Bailout 8: Who Needs a Pay Cut?

In discussions of General Motors, Ford, and Chrysler during recent days, many people have sought to name the problem that has brought these automakers into such serious difficulties. Of course, the precipitating events have to do with the decline of wealth among U. S. car buyers because of the drop in home values after the housing bubble deflated. The general economic crisis that includes layoffs and fear of layoffs also led to an unprecedented drop in auto sales.

These immediate and serious causes are part of the picture, but there are other reasons. Many people believe that the next credit crisis will come in consumer debt. People have been living as if they can buy more and more things they can't afford, and lending institutions have allowed it. This is again related to the housing price bubble. If consumer debt got too large, the paper wealth of the ever increasing real estate market was the counterbalance. People could refinance consumer debt with home equity loans. So as credit card debt gets tight, people can't or won't buy a car.

Other people address the environmental and energy-efficiency issues in relation to the Big Three automakers. These companies resisted alternative energy sources, even killing previous progress on electric vehicles. They resisted fuel efficiency standards and majored on building larger gas-guzzler vehicles. Unlike some other automakers, they did not keep up the pace of developing new and better technology for automobiles. They failed to adopt a business model by which they could make strong profits from selling smaller, more efficient cars. When the volatility of gasoline prices struck, driving transportation costs higher and higher, they found themselves stuck with large numbers of vehicles that people were less and less interested in owning.

Among many other reasons given, some people have blamed the automakers' problems on unionized workers. Certainly the benefit plans and retirement plans for these workers are expensive. But most of the attacks on the union workers' wages hid or ignored important facts.

For instance, the highest paid auto workers in the U. S. last year worked for Toyota building Camrys, not for GM. The worker pay differential between companies selling cars in the U. S. is changing. That does not, however, mean that all non-union auto factories in the U. S. are paying comparable wages. It does mean that it is possible to pay high wages, comparable to or greater than the union wages paid to GM workers, and make great profits.

Second, it targets union workers and not other potential candidates for pay cuts in the industry. Who else is getting good pay in the auto industry? Why not cut their pay? As Congressional questioners wondered, why not cut corporate jets for the executives?

Dean Baker makes this point well when he addresses the case of Robert Rubin, an economist who is having a great deal of opportunity to speak about how to solve the current economic crisis. Rubin worked in the Clinton administration, and his allies are being named as Obama advisers. But in January of this year, he said that the economy's struggles would not lead to any serious problems, and certainly no economic meltdown.

Baker points out that Rubin was interim CEO of Citigroup, and that he remains an executive and a director of the corporation that the government bailed out again over the weekend. He was part of the leadership who oversaw the bad loans and the risks of an inflated housing market. Even farther back, he was a central figure in U. S. economic institutions during the dot.com bubble that led to the last recession. Baker asks why with all the hoopla about GM autoworker wages, no one is asking whether Robert Rubin will be taking a pay cut. Who needs a pay cut when corporations are struggling? Why not the executives who helped lead the corporation into their crises?

Bailout 2: Bailout or Feeding Frenzy?

Bailout or feeding frenzy?

The failure to pass today's bill promising a solution to the credit crisis should not be a big surprise. Numerous members of Congress were reporting contacts from constituents opposing the Bush/Paulson plan at ratios between 100/1 and 1000/1. This weekend's Citigroup acquisition of Wachovia Bank should give us a clue into the anger and opposition of the populace. Citigroup swooped in and acquired an enormous range of financial resources at fire sale prices. This is exactly the kind of profiteering, even racketeering, that the average person suspects is going to happen.

Citigroup, it is said, has tried without success to build a consumer banking business for many years. Raking in money in other ways, they were among the financial institutions not overwhelmed by the mortgage crisis. (What happens when this morphs into a consumer credit card debt crisis, is yet to be seen.) Bad decisions by First Union, which renamed itself Wachovia when it acquired the previously well-managed bank, included buying the mortgage company which specialized in one of the now-despised mortage innovations, option adjustible-rate mortgages. These are the ones that let the borrower take the option of not making a payment now and then (and adding it on the end of the loan period). Now they own too many bad mortgages.

The strange thing about this crisis of "securitized" mortgages is that they are really worth much more than the market is saying. Around 2.5% of mortgages are in foreclosure. Many of those have been processed into interest-bearing securities, or bonds. So on average, it might be that the value of such a bond, in real terms of how much it would pay out, may have dropped to around 97.5 cents on a dollar. But let's estimate that the mortgage bonds are worse off than that because they are encumbered by additional mortgages which are not yet in foreclosure, but in danger. And let's say that these securitized mortgages have a larger share of the bad mortgages from the recent frenzy of bad financing than the 2.5% rate would indicate. So maybe these interest-bearing bonds may pay out 90 to 95% of their face value. Maybe a few would be even lower, or much lower. But that would not cause such a crash. What causes the crash is that since no one wants to buy these securities, their price drops way below their adjusted value. Then the holders may find themselves with a cash-flow problem. They need to sell some securities, but they can't get a buyer at a fair price. When this infects the whole market, the financial institutions start to treat these securities as if they are worth almost nothing. As a side effect, a powerful and wealthy institution like Wachovia finds its stock dropping to pennies. But buying them at a low price is a great idea if you don't have to worry about cash flow. The government has time to see them pay off, and maybe at a good profit.

In walks Citigroup, with the help of the FDIC, to pay a measly $1 per share to buy one of the largest banks in the world with assets galore. Buying at a fire sale lets them reap a huge reward. Just like Bank of America bought Countrywide and Merrill Lynch. Just like J. P. Morgan Chase bought Washington Mutual. After all this hoop and holler about a financial crisis, the US is left with three financial giants who have an even greater ability to dominate the financial business and exercise a joint monopoly over setting interest rates and fees.

This so-called bailout had nothing to say about the concentrated power of wealth in the hands of the few. And its fatal flaw was that it did nothing to help the other people caught in the mess of bad mortgages. The bailout plan had no provisions to help refinance mortgages for common people, homeowners who are facing foreclosure in a weak economy. It was suggested that by buying these mortgage-based securities, the government would be able to refinance mortgages for homeowners. But owning the security is not the same as owning the actual mortgage. These remain in the hands of banks, savings and loans, and other mortgage institutions all over the place. This plan does not offer any relief to them. It offers relief to large financial instutitions who have questionable securities.

So an additional provision to assist homeowners might have been enough to win a few more votes. The provision to deny "golden parachutes" are a gesture toward the common borrower, but not much more than that. Real help to homeowners is what was needed. The long and heated meetings about bailing out the economy could not muster the compassion and courage to do what was right. The proposal allows the same feeding frenzy to go on. As one commentator said today (I can't remember who), the homeowners who endure foreclosure faces the greatest crisis. They can't go back to their neighborhoods. They lose the bedrooms and kitchens where they lived. They no longer live where their ball teams or other social connections had been built up.

The Neighborhood Assistance Corporation of America released the following comments:

There is one reason for the financial crisis – Foreclosures.
There is only one solution – Restructure mortgages to make them affordable.
Who would benefit – Everyone.

This seems to me to sum up the shortcomings of the proposed bailout.

Thanks to reports on NPR's Morning Addition, AP news reporting by Sara Lepro, and the insights of my friend Steve Bumgardner for helping me think abou this issue. Any erroneous reporting and reasoning is mine.