Populist movements don't build themselves ...

... It doesn't matter what the "horse race" outcome of the campaign is, if we fight the campaign. Fighting it, we learn how to fight. Learning how to fight political battles, we become citizens again. Becoming citizens again, we reclaim the Republic that lies dormant beneath the bread and circuses of modern American society.

Friday, November 21, 2008

A New Deal With the Big Three

Burning the Midnight Oil for Real World Economics

A while ago, as an off-shoot of the Beauty Platform, I set out a Beautiful Bail-Out plan.

Two key parts were: 50:50 on money going to help regular home buyers to extricate themselves from the mortgage meltdown, and on bailing out the finance sector from the mess they got themselves into ...

... and having the finance sector bail out consisting of both unloading dubious assets and issue of Senior Preferred shares with heavy strings attached.

Now, the Administration did not, in fact, listen to me, but when Senator Dodd was complaining about what banks had done with their bail out money, waddya know ... I got a perfect three out of three on what strings needed to be attached to the money:
  • Limits on Mergers and Acquisition
  • No payments of any other dividends
  • Limits on Executive Compensation

... until the Senior Preferred Dividend had been paid for four quarters straight ... and kicking back in if the firm in the future ran into problems meeting the Senior Preferred Dividend.

But ... does the Beautiful Bail Out model extend to the Big Three?

Gosh, if my answer was no, this would be an awfully short essay, wouldn't it?

Why Strike A Deal Anyway

There are four Real World Economics reasons to strike a deal.

(1) The first is that a bankruptcy in the middle of a credit crisis is not the same as a bankruptcy in more normal times. Bankruptcy protection that allows an insolvent firm to continue operating. It can even allow the bankrupt firm to ensure that credit advanced after the bankruptcy moves to the head of the line in case things fall apart.

But in the current state of the finance sector, there is no guarantee that it will be possible for GM or Ford or Chrysler to obtain the funding they need to continue operating while restructuring their debt.

(2) Why are there so many arguing in favor of bankruptcy anyway? Well, going by the record of multiple airline bankruptcies, they are hoping to break the UAW. That is why "let them go bankrupt and then sort it out" is married with "its all the Unions Fault for winning decent pay for their membership".

Except, of course, if it was up to the UAW, the Big Three would not have conceded small cars to overseas competition. The small car sector was conceded precisely because the operating profit margin per car was so low. So the industry downsized, chasing higher operating profit margins per car. But downsizing means that benefits to retired workers are a big burden on each car sold, in large part because the Big Three decided to sell fewer, and on average bigger, cars and cars-classified-as-trucks.

And where did all those benefits come from in the first place? Its not like the UAW dictated the terms ... those came from negotiated contracts, and the terms we heavy in benefits rather than up front pay precisely because the management of the Big Three thought that was the best deal for the upper management.

And the reasoning is straightforward ... there is an overtime penalty in place in the US, to encourage employers to share work around during an upturn, spreading work experience around the population and adding new rungs on the ladder of opportunity. However, the overtime penalty is on the hourly wage. If only 2/3 of the full-time, 40 hours per week pay is in the wage rate, and 1/3 is in the benefits, then an hour of overtime costs exactly the same as an hour of regular time, and the company can duck out on its responsibility to spread the work around during periods of strong demand.

Of course, GM, Ford and Chrysler, when they signed those contracts, did not look decades ahead to worry about the downside ... they are not companies that look decades ahead. But its management that pushed deals toward a heavy dose of benefits ... and Republicans in Congress are now using those deals to blame the Unions for the decisions of management.

(3) Then there's the employment impact. I'm going to repeat it, since it seems like many of the opponents of a bail-out have missed the point, but the Panic of 2008 was the most serious since the Panic of 1929. And now we are sliding into a steep and globalized recession. Even if $25b just pushed the collapse off for a while, turning it into a slow motion process spread over three or four years rather than a sudden jolt, it would be well worth it. Being generically Pro allowing the Big Three to collapse is, in other words, a quite different thing than allowing the Big Three to collapse now.

