AIG: Americans Investing in Graft

There's the ridiculous and the absurd. Then there's AIG. AIG paid $165 million in bonuses last week to select employees. How can a company that needed $170 billion in bailouts (taxpayer money) possibly justify bonuses of any amount? Perhaps they had budgeted for a $200 billion bailout and are now rewarding themselves for their $30 billion outperformance.

To add to the absurdity, these payments have been deemed retention bonuses. 73 individuals were given retention bonuses in excess of $1 million. 11 of these individuals are no longer with the firm! You read that correctly. 11 individuals who were given bonuses that were designed to keep them at the firm are no longer with the firm. Apparently, they only had to be retained through 5:00 p.m. on the day the bonus was announced. Perhaps this was a stroke of genius, and these people were actually paid to leave before they could do billions more in damage.

The leadership at AIG seems to be unaware that if the U.S. taxpayer hadn't stepped in to bail the company out, AIG would no longer exist. A company that doesn't exist is quite unlikely to pay your salary, let alone a bonus.

By all accounts, some of the people receiving the bonus were involved in the poor decisions that nearly brought the global financial system to a halt. It boggles the mind that people who should have long ago been fired are now receiving retention bonuses. What about those whose hands are clean? We're in the deepest recession since the Great Depression with a finance industry that's firing thousands of very experienced and intelligent people every month. I imagine many of those people would be happy to go to work for AIG with no bonus and less pay than the people currently at AIG.

The argument that the people responsible for creating the mess at AIG are now needed because only they can unwind the mess borders on insanity. These people were either idiots or crooks. Do we really need idiots, crooks, or idiotic crooks managing anything more sophisticated than a gumball machine?

Flash: It just crossed the tape that AIG CEO Edward Liddy is "asking" executives to return half of the bonus money. He's half right.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

60 Minutes Video Of Bank Takeover

Interesting 60 Minutes video offering a peek behind the scenes of an FDIC takeover. I particularly like the comments towards the end by the CEO of MB Financial about the ultimate benefit of taking out the weak banks and cleaning up the system. Granted, if I were being paid upfront to take over a bank and then insured on 80% of all future losses, I'd be pretty upbeat too.




Link to video on 60 Minutes site

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Auto Industry Bailout - Nyet Comrade!

Kudos to the Senate for standing strong on the auto bailout, and shame on the UAW for not agreeing to cut compensation next year to the hardly unreasonable level of their Japanese competitors. I guess unions feels they need all the money they can get their hands on in order to keep buying political appointments (ok, low blow). This is clearly (well, clearly to me) an instance of the UAW giving the finger to the American taxpayer. The UAW is calling Congress's bluff. Unfortunately, with weak-kneed politicians as their opponent, they're likely to win (link to "Special Loan Financing" post).

The autos are in trouble for a number of reasons, one of which is the cost of their labor force. It's difficult to have too much sympathy for overpaid union workers who aren't willing to step up and share the pain. Unfortunately, it's hard to imagine that some form of congressional compromise, executive action, or Fed intervention still won't occur to bail out the auto industry.

I've had a number of questions about what I think should happen with the autos. I have my idealistic answer and then my slightly more realistic answer. Ideally, the government would just step out of the way, and let the market choose the winners and losers. GM and Chrysler would likely fail and be liquidated (in a perfect world). People would still buy cars, but now there would be more business to be spread among the survivors, including Ford. This would help accelerate the shift of industry capacity to the new reality of demand. (It's critical to understand that the level of demand for autos can only support an auto industry of a certain size, and at the moment, the auto industry has more plants, workers, and debt than demand can support.) It's likely that the surviving auto firms would even have to hire some of the ex-GM and Chrysler workers and buy some of their facilities, especially once the economy begins to improve. This is capitalism. The weak are destroyed, and the strong benefit. The industry as a whole would be stronger.

