News, Views and Analysis

Chrysler, GM and the New Industrial Policy
May 14, 2009

text-to-speech MP3 audio version.

"While President Hoover had some understanding of the political implication of the crisis, he lacked any clear comprehension of the economic realities that underlay it. He accepted the views of most monopolists and of the conservative economists who advised them. He had been completely seduced by the prosperity myth; as a result, he thought at first that the stock market crash was an isolated event indicating nothing more than the correction of the worst abuses encouraged by him and perpetuated by the speculative fraternity. When shortly his initial appraisal proved incorrect, Hoover could not understand why such an outwardly powerful economic system as this country boasted could not without great difficulty pull itself out of the doldrums. He failed to grasp the paradox that it was the display of economic power that denoted the most severe contradictions. The strategy he adopted was the strategy pursued before in dealing with the cyclical crisis - let the disaster rack the country, purge it, and wear itself out." Bruce Minton & John Stewart The Fat Years and the Lean International Publishers (1940) First we have to note the passing of two great Americans: Former Congressman Jack Kemp (R-NY) and former FDIC Chairman Bill Seidman. Both of these men believed in the power of free people and free markets, qualities sorely lacking in our current leaders. Their clear vision will be missed as we grapple with the challenges in the financial markets. The response to our release of the preliminary Q1 2009 results for the IRA Bank Stress Index has been excellent. We appreciate the user feedback and the media attention. Bottom line is that the jump in the Stress Index, from 1.8 at year-end 2008 to 5.7 at the end of Q1, suggests a year-end 2009 loss rate peak for commercial and residential exposures. Click here to learn more. To us, the use of the enhanced FDIC data distribution technology illustrates how better public access to financial disclosure and automated distillation can improve timeliness and relevance, thereby encourage debate and dialog among and between analysts, and in turn drive better asset allocation choices by investors. Our census of the US banking industry also shows that, more often than not, politicians prevaricate when speaking about the soundness of large financial institutions - who are their clients, after all. In the most recent comment in IRA's Advisory Service, we talk about bank valuation in the age of "Industrial Policy" reborn, reflecting the clear shift away from the interests of private investors visible in the White House's handling of the Chrysler bankruptcy and in prospect with the impending failure of General Motors (NYSE:GM) and GMAC. In the cases of both companies, several sources tell the IRA, Obama Administration officials have threatened professional advisers with various official sanctions if they do not go along with the new political agenda of giving control of GM and Chrysler to the UAW. The unions have taken a disproportionate share of the economic output from the Big Three automakers for decades, measured by

salary and benefits, but now Washington will give the UAW the rest, leaving creditors disenfranchised by the arbitrary action of the Executive Branch? While some people within the Obama Administration may think that threatening investors and violating their legal rights is a good way to conduct public policy, to us this puts the US in the same column as outlaw states like Venezuela and Russia, where investors and property owners have no rights. Will Secretary Geithner next be taking the example of Hugo Chavez in Venezuela and announce the expropriation of private property owned by speculators? We applaud the Obama Administration for forcing the issue with respect to both GM and Chrysler, two festering situations that are overripe, but due process must be observed or the restructuring process is invalid. Get the bondholders to convert to equity voluntarily and give them an equal share of the residue of the estate, then the restructuring has the broadest possible support and is consistent with the rule of law. More, can you talk to us about the rationale for saving Chrysler with North American sales at 10-12 million units in 2010? Even without the crisis, Chrysler was redundant and now that demand has fallen with the recession of available credit, a bailout of Chrysler seems a losing proposition for the taxpayer but a win for incumbent politicians. What about the shareholders and creditors of Ford (NYSE:F), who now face competition with two auto GSEs controlled by Barack Obama and the UAW? To us, the Chrysler and GM bailouts look a lot like a play by the Obama Administration to begin assembling a portfolio of state-owned industries a la Italy in the 1920s. Thus the FiatChrysler connection is most appropriate. Remember, GM parts maker Delphi is still sitting in bankruptcy and shows no signs of emerging. Once GM and GMAC are before the bankruptcy court, the US and the UAW will control all three entities. Bankruptcy judges rarely force liquidations, thus bankruptcy for Chrysler, GM and GMAC serves the interests of Obama and the Democrats very nicely. To have millions of captive supporters among the employees and suppliers of GM and Chrysler going into the 2010 and 2012 elections is not a bad thing, a least using the logic of Washington. Wonder if and when the Big Media will figure this out. Now you also know at least one reason why the four or so large zombie regional banks in the Midwest have not been resolved by the FDIC. Whether you talk about insolvent banks or automakers, the decisions made in Washington are increasingly political and accordingly, unlikely to be enduring or positive for the economy. Indeed, the growing sovereign risk evidenced by Washington's increasingly lawless behavior is becoming "Topic A" for large investors. It is most striking to us that in conversations we have with clients, the advisability in political terms of doing business with the government of the United States is raised as a significant negative factor. These comments arose several times in the past month when evaluating some of the asset and loan purchase proposals floated by the US Treasury to help address the problem of toxic assets. It will be interesting to see if any of the financial professionals who represent the bond holders of GM and GMAC will be willing to go to war against the US Government, for example via an adversarial litigation in bankruptcy, as and when they are asked to violate their fiduciary duty to clients in a GM bankruptcy. Apparently that threat was quashed in the Chrysler bankruptcy. Remember, we figure that GMAC, the bank holding company whose FDIC-insured bank unit we rate an "F" as of Q1 2009, will need $10 billion per quarter in subsidies just to keep the doors open. The preliminary score for GMAC Bank calculated by The IRA Bank Monitor was 21.2, more than a full order of magnitude above the industry average Stress Index score of 5.7 for Q1 2009. And the erstwhile regulator of GMAC, the Fed, may be providing the subsidies to keep the BHC open! Can the Congress look at the conflict illustrated by the Fed's role in the GMAC nationalization and

