Rolfe Winkler

Circuit City made the filing today:

Circuit City Stores, the struggling electronics retailer, filed for bankruptcy protection on Monday, becoming one of the biggest, best-known corporate names to collapse amid the faltering economy. …

Retailers have been especially hard hit by the slowdown in consumer spending and the clampdown in the credit markets. Circuit City announced last week that it was closing 155 stores and laying off 17 percent of its work force, or about 1,300 employees. …

The company said in its filing that it is seeking the court’s permission to obtain $1.1 billion in debtor-in-possession financing. Together with about $400 million remaining from a $1.3 billion credit line obtained before the bankruptcy filing, Circuit City said that it should have enough financing to make it through the holiday shopping season.

There will be a wave of corporate bankruptcies this year and next as overlevered companies that can’t service their debt find no one is willing to roll it over.  And the fact that debtor-in-possession financing has been harder to come by could mean many bankruptcies will be very messy.

David Roche has an interesting op-ed in Saturday’s WSJ:

The bottom line is that, assuming further credit losses from global recession take U.S. and EU tier-one bank capital back to where it was before state injections and capital raisings, then financial-sector credit would have to shrink 37% just to keep leverage constant at precrisis levels — that’s how you get global depression.

But government is now part of bank management. Government intervention could manage to limit the credit decline to less than 10%, at the cost of more capital injections, further longer-term guarantees of liabilities, tolerance of higher leverage within socialized banks, and not a little credit “dirigisme,” i.e., directing banks to lend.

This will avoid the global depression that many fear, but at the high long-term cost of a socialized financial system. And it still heralds a very long, gray, global recession as the world learns to use less capital to meet its needs.

I haven’t seen anything published on the Journal editorial/op-ed pages that articulated even the possibility of a “depression,” much less a “global” one.  As recently as this past Spring, they were still publishing op-eds saying the economy was fine and would continue growing.

I caught a little flack back in March ’07 when I published an op-ed that mentioned the “D” word.  Still, I concluded that the worldwide economy was probably too strong for another G.D. to occur.  I hope I was right.

—One world government? No.  Still, when UK Prime Minister Gordon Brown says we should “seize the moment” to build a “global society,” I get a bit queasy.  Will leaders at this week’s G20 meeting propose a new supra-national framework to solve various world problems? (See the bottom of this post for more)

—The NYT magazine makes a related point that Barack Obama “will enter office as the most powerful president who has ever sat in the White House.”  Security-related power grabs passed down from Bush are certainly big, but larger still will be Obama’s virtual control of the U.S. financial system and whatever other industries get nationalized.  Will Obama renounce some of the new powers Bush grabbed for himself?

In any case, so long as the U.S. remains a debtor nation, the bond market will have more power over policy than even the president.

—Speaking of debt, our national debt is up to $10.62 trillion.  Last week Treasury listed it at $10.57 trillion.

—And A.I.G. is getting more money: “When the restructured deal is complete, taxpayers will have invested and lent a total of $150 billion to A.I.G., the most the government has ever directed to a single private enterprise. It is a stark reversal of the government’s assurance that its previous moves had stemmed the bleeding at A.I.G.”

—The Fed “is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.”  Sunlight is the best disinfectant and Bloomberg has filed a Freedom of Information Act suit against the Fed to force disclosure.  I hope they succeed.

—China steps up with its own $586 billion stimulus plan.  Amazing to consider a “developing” nation has that sum to spend.  “Has” being the operative word.  China actually has reserves to bankroll fiscal injections.  Just a curious question: as China puts more of its reserves to use at home, will that decrease its demand for U.S. Treasuries?  (See my prior point regarding the bond market’s power over U.S. policy…if investors like China buy fewer U.S. treasury bonds, U.S. interest rates could increase substantially.)  Also: will China’s stimulus work?

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GM’s latest earnings report is ugly.  They burned through $6.9 billion in Q3 and have $16.2 billion left.  According to the release, they need at least $11 billion to keep operating.  If true, that gives them only a couple more months before they’ll be forced into bankruptcy.  (Not sure what status is on the $25 billion loan for all three automakers that has already passed Congress.)

How ’bout this quote from the earnings release:

Even if GM implements the planned operating actions that are substantially within its control, GM’s estimated liquidity during the remainder of 2008 will approach the minimum amount necessary to operate its business. Looking into the first two quarters of 2009, even with its planned actions, the company’s estimated liquidity will fall significantly short of that amount unless economic and automotive industry conditions significantly improve, it receives substantial proceeds from asset sales, takes more aggressive working capital initiatives, gains access to capital markets and other private sources of funding, receives government funding under one or more current or future programs, or some combination of the foregoing.

Normally earnings releases try to put a happy face on bad news.  Not so with GM, which is trying to scare Congress and the President(s) into handing them more cash.  If we don’t, GM will file for bankruptcy and hundreds of thousands of jobs will be lost.