Of course, we don't live in a capitalist society, and this isn't going to happen. In light of that, I think the best likely solution would be for the government to provide debtor-in-possession (DIP) financing to whichever of the (shrinking) Big 3 file for bankruptcy. This would enable them to continue operating, their equity holders would be wiped out, and the firms would be able to more quickly slash operating costs, reduce debt, rationalize capacity, and renegotiate absurd labor contracts. The government would be providing the bailout, but at least we would be first in line with our claim on assets when they eventually fail.

If you really want the U.S. auto industry to have any chance of surviving and prospering then capacity needs to be reduced further and labor wages and benefits should be reduced to levels below those paid by the Japanese automakers to their U.S. auto workers. The debt needs to be eliminated or substantially reduced. The unions should be abolished, corporate jets sold, and executive cash bonuses eliminated. We should not have a bureaucratic "Car Czar" overseeing the industry. A prepackaged bankruptcy with the government providing DIP financing is the only realistic means to effect these changes. Ideally, a consortium of private banks would step up and provide the DIP financing, but that's not likely in this environment.

Of course, none of these actions would guarantee success -- they are necessary but not sufficient. The auto companies would still need to produce products that people want to buy and that can compete with the Japanese. However, without drastic changes to cost structure and the balance sheet, the autos stand little chance of surviving.

Unfortunately, the government is still likely to approve a bailout without demanding the drastic measures really needed. The tune will be familiar. We start with the modest mid-teen billion dollar "loan." Next year, Obama's administration will spearhead a much larger bailout package. Later in the year, once it becomes apparent that more is still needed, more will be provided.

It would be far cheaper to have these companies declare bankruptcy today with the government providing DIP financing than to keep approving serial bailouts. Besides, if after 100 years, an industry hasn't figured out how to make money, is it really worthy of taxpayer dollars (link to my post on GM from this summer)? The Rubbernecker says "Nyet, comrade."

[As I'm getting ready to send this I see that GM has gone from -40% in the pre-market to down only 4% as talk escalates of the White House bypassing Congress and tapping the TARP funds to provide the first leg of this bailout. Hardly surprising.]

Disclosure: The Rubbernecker is long liquidation and short overpaid, out-of-touch, selfish union "leaders" and short-sighted politicians.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Citigroup Bailout: Payback For Wachovia?

If you can't beat 'em...

I'm having some mixed feelings this morning. I've repeatedly expressed my frustration with the serial bailouts by the government and the Fed, and this morning we wake to learn that Citigroup will be added to our Bailout Wall of Shame. On the one hand, it pains me to see more taxpayer money being wasted.

On the other hand, I bought shares of Citigroup late last week for our more aggressive clients. This was my first foray into financials on the long side in quite a while, and I can't say that the purchase (a modest position) was made with an extreme amount of confidence. I viewed the purchase of the common more like a call option with (hopefully) no expiration.

It was clear to all that Citi was too big too fail. It was also clear later last week that the company was likely to need some government assistance, if for no other reason than to shore up confidence. The questions were how extensive the support would be and how much dilution would occur to the existing shareholders.

Now it's time for a little conspiracy theory. My sense was that Citigroup had a "get out of jail free" card to play. Recall, Citi had reached a deal to buy Wachovia with a government backstop not too dissimilar from what they are now receiving. That Wachovia deal was eventually scuttled when Wells Fargo came in with a counter offer. Citi then filed but soon dropped a $60 billion lawsuit to block the Wells deal. Why concede Wachovia so quickly, and why drop the suit? I can't help but think that Citi was assured of some preferential treatment in the future for quietly stepping aside in the Wachovia fight.

Whether or not there was any backroom agreement, Citi is certainly getting some good terms with this bailout.

• Citi is getting another $20 billion in cash from the Treasury.
  
• Citi will also get governement guarantees on a $306 billion pool of garbage assets. Citi will eat the first $29 billion of losses on this pool, and the government will cover 90% of additional losses. The guarantees are for 10 years on residential assets and five years for nonresidential assets.
• The government receives $27 billion of preferred shares yielding 8%. This is a higher yield than the Treasury is receiving from its first round of preferred share issuance under the TARP plan, but it's less than Warren Buffet is receiving from his GE and Goldman deals (10%).
  
