The (Really Long) Road to Perdition

This past week presented more signs that, at least with respect to common stocks, the great liquidation sale of 2008 is winding down. Knock on wood, but since December 2 (the day after that precipitous end to the prior week’s holiday-muddled rally), the volatility isn’t what it used to be. “18% either way in three or so days” so typical since mid September seems to be over, and really outsized moves by individual stocks (like 25%+ in a day) are quite predominately to the upside.

What was really striking about the week is the reaction to the unremitting stream of lousy news. The geniuses at the news wires and the chronically-insecure-about-their-future in the business sell-side analysts keep shoveling out the despair, but the Market is having none of it. Tech is up nicely in the face of all kinds of news about inventory glut and reduced guidance. Friday morning was especially instructive in this respect. We were greeted not only with the usual litany of lay-offs and the prospect of Chicagoland scandal sapping the effectiveness of the new Administration before it even gets started, but two hammer blows of uncertainty. Once again, but on an apparently unprecedented scale, a number of wealthy individuals learned in an up close and personal sort of way that if an investment advisor’s returns seem too good to be true, they are probably aren’t. And the futures market flinched mightily at the inability of the US Senate and the United Auto Workers to come to terms. These developments probably account for why the Market seemed to have a relapse on Thursday afternoon. But after a familiar gap down opening on Friday, it quickly found its feet again, and with Tech leading the way (despite a peculiar funk creeping into MSFT) moved nicely higher for the day.

One hopes that the number of families who entrusted all or even most of their savings to an apparent Ponzi schemer operating under the halo of Wall Street respectability is only a fraction of the apparent total. There is tragedy in this that is not to be made light of, widows and orphans suddenly rendered into poor widows and orphans. That said, this unfortunate episode does illustrate the limitations of applying the “wealth effect” to economic prognostication. I am big believer that perceived changes household wealth will affect consumer behavior above and beyond changes induced by changes in income. As with any principle, though, it is easy to stretch it beyond usefulness and unto distortion. Many, if not most households in the US are more affected by things like fuel prices than by the value of real estate or stocks. To the extent wealth destruction affects them, it is income related, the loss of employment as more affluent (though less affluent than they used to be!) households opt to take back tasks they used to outsource (lawn care, child care, food preparation, auto detailing, etc.) This is not to say that there are not tens of millions of households cutting back their expenditures because their declining home equity and/or 401 makes them feel poorer, but that there are tens of millions more for whom asset bubbles are a spectator sport probably not worthy of their attention. But what about that million or so households that make up the “upper crust”, the sort of folks who get invited into a deal like this Wall Street luminary apparently offered? If someone had $10MM and it all got lost in a “by invitation only” Ponzi scheme, their spending behavior would certainly change. But what if only half of their $10MM was in the scheme, would they really start living all that differently? Eating any less? Taking the bus? One supposes that there might be a few putative heirs reconsidering early retirement (or considering the possibility of a J-O-B in a whole different light) but as far as moving the needle on what shows up in the accounts of economic activity, it doesn’t seem likely that the instantaneous immolation of several $B in savings of this sort will be a system-rocking event. We hear a lot about wealth effects, and these effects are real, but to the extent that the changes in wealth are concentrated in relatively few (out of 100MM+) households, they are likely to be over estimated, both on the way up and when the “wealth” is finding its way back into the “thin air” from whence it came.