It would be remarkably courageous to let GM go bankrupt.  But that seems like the best option.  Clearly U.S. automakers are no longer viable businesses in which to invest capital.  Is it a good idea to borrow billions at the federal level to try to save GM?  Government borrowing is going to push up interest rates, which will depress the economy, and make it more difficult to get a loan to buy a car.

Taxpayers have one incentive to bail out the company: federal pension insurance already has us on the hook for tens of billions to cover retirement obligations for GM’s unionized work force.

But if GM is going to fail anyway, better to skip the bailout so that we have some dry powder to pay the company’s pension liabilities.  By the end of next year, my bet is that “PBGC” will have replaced FDIC in dinner table conversations around the country.

By the way, does anyone want to guess how the CDS market will be impacted by a GM bankruptcy filing?

Seen the “Gov’t Gold” ad campaign running on CNBC? The one selling tenth-of-an-ounce gold coins for $98 each? Compare to the spot price for a full ounce of gold at $734. That’s a tidy mark-up.

You’d think the guys behind the ad would ask CNBC to shut off the ticker…

I know there’s plenty of debate as to the accuracy of the quoted spot price. Still, I thought this was a funny screen capture…

Bloomberg has some bad news for those of us who thought the recently issued report by the Depository Trust and Clearing Corporation (DTCC) was a nice glimpse of what the market for credit default swaps (CDS) truly looks like. It isn’t.

As the Bloomberg folks make clear, the DTCC’s info does not include credit protection written on collateralized debt obligations (CDO), the hodge podge of debt backed securities made up of mortgages, credit cards or perhaps a little of each with some bank debt thrown in. This is where the bodies are hidden in the CDS market…this is where things have been going wrong and will continue to go wrong as consumers hit a wall.

Moreover, because CDOs track baskets of debt and don’t really match up with a single instrument the CDS insuring them are more likely to be cash settled, meaning I don’t have to go out an find the underlying reference entity. This is good for those who want to use the CDS market to make negative bets. If you wanted to bet against the housing market, for instance, this is where you’d put your money. The housing market or the credit card market is not represented by any one security. CDOs allow you to index your credit exposure, or perhaps slice and dice is the better phrase.

Either way, if I wanted to make net negative bets that different sectors of the economy were going to default, this is where I would be betting. It’s how John Paulson won big last year. CDS on CDOs (sorry for all the acronyms) is where the troubles are and the DTCC info doesn’t give us any info on it at all.

So we’ve been shown the part of the plumbing that doesn’t really matter. When do we get to see the septic tank?

Did y’all notice that Obama didn’t seem very enthusiastic during his victory speech last night?  He was clearly tempering expectations:

The road ahead will be long. Our climb will be steep. We may not get there in one year or even one term, but America – I have never been more hopeful than I am tonight that we will get there. I promise you – we as a people will get there.

There will be setbacks and false starts. There are many who wont agree with every decision or policy I make as President, and we know that government cant solve every problem. But I will always be honest with you about the challenges we face. I will listen to you, especially when we disagree. And above all, I will ask you join in the work of remaking this nation the only way its been done in America for two-hundred and twenty-one years – block by block, brick by brick, calloused hand by calloused hand.

Those words don’t suggest he was very excited.  And it appears he isn’t.  The WSJ is reporting that the mood among Obama and his transition team today was “more somber than celebratory.”  And not because Obama’s grandmother just died.

I’ve speculated that we could end up like Argentina, which borrowed too much money through the 90s and defaulted on its debt in 2001, sending the economy into a tailspin.  Indeed, amidst that upheaval, no one wanted to be president.  Check out the Argentine presidential timeline from that period.  They had five presidents in two months!

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A great deal of important information regarding the credit-default-swap (CDS) market has come out over the last week. Many of us who have tried to keep abreast of this unregulated insurance market have been proven in some ways to be quite the Cassandras. The systemic threat posed by CDS may have more to do with how the contracts work than with how they are used. But that doesn’t mean there isn’t a problem. In fact the problem is pretty big.

First, the DTCC released some great information today. According to them, the CDS market is not as big and bad as estimated. The proportion of contracts to debt size is relatively even, so negative economic incentives—using CDS to speculate against debt you don’t hold, rather than as insurance against debt you do hold—doesn’t seem to be such a big problem. This is good in that it means the heart of the market seems to be in the right place. Sure, there are operators out there using the CDS market in unsavory ways. But as with most things, most of those using the system seem to be using it the way in which it was intended. (Update: already CDS cognoscenti are casting doubt on the DTCC’s figures for outstanding derivative contracts.  They say DTCC completely ignores CDO-related CDS, perhaps 40% of the market.)

Second, news about AIG reveals that the current problem with CDS has very little to do with the nature of the market and negative economic incentives, but with how the contracts work. As Martin Mayer says, it’s the plumbing, not the principals, that matters most. AIG does not seem to have lost all that much money, or I should say does not seem to have handed it over to counterparties. Rather, as the nature of the bad bets AIG made became clear the insurance giant has been forced to post larger and larger amounts of cash in collateral accounts to prove that it can pay its CDS obligations if in fact the underlying companies do default.

