Fluctuating Currenices and the Problem of China's Massive Dollar Reserves

Beijing's Would-Be Houdinis

By Sebastian Mallaby
Tuesday, May 26, 2009


With extraordinary speed, China has morphed from a diffident player in international finance into an impatient table-banger. Six months ago, one could muse about whether the Chinese were interested in a larger role within the International Monetary Fund or in helping to rebuild the crisis-battered global system. Now, the Chinese are pumping almost $40 billion into a new East Asian version of the IMF, browbeating trading partners into using the yuan, and floating fantastical ideas about a new international reserve currency. Visiting Beijing last week, Brazilian President Luiz Inácio Lula da Silva picked up on his hosts' changed mood. Calling for a "new economic order," he suggested that it was time to stop denominating trade in dollars.

It's great that China is speaking up. The country accounts for a large share of the world's savings and much of its growth; if a stable economic order is to emerge from this crisis, it will need Chinese buy-in. But there's a not-so-great side to China's transformation, too: Its contribution to the global debate is mostly muddled.

Why have the Chinese found their voice? Put simply, they have bought so much of the international system that they can no longer be indifferent to it. By running colossal trade surpluses, they have accumulated vast holdings of bonds and shares denominated in dollars, the currency at the core of global finance. If the greenback declines, China's government stands to lose a fortune.

The political backlash from such a loss could be brutal. Already, Chinese bloggers have ripped into the officials who invested $3 billion in the U.S. private equity group Blackstone, only to see the stock plummet. "They are worse than wartime traitors," one online chatter fumed, according to the Financial Times. A large fall in the dollar would make the Blackstone loss look like a picnic.

So Chinese authorities are searching for a way to reduce their exposure to the greenback. The surest method would be to stop buying so many U.S. Treasury bonds, but that would mean allowing the Chinese currency to rise against the dollar, which would hurt Chinese exporters when they are already suffering. So the government is scrabbling around for something -- anything -- that can spring it from the dollar trap without driving up its currency.

China's ideas come in two categories. The wackiest popped up unexpectedly on the Web site of the Chinese central bank -- itself a stunning sign of the nation's ambitions to shape the new order. It proposed that the IMF greatly expand its issuance of "special drawing rights," the multilateral quasi-currency it dreamed up in the late 1960s. The notion is that the IMF would trade these SDRs for some of China's dollars, and -- presto! -- China's dollar exposure would go down. But the hitch is that either the IMF or one of its member governments would be left holding the bag. The idea is a non-starter.

China's other approach is to promote the global use of its own currency. Its central bank has offered yuan to Indonesia and Argentina in return for rupiah and pesos. It hopes more trade will be denominated in yuan. Its contribution to the new IMF-like East Asian reserve fund may one day mean that a crisis-prone country in the region borrows partly in yuan.

All this is intended to buy China's currency some respectability. But as an escape from China's dollar trap, it is laughable. The idea is that once the yuan goes international, foreigners may be willing to borrow in it. That way, China can keep running a trade surplus and exporting capital, but instead of accumulating bonds denominated in dollars it would be able to accumulate bonds denominated in yuan. Again -- presto! -- China's exposure to the greenback would be reduced. But the hitch is the same as with the IMF idea: The currency risk would be transferred, in this case to China's borrowers. Given that the yuan is artificially held down by Chinese policy and will almost certainly rise over the medium term, a foreigner would have to be desperate (or intimidated) to help China out of its impasse by borrowing in its currency.

So neither the IMF idea nor the scattershot attempts to internationalize the yuan will rescue the Chinese from their dilemma. China has accumulated at least $1.5 trillion in dollar assets, according to my Council on Foreign Relations colleague Brad Setser, so a (highly plausible) 30 percent move in the yuan-dollar rate would cost the country around $450 billion -- about a tenth of its economy. And, to make the dilemma even more painful, China's determination to control the appreciation of its currency forces it to buy billions more in dollar assets every month. Like an addict at a slot machine, China is adding to its hopeless bet, ensuring that its eventual losses will be even heavier.

It is easy to appreciate China's sudden appetite for bold new ideas about international finance. But Beijing's leaders look less like the architects of a new Bretton Woods than like aspiring Houdinis.

The Muffled War on Accountability

KBR Got Bonuses for Work that Killed Soldiers
By Jeremy Scahill

May 20, 2009


The Department of Defense paid former Halliburton subsidiary KBR more than $80 million in bonuses for contracts to install electrical wiring in Iraq. The award payments were for the very work that resulted in the electrocution deaths of US soldiers, according to Department of Defense documents revealed today in a Senate hearing. More than $30 million in bonuses were paid months after the death of Sgt. Ryan Maseth, a highly decorated, 24-year-old Green Beret, who was electrocuted while taking a show at a US base in January 2008. His death, the result of improper grounding for a water pump, has been classified by the US Army Criminal Investigations Division (CID) as a "negligent homicide." Maseth's death had originally been labeled an accident. Bonuses were paid to KBR in 2007 and 2008, after CID investigators had officially expressed concerns about the quality of KBR's electrical work. For its part, KBR denies any culpability for the electrocution deaths.