The stand-off over life support for the US auto industry brought to mind that this “day of reckoning” has been a very long time coming. Much of what is going on here is so wrapped up in posturing and politics that it is not worth commenting on. I remember some 35 years ago, when cars and the inconvenient reality of having to go to work were very much on my mind. OPEC was just starting to reorder a few economic assumptions, and the Japanese were showing up with little Hondas, Toyotas and Datsuns that ran like tanks and didn’t need much gas. They were leveraging their success with reasonably priced “rice rocket” motorcycles (ad jingle c. 1968 “..and the world’s biggest seller is priced about two-fifteen. And don’t you know, you meet the nicest people on a Honda!”) There weren’t a whole lot of jobs around, but some of the best paying and least demanding jobs were in unionized industries. Trouble was, you had to know someone in the union. Everyone who gave it a minute’s thought understood that the US automakers had inherited a strong position, but were saddled with higher cost labor and structural inefficiencies imposed by union work rules. As the Seventies wore on, there was much anxiety about whether Detroit could compete with the Japanese. So point #1, this crisis that dominated the week’s headlines did not exactly sneak up on us. Even a callow youth could see way back then that if there was anything at all to the notion of a more global economy, it was only a matter of time before the Detroit model would take its place in the proverbial ashcan of history.

That said, it’s not like Detroit and the UAW sat and did nothing and hoped things would get better. The industry certainly came up with a number of compelling products along the way, and the quality gap (as one recollects, say, Ford Pinto versus Toyota Corolla) has been relegated to the realm of the subjective, if it exists at all. Whatever blame might be heaped on senior management has to reckon with the fact that two of the Big Three have CEOs who only very recently came to the auto industry. (I got to know Alan Mulally when he was at Boeing, and if anyone can fix Ford, it’s him.) I think what has happened is that a long time ago union leadership defined its mission as being a “prudent parasite”, extracting as much nourishment from the host as it can without actually killing it, exercising just enough restraint and cooperation so that, hopefully, it lives until “after we’re gone”. Up until very recently, they were doing a good job at this. Those fellows who graduated high school (sans academic effort, as “the job” was waiting for them) and started at Ford or GM at about the time I was trying to decide on a major and Honda Civics were starting to roll off of ships are probably retired by now (if their lifestyle choices haven’t put them in the grave). If it was all just a delaying action, give them high marks.

As I look at the global auto industry, there is no reason there could not be a couple of successful US based companies producing lots of vehicles close to their markets, which would include right here in the US. I believe the problem can be boiled down to unwillingness on the part of union and political leaders to recognize the “understanding” between capital and labor has one foot rooted in a bygone era. That era was Pax Americana. Like much of American industry, the auto industry of sixty years ago found itself astride a world still smoldering from world war. The US industrial heartland was about the only place on earth that had not been bombed halfway to the Stone Age (or never got more than about halfway out of the Stone Age). Given the rising economic tide and dearth of competition, it was not irrational for management to share the fruits of prosperity with all of the stakeholders. Trouble is, as the decades slip by, things change. This was apparent only thirty years along, when Japanese imports meant little cars made far away. It started getting obvious when Chrysler had its near death experience. In the mean time, other industries either disappeared from the US or evolved away from what only made sense before Pax Americana gave way to globalization. And one of the most salient aspects of this evolution was around post retirement benefits, especially medical. Not every industry, and certainly not the municipalities and such that have the rate payers by the collective short hairs, but by and large, survival has dictated that very deliberate steps be taken to limit or eliminate this seemingly bottomless source of liability.

I am a bit concerned that what is really going on with the high drama of “saving Detroit” is that you could fix the whole thing, for another business cycle or two anyway, if you could make the retiree health care liability “go away”. Actually, I suspect that if you could rationalize some work rules, ditto the dealer networks and “contain” the retiree obligations, and not muck it up with overly ambitious mandates a la solar powered cars, you could probably end up with a couple of reasonably profitable entities. These are big, no, make that humongous, “ifs”. The mischief afoot is that this dire situation de jour is “Exhibit A” as to “why health care needs to start being handed over to the government”. We can argue it to death, like we have with human caused global warming, but if we take action in the form of a government program that would make “break the log jam” and allow the auto industry to recover, then our stocks will start to go up again and everything will be alright. Like the man said, “Never let a crisis go to waste”. How this plays out over the next couple of months will have much to say about the ever evolving relationship between the government and the governed.