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Bailout Analysis Ahead Of The Times

Jim Prevor’s Perishable Pundit, October 23, 2008

As we get ready to leave for PMA’s Fresh Summit convention, thought we would give a two-minute shout out to point out some of the really incredible value we’ve been delivering on the Pundit.

Perhaps, for example, you got to read Alternative Energy Suddenly Faces Headwinds or 3 Oil-Rich Countries Face a Reckoning, both which were published by The New York Times on the web on October 20, 2008, and in the print edition on October 21, 2008. Of course, you could have just skipped the pieces, because on October 17, 2008, we published Oil Price Decline Dampens Alternative-Energy Fervor, which basically said the same thing three days earlier!

Our two main points presage The New York Times articles precisely:

1. “…the other sound you hear is that of brakes screeching all over the world as alternative energy projects no longer make sense and consumer sacrifices for conservation — say smaller cars — become less appealing.”

2. “…lower oil prices mean some people who make a lot of trouble will have less money to make trouble with and may even have trouble keeping control of their own people.”

If your tastes run more to The Wall Street Journal than The New York Times, you might have caught the piece entitled, Uncle Sam Goes Car Crazy, published October 22, 2008. The key point:

The talk is of synergies and cost-cutting, of tapping new lodes of cash to ride out the storm. Don’t believe it. These negotiations are about one thing: creating a political last stand of American auto making that a Democratic Congress and president won’t be able to resist bailing out.”

Or you might have read the Pundit piece that we published on October 16, 2008 — six days earlier! — entitled Bolstered By ‘Too-Big-to-Fail’ Theory GM/Chrysler-Merger Plan Is To Make Two losers Into a Winner, where we pointed out:

Both companies are hemorrhaging money, and their products are not particularly complimentary. The combination will not provide much in the way of pricing power, and eliminating overcapacity will be difficult as a result of union contracts.

So what could be the point? How can combining these two losers make a winner? How about this as a theory: GM wants to bulk up. GM has a 24% share of the US auto market, Chrysler 11%. Combine them and you have over a third of the market. The combined company will employ almost 200,000 people in North America, plus many more at parts suppliers. Its 11 brands will have over 10,000 dealers.

What is the lesson of the last few weeks? Be “too big to fail”!!! The word on the street is that GM President Frederick Henderson has been pushing the deal. Perhaps he is thinking he can become so big so that if GM threatens bankruptcy the government will feel it has to lend it money until the business cycle turns.

We’ve also learned that the Pundit is in excellent company. While we are discussing The Wall Street Journal, know that if you can only read one article about the financial crisis, we suggest you read Bernanke Is Fighting the Last War, published in The Wall Street Journalon October 19, 2008. The article contains an interview with Anna Schwartz, now 92 years old and still going to work at the National Bureau of Economic Research in New York. Ms. Schwartz co-authored with Milton Friedman the classic work “A Monetary History of the United States.

Ben Bernanke, Chairman of the Federal Reserve, has called their joint work: “the leading and most persuasive explanation of the worst economic disaster in American history.”

It is a fascinating interview and we recommend you read every word, but here is the key point:

Ms. Schwartz thinks that our central bankers and our Treasury Department are getting it wrong again.

To understand why, one first has to understand the nature of the current “credit market disturbance,” as Ms. Schwartz delicately calls it. We now hear almost every day that banks will not lend to each other, or will do so only at punitive interest rates. Credit spreads — the difference between what it costs the government to borrow and what private-sector borrowers must pay — are at historic highs.

This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. “The Fed," she argues, "has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible."

So even though the Fed has flooded the credit markets with cash, spreads haven’t budged because banks don’t know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is “the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue.”

As we said, it is a fascinating interview and filled with a lifetime of wisdom but on its essential point — that the government is barking up the wrong tree because the problem is not liquidity but a lack of certainty as to asset value — well you could have read our piece, Lessons For Everyone From Bear Stearns, which was published on March 25, 2008. In that article, we said:

“Although stepping up to save Bear Stearns may have avoided panic, it reduced the transparency of the market. In some ways, the best thing would have been to auction off Bear Stearns assets so clear values could be assigned. This would make people confident in doing business with other holders of the same assets.”

Or you might have read our piece, Perishable Thoughts — Lessons From Bernard Baruch, published September 16, 2008:

The truth is that there is plenty of money out there. What has been missing is good information to allow legitimate business decisions….

…government bailouts of companies such as Bear Stearns and Fannie Mae and Freddie Mac have kept hundreds of billions of dollars of assets that eventually will need to be liquidated off the market. This artificial restraint on supply has served to confuse the market as to what the true value of financial assets actually are….

Markets have to clear before they start to rise, and the dissemination of accurate valuations of financial assets is the key ingredient necessary for markets to clear on real estate and financial instruments.

Perhaps you read our piece, AIG Bailout Gives Short-term Relief Many Dangers Long-term, published September 18, 2008”

“…by not compelling the sale of assets, the Treasury’s bailout will avoid a speedy reckoning. What was needed was a quick liquidation so valuation could be clearly established.”

Then we had Government Bailout Requires Deeper Analysis, published September 26, 2008, which said:

“To the extent there is a problem with credit between financial institutions, it is a reflection of the difficulty potential buyers or lenders have in valuing the assets held by other financial institutions. The more the government buys these assets, bails people out so they don’t have to sell these assets, etc., the longer this period of evaluation difficulty continues.”

So with all this value being delivered, if we bump into each other at PMA, or if you come by our booth # 515 to say hello, we don’t want to hear that you are not getting value for your subscription price.

Oh wait, other publications charge hundreds of dollars for subscription. The Perishable Pundit? We don’t charge at all. What a value indeed.

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