The New Year gives rise to reflection on the past months of 2008 as well as a look forward into 2009.
We are living in historic times and sailing uncharted waters.
The following is a look at where we've been and where we might be going.
By late summer 2008 the auto business was already in trouble with high fuel prices destroying volume, product mix, and resale values.
Overnight, consumers and their banks found themselves thousands of dollars upside down, whether they were leases or long term finance contracts.
Lenders, already running scared because of increasing delinquencies and defaults, experienced horrendous residual losses in their off lease portfolios.
GAP insurance providers became nervous.
Further, the housing and mortgage meltdown, which began in 2007, was building steam.
Few knew the width and depth of mortgage securitization exposure and its possible effect on the financial sector.
Who knew that speculation, primarily in the 4 states of CA, AZ, NV, and FL, and fundamental flaws in Fannie and Freddie's risk management could wreak such havoc? In my oversimplified view, the meltdown resulted from the perverse alignments of conservatives' desire to minimize regulation and the liberals' desire for everyone to be able to own a home.
On September 7, it was announced that Fannie Mae and Freddie Mac were being placed into government conservatorship.
They have since be re-juiced with billions of federal dollars and given a new mandate.
Detailed notes of the Congressional hearings regarding Fannie and Freddie can by received by emailing the author at ruggles@msn.
com Use subject line "Request Notes" For a detailed synopsis of how mathematical risk modeling led to the financial system meltdown Google "A Mountain, Overlooked, How Risk Models Failed Wall St.
and Washington, By James G.
Rickards On September 15 Lehman Brothers declared Chapter 11 bankruptcy, the largest in U.
S.
history.
Surprisingly, the government didn't bail them out.
The markets asked, "If Lehman can go, who's next?" The government then announced a bailout of AIG, the largest bailout in history.
Panic was setting in.
September 2008 will go down as one of the darkest months in our economic history and it didn't get much better from there.
In October we had a brief suspension in the presidential campaign so the Congress could focus on an economic bailout plan named T.
A.
R.
P.
for Troubled Asset Relief Program.
Its author, Hank Paulson, started off with some credibility.
By the time Congress got finished with the bill we all had more reason to revile our elected officials as they added in billions for their special interests.
Later on, Paulsen and his people lost all credibility when it was revealed that the money wasn't used for the purpose stated when we were all sold the program.
Then we learned about AIG executives going off on an expensive retreat on what was viewed as taxpayer money and banks who couldn't or wouldn't answer questions about what they had done with their share of the T.
A.
R.
P.
money.
We learned new terms like "credit default swap", "risk modeling", and "tranche".
Googling "The Perfect Machine" will allow you to view the rather lengthy story of AIG as published in the Washington Post.
Its a great read and very informative! In July, Wall Street pressured Chrysler Credit into giving up leasing as part of a refinancing deal.
This was not commonly known at the time.
Once this was announced independent banks figured if Chrysler wouldn't stand behind their own vehicles, why should we? What do they know that we don't? The banking climate was already uncertain enough.
Lenders bailed out of leasing one after another.
Predicting residuals turned out to be a most inexact science if one could not predict fuel prices.
Lessors took major baths on luxury models and "heavies.
" A few OEM captives stayed in leasing but they were either German or Japanese brands.
The German luxury brands in particular rely on leasing for a major portion of their volume.
Unfortunately, there are rumors of MANY off lease vehicles stored in marshalling yards around the country.
Ford stayed in leasing on a very limited basis.
U.
S.
Bank stands alone as the only bank with national scope that has stayed in new vehicle leasing.
Even they abandoned pre-owned leasing leaving only the programs of certain OEMs for those who want to lease pre-owned vehicles.
A few regional banks and credit unions have stayed in as well but have backed off of their residuals.
Yet, EVERYONE agrees that after a period of time with a low SAAR (Seasonally Adjusted Annual Rate) we will experience an extreme used vehicle shortage at some point down the road.
We saw the CEOs of the "Big 3 come to Washington in private jets with their hands out only to get spanked, lectured, and told to come back in two weeks using a different means of conveyance and with a plan.
I stubbornly insist on referring to them as the Big 3 even though they aren't any more.
Perhaps I should call them the Detroit 3.