This information was revealed at a hearing of the Senate Democratic Policy Committee. According to the committee's chair, Sen. Byron Dorgan, the rewards KBR received under its LOGCAP contracts were supposed to be for work of the "highest quality" with "no deficiencies" or problems. Dorgan said KBR's work was "shoddy" and "unprofessional." Some eighteen US soldiers have died since 2003 as a result of KBR's "shoddy work," according to Sen. Frank Lautenberg. KBR/Halliburton, of which Dick Cheney was chairman and CEO from 1995 to 2000, has been the single largest corporate beneficiary of the US wars in Iraq and Afghanistan. It continues to operate globally on US government contracts.


Charles Smith, the former Army official who managed the contracts under which KBR performed electrical work in Iraq, testified that it was "highly inappropriate" that KBR received these bonuses for what he called "dangerously substandard" work. He said that the Army was well aware of KBR's "poor performance" since the beginning of the Iraq invasion, and yet continued to reward KBR because the military was "afraid" KBR would cease work. He said there was "a culture that decided KBR was too big to fail and too important to be held to account." The "perverse incentive is that there was no incentive" for KBR to do quality work because they received bonuses for poor work.

Senator Dorgan said there are "tens of thousands of examples" of unnecessary risks to US soldiers, including deaths that have arisen as a result of KBR's work. "Why should [KBR] be getting more contracts now that we know all this information?" asked Sen. Bob Casey. "The Defense Department has not answered these questions."

James Childs, a master electrician hired by the Army to review electrical work in Iraq during 2008, testified that KBR's work in Iraq was the "most hazardous, worst quality work" he'd ever seen. He said his investigation found improper wiring in "every" building KBR wired in Iraq (of which there are thousands) and that KBR's rewiring work in buildings that were previously safely wired resulted in the electrical system becoming unsafe. Childs said that KBR did not do any work "according to code." He also testified that the same risks exist in Afghanistan, which he recently visited. "While doing inspections in Afghanistan, I found the exact same code violations," Childs said.

Eric Peters, a master electrician who worked for KBR in Iraq as recently as 2009, said that 50 percent of the KBR-managed buildings he saw were not properly wired. "I worried every day people would be injured or killed as a result of this work," Peters testified. He estimated that at least half the electricians hired by KBR--many of them cheaper-costing Third Country Nationals (TCNs)--to service the US military in Iraq would not have been hired to work in the United States, saying they were not trained in US or UK electrical standards. TCNs--from places like India, Bangladesh and Bosnia--are estimated to have done some 60 percent of the electrical work for KBR in Iraq. Peters charged that KBR allowed trainees to take notes in to certification tests, making it very easy to be cleared for work.

Peters also charged that KBR "frowned upon" any refusal to sign off on work that Peters deemed incomplete or unsafe. Peters and others who testified said that "all over theater," meaning everywhere in Iraq, KBR would effectively double-bill US taxpayers by leaving electrical work half-done or incorrectly done and then billing taxpayers again to repair its own shoddy work.

Peters characterized KBR managers as "completely unqualified" and said he is not a "disgruntled former employee" but rather a "disgusted former employee."

How the Law Really Works

Documents About Lost E-Mail Can Stay Secret
Court Sides With White House Office

By Del Quentin Wilber
Washington Post Staff Writer
Wednesday, May 20, 2009

A federal appeals court ruled yesterday that the White House does not have to make public internal documents examining the potential disappearance of e-mails during the administration of President George W. Bush. In upholding a 2008 decision by a federal judge in a lawsuit brought by a watchdog group, the appeals court found that the White House's Office of Administration is not subject to the Freedom of Information Act.

Citizens for Responsibility and Ethics in Washington (CREW) filed the suit seeking to force the White House office to comply with a 2007 request for documents related to the alleged sloppy retention of e-mails between 2001 and 2005, a period that included the lead-up to and start of the Iraq war. The group was seeking the records to get a better sense of what happened to the e-mails, said Anne Weismann, the organization's chief counsel.

The Office of Administration, which performs a variety of administrative services for the Executive Office of the President, had complied with similar requests for years. But officials changed the policy after CREW's request, arguing that the office does not exercise enough independent authority to be subject to open-records laws.

Government agencies and offices generally must do more than advise and assist the president or his immediate staff to be subject to the laws. Because the Office of Administration does not perform "tasks other than operational and administrative support for the President and his staff, we conclude that [it] lacks substantial independent authority and is therefore not an agency under FOIA," wrote Judge Thomas B. Griffith of the U.S. Court of Appeals for the D.C. Circuit, who was joined in the 13-page opinion by Chief Judge David B. Sentelle and Judge A. Raymond Randolph.

CREW's executive director, Melanie Sloan, said her organization is unlikely to appeal the ruling. But she said her group and others like it recently sent a letter to the Obama administration urging it to apply freedom-of-information laws to the Office of Administration.

