Fueling Energy Independence

Thomas Friedman shared an opinion in the NY Times today. In his OpEd piece he advocates, strongly and convincingly, for a high federal gasoline tax. Whereas I agree with him, I understand why it will never happen.

The American consumer has a very short attention span, and our political leaders have very little backbone.

We, as a nation, go from frugality when the price of gas is high, to profligacy when it is low. Mr. Friedman points out that in December, trucks and SUVs are outselling cars - the first time in nearly a year that has happened.

It will not be an easy thing to do, but something must be done to break the boom-bust mentality of consumer habits. Otherwise America will remain at the mercy of OPEC and the middle-eastern oil exporters, our foreign policy will remain driven by our need for oil, and our automobile industry will remain paralyzed by the inability to build the vehicle du jour.

One of the main reasons that the Big 3 automakers are in trouble is because during times of low gas prices the consumer demands big gas-guzzling trucks, SUVs and muscle cars. Then when prices ramp up they demand extreme fuel efficiency. The car makers can't retool their factories and their marketing campaigns fast enough to satisfy this capricious demand.

We need to understand that there is a high price to be paid, even when gasoline is cheap. That high price needs to be at the pump - not in bankruptcy court for the automobile industry, not in the lives of our soldiers in trying to defend an indefensible foreign policy motivated by a lust for oil, and not in international political capital.

Once the consumer understands that the days of cheap gas are over, they will adjust their psyche, their habits, and their budgets to accommodate that reality. Then, and only then, can a robust alternative fuel industry become viable. A gasoline tax which permanently fixes the price of gas at $5 a gallon would be a boon for that burgeoning industry, and the revenue generated from the tax could be used to fund research and development for it.

But consumers have a very short memory and our political leaders have very little will.

We accept the verdict of the past until the need for change cries out loudly enough to force upon us a choice between the comforts of further inertia and the irksomeness of action. --Judge Learned Hand

Don't Be Surprised If Bush Fails to Bail Out Auto Makers

When evaluating current events and the public's reaction to them, I seldom take the "common wisdom" as doctrine. The general public has a herd mentality which succumbs to the first reasonable analysis and goes no further to examine the nuances of the issues. The public is not stupid, just overly informed. No one has the time to redo or rethink the analysis that has already been spoon-fed to them by the mainstream media.

For example, the common wisdom is that the Bush administration will bail out the car makers when the congress refused to do so. Indeed, President Bush has said as much. An administration spokesman stated that they will release TARP funds for Detroit's Big Three in the form of a $14-15 billion bridge loan. But I have my doubts that this will actually happen.

Bush may want to be remembered as having helped rescue the automakers from collapse, but would that be the best course for the Republicans? I am almost certain that there must be a powerful Republican lobby persuading Bush behind the scenes, that the best course of action would be to let the Democrats inherit the mess.

The only thing that a Bush application of TARP funds to Detroit would accomplish is making the Democrats job that much easier come January 20th. Call me a cynic, but partisanship being what it is in Washington, I fear that the Republican strategy for getting back in control of the White House and the congress in 2012 is to have the democrats fail miserably on their platform of change.

During the recent campaign, the Democrats foolishly blamed all things bad about America on the Republicans. This, of course, is de rigeur in national politics. But it does little to engender bi-partisan support for solutions. They claimed that they would come into Washington with miracle cures for that which ails the country, and perhaps they will. But are the Republicans going to participate in a reform effort which has the goal of rectifying Republican folly?

Yes, I believe that, behind the scenes, Bush is being instructed to hold back on TARP funds for Detroit. The rationale will be that the TARP money was explicitly for financial institutions, not car manufacturers.

I hope that I'm wrong. We should know, one way or the other, this week.

Please Don't Throw Us In The Briar Patch!

I am having a little bit of difficulty following the Auto Bailout rationale. Why do we want to give the poorly managed, obscenely paid, wasteful, and arrogant companies billions of taxpayer money without any clue as to how it will help them in any meaningful way? Why is it that we shouldn't let them go into Chapter 11 bankruptcy, a program which was designed to help struggling companies relieve their burdens, reorganize, and restructure their business? This is hard to understand.