The hearings played out on television.
The country became familiar with both old and new players like Bob Nardelli from Chrysler, Barney Frank, D-MA, and Bob Corker R-TN.
After much theatrics Congress failed to act, divided on mostly party lines on UAW labor cost issues.
The Bush administration stepped in at the last minute to prevent GM and Chrysler from going bankrupt with a cash infusion from T.
A.
R.
P.
funds.
In the meantime, T.
A.
R.
P.
had ended up not being used for its intended purpose anyway.
Since the initial T.
A.
R.
P.
funds were not used to buy up mortgage securities, no one seemed to know what the mortgage securities were worth.
Fear of both the known and the unknown caused the credit markets to seize up.
In the auto business, consumers with credit scores above 700 or below 580 could probably get credit, although the low credit scores were almost exclusively BHPH (Buy Here, Pay Here) transactions.
Those in between were largely out of luck unless they had a credit union or a special circumstance they could call on.
Negative equity? Forget about getting it financed! Ford's CEO Alan Mullaly came to Washington with his two Detroit competitors but stated his company's situation was not so dire as to need an immediate "bailout.
" Ford had raised a lot of cash early on before the credit market dried up.
Instead they asked to be considered for a line of credit in the case the economy stayed in recession longer than their cash cushion could last.
It makes one wonder if someone in the Ford family might have seen the potential for a situation to arise where the company would have to go to the government for help.
One wonders what might happen to the Ford family's special category of voting stock in the case of taxpayer money being injected into the company.
Ford hopes to benefit from favorable PR as the only U.
S.
OEM to not need taxpayer money.
They are also banking on being able to bring small vehicles to the U.
S.
from Europe if needed.
In addition, they have some new technology almost ready for release that allows them to extract larger engine power from small displacement engines using direct injection and twin turbochargers.
They stand to benefit from any concessions the UAW negotiates with their competitors.
Having said all of this, the American buying public has short memories.
With the price of fuel around $1.
60, hybrid and small vehicle sales have dropped remarkably.
Toyota recently announced a 45% drop in Prius hybrid sales.
This gives residual value prognosticators even more heartburn.
Let's face it, if gasoline stays this cheap Americans absolutely will not pay extra for advanced fuel economy.
It's been proven time and again.
Bob Lutz of GM has weighed in on the subject.
Accessing the link will reference his comments made to Ward's Auto World.
Keep in mind that Lee Iacocca pitched a 25 cent gasoline tax in the early eighties.
To say that industry leaders are mixed on this issue would be an understatement.
Energy policy is an issue that goes beyond the auto industry as it is truly an issue of national security.
Also at issue is the value of the dollar and our country's balance of payments based on the extreme outflow of dollars to pay for foreign oil.
Google "Bob Lutz in Wards Auto World" for this very important article.
Detroit was accused by some Washington lawmakers and media pundits, of building cars no one wanted to buy.
Yet the sales slump hit South Detroit and imports alike.
Even Lexus was down over 40% and has inventory stacked up at the port.
Toyota idled their Tundra plant in San Antonio for 3 months and suspended plans for a new hybrid plant in Mississippi.
They ran the first quarter of red ink in company history.
Despite the fact that the Detroit 3's market share has been steadily eroding they still build a lot of vehicles and employ a lot of people.
They are also responsible for the payment of a lot of taxes as are their dealers in their individual markets.
South Detroit got their "bailouts" up front in the form of incentives and tax subsidies from the southern states where they located in the first place.
This is not to defend the stupid moves made by the decision makers at the Detroit 3, but most of those decisions are the subject for a subsequent report.
In my view, the government has some responsibility for what has happened.
It's not the Big 3's fault that we have no comprehensive energy policy in this country as do other developed nations.
It's also not their fault that the government's role in the housing and mortgage market through the debacles at Fannie and Freddie caused the financial markets to seize up and prevented the Big 3 from being able to go through normal financing channels to "bridge" themselves.
Through all of this the economy lost millions of jobs.
The stock market continued its slide from earlier in the year.
Its roller coaster nature during the dark days of September and October left many of us with a feeling of nausea.
The auto industry SAAR slowed to a below 11 million.