• The government also receives warrants to buy 254 million common shares of Citigroup at $10.61.
  
• Citi essentially has to eliminate its dividend, which is something it should have done anyway.
• There will be some controls placed on executive compensation.
• No management changes at Citi are required.
  

This strikes me as a great deal for Citigroup considering the market value of the company was only $20 billion heading into the weekend. This deal certainly doesn't guarantee that Citi will now prosper. They have a huge balance sheet beyond the $306 billion pool that will be covered by this agreement, and with the economy flailing, the company is sure to experience continued difficulties in the near-term.

This agreement does, however, buy Citi more time to address its balance sheet. The pressure will continue for the company to shed some of its assets. Buyers will be hard to come by, but just today we're hearing of potential interest from HSBC in some of Citi's foreign assets. Any asset sale would probably be greeted warmly by the market.

As for what to do now with this position given today's news, I plan to sit tight. I still view it as a call option - hopefully now a LEAP. It's nice that it's in-the-money (at least for the moment), and if it had an expiration (bankruptcy) date, that date has now been extended into the future. The government has explicitly signaled today that Citigroup is clearly too big too fail, and importantly, the government wasn't interested in wiping out the shareholders. Perhaps they feared that wiping out Citi's common shareholders would only make it harder for other banks to raise new equity capital.

Disclosure: The Rubbernecker is actually long a financial but still short the poor U.S. taxpayer.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Auto Industry: Special Loan Financing!

What do you do with an industry that has been losing billions of dollars, has an uncompetitive cost structure, is struggling to raise enough cash to fund itself, and is slow to innovate?

a) Short the stock, and wait for the bankruptcy announcement.

b) Hire an arsonist to torch the place in hopes of collecting some insurance money.

c) Lend it a huge amount of money at a ridiculously low interest rate.

If you chose A, you are of above-average intelligence and think quickly on your feet. You're well-liked, held in high esteem by your friends, and are very attractive. You're also wrong.

If you chose B, you are either a criminal, a pyromaniac, an aspiring Mafioso, or you work at the Federal Reserve. You are also wrong and should stay well away from my house and family.

If you chose C, you are correct. Unfortunately, you are either a village idiot, a U.S. Congressman, or an auto industry executive. You are not good with numbers, investments, ethics, or the truth. You think you are well-liked, but behind your back people are constantly mumbling, "Wow. I feel sorry for the village that idiot comes from."

The socialization of America continues to run amok. With the nation busy quibbling over the relatively insignificant foreign and economic policy differences between McCain and Obama and with the distraction provided by the teetering of the global financial markets, the mere $25 billion that our U.S. Congress just approved in loans to the auto industry may slip through the cracks.

Remember the widespread consternation over the $29 billion "rescue" of Bear Stearns? Just a few months ago, $20-something billion was considered a substantial amount of money and caused quite a tizzy. Ah, the good old days. Since then, we've had an $85 billion "rescue" of AIG and are now facing an impending $700 billion bailout of the financial industry. In this brave new world, $25 billion is practically quaint. It's the change between the cushions of Uncle Sam's sofa.

Nevertheless, let's put that $25 billion in perspective. Our entire annual federal education budget is $56 billion. Homeland security is getting $34.3 billion this year. $25 billion is greater than the annual federal budget for each of the following agencies: Agriculture, Commerce, Energy, Interior, Justice, Labor, Transportation, Treasury, EPA, Judicial Branch, NASA, and the National Science Foundation. I'm not saying we should spend more on these departments -- just providing some perspective.

The combined market value of Ford and General Motors is $16 billion. Raising significant equity capital would, if even possible, result in massive dilution. No private bank in the world will loan them a dime, and let's not naively blame that solely on the banking crisis. Banks weren't rushing to loan the U.S. auto industry any money before the meltdown either. The capital markets simply don't deem them worthy of investment.

