[Cloud9...68]

Duckman,



As promised, I have some questions I've been pondering that I'd like to hear your take on. There's been so much focus placed on "unfreezing" the credit markets by removing as much of the "toxic debt" in the form of non-performing mortgage backed securities from the banks' balance sheets as possible. This all makes a certain amount of sense, and you did a great job explaining why this was important, as well as the mechanics of how it works. But at this point in the current economic cycle, it appears that consumers are collectively simply not in a buying or borrowing mood. In my mind, this is caused by a combination of a widespread fear among many people of losing their jobs, and, I believe more significantly, of a desire to pay down their existing loan balances before they start buying and borrowing again. This has me questioning how "unfreezing" the credit markets will do any good.



Put a little more colorfully, picture a gaggle of little green men landing on the steps of Wall Street, and proclaiming, "We hear your people are loaded with toxic debt. In our culture, toxic debt is a great delicacy, and we're willing to buy out all your banks' toxic debt at face value." So, poof!, the banks' balance sheets would be instantly returned to robust good health, but would it really make any difference? Would consumers staggering along with the effects of a hangover from a 25-year debt-fueled drunken spending binge, really start taking out new loans to buy cars, houses, and other big ticket items? And, even more to the point, should they? Isn't that how we got into this mess in the first place?



I can see how frozen credit would be devestating to an economy just coming out of a recession, but we're in the exact opposite part of the cycle. Don't we just need to wait things out, let people pay down their credit cards, and pay off their car loans, and then hope we've collectively learned our lesson and start acting more responsibly? Thanks.

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[rxter]

I know you asked Duckman, but this is a forum, afterall <img src="/forum/images/smilies/968/smile.gif" class="smilie" alt="" />



I agree with you completely wrt consumer sentiment. Makes me laugh when Rick Wagoner says that $14B or whatever will keep GM solvent. It will for a few months. I don't see how he gets Volt to dealerships by March though. Even mighty Toyota lost money in 08. Scary business indeed.



The same logic applies to any other large purchase, and especially one that can wait. Home, car, vacation, etc. So without a buyer there is no happy seller. Shoot it seems to be a buyer's market for darned near anything at the moment. If you are cash you are king. But very few do, so..... Having said that, frozen credit markets make this bad situation absolutely a life support situation. When consumer sentiment comes back, and it will, eventually, because we all 'need' to buy that new car or house or dryer sometime, if there is no credit then everyone is horked. Seems odd that as a society, and as a global community, we all need credit to make the market work, but without large financial aggregators very few would own a home. How many years, at a good living wage/salary, would it take to save up enough to buy 90% of a $200,000 house? At $100,000K per year saving 5% diligently that's 36 years. Hmm.....



Frankly I would have let a few more of these big financial houses fail, and I would let greedy homeowners who were speculating on the bubble go bust as well. However, the biggest aggregatore we have, the US gov't, is the only one who can push enough cash to get banks willing to loan again. It's all a faith-based economic system, and unfortunately the guys with the most to loose (bankers) are also the ones with the least amount of trust right now. And until they get their heads right the rest of us will continue to struggle. When rates are low enough some people with cash will take a chance. The only way to push rates down is to flood the market with cash (assuming that good old supply and demand still works). Might be ugly on the other side (inflation), but it does seem necessary.

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[Cloud9...68]

Of course, any questions on this forum are open to all <img src="/forum/images/smilies/968/smile.gif" class="smilie" alt="" /> . What you say makes sense, especially the part about the foolishness of giving the automakers a pile of cash, without any plan, or even hope, of it translating into more car sales. And the Volt wouldn't do it, even if t were available tomorrow, given how much I hear that thing is going to cost.



But the thing I'm struggling with is that I get the distinct impression, and I may be wrong here, that the only people being denied credit these days, are people who probably shouldn't be applying for it in the first place. My only debt is a small amount left on my 15-year mortgage, and I always pay off all loans I do take out very early. So I recently asked my credit union if would have any difficulty securing a loan with them, and the loan officer replied, "Absolutely not." So this makes me wonder if we really have a cedit problem at all, or just boatloads of people so maxed out on their available credit, that they are rightfully not taking out any new loans at the moment, and shouldn't until they straigten themselves out. But I'm not a financial guy, so if I'm way off base here, I'm all ears.