"Transparency and accountability start at home," Sloan said.

"This is load of bullshit, a blueprint for government abuse!" exclaimed blogger R.W. Twain. "This ruling sets a precedent for allowing government actors to conduct illegal acts outside the reach of FOIA, as long as the government agency claims its activities were 'operational and administrative support for the President and his staff."

Yet One More Gift From the Taxpayers to Wall Street

Efforts to Repay Bailouts May Undercut Benefit for Taxpayers
By ERIC DASH, www.newyorktimes.com
May 18, 2009

Americans were promised a reward for rescuing the nation’s banks. In return for all those bailouts, the banks essentially granted stock options to the government — a potential jackpot for taxpayers once the crisis blew over.

But now banks, eager to get Washington out of their hair, are pushing to undo those investments as quickly — and cheaply — as possible. If the Obama administration acquiesces, billions of taxpayer dollars could be left on the table.

At issue are so-called warrants that the government received from the banks last autumn, when the financial world was teetering. Like options, warrants give their owners the right to buy stock at a set price over a certain period of time, in this case, 10 years.

Now, with many banks itching to return their bailout money, the warrants are raising some thorny questions. What are these investments worth? Should the government drive a hard bargain, or let the banks off easy? Should it maximize profit for taxpayers, or minimize pain for banks?

Many banks want to buy back the warrants and wriggle free of the government. Big banks like JPMorgan Chase, Goldman Sachs and Morgan Stanley have formally notified regulators that they want to return their bailout money, according to people briefed on the situation. But as long as the government holds the warrants, it still has some leverage over the industry.

For taxpayers, a lot of money is at stake. The government has an option to buy stock in 579 banks. By some estimates, the warrants on JPMorgan alone are currently worth more than $1.1 billion. They could be worth much more if JPMorgan’s share price rose.

So far, one publicly traded bank, Old National Bancorp in Indiana, has repaid the government in full by returning its bailout money and repurchasing its warrants. (Two small privately held banks have done the same.)

How Old National pulled this off, and the seemingly favorable terms it secured, shows how aggressively banks big and small are pushing, even after they repay money from the Troubled Asset Relief Program, or TARP. Old National paid $1.2 million for its warrants. Analysts estimate the investments might have been worth as much as $6.9 million.

“It’s a great deal for Old National,” said Linus Wilson, a finance professor at the University of Louisiana, Lafayette. “Treasury accepted a lowball offer.”

Andrew Williams, a Treasury spokesman, declined to comment about the negotiations, but said the government “has a robust process in place for valuing warrants.” He added that the Treasury was required by law to sell the warrants once a bank repaid its bailout money.

Analysts say that has made it difficult for the government to pursue a goal of maximizing profits for taxpayers, though a recent change to the law might give the Treasury more flexibility. Even if it had the option, it is unclear how successful the government would be at actively managing such a complicated investment portfolio.

Mr. Williams said the Treasury’s total warrant holdings were worth more than $5 billion, but the value changes along with the underlying stock prices and other factors.

But Prof. Wilson estimated that the warrants on nearly 300 publicly traded banks, which account for more than 95 percent of the government’s investments, were conservatively worth $2.4 billion to $10.9 billion. Some lawmakers worry that taxpayers will lose out. “Taxpayers were there at a critical moment,” said Senator Jack Reed, Democrat of Rhode Island and a member of the banking committee. “They should enjoy the upside when these institutions recover.”

To extinguish the warrants, the banks can let the Treasury auction them off to private investors or can choose to buy them back themselves. As with other bank rescue efforts, like moves to buy banks’ problem assets, the central issue with the repurchases is determining a fair price.

“That is the problem in TARP asset purchases, and it is the problem here,” said Vincent R. Reinhart, a former Federal Reserve official who is now a resident scholar at the American Enterprise Institute. “Do you value it at roughly comparable asset prices or do you acknowledge that the current market prices reflect an unusual uncertainty in markets and aversion to risk?”

For the government, the decision is about more than dollars and cents. It may be willing to sell the warrants simply to send a positive message about the stability of the banks.

“The U.S. Treasury would be better off rejecting a lot of these bids and selling these warrants to third-party investors,” Prof. Wilson, at the University of Louisiana, said. “Instead of having one buyer, they would have many buyers from all over the world trying to decide what the proper price should be.”

Old National’s move to buy back its warrants illustrates how tricky it is to strike the right balance. Executives at the bank, based in Evansville, Ind., and a large community lender with 100 branches and $8 billion in assets, began seeking to exit TARP almost as soon as the Treasury wired it the money in December.

By the end of March, Old National had won approval from its regulators to repay its $100 million of bailout funds. But the bank also wanted to repurchase its warrants, fearing it could remain subject to pressure from the government or another outside investor.

