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Chrysler, Stress Tests and Swine Flu

Prof. Peter Morici - 5/3/2009

This week we will get a first glimpse of the beginning of the end of the recession, perhaps.

The Numbers

Monday, March construction spending will be a backward looking indicator—stimulus spending, the thinning inventories of new homes and elevated mortgage applications will not be apparent in lumber sales, new steel framing and cement flowing for a few more months. Economists expect March spending to be down, again, by 1.3 percent.

Tuesday, the Institute of Supply Chain Management reports on April service sector activity. Economists expect the ISM Service Index to inch up to 42 from 40.8. Still, that would be below the breakeven 50 mark.

If retailing is doing better than Department of Commerce numbers have been telling, as some private analysts claim, we should see the ISM index edge up, indicating the rise in first quarter consumer spending was no fluke.

Friday, April employment data will be released. If things are getting better, then job losses should be well off the 663 thousand posted in May. Forecasters expect a loss of about 630 thousand, reflecting the easing of new unemployment claims off record levels. With job losses so high, it would be hard to argue the recovery is at hand, yet should that figure plunge below 500 thousand, we could at least start window shopping for champagne for summer delivery.

My electronic Ouija board tells me to order caviar for consumpton no earlier than the fall.

Chrysler

When I testified with the Detroit Three CEOs in November, I warned the senators that giving the automakers billions would only prolong the agony—one way or another one or more of those companies would end up in Chapter 11.

The economics of the industry required Chapter 11 for at least one major carmaker.

Quite aside from legacy costs—payments for retiree health benefits and interest payments on loans and bonds—the wages paid to make cars today and factory work rules imposed by the UAW are too burdensome and unrealistic to sustain the domestic industry.

Since President Obama took office, politics not economics have trumped in the government lending and negotiations process that has kept GM and Chrysler turning out vehicles that are too expensive and often not relevant to consumers.

Essentially, Obama has been unwilling to tell Ron Gettelfinger that his workers are too expensive and will have to make the kinds of sacrifices regarding wages, work rules and retiree benefits that the steelworkers endured to make the integrated mills competitive during the first term of George W. Bush.

In Washington, it is clear who is in charge when it comes to industrial policy and it is not the former Senator from Illinois. Better to call “Solidarity House” for the real scoop.

Chrysler owes creditors $6.9 billion but the company in liquidation is worth only about half that amount. The creditors come first in bankruptcy court, so the union should get nothing there.

Yet lawyer Obama tried to force creditors to take much less than 50 cents on the dollar and award the lion share of the stock in a reorganized Chrysler to the UAW. The fact is creditors should share ownership with Fiat, a new investor, and the UAW should get what the steelworkers got—a chance to work in a competitive enterprise at decent wages but without medieval work rules.

President Obama, a product of Chicago, knows how to judge shop—he took the Chrysler bankruptcy to the Big Apple—a reliably liberal location attuned much out of touch with manufacturing.

He is looking for the New York bankruptcy courts to “quick rinse” the legitimate rights of lenders. The big New York bankers are willing to play along—at the expense of their shareholders—because Obama keeps validating their outsized compensation at the expense of those shareholders.

Demagoguing the small lenders as speculators, President Obama is proving as skillful as a carnival barker. He is fooling people into thinking his award of Chrysler to an undeserving UAW is just and right. Instead, it is a cynical political payoff for union campaign support that will compromise the rule of law.

Aren’t we glad we elected a constitutional lawyer president?

Hopefully, Gotham City bankruptcy judge can well up the integrity of Fiorello La Guardia instead of exhibiting the instincts of Boss Tweed.

Award Chrysler to the creditors and offer the UAW what it deserves—a handshake, a smile and perhaps a good kick in the ___ .

Stress Tests

Simply the Administration has a bear by the tail. The stress tests impose a severe economic scenario to test the capital adequacy of the nation’s largest banks, and they require that adequate capital only be in paid-in common stock.

To avert a hypothetical calamity and theoretical big bank failures, President Obama will require banks found lacking in this fabricated financial tsunami to sell more common shares. If they can’t find enough buyers, TARP investments will be converted to common shares and additional government funds will be provided as may be necessary.

After seeing the Obama Administration’s helping hand at Bank of America, Citigroup, Chrysler and GM, an investor would have to be nuts to buy shares in a bank that requires more capital according to the government’s criteria, because private investors will likely end up with Washington as a partial and dominant shareholder too.

After seeing how President Obama handled the car companies, I would just as soon take a beating from a prize fighter than buy stocks or bonds in a bank ordered to raise capital by the Obama stress tests.

Swine Flu

So far, the swine flu epidemic tallies up in its consequences much like a typical winter flu season—we are rerunning January in May. That is manageable.

The Obama administration deserves high marks for moving quickly and communicating effectively the need for containment and preventative steps, and unless things get a lot worse, the economic impact in the United States will be minimal.

Pockets of hardship will be felt among schools and businesses forced to furlough students and workers, and among airlines who will be routing tourists to different locations.

Mexico, already reeling from the recession, will be plunged further into crisis but generally, economic activity lost in one part of the globe will be added in another. Look for travelers to head to other locations to enjoy a summer holiday.

U.S. airlines may blame the flu for their anemic profits reports, as will no doubt some tourist locations, but the recession is their real villain, and also pricing policies and business practices more attuned to a credit bubble economy. After all, look at how much the airlines want to charge for an extra bag.

One of these days the airlines will learn that treating customers well is the best way to keep them out of their cars and off the trains.