Photo by Dave Makes

Two news items yesterday, when put together, start to tell an interesting story. Warren Buffett invested $5 billion in Bank of America in a private sweetheart deal that will guarantee him a 6% return (that’s $300 million per year) and he is hosting a fund raiser for Barack Obama in New York where the tickets start at $10,000. What’s going on?

Barack Obama is the worst jobs president since Herbert Hoover (see previous post on this); the economy is flat lining; and yet Buffet thinks Obama is doing a great job. Think of some of Obama’s other supporters among the captains of industry: Jeffrey Immelt of GE and Howard Schultz of Starbucks.

Crony Capitalism

What is crony capitalism? Crony capitalism is where we have a capitalist economy but instead of truly free markets, some business leaders get cozy with government to tilt the playing field in their favor. Those on the left like to paint conservatives as the champions of big business and the wealthy, but if you look at the campaign contributions of many big business CEOs you will be surprised at who they support. Let’s look at two examples, Warren Buffett and Jeffrey Immelt.

Warren Buffet

In the financial meltdown triggered by the housing bubble bursting, the government stepped in to prevent large financial institutions from failing. This creates what is known as a moral hazard. A moral hazard is where the risks associated with a particular transaction are covered by someone else such as the government or insurance, so the investor is willing to take overly large gambles. Why? Generally, the bigger the risk, the bigger the payoff if you are right and if the downside is protected by government or other parties you have less to lose. Big upside, small downside, let’s play!

Warren Buffett invested in Goldman Sachs in the midst of the financial crisis in 2008, as a result of his $5 billion investment he reaped “$10 billion in interest, fees, and dividends,” according to Mark DeCambre at the New York Post. If you know that the government won’t let the bank fail, what is your downside risk? The upside turned out pretty sweet. Warren Buffett was an adviser to candidate Barack Obama and you can be sure the topic of how to handle the fiscal crisis was discussed. Buffett is now investing in Bank of America where his company, Berkshire Hathaway stands to make another killing. Would the government stand by and let Bank of America go under? What do you think?

Warren Buffett has also been making the rounds calling for more taxes on the rich. This writer and others have suggested that if Warren Buffett thinks the government deserves more of his money, go ahead and write the check, but he balks at that suggestion. Why? Depending on when you measure it, Warren Buffett is one of the three richest people in America. No matter how high to raise the tax rates, he will be able to afford it. Other entrepreneurs and small businesses may not be able to afford the higher taxes and thus find their companies financially squeezed. Buffett’s company Berkshire Hathaway has made a lot of money buying up good companies. Could his high tax advocacy be a way for the government to create some new investment opportunities for him?

Buffett has also invested in a Chinese company to build electric cars. Why didn’t he invest in GM to help sell the Chevy Volt? In the midst of this lousy economy President Obama announces new CAFE standards that would require car companies to build cars that would get over 52 miles per gallon by 2025. That will probably drive GM and Chrysler out of business with their heavily unionized companies already at a severe cost disadvantage of around $2,000 per car. What a great opportunity this would create for a company with an electric car! Slap a GM or Chrysler nameplate on it and voila, problem solved.

Jeffrey Immelt

For all the talk about higher taxes, General Electric paid no taxes in 2010. During the fiscal crisis GE got large sums of money from the government.

During the wild Congressional spending spree of the last couple of years, GE miraculously became the largest beneficiary of the government’s Troubled Asset Recovery Program (TARP) bank bailout. Although GE did not initially qualify for TARP, the company’s $18 million annual investment in battalions of Washington DC lobbyists convinced Administration regulators to push that “reset” button and extend TARP guarantees and subsidies to GE. Public records demonstrate GE Capital, the company’s massive financing arm, pocketed $120 Billion in loans from the Federal Deposit Insurance Corporation at interest rates of less than 1% and snatched 25% of the entire $340 billion in subsidies from “Temporary Liquidity Guarantee Program” (TLGP) rescue fund. — Chriss W. Street

Immelt has also been appointed as the head of President Obama’s job council. At the same time Immelt is entering into an agreement with China to build airplanes to compete against Boeing. Meanwhile do you recall Boeing and the government being in the news lately? Well the National Labor Relations Board has told Boeing that it cannot open another factory that will hire 5,000 employes in South Carolina. In the midst of 9% unemployment, Obama said that the NLRB was an independent agency and his hands were tied. How convenient?