“We felt more comfortable that we controlled our own destiny rather than have the hands of the Treasury or a third party,” Bob Jones, Old National’s chief executive, said. “We think our stock has plenty of upside and would rather have that in our hands.” On April 20, Old National submitted an initial offer of around $600,000. Ten days later, Treasury officials, after gathering their own estimates from two asset managers and two market participants, rejected the bid as too low. Over the next week, both sides haggled over the price.

“We both walked through where we were,” Mr. Jones said. “They held their ground on a number of cases, and clearly we had to compromise.” On May 7, Old National was given approval to buy back its warrants for $1.2 million. The bank wired the money four days later.

At Old National’s annual meeting, shareholders were elated by the news. “It was the only applause I drew the whole meeting,” Mr. Jones said.

Another Gift From Taxpayers to Wall Street

By William D. Cohan, contributor www.cnnmoney.com
Last Updated: May 18, 2009: 10:39 AM ET

NEW YORK (Fortune) -- Imagine if you were not really in the market for a house but the government came along and said that it would finance 94% of a home's purchase price with a mortgage rate of less than 3%. Still not interested? Wait, Uncle Sam has some additional sweeteners: if you do the deal and buy the house for only 6% down, you also get the equivalent of rental income every month to the tune of at least an annualized yield of 10% of the purchase price.

But wait there's still more: if, say, after two years, you decide you don't want the house any longer, you can just walk away from it. No need to pay the balance of the mortgage (it won't affect your credit rating), and you can keep the rental income received to date.

That's essentially the deal that Treasury Secretary Timothy Geithner has offered qualified professional investors who participate in the so-called TALF (Term Asset-Backed Securities Loan Facility). Two months into the program as the first TALF- backed deals hit the market, you can see why the likes of hedge fund Fortress Investment Group are drooling over it. "I'm a big believer in the impact that TALF can and should have," Fortress CEO Wes Edens said on a May 6 investor call, adding that he expects that Fortress will be "a big participant" in the TALF program "three to six months from now."

The first few TALF deals -- one for Ford Credit (the financing arm of the automaker), another for American Honda Receivables Corp., a third for the student loan company Sallie Mae and a fourth for motorcycle icon Harley Davidson -- shed some light on our tax dollars at work.

"I've had accounts that dropped everything they were doing to take a look at this TALF financing," one Wall Street trader explained. "It was like nothing they had ever seen. It beats any financing that the private sector could ever come up with. I almost want to say it is irresponsible." For instance, Prudential Financial, Inc. (PRU, Fortune 500), the large insurer and investment manager, borrowed $786 million from the TALF as of March 31 and put up only $50 million to do so, some 6.4% of the deals.

In case you're not totally conversant with the alphabet soup of financial remedies emanating from the Obama Administration, here's a brief refresher: Geithner and the Federal Reserve announced the launch of the TALF in March. The TALF is a $200 billion (on its way to $1 trillion) non-recourse lending program to private investors as a way to encourage them to buy newly underwritten securities backed by auto loans, credit-card receivables and student loans, among other asset classes. (The TALF program is set to extend, in June, to the issue of new commercial real-estate mortgage-backed securities.)

These securitizations were once upon a time a key component of the so-called "shadow" financing system that helped raise trillions of dollars of capital worldwide. Of course, the securitization and sale of mortgage-backed securities was one of the leading causes of the current financial crisis as the people who took out the underlying mortgages started to default upon them in unexpected numbers. Still, Geithner has determined, correctly, that getting these securities circulating again is crucial to restoring the health of the credit markets. The Treasury designed the program, but it is the Federal Reserve that provides the government's share of the capital. "The increase in the TALF is expected to help stimulate both new issuances and the removal of assets from bank balance sheets," Credit Suisse wrote to its shareholders on May 8.

Investors interested in borrowing from the TALF program have to be approved by the Treasury and then, once approved, have to set up an account with a broker-dealer that is subject to a variety of the usual terms and conditions. The investor then must indicate a desire to buy, say, at least $10 million of one of the dozen or so deals, worth an aggregate of around $25 billion, which have come to market since the TALF program was set up in March. An early test for TALF was a May 5, $1.5 billion car-receivables securitization for American Honda Receivables Corp. and underwritten by JPMorgan Securities (JPM, Fortune 500) and BNP Paribas Securities. Investor demand for the deals so far is said by one trader to be "strong" and the deals are selling well. The real market test, though, of TALF will come when the first deals involving CMBS (Commercial Mortgage Backed Securities) start coming to market in the next few months.

The way the TALF works in practice is this: The amount of equity an investor has to put up, or the "haircut" as the TALF documents call it, depends upon the assets involved, the term of the loan or lease of the underlying asset (say, a car) and the credit quality of the underlying borrower. A loan to buy a three-year security backed by a group of credit-card receivables from high-quality borrowers would require an investor to put up 6% of the capital -- a 6% "haircut" -- and then can borrow the rest from the TALF through his brokerage account. To buy a two-year high-quality credit-card receivable security, a borrower would put up 5% of the face amount of the securities purchased. Auto receivables require as 12% equity investment for a three-year security. Small business loans require 5% down. Student loans require 10% down for a three-year deal.