Yes, I do understand that if even one of these companies went out of business, it would have a very disruptive effect on our already weakened economy. Such an event would surely morph this recession into a depression. I understand that quite well. But what the Big Three, the UAW, and the other wolf-criers either don't understand or don't want to admit, is that bankruptcy does not equal going out of business. Not by a long shot!

The proponents of a bailout are very cynically painting a worst-case scenario when they know full-well that bankruptcy would not even be close to the worst case. Bankruptcy, far from being a dire prospect, holds the promise of viability and a rosy future for any of the three companies that decide they can't stay afloat without some sort of relief. Bankruptcy offers the perfect relief.

Under Chapter 11, the companies would get a reprieve from their creditors. Their overall debt could be reduced dramatically. In addition they could get out from under onerous union contracts, do away with the absurdly profligate union job bank, and renegotiate wages and benefits that are in line with the rest of the industry.

Another ancillary benefit of bankruptcy would be the renegotiation of their dealership contracts. The dealership networks of the US car makers is full of redundancy and waste. Bankruptcy could be the remedy.

The executives of the auto companies also say that bankruptcy would scare off car buyers. This mental sleight-of-hand claims that no one is going to want to buy a car from a bankrupt manufacturer because they wouldn't have any confidence that the company or its dealers would be around to honor the warranty. This argument almost holds water, but then dissolves when you realize that the government could guarantee the warranties, and this much public involvement would be magnitudes cheaper than just throwing billions of dollars at failed business plans and poor management via a bailout.

So if bankruptcy offers so many benefits and protects the taxpayer from unwillingly and unwittingly becoming a partner with the auto companies -- a partner with no voice and no equity or compensation -- why wouldn't the auto executives embrace it rather than decry it as the worst possible medicine?

That's a very good question! Could it have something to do with not wanting to lose power over such a leviathan company and run the risk of having their pay reduced dramatically or terminated altogether? A US car manufacturer emerging from bankruptcy would be a much leaner entity and would undoubtedly have its pay structure totally redesigned. Executive salaries and perks would be greatly reduced. Bonuses might actually have to be earned. Corporate jets and country club memberships might become endangered species.

Yes, a CEO 's job post-bankruptcy would not be nearly as lucrative or pleasant. It is easy to understand why a bailout which allows them to continue on with business-as-usual (at least for a few months, perhaps a year) would be preferable to the reduction in size, salary,and prestige which would probably accompany a bankruptcy. And yet, the chance to start from scratch with much less debt, reasonable wages, and sensible dealer contracts offers a very real promise of profitability and self-sufficiency. Wouldn't that assuage the short-term distress?

I know that bankruptcy would be the best course for the Big Three, and I have to believe the their executives know this, too. If that is the case, then there are two reasons that I can think of that they are dragging their feet on this issue.

Either they are too greedy to want to make the concomitant sacrifices that Chapter 11 would require, or they are clever like a rabbit -- Br'er Rabbit, that is.

Could it be possible that all this kicking a screaming about bankruptcy is just a ruse? Could it be that, knowing that they will still have to live with the UAW and their dealers after bankruptcy, they are pretending not to want it? This tact would surely allow them to maintain a good business relationship with union members, suppliers, and dealers even though they threw them under the wheels of the bankruptcy judgement.

I can hear them now. "Gosh darn it! We didn't want this any more than you did, but the danged congress insisted that we go through Chapter 11. Golly, I'm sorry! What a shame that the congress and the taxpayers are just too selfish to loan us enough to get by! I guess we just have to make the best of it."

Do'th they now protest too much to congress and the public? Are they really saying, "Please! Oh, please! Don't throw us in the bankruptcy patch!"?

I consider this possibility and then I realize that this posture would require a good deal of wisdom and subtlety. Such a clever tactic would entail a fair amount of civic-mindedness, a modicum of humanitarianism, and a dollop of philanthropy.

