TOPICS IN POLITICAL ECONOMY

THE CHRYSLER BANKRUPTCY: ECONOMICS, POLITICS AND MORAL HAZARD

Economics and politics can make for a messy stew.  And the Chrysler Chapter 11 bankruptcy filing  ("Give them another chance!") is a pretty big kettle. 

The true tragedy is that this mess (and the forthcoming General Motors imbroglio) could have been avoided - in 1979-1980, when Chrysler was bailed out with a $1.2 billion federal government loan guarantee and a quasi-Chapter 11 bankruptcy. Rather than let a badly managed company truly go under, President Jimmy Carter bailed out the company and stiffed a lot of creditors. Detroit took note that when disaster threatened, Washington could probably be counted on, creating "moral hazard" - for taxpayers.

So, here we are again ("Groundhog Day" for you middle-aged movie fans?) with a prostrate Chrysler (plus GM) trying to avoid the cemetery.

As I wrote in this blog last November 16th, "if Chrysler, and all its stakeholders, had been eliminated as an independent automaker in 1980, much as LTV, Bethlehem, and various other American steel companies disappeared into bankruptcy over the past ten years, chances are that GM management and workers would have “seen the light.”  They would have taken the necessary drastic and painful steps to get their house in order. This is what U.S. Steel did after Wilbur Ross and Lakshmi Mittal (two rank outsiders) established  their credibility with the steel workers’ union and  reorganized much of the faltering U.S. steel industry."

Look Who's Running the Asylum. The fatal flaw with the government-assisted Chapter 11 bankruptcy filing (taxpayers will have $12 billion in loans outstanding to Chrysler) is that Wilbur Ross and Lakshmi Mittal are not on the scene.  Instead, the majority shareholder (55%) will be - the automobile workers' union! How can we expect such an organization to compete effectively, even assuming a level playing field, against Ford and foreign-owned manufacturing plants already in the U.S.?

A particularly nasty slant in President Obama's presentation of the plan (which may well be modified by a federal bankruptcy court) was his dissing of hedge funds and various smaller creditors who forced the bankruptcy filing (most of the major creditors were banks with TARP capital infusions). Maybe he forgot that a major hedge fund, Cerebus (and its shareholders, who no doubt include a lot of pension funds) has lost at least $7.5 billion.  As the Financial Times put it yesterday,

 Americans remember Washington as a far more paternalistic place in 1979, but respect for private contracts and protecting taxpayer dollars was higher given the terms of the first Chrysler rescue and today’s messier sequel.

The Politician At Work.  Throughout all his Administration's maneuvering, however, in Obama one can see a relatively, for a Democrat, non-ideological politician at work.  The rule of thumb he is following in trying to salvage Detroit's ailing giants is "the uniform distribution of dis-satisfaction," an age-old Washington formula that political foxes employ whenever needed. And cheap shots at risk takers who aren't on the Federal dole are costless.

There are no lions in the White House.

"FINANCIAL CRISIS MANAGEMENT 101" FOR POLITICIANS - AND THE PUBLIC

A short course in current financial market realities is badly needed for most members of Congress and a fair number of the chattering class, many of whom are threatening to exacerbate the current situation.

1. Please don't forget that the primary objective of nearly all of the money that has been pumped into commercial and investment banks and AIG, as well as the expansion of government deposit/money market fund insurance by the FDIC and the Treasury was intended to stop a massive and highly dangerous run on the nation's banking system in the last six months of 2008.

2. That effort has been successful. Give the Treasury and the Federal Reserve some credit for what they did, even if their public explanations were unsatisfactory - as they still are.

3. Stop asking the banks "Where did the TARP money go?" The complexity and daily volume of multimillion dollar transactions on any large bank's balance sheet makes this essentially a rhetorical question. Stopping the run on bank and money fund deposits was the first and most important step in avoiding an excessive contraction of the banking system.

4. Stop trying to get the banks (and the government mortgage agencies) to lend or guarantee more loans. In a recession, such as we are now experiencing, lenders quite properly become more cautious, as do potential borrowers. Wasn't it the combination of loose lending standards and over-leveraged lenders and borrowers/buyers that made this downturn so serious?  The need to generate income will provide sufficient incentive for lenders to extend new credits. (No bank can cover its overhead investing in Treasury bills at 1%.)

5.  Understand business cycles. All recessions are characterized by sharp slowdowns in credit extensions. In fact, in March loans outstanding at large commercial banks to both business and consumers were still at higher levels than a year ago.  At some point in the near future, we should expect them to be below year earlier levels, as they normally are at later stages of the business cycle.   

6. Stop bad-mouthing bankers and threatening to impose regulatory burdens on hedge funds. You need them (1) to sort out the mess of bad assets still on banks' balance sheets and (2) to restart the markets for securitized mortgages and loans if you want the credit markets to open up fully.

7.  Study what recently happened in Iceland where a politician was appointed to head up the Central Bank and was instrumental in creating a real financial disaster.