An investor interested in a $10 million slice of three-year credit card receivable would put up 6% of the money -- $600,000 -- and borrow the balance of $9.4 million from the TALF at a rate of three-year LIBOR plus 100 basis points (Attention K-Mart shoppers, that's 2.85% at this moment.) Depending on all sorts of assumptions, the yields on these investments are said to be in the 11% to 15% range, especially attractive since the TALF loans are non-recourse to the borrowers -- you can just walk away and lose only your underlying equity investment and the collateral but you are not held responsible for the unpaid portion of the TALF loan itself.

In addition, the TALF loan is not marked-to-market so if the underlying collateral deteriorates in value, the investor is not required to put up more equity. What's more as the car payments or credit-card payments on the underlying security are made, the payments are distributed to the government and the investor on equal footing -- that means the investor starts getting paid back at the same time as the government even though the government is the senior secured creditor and even though an investor has put up only a small fraction of the original money. One private equity investor, who would not normally have looked at investing in such a deal but did, called this particular aspect of the TALF "shockingly good."

But who will the TALF deals be shockingly good for -- the players on the field or those of us in the bleachers? If what Geithner calls "our lending facility with the Fed" does its job and jumpstarts the credit markets then the extraordinary concessions the government has made to attract private capital may have been worth it.

William Cohan is the author of House of Cards: A Tale of Hubris and Wretched Excess on Wall Street, published this month by Doubleday Books, a division of Random House, Inc.

Let's Have Cap and No Trade

By David Sokol
www.washingtonpost.com
Tuesday, May 19, 2009


The adage that everyone wants to go to heaven but no one wants to die is on display again as the House considers a massive 932-page climate-change bill, introduced by Reps. Henry Waxman (D-Calif.) and Ed Markey (D-Mass.), that would establish a "cap and trade" system for carbon dioxide and other greenhouse gas emissions. Its sponsors say it will keep low- and middle-income consumers whole while the United States cuts emissions 83 percent below 2005 levels by 2050 and transitions to a clean-energy economy.

Nothing could be further from the truth.

On paper, the Waxman-Markey bill puts a cost on carbon dioxide by imposing a ceiling, or cap, on greenhouse gas emissions and then setting up a market for regulated industries -- such as the electric power sector -- to buy and sell allowances to pollute under that cap. As the cap is reduced each year, market participants will exchange allowances in a complex auction market.

If you liked what credit default swaps did to our economy, you're going to love cap-and-trade. Just read Title VIII of the bill, which lets investment banks, hedge funds and other speculators participate in the cap-and-trade market. They don't have emissions to cut; they have commissions to make.

The real hidden catch of the cap-and-trade system, though, is that it will require consumers to pay twice: first for emission allowances and then for the construction of new low- and zero-carbon power plants.

Congressional estimates of government revenue from the sale of cap-and-trade allowances range from hundreds of billions to trillions of dollars. Contrary to assurances from the bill's sponsors that utility customers wouldn't have to pay these costs for the first decade, some coal-dependent utilities would be forced to purchase more than half of their allowances when the program is scheduled to begin in 2012. Would these allowances reduce our greenhouse gas emissions? No; that would come when consumers footed a second bill -- for the cost of their utilities either to retrofit coal and gas plants to capture carbon -- something that cannot be done today on a commercial scale -- or to shut them down and build non-carbon-producing nuclear plants and wind farms instead.

In fact, to the extent that cap-and-trade auctions increase ratepayers' bills, they will impede utilities' ability to develop a less carbon-intensive infrastructure.

Markets thrive on volatility. Electricity utilities, on the other hand, are highly regulated to ensure price stability -- not volatility -- for their customers. The Waxman-Markey bill imposes a market-based (read: unregulated) trading program on a highly regulated industry that must make enormous long-term and least-cost capital decisions to reduce carbon dioxide emissions. In an unprecedented and unwise fashion, it turns American industry over to the federal Environmental Protection Agency by giving the agency the authority to change the rules on allowances every five years. Is this sound public and economic policy? I think not.

If Congress wants to achieve 83 percent reductions in greenhouse gas emissions by 2050, the electricity sector can get there, but there is no need for that first cost. Get rid of auctions, speculation, trading, new Wall Street "products" (yes, the bill allows for credit default swaps and carbon derivatives) and the trillions of dollars in government revenue that may end up being spent on other programs. Get rid of the 12 new advisory boards, committees and other institutions established under the Waxman-Markey bill. Focus instead on the most efficient and inexpensive way to cut carbon dioxide emissions.