Many auto dealers were left by the roadside, with more to fail in the coming months.
The T.
A.
R.
P.
finds that were released to the big banks allowed them to gobble up small banks who were in trouble and would probably have gone bust.
Even though this didn't do anything to firm up the value of the so called "toxic assets" it did serve the function of keeping the small banks from closing without the Feds having to micromanage each situation.
It was thought that even small bank failures could potentially cause a run on many banks.
But the taxpaying public felt betrayed.
In late November CitiBank received a 300 billion plus commitment from the Feds that was over and above the T.
A.
R.
P.
In the middle of all this, we elected a new President largely based on hope for the future.
So where are we now? The Detroit 3 have been "bridged" with the prospect of additional financing looking good under the incoming administration.
GMAC/Cerberus has received a change in banking status to qualify for government funds.
This is a MAJOR deal as they desperately need cheap money to lend to support their dealer's sales efforts.
Mortgage applications are up 82% in Las Vegas, due mostly to low interest rate refinancing.
But it's a start.
The "bottom feeders" are starting to pick up distressed properties.
We still have the cloud of unknown value mortgage securities hanging over the head of the economy, but the first step is getting a handle on home values.
Here in Las Vegas it has been hard to know what a house is worth.
But as transactions occur, values for other properties can be ascertained.
If a mortgage security includes mortgages from states where values just aren't known, how can Fitch or anyone else rate or value that security? How can a bank value these assets on their balance sheet, let alone turn them into cash? Getting a handle on the value of these securities will be a major task of the new administration, as well as coming up with a major stimulus and jobs package.
I expect them to hit the ground running.
So what else has to happen for the economy to recover? Americans have to start buying more stuff.
As usual I expect the auto industry to be the "leading indicator.
" Maybe we should dig up Joe Garagiola who with Chrysler almost single handedly yanked us out of the recession of the mid seventies with "Buy a car, Get a check!" But rebates won't work this time.
Buyers are so accustomed to them they don't represent anything "special".
An auto buyer's tax holiday might get some attention.
This has been effective in some foreign countries where the consumption tax is federal, not state by state.
Repealing the federal excise tax on vehicles worked in the early seventies to yank us out of the economic downturn of 1970.
How I date myself, as I was actively in the auto business as a new car sales person when these events took place.
But we will first have to work through tremendous unsold inventories of both new AND pre-owned.
There are other issues as itemized by Brian Wesbury, Chief Economist from First Trust.
Google "We Are the Catalyst," by Brian Wesbury of First Trust for his forward thinking commentary.
So what's the outlook for the long term of the auto industry? The Detroit 3 have been touting their quality and J.
D.
Power statistics have supported their claims to some degree.
But in my opinion a huge problem the Detroit 3 has in competing in the marketplace is in resale value.
Years of desperation "push marketing" brought on by short sightedness and over production have undermined the value of most Detroit 3 vehicles.
Many sophisticated consumers purchase a Toyota or Honda because they know that a Honda or Toyota at MSRP is a relatively better long term value than most Big 3 products are at invoice or under.
This is not to say that everyone buys a particular product for the same reason, but it doesn't take a genius to figure out that a big rebate or discount upfront doesn't mean much if it gets eaten up in depreciation in the first year of ownership.
Low resale value tarnishes an OEM's image.
It betrays their owner body.
It makes it more difficult for a borrower to achieve anything close to equity which makes it more difficult for them to trade in their encumbered vehicle on a new one.
In other words, it costs sales.
It reduces owner loyalty.
It also means that leasing strategies to make monthly payments more achievable on new vehicles are more costly and/or not as competitive.
All OEMs know these things.
But when trying desperately to survive they resist allocating resources to bolster their resale values, especially if it involves using their captive finance arm to aggressively finance or lease their late model pre-owned vehicles.
CPO (Certified Pre-Owned) is a great strategy but without strong finance and lease support it will never realize its potential.
For the sake of the Detroit 3 and their dealers let's hope they survive and take a long term view of their business that includes taking necessary measures to maintain a high resale value.
A great way to move the over flow of pre-owned late model vehicles currently in the pipeline would be through pre-owned leasing.
With the current low SAAR and the projected pre-owned vehicle shortage down the road, pre-owned leasing would be a really safe bet!