What’s that Smell?

While the engines of job creation, small businesses, are stuck wondering what will hit them next, the crony capitalists are cozying up to President Obama and getting fat while stymieing their competition. I don’t know if this is illegal or not, but how much different from insider trading, at least from appearances, is this? The heads of major corporations give advice to President Obama, go out and make spectacular deals, and the economy continues to languish while they get rich. They get rich not because they have a better idea, or are more nimble, but because taxpayers are absorbing much of the risks while they make the dough. Perhaps Congressman Issa can use his Government Oversight committee to ask a few key questions.

That’s my opinion; I’d like to know yours. Please comment below.

As I check the current price of GM stock this morning, $31 per share, and I contemplate how in the world it is going to reach the $53 per share price Americans need to fully recover their “investment” in the automaker, a recent news story lays it on the line. It’s not going to happen. The Obama administration has announced that it is demanding that auto companies double the mileage that their fleets get, to 56.2 miles per gallon, by 2025.

Once again we have the statists thinking that they are the smarter version of soviet planners who can demand that the wind blows, the sun shines, and the seas fall, and can just order that private industry do something and it will be done. As I point out in my book Liberty’s Lifeline, U.S. auto companies have about a $2,000 per car disadvantage relative to their foreign competitors due to health care benefits. So unless people think environmental green is superior to the green in their wallets, they are not going to pay a premium for high mileage cars. After all, the point of a high mileage car is to save on  the rising cost of gasoline, but if you never get the savings because the of the high price of the car, why do it. The clear example of this is the Chevy Volt.

The Chevy Volt is a $40,000 electric car, that is General Motors pride and joy. To encourage people to pay the ridiculous sticker price, the government offers a $7,500 subsidy, that is, you pay for the privilege of your neighbor driving his green car. The good news is that March sales were more than January and February combined. The bad news is that March sales were a total of 608 cars. For the first quarter the number of Volts sold totaled 1,210, compared to 50,000 for the Chevy Cruze.

GM makes money when it sells a Cadillac. Ford makes money selling F-150 pickup trucks. But the government has to get involved and tell these companies that they must sell cars in a sufficient mix that their Corporate Average Fuel Economy (CAFE) meets the government mandate, which will rise to the aforementioned 56.2 miles per gallon.

The market consists of demand for a variety of vehicles. Some companies can produce small, light, high mileage vehicles. Others can produce stronger, heavier trucks and luxury cars. Who is Washington to say what each can build? Let the market decide. If gasoline prices continue to rise, the car company that can continue to build high mileage cars will do well. GM and Chrylser are caught between the unions and a hard place. Their higher labor costs put them at a serious disadvantage in the low end, high mileage market and then Washington says that they have to sell more cars in that space to hit the CAFE averages. It is a recipe for disaster. But don’t worry, you have their back. You wallet is just a stroke of the pen away from this administration doling out more money to their friends and sticking you with the bill.

That’s my opinion; I’d like to know yours. Please comment below.

He looked nervous.  He curled up the corners of his two hole cards, aces.  He eased them back down on the table and scanned the other players.  Nancy Pelosi had a stack of chips totaling $25 billion and he wanted all of them.  No, he needed all of them.  Desperately.  The other three, all Japanese, sat expressionless behind their dark glasses.  At every hand all they said was “Call”.   No raise.  No drama.  Very cool.  Very dangerous.

He looks again at the four cards on the table.  Nothing to help him there.  He needs another ace. He needs the ace he calls the Volt. Pelosi turns to him. “So, what’s your plan?”  He swallows hard, trying hard not to show it and says, “All in,” and pushes his remaining chips into the center of the table.  The dealer burns another card and then peels off the “river.” And we’ll be right back for the final outcome of tonight’s game.