The solution? Keep the cap and remove trading from the equation: Mandate that the industry, over the same 40-year period, simply limit its emissions to the same levels proposed in the Waxman-Markey bill. This can be accomplished with a clear plan that gives states an option: Either they participate in a cap-and-trade program or they elect an alternative compliance mechanism to reach the same greenhouse gas emission goals by working with their utilities to develop a 40-year program of shutting down aging coal plants, retrofitting plants to capture carbon dioxide if the technology becomes available, and/or building zero-carbon energy plants. More important, the carbon dioxide reductions in this proposal can be achieved while providing adequate time to plan to minimize price shock and economic dislocation. It is the states, through their public utilities commissions -- not the federal government -- that have both the interest and obligation to manage citizens' costs while transitioning to a carbon-free future.

This transformation of our entire electricity sector won't be cheap, but it would be less expensive than the double cost of a complex cap-and-trade program followed by that same transformation.

The writer is chairman of the board of Iowa-based MidAmerican Energy Holdings Co., a subsidiary of Berkshire Hathaway, which also owns an 18 percent stake in The Washington Post Co.

Sunbeams From Cucumbers

By George F. Will; www.washingtonpost.com
Thursday, May 7, 2009


Gulliver's travels took him to the Academy of Lagado, where "professors contrive new rules and methods" for everything: "One man shall do the work of ten; a palace may be built in a week, of materials so durable as to last forever without repairing. All the fruits of the earth shall come to maturity at whatever season we think fit to choose, and increase a hundredfold more than they do at present." There was, however, the "inconvenience" that "none of these projects" had yet come to fruition and "the whole country lies miserably waste." But "instead of being discouraged," people were "fifty times more violently bent upon prosecuting their schemes," which included "extracting sunbeams out of cucumbers."

At the Academy of Obama, professors and others devise plans for extracting a new and improved automobile industry from a semi-sort-of-bankruptcy arrangement that -- if it survives judicial scrutiny; that is not certain -- will give the United Auto Workers 39 percent of General Motors, with the government owning 50 percent. During future contract negotiations, will the union's adversary be an administration that the union helped to put in power?

The UAW will own 55 percent of Chrysler, so perhaps the union will sit on both sides of the table in negotiations. They should go smoothly, although the UAW may think it has made sufficient concessions, such as the one that says henceforth overtime pay will not begin until the worker has toiled 40 hours in a week.

Many months and many billions of dollars are being wasted by the administration's determination to spare the car companies, and especially the UAW, the rigors of a straightforward bankruptcy. The president's "surgical" bankruptcy plan for Chrysler requires some of the company's lenders, mostly non-banks, to receive less than they would as secured creditors under bankruptcy law.

The law may still make itself heard over the political thunder. Meanwhile, the president faults these "speculators" for not being as cooperative as are most of the banks that have lent to Chrysler. But the banks are compliant because they are mendicants: Having taken the government's money, they are the government's minions.

When the president was recently asked what had "humbled" him in office, he mentioned that "there are a lot of different power centers" in America, so, for example, "I can't just press a button and suddenly have the bankers do exactly what I want." Perhaps not a button, and not exactly what he wants, but in dealing with Detroit he pressed and they were accommodating.

It is Demagoguery 101 to identify an unpopular minority to blame for problems. The president has chosen to blame "speculators" -- a.k.a. investors; anyone who buys a share of a company's stock is speculating about the company's future -- for Chrysler's bankruptcy and the dubious legality of his proposal. Yet he simultaneously says he hopes that private investors will begin supplanting government as a source of capital for the companies. Breathes there an investor/speculator with such a stunted sense of risk that he or she would go into business with this capricious government?

Its chief executive says: "If the Japanese can design [an] affordable, well-designed hybrid, then, doggone it, the American people should be able to do the same." Yes they can -- if the American manufacturer can do what Toyota does with the Prius: Sell its hybrid without significant, if any, profit and sustain this practice, as Toyota does, by selling about twice as many of the gas-thirsty pickup trucks that the president thinks are destroying the planet.

Obama overflows with advice for Americans who he thinks need admonitions such as "wash your hands when you shake hands" and "cover your mouth when you cough." He also advises that this is a good time for Americans to put their hygienic hands on the steering wheel of a new car. He hopes buyers will choose American cars. A sensible person might add: Buyers should choose cars made by the Ford Motor Co.

This is so because Ford has, so far, avoided becoming an appendage of the government. And because the national interest will not be served by GM and Chrysler flourishing. It might cost taxpayers more in the short run, but in the long run it will be less costly for the country if the government finds its confident plunge into industrial policy so unpleasant that, sadder but wiser, the incumbent professors and others will flee from such adventures in extracting sunbeams from cucumbers.