decide to give the agency more powers? Oh, and come to think of it, when do the "unusual and exigent" circumstances that currently authorize trillions of dollars in Fed loans under Section 13(3) of the Federal Reserve Act end? If the Fed and Treasury have in fact stabilized the banks by making of them government-sponsored entities or GSEs, is the emergency not over? Should Congress require the Fed to start unwinding its loans and investment portfolio? That ends the need for the Fed to employ private managers to maintain these assets, BTW. Some of the same big Buy Side managers currently helping the Fed with its floating toxic waste dump you know the names - apparently also have been told by the same Obama Administration officials that they will lose lucrative contracts to manage assets for the Fed and Treasury should they rock the boat on Chrysler and GM. There is a growing list of firms that would like to bid for projects like managing the Maiden Lane toxic waste repository, for example, giving a threat from Treasury to take the ball away added weight. And speaking of Maiden Lane, this gem comes from a long-time reader of The IRA: "I started at [Goldman Sachs (NYSE:GS)] in 1977....the first "hedge fund" we set in 1983 or so was called Maiden Lane, LLC. and I invested in it. It subsequently blew up and converted most of its holdings into "GIC's" which we had to hold out to for six years longer than planned. Just thought it was interesting that Paulson was silly enough to use the same name.......dead giveaway!" Maiden Lane, of course, is the street in lower Manhattan on the north side of the Federal Reserve Bank of New York that meets Liberty Street on the bank's Eastern side. As promised, we have a very interesting interview in production talking about the financial situation in German and how the political class in that country are ignoring the toxic asset problem, much like the response of the Obama Administration to the festering situation in the market for non-bank finance that we illustrated last week ("Mortgage Duration Risk: The Banks Are No Longer the Problem", May 8, 2009). Could Barack Obama be walking in the footsteps of Herbert Hoover? We also have a project in the works regarding the "reform" proposals for OTC derivatives, including credit default swaps ("CDS") and the like. You'll notice today the Big Media trumpet the bold new regulatory initiative from the Obama Treasury regarding OTC derivatives. In fact, the proposal that Treasury has just floated could have been done years ago, but the Fed and the dealers have managed to delay until now. And naturally the OTC dealers and the DTCC will still control the data and all of the related infrastructure. More in this space on the true reform agenda for OTC derivatives of JPMorganChase (NYSE:JPM), GS and the other big OTC dealers in a future issue of The IRA - if the draft we have in front of several Big Media outlets is not accepted. Suffice to say that 90% of what you hear coming from Washington on OTC derivatives is either outright propaganda from the large OTC dealers or spun to suit the needs of the captive regulators and their political sponsors. In the language of Washington, reform is equal to the status quo, transparency is the managed reality of a dealer-owned marketplace, and regulation is merely the Treasury and White House running interference for the industry on Capitol Hill. In order to better understand the reform proposals for CDS and related markets for complex structured assets such as collateralized debt obligations, the DC chapter of Professional Risk Managers International Association is holding a discussion on June 10, 2009 in Washington entitled "Regulation of Credit Default Swaps & Collateralized Debt Obligations." PRMIA's DC chapter has assembled a very strong panel of industry practitioners and researchers to discuss the proposals from the Treasury, the Fed and the industry to regulate the OTC CDS and CDO markets. For more information or to register, please click here. A working group on CDS and CDO reform is also in formation to follow these issues on an ongoing basis.

Remember that membership in PRMIA is free and is a great way to keep abreast of current issues in the financial markets and take advantage of PRMIA's excellent education and training activities. Questions? Comments? About IRA Products and Services IRA offers advanced analytics for risk surveillance and investment research via subscription products such as the IRA Bank Monitor for Professionals covering the US banking industry and the IRA Corporate Monitor covering public companies. For a trial subscription or an on-line demonstration, please register here. IRA Advisory Services including our channel research and diligence support services are available to qualified clients. For more information, please contact our offices. IRA for Consumers IRA provides consumers easy to buy online reports to independently check on their banks via our How's My Bank? system. IRA on Web 2.0 For updates during the week please follow IRA

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