GM on the Precipice

That must be how Rick Wagoner feels.  It seems he’s betting everything on the Chevy Volt. If he draws that ace, he’s a hero.  If not, he’s history.  So what are his chances?

If that’s all he’s got, they’re pretty long odds.  The Volt is not due to hit the showroom floor until 2010, and at a whopping $40,000 per copy.  Not a bad price for a Cadillac, but for an untested electric car with a 40 mile range?  That’s a tough sell.  Even at that, the $40,000 might not be profitable, just break even.  But, there will be a tax credit of $7,500 to help take the sting out of it.

Without Bankruptcy

Without a major revamping of their cost structure that can probably only be achieved through the bankruptcy courts, GM is still carrying $2,000 per vehicle in labor costs that its competition doesn’t have.  And what about those three players to his right in the dark glasses, do you think they are standing pat?  Although very low key, it is reported that Toyota, Nissan and Mitsubishi are all planning to introduce electric cars in the same time frame.  If they do that and they also have the $2,000 per vehicle edge, it will be very bad for GM and any bailout will go down the drain.

The other factor is the way the Japanese do strategic planning.  They typically do not look to just the next quarter.  They are known for developing 50 and 100 year plans.  That is not a typo.  So if they introduce a vehicle they will do it for the long haul.  Believe it or not the Toyota Prius has been on the market for seven years already.  The Japanese are not afraid to introduce a pretty good model and then continuously improve it and if they believe the direction is right, they are willing to wait for the results.  The Big Three, on the other hand tend to have a shorter planning horizon.  Witness Ford’s announcement that it intended to build 250,000 hybrids and then did a market survey when gasoline was about $2.30 per gallon, and decided that they should not go forward.  When gas prices took off they were caught flatfooted while Toyota was selling Priuses at a premium and they couldn’t make them fast enough.

New Administration, New Congress, New Energy Policy

Then there is the energy issue.  Putting more and more electric cars on the road is a good idea and a way toward energy independence.  However, the new administration and the incoming Democratic Congress want to kill the coal industry.  Coal currently generates 49% of our country’s electricity and when it comes to coal reserves, the U.S. is to coal what Saudi Arabia is to oil.  But the new incoming chairman of the House Energy committee, Henry Waxman of Beverly Hills, California, is more determined than ever to implement a green agenda and kill coal.

So what do you replace the coal with?  Oil? Gas? Nuclear?  On the campaign trail, I heard Barack Obama and Joe Biden mumble some things about nuclear being okay, but it was hardly a ringing endorsement.  Do they think for a minute that wind or solar are anywhere near replacing coal?  So, they actually plan to reduce our electric generating capacity by 49% and then not only replace it but grow it to be able to handle all these electric cars.  Where’s that plan?

If you don’t have enough electricity, you can’t charge up your electric cars.  If good old supply and demand does its usual thing, the price of electricity should skyrocket and I can tell you first hand that in New York, it’s not cheap right now.  If electricity skyrockets, whatever manufacturing is left in New York and other rust belt areas will be pulling up stakes left and right and heading south.  If that population follows the jobs, does that mean more votes for the red states and a shift in Congressional seats as well?

The Democrats better re-think that plan if they want to stay in power.

I was having lunch with a colleague the other day and the conversation turned to the economy. He spoke of some recent analysis of the number of jobs that would be lost if the Big Three failed.  He recounted not just the employees of the auto companies themselves, but the employees of their suppliers, advertising firms that produce car ads, and on and on.  His final tally was well over 1 million jobs lost.  He concluded by saying it would make the current financial crisis a walk in the park.

Getting enough exercise?

Does that mean that we are all going to start walking?  Not that that would be a bad idea, we could all stand to lose some pounds, but for someone who has a 23 mile one-way commute with no option for mass transit, it’s just not going to happen.  So what do we do?  Well, one of several scenarios is going to happen.