Our legislators, however, always think they know better, so they've rushed in to supply the industry with $25 billion that no other sane institution/investor would provide. To add a touch more insult to the U.S. taxpayer, this loan is not accompanied by an equity stake in the participants, and these loans are coming at a below-market interest rate. According to a Detroit Free Press article:

Under the loan program, automakers and suppliers could borrow at interest rates close to what the U.S. Treasury does -- roughly 5% -- rather than the 15% they would have to pay on financial markets. On a loan of $1 billion, that's a savings of $100 million.

That, of course, is $100 million less that the U.S. taxpayer will make from this "investment," and that 5% interest rate is lower than even our best companies can get in the market. Let's remember this the next time we read how our U.S. officials are complaining about foreign tariffs, subsidies, trade barriers, and unfair trade practices. This is no different.

Why is the government intervening to prop up these companies? As I detailed in my article "General Motors - It's Your Money Demand Better", GM has lost a cumulative $33 billion since 1993. Shouldn't it be clear by now that the U.S. has no competitive advantage in auto manufacturing? Is the auto industry really vital to the US? If our ambition is to solidify our position as a leader in the manufacture of inferior and unprofitable products, then by all means, this loan package is a master stroke.

I don't know about you, but I don't need GM, Chrysler, or Ford. There are plenty of foreign-owned car manufacturers making a better product at a better price who are eager to sell to me. Furthermore, many of these competitors have been opening up manufacturing facilities and creating jobs in the U.S. over the years. They have the cost structure and manufacturing know-how to produce profitably, and some of them have been leaders in the development of more fuel efficient vehicles. This loan supports those who have failed and is a slap in the face to every strong competitor.

Clearly, the only reason the government is making this loan is to stem the loss of thousands of jobs that would result from the failure of the industry. It's all politics, all the time. Where do we draw the line? Nokia and Research In Motion have better cell phones than Motorola, and Motorola has had to cut jobs. Why don't we give Motorola a sweetheart deal? Our U.S. furniture manufacturing industry has suffered due to low cost Chinese competition. Let's throw billions at them. And what about our Swiss Army knife manufacturers? The Swiss are killing us! Let's give them some cash so they can compete!

Disclosure: The Rubbernecker is long the Bankruptcy Code and short arsonists.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Dictator Paulson's Bailout

The Treasury issued a "Fact Sheet" yesterday which shed a little more light on its proposed $700 billion bailout. Although the fact sheet was fairly brief, I'll quickly summarize it for those of you who don't have the time to read my full write-up.

I, Hank Paulson, will be granted absolute dictatorial control and power over $700 billion to buy whatever assets I damn well please under the terms of my choosing from any U.S. or foreign financial institutions that operate in the U.S. I will personally select which of my friends get to manage these assets, and you should consider yourself lucky that I intend to give you an update in a few months.

Let's look at some of the details that are coming out more closely. For starters, according to the fact sheet:

"The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. The Secretary will have the discretion, in consultation with the Chairman of the Federal Reserve, to purchase other assets, as deemed necessary to effectively stabilize financial markets."

We're first told that the intent is to purchase residential and commercial mortgage-related securities, but then we read that the Treasury can also buy other assets. So, that really means that the Treasury can buy pretty much whatever it wants.

Next:

"To qualify for the program, assets must have been originated or issued on or before September 17, 2008."

It's been incredibly clear for at least 6 months to even the most ignorant observer that the housing bubble was imploding, deleveraging was underway, foreclosures were rising, risk aversion was increasing, and credit quality was deteriorating. Why in the world are we going to bail out those who were foolish enough to continue gambling these past 6 months?

Also:

"Participating financial institutions must have significant operations in the U.S., unless the Secretary makes a determination, in consultation with the Chairman of the Federal Reserve, that broader eligibility is necessary to effectively stabilize financial markets."

This makes it abundantly clear that U.S. taxpayer dollars will be going to help support foreign-owned financial institutions. Why are we bailing them out with our money? Why aren't their own governments bailing them out? Are U.S. financial institutions with an international presence being bailed out by the foreign countries in which they operate? This looks like yet another gift to our foreign benefactors upon whom we're dependent for funding our ever-increasing debt.

Moving along:

"The assets will be managed by private asset managers at the direction of Treasury to meet program objectives."

