Archive for June 1st, 2009

Sovereign Funds Explained

Monday, June 1st, 2009

You may have heard people on the news mention “Sovereign funds”, and some are pointing fingers at them as being the boogey man behind the global economic problems – especially people like Alex Jones.   What are they and what do they do?

From time to time, people suggest that Social Security invest in stocks rather than putting money in the “Social Security” lock box.   The Government would then own assets more substantial than an IOU from the U.S. Treasury.  If they did that, it would be an example of a sovereign fund.   They are pools of money that are owned by governments (or government agencies) to go around the world and “buy up stuff”.  Much of the money in the funds is oil money.   Here is [a list of the world’s largest sovereign funds].    Sovereign funds (in total) control about $3.6 trillion in assets.  [Keep that number in mind when you hear the U.S. is going to run a $1.7 trillion deficit for a single year].

Secretary of Treasury Paulson last year told these funds to “Bring it on“, inviting them to buy up as much of America as they wanted.   It’s very probable that the “Private Equity funds” in the United States that have financed much of the radio business are funded by these funds, either directly or indirectly.  U.S. law prohibits foreign governments from owning FCC licenses, but if you put up the facade of an “American” Private Equity fund managed by a group of Harvard MBAs, that satisfies the legal requirement.  If the countries are members of the WTO (like China), the presumption is that they can own U.S. Radio and TV stations, unless someone can make a case that they shouldn’t.

Congress is making noise about requiring more disclosure of where Private Equity Funds are getting their money.   Pay attention to see if that gains any traction.   With the US Government begging for money anywhere they can find it, it seems unlikely that anything will happen that might increase transparency or alienate sovereign funds.

The Hopelessly Naive Auto Task force

Monday, June 1st, 2009

So much to say so little time.

Bloomberg has a blow by blow story of how the Obama Administration concluded that GM Must Go Bankrupt.  The people on the task force are the same Harvard MBA types that have destroyed the U.S. Radio business – believing that businesses are run by free cash flows, leverage ratios and LIBOR interest rate swaps – get the numbers right in the spread sheets and your job is done .

My ire rose to the level to write this when I read “One member of the task force said he was surprised to learn that Japanese manufacturers can charge more than GM for a similar car because of their superior brand image.“.  Oh God, We’re all doomed.  How could someone involved in deciding the future of the car business and firing Rick Wagoner be so completely ignorant of the underlying business problems?

This is not a new observation.  When Ford and Mazda created their joint facility in Flat Rock, Michigan (1987) and GM and Toyota formed the partnership in Fremont California.(1984), both companies learned (or should have learned) a very important lesson.   The same plant with the same workers using the same parts producing essentially identical cars – people waited in line to buy the Japanese version and you couldn’t give away the American version.  This is 25 years ago.   If you don’t figure out why that is, no amount of “government backstopping” is going to turn the company around.   They should have started by spending a weekend speed reading “The Decline and Fall of the American Auto Industry” by Brock Yates.  [See what he is saying lately [here]).   While the car companies and their products have improved since the 1980s, you aren’t going to fix their problems until you ask the right questions.

There are two basic trains of thought on why this “brand image” problem persists.  One version is that prior to the arrival of serious foreign competition, GM, Ford and Chrysler produced cars that were increasingly cheap shoddy, unreliable, and poorly engineered and resisted any change to improve the technology, like radial tires, fuel injection, overhead cam engines, turbochargers, electronic ignition, antilock braking, air bags, catalytic converters, etc…   and cars were designed to wear out the day the warranty ran out.   People’s perceptions of “American” cars are that they are shoddy pieces of crap – even if they aren’t.  Once people believe you make junk, you won’t get a second chance….  and people talk to each other about their experiences…. and Consumer Reports systematically documents that you’re selling crap.  And Oldsmobile tries to create a diesel engine from an old Gasoline engine block, and then tries to run away from the disaster they created.

The other train of thought is that the issue has less to do with the cars than with the dealers and the “screw the customer” corporate culture.  Even if people understand that the Toyota and GM car were made at the same plant by the same workers from the same parts, they’ll pay $1000s more for the Toyota because they trust the dealership.  With the companies shifting corporate profits to the financing arms (so they can claim to the UAW that they’re losing money by making cars), the profit was in the financing, not selling the cars – dealers had any number of strategies to cheat the customer.  