The money is not gone, it’s just stuck waiting for things to get better or get worse. Sure eventual payouts might be needed and that would be bad for those who have to pay, but then at least the money could be put back to work by those on the receiving end. Right now CDS seems to be working as a big liquidity sponge, sucking up cash into collateral accounts and keeping it from greasing the economy. This is likely happening to everyone, though on a scale smaller than AIG.

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—Ugh.  Obama looks like he’s going to win and already Dems are talking about reviving the “Fairness Doctrine,” which would force conservative talk radio to balance itself out with liberal programming.  Don’t get me wrong, I’m no fan of Rush Limbaugh or his imitators.  I think their rhetoric is detrimental to our society; they twist truth to make their ideological points.  And yet, wouldn’t this be a violation of first amendment rights to free speech?  Every minute of liberal programming mandated by Democrats would be a minute that Rush is off the air.  That’s tantamount to shutting him up via legislation.  And who decides what qualifies as properly “liberal” programming?  If liberals can do this, why can’t conservatives retaliate by mandating an equal allocation of public university professorships be given to registered Republicans?  Obama must resist his party on issues like this.

—In case you missed it yesterday, U.S. auto sales fell through the floor in October.  A great chart laying out year-over-year changes is available at Econbrowser.  Notice how auto sales only really started to decline in June.

—We’ve argued on this blog that one of the most corrosive effects of mortgage securitization—that is, packaging mortgages into pools to be sold to far-flung investors—is to remove bankers’ incentive to manage credit risk.  If mortgage defaults are someone else’s problem, then why should banks take care to avoid them?  The New York Times has a great story about how this played out with one underwriter at WaMu.

—How much are bailouts costing taxpayers?  The Feds borrowed $530 billion from July to Sept, and may borrow another $550 billion from Oct to December.  That’s over a trillion dollars added to the national debt in 6 months.  Stunning.  For more, see CalculatedRisk.

—Putting this massive borrowing into perspective, here is a half-hour snippet of documentary I.O.U.S.A. This is a very good piece laying out the entitlement funding crisis facing the country as baby boomers retire.

—There hasn’t been an IPO since August.

—As so-called “debtor-in-possession” financing disappears, the expected spike in corporate bankruptcies will lead to a very painful liquidation of assets. (That’s an older link I just saw today, but still interesting…)  DIP financing allows companies to make it through the bankruptcy process in one piece.  If there’s no prospect they can do so, assets have to be sold in a fire sale.  Forced selling of assets by companies that can’t pay their debt isn’t just a problem within the banking and housing sectors.  Also known as “deleveraging,” this process will continue to hammer asset values all over the economy for the next couple years.

A book recommendation to understand deleveraging:  Roger Lowenstein’s “When Genius Failed.”

At the risk of pissing off many of my readers, I thought I’d step into the election buzzsaw with an endorsement. And by “OA’s” endorsement I mean my own.

I’ll preface this by saying it’s almost a toss-up for me as usual: The lesser of two evils? Or a protest vote for someone who can’t win? Ron Paul would have been a worthy recipient of a protest vote. But he’s not on my ballot, so I’m going with the lesser of two evils.

I’ve wrestled with my choice for some time. Frankly, I wasn’t impressed with any of the major party candidates this election cycle. Though I guess I’ve never really been impressed by a major-party candidate. The level of equivocation, lying, and outright spinelessness required to rise to the top of either major party emasculates all who attempt the climb. (Though I wonder: is this because our politicians lack vertebrae or because campaigning must reflect capricious voters that want everything but will sacrifice nothing?)

And frankly both major parties are ideologically bankrupt. I hardly think I need to provide evidence to back up that claim. For years Democrats and Republicans have proven that their goal isn’t to govern well, it’s simply to win.

Once upon a time, Republicans believed in small government. Over the last eight years we’ve had one of the largest expansions of government in history. They believed in freedom and states’ rights. Nevermind those if gay marriage bans and saving Terry Schaivo can drive turnout among “the base.” And isn’t it hilarious that at one point the Republican primary seemed to turn on which candidate would talk toughest about Mexicans? Forget, for the moment, that we’re a nation of immigrants. Just let’s take immigrant labor out of the work force and see what that does to inflation…

As for the Democrats, they actually believe in big government, which scares me just as much. Ted Kennedy’s Medicare prescription drug benefit, tax refunds for people that don’t pay taxes, borrowing billions to encourage folks to buy houses they can’t afford. Are you ready for “universal” health care? For government beauracrats telling you what treatments are and are not allowed for certain medical conditions? And Democrats’ base of voters is just as nuts. Fully a third of Americans think Bush either planned 9/11 or had advance knowledge and failed to stop it. A great excuse to go to war! My guess is that the vast majority of these folks vote Democratic. (Have any of them stopped to ponder the size of the operation needed to pull off that kind of conspiracy? In a town that can’t keep a blow-job a secret, they think an adminstration with the demonstrated incompetence of the present one could mobilize hundreds of guys to pull off those attacks and keep their mouths shut all this time?)

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