Chrysler and the Absolute Priority Rule

The bankruptcy process is, from a procedural standpoint, solely a function of federal law. One aspect of the the federal bankruptcy law applicable to chapter 11 bankruptcies is the absolute priority rule, codified at 11 USC 1129(b)(2). Essentially, the absolute priority rule requires that secured creditors (loans made to company secured by assets of company) and senior unsecured creditors (unsecured lines of credit, trade claims, etc.) will be paid 100% of their claims before equity (company investors and management) receive anything. The article below questions whether the absolute priority rule should be applicable to the chapter 11 reorganization of Chrysler. tom Lauria, lawyer for secured and senior creditors of Chrysler is asserting that his clients must be paid in full before equity can receive anything, fully in accordance with the absolute priority rule. Judge Gonzalez, who oversaw the Enron and WorldCom bankruptcies, has developed a reputation as a debtor-friendly judge, meaning that in some cases, the rules (and creditors) be damned. While it perhaps morally pleasant that a judge would invoke equitable concerns (people will lose their jobs and retirements) over of the commandments of the law, such a tack provides no assurance that creditors who extend funds to a debtor under the premise that the creditors' rights will be protected by law. Moreover, one can easily presume the retirees of WorldCom and Enron would have liked a piece of their reorganized companies, instead of getting the jack squat they received. Where were you then, Judge Gonzalez?

"What's Good for Chrysler..."

By Harold Meyerson
www.washingtonpost.com
Wednesday, May 6, 2009


There's creative destruction -- economist Joseph Schumpeter's term for the normal churnings of capitalism -- and then there's destructive destruction. Anyone interested in the latter should pay close attention to the arguments being made in federal bankruptcy court by attorneys for the hedge funds that held out for more in the Chrysler bankruptcy deal.

Thomas Lauria, who represents those funds, argued Monday that the court should block the federal bridge loan that will keep Chrysler afloat during the bankruptcy proceedings. As Judge Arthur Gonzalez noted in denying Lauria's request, blocking the loan would force Chrysler (and, he could have added, many of its suppliers and dealers) to liquidate -- throwing tens (perhaps hundreds) of thousands of Americans out of work during the most serious recession since the 1930s and terminating medical benefits to tens of thousands of Chrysler retirees. Liquidation would also compel the American public to write off the loans the government has made to the company, rather than become shareholders in the slimmed-down Chrysler, as the Treasury's plan suggests.

But the public, the retirees, the dealers, the suppliers and the workers be damned. Liquidation is what the hedge funds want, on the theory that they could realize more than what the Treasury's plan offered them, from the sale of -- well, it's not clear what they think Chrysler can sell off at a decent price. Old auto factories in Michigan and Indiana? Who would buy them? To what end?

If the hedge funds are standing on principle, it's the principle that holders of secured debt should always have first claim to a bankrupt company's assets. But if they thought the administration would honor their claims above those of the public and other Chrysler stakeholders, they didn't do their due diligence about the Treasury officials who are in charge of restructuring the auto industry. In particular, they missed a 2006 speech delivered to a group of investors by Ron Bloom, the onetime investment banker who left Wall Street for the Steelworkers union, which he represented in scores of steel company restructurings, and whom President Obama tapped, along with Steve Rattner, to head up the administration's auto task force.

The banks and bondholders that lend companies money, Bloom said, constantly track the value of the bonds they hold, which enables "those who like the risk-reward ratio to take it and those who don't to liquidate their position and move on." Compare that, Bloom went on, to the position of retirees who deferred wage claims so that they could have a pension and medical benefits in retirement. If the company can't honor those claims, the retiree, unlike the bondholder, can't "take the company's promise, convert it to its present value and sell it to someone who would like to own it."

The Treasury's plan for Chrysler, and its proposed plan for General Motors, gives those retirees stock in the company -- the only way to keep afloat their otherwise unredeemable investment in Chrysler (that is, their medical benefits). It gives the public a stake in the company in return for its loans. It scraps the old management and board of directors, and downsizes the company to a point where the government believes it can become profitable again. It requires that 40 percent of Chrysler's production be performed in the United States -- a perfectly sensible, if groundbreaking, condition from a government that is committed to preserving and boosting domestic manufacturing.

In other words, the Treasury's approach to the auto industry is equitable, responsible to taxpayers and economically sensible. It is also, in almost every particular, the diametric opposite of its approach to the banks. In return for its major loans to floundering auto companies too big and strategic to be allowed to go under, the Treasury opted for a structured bankruptcy, converting its loans to shares, ousting top executives, shrinking the companies. In return for its mega-loans to floundering banks that were also too big and strategic to fail, the Treasury has not opted for structured bankruptcy, has not converted its loans into shares, has not forced out top executives, has not moved to make banks smaller (save in its proposal to limit leverage). Indeed, its bailout of AIG rewarded bondholders such as Goldman Sachs to the detriment of everyone else.

Why the difference? Why compel the restructuring of one crucial industry and leave another, whose mismanagement all but brought down the world economy, basically untouched? Could it be that the leaders and folkways of American banking are familiar to the men who run the Treasury, while the leaders and folkways of the American auto industry are not -- meaning that they can assess Detroit more dispassionately than they can Wall Street? In short, where is the Treasury's Ron Bloom for banking?

Cramdown Bill Defeated: Homeowners Crammed Down by Special Interests?