Private asset managers? I wonder how many companies who will be benefiting from this bailout will also be benefiting from the fees they'll earn managing these assets. The Treasury could have at least mandated that no firm that participates in the bailout will be eligible to manage the Treasury-purchased portfolio.

Other details of the plan have begun emerging as well. One of the most disturbing is that Paulson is asking that no court or government agency be able to review any of his decisions. I'm sure Paulson is a nice guy and all, but I wouldn't trust him to cat-sit for me, and I don't even have a cat. I imagine even Chavez of Venezuela and Ahmadinejad of Iran are subject to some oversight.

I still haven't heard about any protections being given to U.S. taxpayers who are the ones incurring all of the risk in this bailout. I've heard no discussion of the Treasury being given equity for access to its funding. This is even more disconcerting given the issue of bank capitalization. As I highlighted a couple days ago ("The Ugly Step-Mother of All Bailouts") the only way this bailout can really help out the banks is if the Treasury buys their distressed securities at well above market prices. Selling at a true market clearing price would likely lead to immediate insolvency for many banks. Of course, buying their toxic securities at a premium would lead to an immediate loss for the U.S. taxpayer. We should be compensated for the immediate loss we'll suffer as well as the risk of significantly larger losses down the line. When we bailed out AIG, at least we were given some consideration in the form of majority ownership and a respectable yield on the debt.

This bailout is terribly flawed. What's worse is that there is a very high likelihood that it won't ultimately save the financial system. There is no guaranty that banks will start lending again. To what degree banks will still need to be recapitalized is unclear. It doesn't improve the financial condition of the U.S. consumer/homeowner. To the degree that it slows or stalls the process of actual market price discovery and deleveraging, the downturn will be strung out over a longer time period.

The market could certainly rally into quarter-end as fund managers are desperate to salvage their performance this quarter, but once the broader implications of this bailout are appreciated, there is a good chance that the market will roll over once again. Should the market begin to doubt and question the effectiveness of this huge comprehensive bailout, we could certainly experience a new high on the VIX (fear index) and a meltdown in confidence.

We have begun to increase our short positions and anticipate building them further should the market continue to rally in the coming weeks. We also anticipate further building our gold, silver, and/or junior mining equity positions.

Buckle up.

Disclosure: The Rubbernecker is short dictators and long transparency.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Debt Bomb

It looks like the size of the latest government bailout will total $700 billion, which works out to an additional 8.2 AIGs or roughly the GDP of the Netherlands. Of course, the U.S. doesn't have an extra $700 billion in savings sitting around to fund this program, so we'll have to borrow it. As a result, our government will yet again need to increase the statutory limit on the national debt, this time from $10.6 trillion to $11.3 trillion.

I'm surprised Congress still calls it a debt limit, since it's nothing of the sort. They've never adhered to any limit. Whenever they bump against it they simply vote to increase it further. Usually, they're far more creative with their nomenclature. You'd think by now they would have changed the name to "Government Stimulus Threshold","Graduated Investment Target", or "Super Patriotic Pro-U.S. Funding Goal."

For those of you keeping score, this latest $700 billion payoff works out to $2,333 per U.S. man, woman, and child. It also works out to $6,350 per U.S. household. The new debt limit of $11.3 trillion comes out to $102,700 per U.S. household. These figures ignore unfunded liabilities (Medicare, Medicaid, Social Security) which conservatively come out to another $50 trillion, or $450,000 per U.S. household. All in, your family's share of our country's debt comes to $552,700.

Are there any proposals to offset this $700 billion with tax increases (which I abhor) or expenditure cuts (which I love)? Of course not. To the contrary, there are discussions about another fiscal stimulus program. McCain and Obama certainly have no plans to lower the debt. We haven't heard either talk of any specific and substantive cuts in expenditure.

This is the problem with Keynesian economic theory. It looks good on paper, but it doesn't work in the real world. Everyone loves the front end of the theory -- borrow money and go on a shopping spree. It's the American way! But when times are good, no one wants to take away the punchbowl, upset the voters who are now dependent on the new government programs, and risk not getting reelected.