One heard over and over on Clark Howard and Tom Martino’s radio shows follow the same basic script.   I went in to look at cars.   They sold me a car and told me a monthly payment and we signed a contract.  They told me to take the new car home and come back tomorrow to finish up the paperwork.  Tomorrow comes, and the dealer declares that unfortunately, the financing didn’t get approved because their credit isn’t good enough [which of course the dealer knew when they pulled the credit report], so the buyer doesn’t qualify for the interest on the contract (which had in small print “Subject to Credit Approval”).  So sorry for the misunderstanding.  So the payment is going to be *way* higher than the amount that was agreed to.   When the buyer says they want to back out because the dealer didn’t honor the agreement, the dealer informs them that unfortunately their old car has already been shipped out of state, and it isn’t possible to give them their old car back, so they can sign the new paperwork or take the dealer to court and sue them to try to get their old car back.  In a year or so, the buyer can’t afford the higher payments and the car ends up being repossessed.

Do that once and you make yourself some extra money…. but it guarantees that person will never ever buy a car from your company again.   Nor will anyone who ever hears that story.   The perception is that this isn’t a rogue dealer here or there, but a systematic way taught at Car Dealer School to screw the customer.  And this is only one of the strategies, let alone what the Repair Department is going to do to you for the next 5 years.

The basic conclusion of the Auto Task force about the way to ‘close the gap’ on the price gap between the GM and Toyota is to shut down GM dealerships and make it harder to get to a GM dealer and negotiate with more than one of  them    Only a Harvard MBA could come up with that as the solution (or a Detroit area GM car dealer).  Don’t they know you can now negotiate and buy the car on the internet, and merely have it delivered to the local dealer for pickup?

I wish some enterprising reporter would interview the members of the Auto Task force and ask them:

  • Do you drive yourself to work in a car you pay for?
  • Is it an “American” Car?
  • When is the last time you personally bought a car from a dealer?
  • Did you finance the purchase or pay cash?  Did you pay list price?
  • When your car is in the shop, do you go to the dealership or does someone else do that for you?

Congress chastised the U.S. Auto executives for flying to Washington on a private plane and being “out of touch” with what real people have to deal with.   The same standard needs to apply to the Auto Task Force.  And ask President Obama if you can see his Driver’s license and what kind of car he drove before becoming President.   And spend an hour asking Brock Yates what his opinion is.

*** update ***

The New York Times has aa [profile] of the 31 year old man who had never been inside a car plant, that is the member of the Auto Task force deciding how to dismember G.M.  So that partially answers the question – he was 6 years old when G.M. learned what he just found out.

The Other GM Shoe – unemployment insurance

Monday, June 1st, 2009

Back when I was working for GM (not as an employee – as a contract person), I learned a number of curious counterintuitive things – like people with seniority wanted to be laid off first during slow times.  Doing so, they would get 90+ percent of their pay and continue to vest in their pensions, then could work “off the books” doing construction work for cash or just tour the country in a motor home on an extended vacation.  The low seniority people were the ones who had to show up for work and make the cars.  It wasn’t called Generous Motors for nothing.

Another quirk was that the State of Michigan gave GM special exemptions on how Unemployment Insurance is supposed to work.   It’s a bit complicated, but there is a state and a federal fund with different sources of money.    The basic principle of funding is that each employer keeps a “balance” in the fund – how much they’ve paid in, and the amount of benefits paid out.  If a company gets in a deficit position, their contribution rate goes up to help rebuild the fund.   Other employers temporarily are subsidizing the ones (like GM) with lots of unemployed workers.

Well, GM had incorporated Unemployment Insurance into their business model.  When GM didn’t need all its workers, it would lay them off and let the State pay them.  Normally doing that would risk that those employees could drift away and when GM needed to restart the line, it would have to rehire and retrain people – so their agreement with the Unemployment folks was that GM workers collecting unemployment were NOT required to look for a new job to keep getting the check.  [Yes, I know that is a scam too] The Fund just became a way to subsidize GM at the expense of other employers.  Michigan didn’t want to lose GM, and many of those other businesses were indirectly in business because of GM so they were not in a position to complain.  This was in the 1980s, and also unemployment benefits were taxed differently than today.

Since GM will be declaring bankruptcy and shutting a lot of plants, those GM workers will be on unemployment for a LONG time, with no real assurance that GM will ever be in a position to pay back into the state uninsurance funds – especially in states where GM is going to shut down its only facility.

Look for a bunch of State Unemployment Funds screaming “we’re out of money” (It’s already started because the condition of the economy in general).  Not only are people collecting unemployment, but a lot fewer employers are paying into the fund.  Look for demands for a Federal Bailout  (did you read that IRS taxes paid in April were down 36% year over year?… yet Bloomberg and the economists think things are about to “turn around”)

In the spirit of just making problems worse, the Democratic party solution to this is to always feel compassion for The Worker – by extending unemployment so long that people forget what it is like to work.   Other employers become so burdened down with the costs and the artifically high costs of labor that they shut down or move to other countries to get out from under.

Do what you’ve always done, you’ll get what you always got.