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[Duckman]

Rates are at historic lows (the Fed Funds Target Rate is set at a range of 0-0.25%) and money is flowing. Credit is available, especially to businesses with viable futures. Banks don't want to make bad loans to companies that can't repay it but a lot of money is moving through our economy daily.



As for viable futures, I just made the following comment for Dow Jones News Plus:





January 5, 2009 1:25 p.m. EST





TALK BACK







David Kloth Wins Monthly Prize For Commentary



David Kloth of Fifth Third Bank in Charlotte was named the Editor's Choice for December for his comment in response to a question we posed on Dow Jones NewsPlus: What do you think should be the next move for U.S. auto makers now that the government rescue has fallen through?



For his insightful comments, the writer wins a Garmin Nuvi GPS. We look forward to hearing from you. Keep your comments coming. Write to us at TalkBackAmericas@dowjones.com.



Here is Kloth's winning comment:



Reader Lays Out 3 Big Solutions To Big 3's Problems



How should we help the auto industry and, by so doing, help ourselves? This is tricky because it has a two-part answer to a simple question.



In the short term, we need to ensure the Big Three's viability by maintaining sufficient liquidity to meet operational cash flow requirements. Operating loans or loan guarantees accomplish this.



However, if the taxpayers (that means us) put our dollars on the line, we need to have assurances that we are first in line to get paid if they fail anyway. That means all other debt should be subordinated to the taxpayers' loans and/or guarantees.



However, and this is the tricky part, if the U.S. auto makers continue to operate business as usual, they will fail anyway. That just won't work. So structural changes need to be made in management and labor.



The Big Three have been losing money on their U.S. operations while Honda, Toyota and BMW build and sell cars here at a profit. Why? What's different about those companies, their cars and/or their processes?



Let's look at the 900-pound gorilla in the room first: labor. The biggest difference between the American manufacturing operations at the U.S. and non-U.S. companies is union versus non-union workers.



The major problem for U.S. companies isn't the hourly wage paid to union workers. It's the arcane, ridiculous work rules and benefits that hamper efficiency and add at least $3,000 to the cost of every car produced by the Big Three when compared to their non-U.S. counterparts. The union should allow the necessary changes to their contracts and those rules or the government should enact the necessary laws to allow the companies to abrogate the terms of their contracts.



Now let's look at management. For decades, management had designed, built and tried to sell inferior cars. The Big Three continued to build cars based on bean counters' models of what was cheapest and assumed to be the most profitable: Let Marketing create a demand for an inferior product that is hopelessly behind the times. Hey, the buying public is so stupid they'll buy this, won't they? Consumers continued to buy some of it, mostly minivans and SUVs, but non-U.S. manufacturers continued to gain market share and build reputations for innovation, technology, satisfaction and quality.



Look back. In 1975 the Big Three were building cars using 1955 technology. The only thing that changed was the size of the fins. When the environment and emissions standards demanded changes, the U.S. industry was lost. To produce the same amount of power, they built engines that were at least twice as big and used twice as much fuel per mile as their non-U.S. counterparts.



As if that weren't bad enough, the cars rattled and banged and fell apart in half the time of their non-U.S. counterparts. The period from the mid-'70s to the mid-'80s will go down in history as the darkest era for American cars. During the same period, our non-U.S. competitors continued to invest in engineering and design and manufacturing processes.



By 1990, the U.S. industry was actually building pretty good cars. Their products were competitive in most respects except for two big problems: 1) Their reputations had been severely damaged, and 2) they were still building ugly cars. Hey, management! Here's a tip. It doesn't cost any more to build and sell an attractive car that people actually want to buy, own and drive as it does to build what you continued to produce. What a concept!