(4) Finally ... there is the opportunity. While the Big Three have been roadblocks in the way of development of a sustainable, energy independent economy, they also collect together substantial development and production capacity that can be used to promote development of a sustainable, energy independent economy.

This financial crisis in the ownership of these capabilities offers us the opportunity to put hooks in to ReOrient from the past to the future. However, this is a process that will take time ... it would normally take five years to see serious results, and ten years to complete the process.

If we allow the Big Three to collapse now, we squander that opportunity.

And now, the New Deal...

I'll start from the "bail out" side and then move up.

Strings Number One and Two: Limits on Mergers & Acquisitions and on Dividends

This is a one-way limit ... that is, any of the Big Three will be free to sell any operation outside the ones that the bail-out are in fact trying to avoid going belly-up in the middle of a recession and financial crisis ... that is, US based design and production of automobiles and components in particular, and transportation stock in general.

But with the Senior Preferred Shares comes a veto over any Merger or Acquisition activity. And don't be distracted by the argument that the auto companies are not in a position to get involved in M&A activity now ... if the bail-out succeeds, then they will be in a better position in the future. But their shareholders will not get the freedom to play any M&A games without getting the OK from the Senior Preferred shareholder.

The limit on Dividend payments is additional insurance that the corporation will attempt to pay the Senior Preferred dividend if they possibly can ... because dividends will not be able to be paid to common shareholders until the Senior Preferred dividend has been met for four consecutive quarters, and common share dividends will be turned off again if the company cannot meet the Senior Preferred dividend.

String Number Three: Executive Compensation

This is in two parts. Direct executive compensation is limited to 10 times median individual income, and the only deferred executive compensation allowed are stock options maturing five years or more in the future.

And, yes, that direct executive compensation includes personal corporate jets.

This will lead to some of these CEO's quitting. Big fat hairy deal. A situation with the CEO and President making something no much more than the Senior Vice Presidents ... and only becoming filthy rich if they succeed in restoring the business to health, allowing them to cash in on long term stock options ... the executives that are willing to make that deal are the ones we want running the company anyway.

De-leveraging the Big Three

Of course, just a cash infusion and nothing more does not necessarily solve the problem. So just like the proposed financial sector bail-out, the package ties the equity infusion with a restoration of the financial health of the balance sheet.

For the finance sector, the problem was on the assets side ... financial instruments created with fictitious ratings supporting the pretense that they were high grade, high return assets, when in reality they were a pile of high return chicken shit grade assets.

The problem for the auto company is on the liability side. And the Hooverites in Congress (oddly enough, still representing a big wing of the House Republicans) are all over this ... they want a bankruptcy in order to break obligations to the UAW membership working for the Big Three. After decades of give backs and concessions on the basis of the firm's increasingly desperate financial shape, the last step is to stick a knife in the UAW and get rid of them.

What a surprise. I am shocked, shocked, that there is gambling going on in my cas... err, that Reagan Republicans would seize on any excuse to engage in union busting.

But House Republicans are not the majority, so screw them. With Begich, Senate Democrats are at 56, Bernie Sanders makes 57, and Lieberman will likely be laying in wait for a more opportune time to screw the administration ... and on his past record, is likely to do that on foreign policy in any event.

Voinovich cannot afford to vote against whatever bail-out comes out of the House, so there is only one more vote to break a fillibuster, and both Lugar and Spectre are from states with a direct stake in the Big Three not going belly up. Indeed, if the Minnesota recount goes against Colman, we are almost certainly there.

So strike a harder deal than that. For each $1 in equity stake, the auto company issues a warrant to convert $1 in corporate bonds to newly issued common stock. The Treasury buys those bonds, exercises the warrants, and puts the common stock in trust. The votes of the common stock trust are exercised by a trust board consisting of three members elected by the employees of the auto-maker, three members selected by Congress, and a chairman selected by majority vote of the balance of the board.

Note that these are US employees ... if other companies want to bail out a member of the Big Three in return for an equity stake and a big voting block voice at the Annual General Meeting for the employees from their countries, they can go right ahead.

All Done!

OK, I am sure it won't by unanimous, but I think its beautiful.

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