Scenario 1:  The Big Three Close Their Doors

If this scenario came about, what would we do?  We would go buy Toyotas, Nissans, Hondas, Volkswagens, etc.  Those companies would have to scale up to fill the void caused by the Big Three closing their doors.  That demand would need people.  So a significant number, but by no means all, of the laid off workers from Detroit would move to North Carolina, Alabama, and other points south, and join these auto companies at their U.S. plants.

Likewise the suppliers would form new alliances to supply these car companies, as would all the other ancillary companies that currently support Detroit.  Would jobs be lost?  Yes.  Would it be anywhere near the number of jobs my friend projected?  No.

Scenario 2: The Big Three Reinvent Themselves

The liberty of the car companies to reinvent themselves is constrained by government regulations.  Surprise!  If the Big Three have any hope of reinventing themselves, they have to have the freedom to do so.  Start by eliminating the CAFE standards.  CAFE, which stands for Corporate Average Fuel Economy, is the mileage standards dictated by the government that the auto companies must comply with or face heavy fines, draining more money from the Big Three’s coffers.  So for every car that the Big Three build that may get 20 mpg, they may have to build and sell perhaps 3 that get 30 mpg, in order to meet the standard.  But what if they can make money on the 20 mpg car, but they lose money on every 30 mpg model?  What if the reason they can’t make money is because of their labor costs per vehicle, their pension costs per vehicle, their health care costs per vehicle, when added up are too high compared to their foreign competitors.  They are basically forced by the government to make an unprofitable product.

Why not abandon the CAFE standards?  Let Detroit build the cars and trucks that they can make at a profit.  Let the foreign manufactures make cars that they can make at a profit, including high mileage cars.  Let the American people have the freedom to choose which they want.  As the price of gasoline climbs as it did, and will again, people will want to buy high mileage cars, hybrids, electric cars, but they will also want to buy SUVs, luxury cars and light trucks.  Why does a particular manufacturer have to produce all kinds?  When has government ever made the right call on what products to produce? (Hint:  think of all the five-year plans and Great Leap Forwards from the Communist world).

Scenario 3: The Government Bails Out the Big Three

The government prints up a bundle of cash, $25 billion or more, gives it to the auto companies and hands the IOU to you and me.  The new Democratic Congress and Administration will toe the line for their backers in the environmental movement and demand higher CAFE standards for the auto companies in the interest of addressing: our dependence on foreign oil; green house gases; and helping consumers.  This will put increased pressure on the Big Three to make more unprofitable products and we will find ourselves back in the same place a few years hence.  More liberties will be vaporized as the government appoints a czar to oversee the auto companies to be sure they are building the right products, that management is not getting paid too much money, and well let’s face it, they would basically be nationalizing the auto companies.  Management talent would dry up, and socialism would make greater inroads into the U.S. economy.

The Best Scenario

The Big Three file for bankruptcy, if that is what they need to do.  The stockholders would probably be wiped out, the management team would be replaced, and this will let them re-negotiate their labor agreements.  Congress and the new Administration realize that people will want to purchase cars with higher mileage as the price of gas climbs regardless of any government requirement.  There is no justifiable reason that any particular auto company has to build a particular car because the government says so.  Achieving this state of enlightenment, Congress repeals the CAFE standards.  With the liberty to manage the company to make a profit rather than meet the constraints of a bevy of interest groups, a more energized management team takes the reins, and returns the Big Three to competitiveness.

Drawing a line in the Sand

If we don’t take a stand here and now, every company that wants a cash cushion will be working the halls of Congress to get their hands on your money.  There is not enough to go around.  In addition, many of the problems we are facing were created by government initiatives.  The mortgage mess was not the result of not enough regulation but by government programs that compelled lenders to give loans to people who could not afford them.  Detroit’s problems are a result of CAFE standards and onerous union contracts.  Since government created many of these problems why do we think that government knows how to fix them?  What we need to do is tell them to back off and let the free market work.