For the last decade, while they were building those pretty good cars, management was lulled into believing that oil and gas would remain cheap in the U.S. and the public would continue to buy bigger and bigger vans and SUVs forever. Instead of using van and SUV profits to continually improve their cars and the engineering in them, they kept building bigger and bigger trucks and SUVs.



Management has to change too. The problem is that I don't believe the existing management can or will change, so the people who are in management must change.



The solutions, then, are relatively simple, even if they are difficult:



- We, in the form of our government acting on our behalf, need to loan and/or guarantee loans to the U.S. auto makers for working capital to ensure short-term survival.



- The unions need to agree to work out rule and benefit changes that will allow our U.S. auto industry to be competitive in the world marketplace. If they don't, our government should force the changes on them.



- Management needs to change -- immediately. If the existing management teams cannot change sufficiently and quickly enough, then they must be replaced.



That's all. Simple.



(TALK BACK comments may well be submitted by readers who have a financial interest in securities that are being discussed.)



--(TALK BACK: We invite readers to send us comments on this or other financial news topics. Please email us at TalkbackAmericas@dowjones.com. Readers should include their full names, work or home addresses and telephone numbers for verification purposes. We reserve the right to edit and publish your comments along with your name; we reserve the right not to publish reader comments. Talk Back comments can be found under the N/TLK code.)



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[Anchorman]

Very nicely done, David - congratulations on winning the prize.



Now - where do we find the government "leaders" with the cojones to force change in those two areas where change is needed - labor and management!



I'm trying to find "leadership" that will do something I think should be even easier - a fuel tax - but that leadership also doesn't seem to exist.



At least bankruptcy for the auto companies might have brought market forces to bear that would require the changes. I'm much less optimistic about that happening with government participation/ownership.

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[Duckman]

One job loss count for December (ADP, not official government numbers, which probably means it's more accurate) was 693k jobs. The consensus expectation was for a loss of 500k jobs. Either way, the total jobs lost for 2008 exceeds 2.5 million. That's terrible.



There are about 300k US auto workers employed directly by the Detroit Three. There are probably twice that number working for various suppliers around the country. For every one of those 900k workers there are about three people in the broader economy providing products and services to them--everthing from sales clerks in shoe stores, to optometrists, and accountants, and--well, you get the picture.



If the US car companies failed and stopped building and selling cars, the impact in lost jobs in our economy could at least equal all of the jobs lost during 2008. If you think things are bad now, guess what it would be like if it were twice as bad.

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[Anchorman]

I personally agree that "failure is not an option". The question, then, is what's the best route to avoid failure? Is it a government "bailout"? If so, what "hooks" should there be to maximize the likelihood that the bailout works? Procedures in the context of a bankruptcy are pretty well defined; a bailout is carving new ground - couldn't whatever is tried be open to litigation (with delays and, ultimately, the failure of the effort)?

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[Duckman]

An organized bankruptcy could work but would be very, very difficult politically. It is likely that bankruptcy would hurt the unions more than government assistance, therefore a Democrat Congress and Whitehouse are not likely to allow it to happen. Democrats are too connected to the unions for that. Pragmatically, government intervention in the form of direct loans or guarantees is a more viable option.

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[Anchorman]

I understand that - but, as you point out, one the two things that has to get fixed is the labor arrangement. Direct loans or guarantees don't do that, unless the Democratic "bank" makes that a condition - but if they're too connected to the unions, don't we end up where we started - just a few billion dollars later?

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[Cloud9...68]

Getting back to my original question, do you guys think continuing to shore up the financial industry (and it's not at all clear how much of the bailout money is still being directed at the financial sector, which was its original intent) will have much of an impact on stimulating the economy? This may be a moot point, as the focus of the government's intervention in the economy seems to be shifting toward helping specific industries (such as autos) and individuals (through the upcoming "stimulus package"), but it seems to the that the last thing we need is to encourage people to start borrowing money again that they won't be able to pay back.

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[Duckman]

Cloud 968, I don't believe the Financial System Rescue will stimulate the economy. It can and probably will keep it from crashing worse than it already has.