We are living in historic times and sailing uncharted waters.
The following is a look at where we've been and where we might be going.
By late summer 2008 the auto business was already in trouble with high fuel prices destroying volume, product mix, and resale values.
Overnight, consumers and their banks found themselves thousands of dollars upside down, whether they were leases or long term finance contracts.
Lenders, already running scared because of increasing delinquencies and defaults, experienced horrendous residual losses in their off lease portfolios.
GAP insurance providers became nervous.
Further, the housing and mortgage meltdown, which began in 2007, was building steam.
Few knew the width and depth of mortgage securitization exposure and its possible effect on the financial sector.
Who knew that speculation, primarily in the 4 states of CA, AZ, NV, and FL, and fundamental flaws in Fannie and Freddie's risk management could wreak such havoc? In my oversimplified view, the meltdown resulted from the perverse alignments of conservatives' desire to minimize regulation and the liberals' desire for everyone to be able to own a home.
On September 7, it was announced that Fannie Mae and Freddie Mac were being placed into government conservatorship.
They have since be re-juiced with billions of federal dollars and given a new mandate.
Detailed notes of the Congressional hearings regarding Fannie and Freddie can by received by emailing the author at ruggles@msn.
com Use subject line "Request Notes" For a detailed synopsis of how mathematical risk modeling led to the financial system meltdown Google "A Mountain, Overlooked, How Risk Models Failed Wall St.
and Washington, By James G.
Rickards On September 15 Lehman Brothers declared Chapter 11 bankruptcy, the largest in U.
S.
history.
Surprisingly, the government didn't bail them out.
The markets asked, "If Lehman can go, who's next?" The government then announced a bailout of AIG, the largest bailout in history.
Panic was setting in.
September 2008 will go down as one of the darkest months in our economic history and it didn't get much better from there.
In October we had a brief suspension in the presidential campaign so the Congress could focus on an economic bailout plan named T.
A.
R.
P.
for Troubled Asset Relief Program.
Its author, Hank Paulson, started off with some credibility.
By the time Congress got finished with the bill we all had more reason to revile our elected officials as they added in billions for their special interests.
Later on, Paulsen and his people lost all credibility when it was revealed that the money wasn't used for the purpose stated when we were all sold the program.
Then we learned about AIG executives going off on an expensive retreat on what was viewed as taxpayer money and banks who couldn't or wouldn't answer questions about what they had done with their share of the T.
A.
R.
P.
money.
We learned new terms like "credit default swap", "risk modeling", and "tranche".
Googling "The Perfect Machine" will allow you to view the rather lengthy story of AIG as published in the Washington Post.
Its a great read and very informative! In July, Wall Street pressured Chrysler Credit into giving up leasing as part of a refinancing deal.
This was not commonly known at the time.
Once this was announced independent banks figured if Chrysler wouldn't stand behind their own vehicles, why should we? What do they know that we don't? The banking climate was already uncertain enough.
Lenders bailed out of leasing one after another.
Predicting residuals turned out to be a most inexact science if one could not predict fuel prices.
Lessors took major baths on luxury models and "heavies.
" A few OEM captives stayed in leasing but they were either German or Japanese brands.
The German luxury brands in particular rely on leasing for a major portion of their volume.
Unfortunately, there are rumors of MANY off lease vehicles stored in marshalling yards around the country.
Ford stayed in leasing on a very limited basis.
U.
S.
Bank stands alone as the only bank with national scope that has stayed in new vehicle leasing.
Even they abandoned pre-owned leasing leaving only the programs of certain OEMs for those who want to lease pre-owned vehicles.
A few regional banks and credit unions have stayed in as well but have backed off of their residuals.
Yet, EVERYONE agrees that after a period of time with a low SAAR (Seasonally Adjusted Annual Rate) we will experience an extreme used vehicle shortage at some point down the road.
We saw the CEOs of the "Big 3 come to Washington in private jets with their hands out only to get spanked, lectured, and told to come back in two weeks using a different means of conveyance and with a plan.
I stubbornly insist on referring to them as the Big 3 even though they aren't any more.
Perhaps I should call them the Detroit 3.
The hearings played out on television.