Could these executives concoct such a brilliant subterfuge? I want to think that they can. But then I wake up.

Brer Bear, he's thinking about what to do, and while he's thinking, Brer Rabbit's already out-thunk him. Brer Rabbit says, "Do anything you want! You can do anything! You can throw me in the water. You can throw me off the cliff. But please don't throw me in the briar patch!"

Brer Bear's thinking, "He sure don't want to get thrown in that briar patch. Maybe that's what I should do."

So Brer Bear takes him, holds on careful not to hold onto that tar. He holds onto that rabbit, and he slings him in the briar patch! -- From Tales of Uncle Remus, "Br'er Rabbit and the Tarbaby"

That Ol' Black Magic

A correspondent on a financial blog this morning wrote,

“Last Friday’s equity market trading reminded us of this old Wall Street saying, 'The market bottom is defined when it stops going down on bad news.'”

Hmmm... the old Wall Street saying I remember is,

"The market bottom is defined when it fails to rally on good news."

The logic is that when even good news can't raise buying interest, we have exhaustion which confirms the capitulation. There is a wide-spread misconception about the meaning of capitulation. Many people and pundits think it is when we have a large downdraft in stocks, and indexes find new lows.

That is a necessary occurrence, but not a sufficient one for a complete capitulation.

From Merriam-Webster's Online Dictionary:

ca·pit·u·la·tion: The act of surrendering.

Capitulation occurs during and after the downdraft, when the majority of market participants just throw up their hands in dismay, throw in the towel, and say, "I'm done!" After capitulation, the market languishes and even good news can't make it smile.

Yes, stocks are rising and all looks rosy. But don’t be deceived. A major missing ingredient in today’s rally is the “wall of worry.” Until we have a real capitulation, until we truly have exhaustion, and until we start climbing that wall, this rally is not only suspect, but can be considered malevolent. It will end badly.

The current generation of investors has been conditioned, thanks in large part to the Internet, (and also to a pervasive herd-mentality of short-term thinking) to believe that things always happen in Internet time, and that events have the longevity of a sound-bite. "OK, the market has bottomed, we can check that off the list. Now we will rally."

The "real world," however, (as opposed to the virtual world that has become the new shibboleth) does not operate like that. We are currently in a bear-market rally, and we have not yet seen the capitulation. Those who feel strongly that we have, will soon be parted from their money.

The economy is getting palpably worse every day, every hour! Do you really think that the companies you are investing in are going to prosper near term? Massive layoffs have been announced and more will come soon. Retail is in the doldrums. Manufacturing has all but ground to a halt. International trade simply is not happening. Foreclosures are causing even safe and sane mortgage borrowers to be upside-down in their homes.

All of the recessions and downturns in recent memory have been "bailed out" by consumer spending. Today’s' circumstances are far worse than any of those others until you go back to the Great Depression. The outcome to this recession will be much worse and it will last much longer because (I hate to break it to you, but...) the mythical consumer will not be carrying the economy on his back this time.

Too many consumers have lost, and will lose, their jobs. Too many consumers are already mired in debt while consumer credit is drying up. Too many consumers have witnessed a major loss in their retirement portfolio. Too many consumers have seen their home equity evaporate.

A report on NPR this morning detailed the problems that a large wholesale clothing distributor in NY is having. They have a warehouse crammed full of top line suits, shirts, slacks, and other apparel that they can't move. They normally supply major retailers with this merchandise, but within the last three weeks, four of their seven largest customers have cancelled all orders for the next season.

Do you really think that we can spend our way to prosperity this time? What fairy tale events are going to magically produce profits for companies that are retrenching and not conducting business?

He that lives upon hope will die fasting. -- Benjamin Franklin

Dead Man Walking

It is, indeed, interesting that the market is showing signs of life. But don't put too much faith in any proclamation that the market has bottomed. It seems very likely to me that the DJIA will close out the year below 8000, and probably below 7400.

There is a popular notion that the market is ruled by greed and fear. As greed increases, the bulls gain control and the market rises. As fear dominates, the bears are out in force and the market falls. There are a couple of other parameters to this equation, however.

