HS Dent | Is Nothing Sacred?

Is Nothing Sacred?

By Charles Sizemore⋅ May 8, 2009 ⋅ ⋅ Post a comment

The Big 3 automakers have long been viewed as “sacred cows.” Their storied histories as icons of American industry, their political connections, and the shear amount of unionized labor their employ make them all but untouchable. This has become painfully obvious to General Motors and Chrysler lenders and investors in recent weeks. The government prescribed “cure” for these two companies is almost certainly worse that the disease because in the process the government is damaging investor confidence in contract law and property rights–the fundamental building blocks of the capitalist system itself.

This is not merely fretting and hand-wringing. A market-based system is based on confidence. Consider the US dollar: you are willing to accept it as currency because you are confident that it is also be accepted elsewhere. When you attempt to spend that dollar later, you will not be told “your money is no good here.”

The same is true of the lending markets. Banks and bondholders lend money because they are confident that they will be paid back. While the character of the borrower is certainly a point of consideration, covenants and collateral are also of paramount importance in protecting creditor property rights. (Along with cash flow, these four criteria make up the “Four C’s of credit analysis learned by every junior banker.) But today, we see covenants broken and collateral being distributed to unsecured creditors with lower lien priority.

As Rodney Johnson mentioned in a prior post, under the Obama plan the unsecured UAW health care trust fund was to recover a far larger percentage of its claims than the secured bankers and bondholders. Many of the banks willing to go along with this also happened to be recipients of government TARP funds. Funny how that works.

Nicole Bullock penned an excellent article in today’s FT that summarizes many of our own concerns. Ms. Bullock writes, ”Worries about the sanctity of contracts and claims in the US could become a more widespread issue that makes less credit available and raises borrowing costs for companies in general.”

Of course, this issue is larger than the auto industry. It seems like ancient history now, but it was only about two months ago that the House of Representatives passed a punitive 90% tax on bonuses earned by the AIG employees who took considerable risk to their careers to stay with the company during its long dismantlement. The ongoing mortgage crisis is another case in point.

Bullock continues, ”The Chrysler saga comes on the back of concerns by mortgage investors that they, too, are having to take losses they had thought would be absorbed by other creditors. The government has made it easier for people to modify mortgages in an effort to mitigate foreclosures, but investors say the details of the news laws in effect push them down the pecking order.”

As Nassim Taleb likes to point out, our views are naturally biased by what has happened as opposed to what could have happened given the odds at the time because the former we have seen, while the latter is theoretical. Thus, opportunity cost can be somewhat hard to measure.

We will never know how low interest rates would be or how forthcoming investment capital would be had these recent attacks on the sanctity of contract law and property rights not happened. It’s not measurable. That said, we agree with Ms. Bullock. The reckless and shortsighted actions taken by the President and Congress will have long-term consequences on the availability of credit and its cost for American companies and consumers.

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4 comments for “Is Nothing Sacred?”

I long coveted to profit from a mortgage backed investment but for most of my life I was the mortgagee. For years I have seen real estate loans advertised for $Zero down, $Zero equity and even 125% loans. During these past decades of lending practices the “Four C’s of credit analysis learned by every junior banker” were not prudently applied because of their own profit motive (greed) to fund loans.

We are experiencing the effects of “Corporate Anarchy” whereby too many educated and trusted industry stewards violated prudent business practice.
The best educated among us broke all the rules of their profession and trade for their profits to leave us with the debts. While the government bailout (our money) lets the corporations keep their house they would use law to get you out of your “house”! Am I the only one who sees this perversion?
I find human behavior to be naturally obsessive and addictive. Instinctive fears of scarcity cause even the rich to continuously accumulate and most humans are credit junkies so when imprudence takes over the process the negative results are overwhelming.

The “confidence” in the market based system works both ways. As a consumer I expected the Bankers to be prudent, but they were not! I expect Insurance Companies to uphold their end of a contract but when the losses would break them they continually get Government bail outs! My own employer violated an overtime law and when they partially paid me what they admitted owing they claimed “statute of limitations” absolved them of paying me in full!

What “free market” pundits don’t admit is that the markets are NOT free for everyone. Our Government is over weighted by special interests and that the good of the Nation has heretofore been non-existent as evidenced by the huge National debt and foreign trade imbalance. These are not caused by consumers without Corporation and Government orchestration.

While President Obama’s detractors continuously attack him on anti-capitalist behavior they do not recognize that “Capitalism” as we have known it for our lifetimes went bankrupt so Obama is reorganizing it for a sustainable future! Additionally, it is the Congress who is complicit in the bankruptcy of Capitalism which they have had decades of oversight upon. It is beyond time to usher the oldest of them out!

Finally, Time Magazine asked recently “What will be the New Normal after the crisis?”. I propose that we will see that people are the market and no business can profit without access to the market. Government (of and by the people) will become entrepreneurial by being a profitable business partner with companies that want market access. It will be the end of government deficits and a new peaceful future for our posterity. The USA, Inc. will competitively win in the Global Economy.

Posted by jbeyhi@yahoo.com | May 10, 2009, 2:26 pm
In his insightful book “The Mystery of Capital” Hernando De Soto explains how property rights and contract law that allows money to be borrowed, collateralized by property, is at the foundation of our wealth building societies. This is a foundation to capital that has been built up over centuries. One of the primary reasons 3rd world countries have difficulty moving into the modern world is the lack of these laws and systems. Great fundamental damage could be done by the administration if these policies are pursued, and certainly some of this damage has already been done.

Posted by garyca | May 10, 2009, 7:35 pm
Gary,

I actually have DeSoto’s book in my office. I read that about 5 years ago, and I still consider it one of the most insightful books I’ve ever read. I HIGHLY recommend it to anyone who will listen to me.

Property rights are THE foundation of capitalism, whether we are talking about a simple agrarian economy or a complex information-based economy.

Charles

Posted by Charles Sizemore | May 11, 2009, 7:47 am
Question to Ponder:

If they will do this to the Automakers bonds-what will they do with Government Backed bonds-treasury, savings and others. This might be the crystal ball warning of what is ahead for Government Debt! Can we the people really trust Government debt? Where are we as a country headed in terms of fincanical credibility and policy?

Could this be the start of the wrong world order?
Harry

Posted by Harrytart | May 11, 2009, 8:19 am

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Is Nothing Sacred?

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