The country became familiar with both old and new players like Bob Nardelli from Chrysler, Barney Frank, D-MA, and Bob Corker R-TN.
After much theatrics Congress failed to act, divided on mostly party lines on UAW labor cost issues.
The Bush administration stepped in at the last minute to prevent GM and Chrysler from going bankrupt with a cash infusion from T.
A.
R.
P.
funds.
In the meantime, T.
A.
R.
P.
had ended up not being used for its intended purpose anyway.
Since the initial T.
A.
R.
P.
funds were not used to buy up mortgage securities, no one seemed to know what the mortgage securities were worth.
Fear of both the known and the unknown caused the credit markets to seize up.
In the auto business, consumers with credit scores above 700 or below 580 could probably get credit, although the low credit scores were almost exclusively BHPH (Buy Here, Pay Here) transactions.
Those in between were largely out of luck unless they had a credit union or a special circumstance they could call on.
Negative equity? Forget about getting it financed! Ford's CEO Alan Mullaly came to Washington with his two Detroit competitors but stated his company's situation was not so dire as to need an immediate "bailout.
" Ford had raised a lot of cash early on before the credit market dried up.
Instead they asked to be considered for a line of credit in the case the economy stayed in recession longer than their cash cushion could last.
It makes one wonder if someone in the Ford family might have seen the potential for a situation to arise where the company would have to go to the government for help.
One wonders what might happen to the Ford family's special category of voting stock in the case of taxpayer money being injected into the company.
Ford hopes to benefit from favorable PR as the only U.
S.
OEM to not need taxpayer money.
They are also banking on being able to bring small vehicles to the U.
S.
from Europe if needed.
In addition, they have some new technology almost ready for release that allows them to extract larger engine power from small displacement engines using direct injection and twin turbochargers.
They stand to benefit from any concessions the UAW negotiates with their competitors.
Having said all of this, the American buying public has short memories.
With the price of fuel around $1.
60, hybrid and small vehicle sales have dropped remarkably.
Toyota recently announced a 45% drop in Prius hybrid sales.
This gives residual value prognosticators even more heartburn.
Let's face it, if gasoline stays this cheap Americans absolutely will not pay extra for advanced fuel economy.
It's been proven time and again.
Bob Lutz of GM has weighed in on the subject.
Accessing the link will reference his comments made to Ward's Auto World.
Keep in mind that Lee Iacocca pitched a 25 cent gasoline tax in the early eighties.
To say that industry leaders are mixed on this issue would be an understatement.
Energy policy is an issue that goes beyond the auto industry as it is truly an issue of national security.
Also at issue is the value of the dollar and our country's balance of payments based on the extreme outflow of dollars to pay for foreign oil.
Google "Bob Lutz in Wards Auto World" for this very important article.
Detroit was accused by some Washington lawmakers and media pundits, of building cars no one wanted to buy.
Yet the sales slump hit South Detroit and imports alike.
Even Lexus was down over 40% and has inventory stacked up at the port.
Toyota idled their Tundra plant in San Antonio for 3 months and suspended plans for a new hybrid plant in Mississippi.
They ran the first quarter of red ink in company history.
Despite the fact that the Detroit 3's market share has been steadily eroding they still build a lot of vehicles and employ a lot of people.
They are also responsible for the payment of a lot of taxes as are their dealers in their individual markets.
South Detroit got their "bailouts" up front in the form of incentives and tax subsidies from the southern states where they located in the first place.
This is not to defend the stupid moves made by the decision makers at the Detroit 3, but most of those decisions are the subject for a subsequent report.
In my view, the government has some responsibility for what has happened.
It's not the Big 3's fault that we have no comprehensive energy policy in this country as do other developed nations.
It's also not their fault that the government's role in the housing and mortgage market through the debacles at Fannie and Freddie caused the financial markets to seize up and prevented the Big 3 from being able to go through normal financing channels to "bridge" themselves.
Through all of this the economy lost millions of jobs.
The stock market continued its slide from earlier in the year.
Its roller coaster nature during the dark days of September and October left many of us with a feeling of nausea.
The auto industry SAAR slowed to a below 11 million.
Many auto dealers were left by the roadside, with more to fail in the coming months.