If you break the market into two distinct sectors, institutional investors and individual investors, it becomes apparent that the institutional part of the market is ruled by greed and caution, and the individual sector is controlled by hope and fear. The institutions, being in greater control by virtue of size and amount of capital, also are also privy to more information than the average individual. They therefore are not as susceptible to fear. They are greedy on the upside, and cautious, not fearful, on the downside.

Individuals are a very optimistic and hopeful lot. Their investment decisions are motivated more by hope and a belief that the "natural" state of affairs is a rising market. When the market falters and breaks down, their hope gives way to fear. Unlike the institutions which are very pragmatic in their decisions, individuals are more emotional, and in a down market they become paralyzed by fear. That is why so many 401ks get wiped out in a market such as the one we have been experiencing.

What does all of this have to do with my feeling that the market is destined to be much lower at year end? My prediction is based on a belief that the recent rally in the market has been driven not by a lot of buying interest, but rather a lack of selling interest. The ever-hopeful individual investor still wants to believe in this rally, while the greedy institutions are quite willing to oblige this fantasy - for a short while longer.

When you realize that the institutions, whose market commitments will always determine the market direction, are faced with a lot of "forced" selling between now an January, they have a vested interest in seeing the stock prices rise as much as possible before they put in their sell orders.

A simple way to accomplish this is to sit on the sidelines and let the small-money, the hopeful money, the imprudent money drive the market higher. By postponing their massive sales as much as possible, they are engineering a significantly higher market from which to extract as much as possible, and they are decoying the individuals into a belief that a real rally is under way. After a few more days of inaction, they will begin to put in their sell orders.

Since the institutions know when they are going to pull the trigger on their exodus, they might even be doing some buying in this bear market rally to capture some short term profits before the collapse. They are well positioned to fleece the small money on the way up before they shear them on the way down.

If this scenario plays out the way I think it will, we will rally the first part of this week. Then you will see a market that goes sideways for a few days, and then a decline will become obvious. At first it will seem like normal profit taking. After all, the pundits will say, it is perfectly normal in a rally for investors to claim some of their profits and take a look at new opportunities -- new stocks and sectors which may being showing leadership, etc.

Then the selling will ramp up to the point that it overwhelms the buyers, and we will see another precipitous decline, with the Dow undercutting 8000, and perhaps going much lower than that.

There are at least three reasons why heavy selling is in the cards for December:

1. The hedge funds have a lot more redemptions coming before January. The hedges are not anywhere near normalization yet. In the interest of disclosure, I have to state that this assertion is more hypothesis than fact. I do not have any figures on what reclamations are lurking. My gut feel is there are still quite a lot.

2. The mutual funds need to get their losers off of their prospectuses before the end of the year. And they have been holding lots of losers! It is a particularly cynical practice in the industry to hide a losing year or quarter by showing a raft of good stocks in their stable when a snapshot is taken of their holdings. Never mind that most of the quarter they were in losing positions, as long as the snapshot doesn't show these losers, they can actually look like they are well on their way to making money for their investors.

3. Year-end tax selling by many investors, large and small. There are many investors who have lost a lot of money this year, and the only way they can deduct those losses on their income taxes is to actually realize the losses. In other words they will be highly motivated to sell their big losers to establish their losses. When the year-end selling hits, the hopeful individuals will be caught off guard again. Their hope will diminish and fear will again dominate. They are being groomed right now to grow the market so that it can be more profitably harvested by those in control of the market.

At some point we will see a true capitulation (we haven't seen it yet). When we do see it, it will be unmistakable. There won't be anyone asking "Is this the capitulation?" because it will declare itself loud and clear. The year-end selling will cause the markets to collapse, and the worsening economy will almost guarantee that climbing up from the capitulated bottom will be long and arduous.

Hope is the denial of reality. It is the carrot dangled before the draft horse to keep him plodding along in a vain attempt to reach it. --Margaret Weis, Dragons of Winter Night