The conga line for companies with their hands out forms on the left.  The next ones bellying up to the slop trough are GM and Chrysler.  They need $25 billion to help them through a tough patch or they may go out of business.  It is a loan?  Is it buying a stake in the company?  Is it that thing of which we dare not speak– socialism?

What’s Next?

The question is are we, by the continued intervention of the government, managing our way out of a recession and into a full blown depression?  For all the warm memories of FDR, the depresion lasted more than twelve years thanks to, “We’re from the government and we’re here to help.”  Perhaps it’s time to take our medicine, pull the covers up under our chin, sweat it out, and get back on our feet.

Business, like many things, runs in cycles.  There are up cycles and there are down cycles.  We can’t eliminate them, they are a necessary part of the process.  But just as there is no cure for the common cold, sometimes it is best to let it take its course as soon as possible and be done.

Was Government Intervention Wrong?

I don’t believe so.  It was unfortunately necessary to end the panic.  When lenders have no confidence that if they lend they will be paid back, and if they have non-performing assets and they can’t sell them because they don’t know how to price them, the whole system locks up.  The system needs a lender of last resort and the only one big enough to step into that role is the government.  However, that should be for the least amount of time possible.

The Problem with the Auto Industry

The auto industry has had 35 years to figure this out.  With the Arab Oil Embargo of 1973, Japanese auto companies made major inroads into the automobile markets.  Imagine buying a car that got 20 miles per gallon, rather than 8, was better built, and cost less.  Well, that’s what the Japanese companies were offering, but what did Detroit learn?  Union contracts too expensive, let’s invest in robots and get rid of the expensive people!  GM bought boatloads of robots and later ended up scrapping them.  Why?  Because the workers weren’t the problem.

Who transformed the Japanese auto industry?  An American by the name of W. Edwards Deming.  After World War II, Japan’s industry was in shambles.  Deming went to help them get their industry back on its feet and taught them about statistics and quality control.  They learned their lessons well.  They focus on incremental changes every day.  If someone sees a problem on the assembly line and takes action to stop the line, he doesn’t get chewed out, he gets applauded.

The Big 3 have had all this time to figure out what they were doing wrong and fix it, but what did they do?  During the good times, they just rolled along.  If signing a big labor contract kept the peace and kept the factories running, they would buy off the unions.  But when the trouble starts, there’s no room to maneuver.

Leading the Way to the Future

The Japanese saw the need to cut back further on fuel consumption, but they knew there was a limit as far as how much mileage you could squeeze out of a gasoline engine, so they came out with hybrids.  Initially they were a novelty, but when gas was headed for $4 per gallon, they we economical.  Where was Detroit on this?  Lagging behind, of course.  Don’t develop a hybrid car until your customers demand it, but by the time they do, they would rather buy the tried and true hybrids being built by Toyota and Honda.  Ford promised to produce 250,000 hybrid cars but rescinded that pledge nine months later.  Why?

“According to a Ford spokesperson, an internal panel of experts analyzed customer interest in hybrid cars and did not feel that there was enough demand to warrant the expense of building 250,000 hybrids.”

What was the price of a gallon of gas when they made that decision? $2.20, the lowest it had been in ten months.  The other half of that article quoted above said, “Toyota remains top hybrid producer.”  GM is now placing a very big bet on the Chevy Volt, which will be an electric car scheduled to launch in 2010.  Although there is little fanfare, Toyota, Nissan and Mitsubishi are all planning electric cars in the next two years.

To Bail or Not to Bail?

So why should the taxpayer be on the hook for the mistakes of the Big 3 auto maker’s management for these past 35 years?  Perhaps they should just go into Chapter 11, reorganize and come out as more competitive companies.  Why prop them up so that they can stumble along for another 5-10 years until the next downturn and come back to the trough?  The stockholders have been electing the boards of directors for these companies for 35 years and buying their stock.  The boards have been hiring the management team and providing them with their compensation.  The management team has made the product decisions, negotiated the labor agreements, and all the other missteps.  Why should American taxpayers have to step up to the plate and bail them out.  They got themselves into this mess, let them get themselves out.

But that’s just my opinion.