The T.
A.
R.
P.
finds that were released to the big banks allowed them to gobble up small banks who were in trouble and would probably have gone bust.
Even though this didn't do anything to firm up the value of the so called "toxic assets" it did serve the function of keeping the small banks from closing without the Feds having to micromanage each situation.
It was thought that even small bank failures could potentially cause a run on many banks.
But the taxpaying public felt betrayed.
In late November CitiBank received a 300 billion plus commitment from the Feds that was over and above the T.
A.
R.
P.
In the middle of all this, we elected a new President largely based on hope for the future.
So where are we now? The Detroit 3 have been "bridged" with the prospect of additional financing looking good under the incoming administration.
GMAC/Cerberus has received a change in banking status to qualify for government funds.
This is a MAJOR deal as they desperately need cheap money to lend to support their dealer's sales efforts.
Mortgage applications are up 82% in Las Vegas, due mostly to low interest rate refinancing.
But it's a start.
The "bottom feeders" are starting to pick up distressed properties.
We still have the cloud of unknown value mortgage securities hanging over the head of the economy, but the first step is getting a handle on home values.
Here in Las Vegas it has been hard to know what a house is worth.
But as transactions occur, values for other properties can be ascertained.
If a mortgage security includes mortgages from states where values just aren't known, how can Fitch or anyone else rate or value that security? How can a bank value these assets on their balance sheet, let alone turn them into cash? Getting a handle on the value of these securities will be a major task of the new administration, as well as coming up with a major stimulus and jobs package.
I expect them to hit the ground running.
So what else has to happen for the economy to recover? Americans have to start buying more stuff.
As usual I expect the auto industry to be the "leading indicator.
" Maybe we should dig up Joe Garagiola who with Chrysler almost single handedly yanked us out of the recession of the mid seventies with "Buy a car, Get a check!" But rebates won't work this time.
Buyers are so accustomed to them they don't represent anything "special".
An auto buyer's tax holiday might get some attention.
This has been effective in some foreign countries where the consumption tax is federal, not state by state.
Repealing the federal excise tax on vehicles worked in the early seventies to yank us out of the economic downturn of 1970.
How I date myself, as I was actively in the auto business as a new car sales person when these events took place.
But we will first have to work through tremendous unsold inventories of both new AND pre-owned.
There are other issues as itemized by Brian Wesbury, Chief Economist from First Trust.
Google "We Are the Catalyst," by Brian Wesbury of First Trust for his forward thinking commentary.
So what's the outlook for the long term of the auto industry? The Detroit 3 have been touting their quality and J.
D.
Power statistics have supported their claims to some degree.
But in my opinion a huge problem the Detroit 3 has in competing in the marketplace is in resale value.
Years of desperation "push marketing" brought on by short sightedness and over production have undermined the value of most Detroit 3 vehicles.
Many sophisticated consumers purchase a Toyota or Honda because they know that a Honda or Toyota at MSRP is a relatively better long term value than most Big 3 products are at invoice or under.
This is not to say that everyone buys a particular product for the same reason, but it doesn't take a genius to figure out that a big rebate or discount upfront doesn't mean much if it gets eaten up in depreciation in the first year of ownership.
Low resale value tarnishes an OEM's image.
It betrays their owner body.
It makes it more difficult for a borrower to achieve anything close to equity which makes it more difficult for them to trade in their encumbered vehicle on a new one.
In other words, it costs sales.
It reduces owner loyalty.
It also means that leasing strategies to make monthly payments more achievable on new vehicles are more costly and/or not as competitive.
All OEMs know these things.
But when trying desperately to survive they resist allocating resources to bolster their resale values, especially if it involves using their captive finance arm to aggressively finance or lease their late model pre-owned vehicles.
CPO (Certified Pre-Owned) is a great strategy but without strong finance and lease support it will never realize its potential.
For the sake of the Detroit 3 and their dealers let's hope they survive and take a long term view of their business that includes taking necessary measures to maintain a high resale value.
A great way to move the over flow of pre-owned late model vehicles currently in the pipeline would be through pre-owned leasing.
With the current low SAAR and the projected pre-owned vehicle shortage down the road, pre-owned leasing would be a really safe bet!
Source...