the bank balance sheets in another unnecessarily complicated plan

Today the Treasury Secretary Tim Geithner revealed yet another plan to fix the banking system and to unfreeze the credit markets. The new plan calls for a public-private partnership to buy upto $1 Trillion in bad assets buried on bank balance sheets.

Partnership with private actors such as pension funds, hedge funds and other money management institutions is intended to allow for price discovery of these assets. However, the initial reports suggest that the private money component could be as little as 7% of the total money committed to the program with the government putting up another 7% and the remaining 86% will be in the form of a low interest loan by FDIC. Essentially, the government will be carrying 93% of the risk. However, the risk could be very little if sufficient discount to the nominal value of the toxic mortgages is obtained. But this is a big IF.

Now here is the problem. If the taxpayers are to take on as little risk as possible, the assets will need to be severely discounted. This means that the banks will need to write down the value of the assets further if they have not yet written it down heavily enough. This would make some of the banks who were not aggressive enough in writing down the value of these assets wary of selling into the program. On the other hand, those banks who did write down the value of the toxic assets very aggressively on their books may in theory be able to get a breakeven or better price when selling into the program.

$1 Trillion in commitments should not mean that this much money will eventually be spent. Existing home sales picked up in February, the mortgage rates have declined to a very low level, and if these trends continue, we may see the real estate markets firming up this year. If the program starts buying these toxic assets and that in turn allows the banks to start making new mortgage loans and the buyers start coming back to the market than it is likely that some of these ‘toxic’ assets on the banks books may start increasing in value, in which case the banks may decide not to sell these to the program. In a sense, a lot depends on how well the recent Fed actions on buying up domestic debt and expanding the Fannie and Freddie capacity to buy mortgages work. However, if Geithner is banking on the economy to firm up to make a success out of this plan than we are probably in for a rough ride ahead.

The bigger question is whether institutions will step up and participate in this program. There is very little incentive for them to do so and the recent furor on executive pay will surely make them leery. It all depends on how attractive the pricing is for these assets and a sense of assurance that the administration will not seek to levy extraordinary tax on the profits thus generated sometime in the future.

I am sure there is a sweet spot for pricing where the banks would be willing to sell and the institutions will be willing to buy and the program depends of this to be effective. Hopefully in the weeks and days to come we will know if this is indeed the case. This plan, as demented as it is, is probably the best we can get out of this Treasury and I hope it works.

I will be very tempted to buy stock in the banks that do sell into this program as it would be a signal that they were very aggressive in writing down the asset values. Assuming of course, that there are buyers in the market for these assets.

As an aside, do I think this is the best plan to fix our banking mess? Absolutely not! A far better plan would be to segregate these toxic assets in a bad bank (there will need to be a bad bank carved out of every large domestic bank), spin off the good parts to existing shareholders so they survive and create economic value for the society and shareholder value is enhanced, and then possibly sell the bad bank in the public markets or let it go bankrupt. No tax payer dollars will be at risk and no price discovery will be needed. Please read my earlier article on how the Government can start this process with Citigroup.

Posted in Commentary.

Tagged with bank rescue, Economy.

1 comment

By Arohan – March 23, 2009