So, our national debt spirals ever higher, which is a bit ironic since it was ever-rising debt of increasingly poorer quality that led to the current credit collapse in the financial sector. Increasing debt necessitates the printing of ever more dollars. The more of something that exists, the less valuable it becomes. In light of this, it's difficult to be constructive on the dollar long-term. There is no way we can ever repay this mountain of debt short of inflating the currency.

We owe a debt of gratitude to the Chinese for their delicious food, movable-type, a beautiful wall, their inexpensive exports, and their continued purchase of our Treasury securities. So far it's been in their best interest to fund our debt and keep the dollar from imploding. A dollar meltdown would lead to higher interest rates which would kill our economy and severely impact our appetite for Chinese goods. In addition, a falling dollar and rising rates would decimate the value of their U.S. Treasury holdings. Over time, China will become less export driven and less dependent on the U.S. consumer, and at some point, the Chinese are going to view the risk of increased dollar purchases as greater than the reward. That is the day when U.S. interest rates will begin an ugly march higher.

Ironically, it was the Chinese who invented paper money.

Disclosure: The Rubbernecker is long gold, silver, and the Renminbi and short the greenback and government bailouts.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

The Ugly Step-Mother Of All Bailouts

In less than a week, we've gone from U.S. Treasury Secretary Paulson being "adamant" that no government money be used to bail out Lehman to an $85 billion bailout of AIG to a rumored $800 billion bailout of the financial industry and a new guaranty program for U.S. money-market funds. On top of that, the SEC is banning the shorting of 799 financial stocks.

All I'm reading is praise for these moves from all corners. Has everyone gone mad? This is a sad day in this country. Taxpayer money on a huge scale will once again be used to rescue failed private businesses, the bar for "too big to fail" is being significantly lowered, and moral hazard is again being trampled on. The "communist" Chinese must be doubled over laughing at us "capitalist" Americans.

I'll save my capitalism and regulation rants for other posts. For now, let's focus on this new government plan to buy distressed securities from financial institutions. First, we need to ask why the banks aren't selling these assets to raise capital. Paulson contends that they want to sell them but can't because there aren't any buyers. That's why the government "needs" to step in as the buyer of last resort. Well, Merrill Lynch was able to offload $31 billion of these securities at what really worked out to about 5 1/2 cents on the dollar. We also know that a number of funds have raised a significant amount of money to invest in distressed debt.

So, is the issue really that the banks can't sell the securities? Perhaps it's more intellectually honest to say that the banks could sell the securities, but if they sold them at a true market price, they would end up taking huge write-offs and would be technically insolvent. If this is the case, the only way the government will be able to help these financial institutions is by buying the securities from them at significantly above market value prices. Great deal for management and the shareholders. Not such a great deal for the U.S. taxpayer.

By the way, who is going to value the securities? The Wall Street financial whiz kids don't know what they're worth. Are we seriously supposed to believe that some government bureaucrats have the answer? I imagine they'll hire some Wall Street firms to tell them how much to offer for the toxic securities owned by the Wall Street firms!

I'm sure we'll hear how the taxpayers could actually make money on this deal, and that's certainly possible if the markets settle down, housing rebounds, employment rises, foreclosures stop, wages increase, and we're able to find some greater fool of a government to sell the securities to. Unfortunately, there isn't likely to be much upside for the taxpayer. If the government offers to buy these securities at true market prices, then very few banks will likely participate, and the bailout is irrelevant. On the other hand, if the government offers to buy the securities at above market prices there will likely be many takers, with the risk being transferred to the U.S. taxpayer who will be starting out this investment already under water (think load mutual fund).

So, the markets are rallying again on news of yet another government bailout. Everyone feels good. Just remember, if you're trying to figure out who the patsy is, and you still don't know after a few minutes, then you (Mr. Taxpayer) are the patsy.

We were fortunate to have reduced a good portion of our short position earlier this week following Wednesday's decline. We're once again gradually adding to our shorts on this rally.

Disclosure: The Rubbernecker is long shorting and short longing.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.