Shrinking capital and money supply as well as a deflationary spiral are often cited as key reasons for the Great Depression of the thirties. To a singificant degree the shrinkage was due to the government allowing banks to fail in significant numbers. During the 1930s, 9,000 banks failed. The government's offical attitude was, "Hey, let 'em fail. Stronger banks will take their place." IMHO that was not a good policy.



An economist by the name of Irving Fisher postulated in the 1940s that the nine causes of The Great Depression were as follows:



1. Debt liquidation and distress selling

2. Contraction of the money supply as bank loans are paid off

3. A fall in the level of asset prices

4. A still greater fall in the net worths of business, precipitating bankruptcies

5. A fall in profits

6. A reduction in output, in trade and in employment.

7. Pessimism and loss of confidence

8. Hoarding of money

9. A fall in nominal interest rates and a rise in deflation adjusted interest rates



Milton Friedman, my personal hero of economics, believed that all of this could be blamed on the lack of proper financial management by the Federal Reserve Bank. Ben Bernanke, our current Federal Reserve Chairman, seems to agree and has vowed it won't happen again on his watch.

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[94SilverCab]

Duckman, I read your "Nine great causes and I am more pessemistic than ever. Care to comment?



[quote name='Duckman' post='65324' date='Jan 8 2009, 05:24 PM']Cloud 968, I don't believe the Financial System Rescue will stimulate the economy. It can and probably will keep it from crashing worse than it already has.



Shrinking capital and money supply as well as a deflationary spiral are often cited as key reasons for the Great Depression of the thirties. To a singificant degree the shrinkage was due to the government allowing banks to fail in significant numbers. During the 1930s, 9,000 banks failed. The government's offical attitude was, "Hey, let 'em fail. Stronger banks will take their place." IMHO that was not a good policy.



An economist by the name of Irving Fisher postulated in the 1940s that the nine causes of The Great Depression were as follows:



1. Debt liquidation and distress selling (LIke Bear Sterns?)

2. Contraction of the money supply as bank loans are paid off (Like today's report that Consumer debt has dropped to $2.57 Trillion)

3. A fall in the level of asset prices (Like Houses?)

4. A still greater fall in the net worths of business, precipitating bankruptcies (Macy's selling off 11 stores?)

5. A fall in profits (Anyone?)

6. A reduction in output, in trade and in employment. (Automakers sell 11.4 million units on '08, predicted that sales below 13 million would be catastrophic)

7. Pessimism and loss of confidence (Check)

8. Hoarding of money (Check, if you're smart)

9. A fall in nominal interest rates and a rise in deflation adjusted interest rates (Mortgages at a 30 year low? Home prices still with no bottom)



Milton Friedman, my personal hero of economics, believed that all of this could be blamed on the lack of proper financial management by the Federal Reserve Bank. Ben Bernanke, our current Federal Reserve Chairman, seems to agree and has vowed it won't happen again on his watch.[/quote]

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[Duckman]

First, the nine causes that I referenced were Irving Fisher's, rather than mine. I take no credit for them.



However, I cannot argue against any of them and, as I stated, Bernanke has accepted that general view. There are lots of competing theories and opinions as to the true underlying causes of The Great Depression. Some of the different ones look the same to me and only the economists themselves can tell them apart.



The similarities between this list and our current predicament are striking. The difference is that The Fed and the Treasury and, reluctantly, Congress are taking steps to ensure that we do not slide into the abyss again.



Look, things are going to get worse before they get better. Unemployment for December was just announced at 7.2%, which is the worst it's been since '83. It is likely to climb over 9%--a height last seen in '81. Consensus is that GDP will contract buy over 1.0% in 2009, compared to growth of over 1.0% in 2008. The stock market, as measured by the Dow Jones Industrial Average, was down about 32% in 2008, the worst single-year decline since 1931.



Enough of this stuff. Let's talk about cars. I'd much rather lose my money in the car market than the stock market. <img src="/forum/images/smilies/968/cool.gif" class="smilie" alt="" />

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