By Ryan Grim, Huffington Post (May 4, 2009)

The Senate on Thursday rejected an effort to stave off home foreclosures by a vote of 51 to 45. It was an overwhelming defeat, with the bill's backers falling 15 votes short -- a quarter of the Democratic caucus -- of the 60 needed to cut off debate and move to a final vote.

The death of the bankruptcy reform measure -- which would have allowed a small number of homeowners who met strict conditions to renegotiate mortgages under bankruptcy protection -- is a major tactical win for the banking industry. But allowing the foreclosure crisis to continue unabated may end up being a failed strategy for the financial sector. It wasn't easy for Majority Whip Dick Durbin (D-Ill.), who led the effort on behalf of homeowners, to wrangle the 45 votes.

Sen. Evan Bayh (D-Ind.), who had been on the fence for weeks, gave Durbin his support and nudged him on the way out of the chamber, alerting him of the anti-bank position he'd just taken.

Sen. Mark Warner of Virginia, a conservative Democrat, also cast a courageous vote in favor of the measure. He gave Durbin a hard slap on the arm on the way out. Sen. Barbara Boxer (D-Calif.), a strong backer of the bill, spent a good deal of time trying to persuade his colleague Jim Webb (D-Va.). As she got close to convincing him, she called in Durbin. "Hey Durbs," she could be heard saying, "help me with Jim." Durbin and Webb spoke for several minutes and Webb cast an aye vote.

Sen. Claire McCaskill (D-Mo.), meanwhile, spent much of the vote checking the tally. Toward the end of the vote, she cast her lot with homeowners. Sen. Ted Kaufman, a Democrat from Delaware, a state nearly wholly-owned by the financial industry, voted his conscience, opposing the banks. He is not running for reelection. "I'm liberated from fundraising," said Kaufman afterwords. His Delaware colleague, Democrat Tom Carper, voted with the banks.

The Chamber of Commerce has deemed the vote a crucial one that will be heavily counted in its annual scorecard, and those who voted yes will pay a financial price from the Chamber and the banking industry. Other Democrats stuck with the banks against the homeowners. Sen. Robert Byrd (D-W.Va.) was wheeled into the chamber and pointed his finger in the air, signaling a yes vote, then dramatically swung it down, as if taunting the backers of the bill. Sens. Jon Tester (Mont.), Mary Landrieu (La.) and Ben Nelson (Neb.) all voted with the banks, as they told the Huffington Post they would. Sen. Blanche Lincoln (D-Ark.) voted no, as did the new Democratic Sen. Arlen Specter of Pennsylvania. Sen. Michael Bennett (D-Colo.), Sen. Tim Johnson (D-S.D.) and Max Baucus (D-Mont.) voted no as well.

Earlier this week, Durbin concluded that banks that "frankly own the place."

How much did the Senate go for? The banking and real estate industry has funneled roughly $2,000,000 into Landrieu's campaign coffers over her 12-year career, according to data from the Center for Responsive Politics. The financial sector is Nelson's biggest backer; he's taken $1.4 million from banks and real estate interests and another $1.2 million from insurance firms. Tester has fielded roughly half a million in his two years in office. Lincoln has taken $1.3 million from banking and real estate interests. Carper has raked in more than $1.5 million. Baucus, chair of the finance committee, has been on the receiving end of $3.5 million over his career. Specter has hauled in more than $4.5 million and Johnson has gotten some $2.5 million.

Across the United States, the measure is estimated to have been able to prevent 1.69 million foreclosures and preserve $300 billion in home equity. Durbin is deeply unhappy with his Democratic colleagues that sided with the banks. "Frankly, I can't match what the bankers are doing in terms of lobbying," he said. Asked by the Huffington Post how bank influence could ever be reduced, he said, "When the voters speak, some elected officials listen. So I hope that, if we fail on mortgage foreclosure and we fail on credit card reform, I hope that people in this country will stand up and say to Congress, 'You've got the wrong friends.'"

After the vote, Durbin said he was surprised to lose so many Democrats. "I had hoped for a better vote. I mean, really, to lose 11 Democrats was disappointing, but, you know, I guess I've gained some ground since the issue last came up. Maybe if the mortgage foreclosures go up dramatically and I call it again next year I can pass it," Durbin told the Huffington Post. (In April 2008, a similar bill received 36 votes.) Reminded of his comment earlier in the day that if the bill failed, he hoped the American people would respond, he didn't back down even though so many in his own party strayed. "I hope they get the message," he said of his wayward colleagues. "Maybe they have an answer to this problem, but I have seen it."

Carper, however, the no vote from Delaware, said the issue was finished in the Senate. "My guess is we're not going to see it again," he said. Earlier this week, Durbin took to the Senate floor to tell his colleagues that the upcoming vote was a test. "Who's going to win this debate? The mortgage bankers and the American Bankers Association or the consumers across this country?" he asked.

We now have the answer. "We led the way on this and we are clearly responsible for defeating this for the third time in the last year," David Kittle, chairman of the Mortgage Bankers Association, told our friends at the American News Project in this must-watch video: