Saturday, February 7, 2009

Risk Of Providing Continual Aid To Banks

With the current debate raging over the best way to apply the remaining TARP fund, there is a tremendous risk that we would not be saving the banks from their own ineptitude, even after giving them the full $700 billion. Here is the basic reasoning, based upon my experience as a risk manager:

In risk management, one has to identify clearly the goal and timeline of any risk mitigation planning, the “Exit Strategy.” The Exit Strategy takes into account (a) the probability of various outcomes, (b) their associated costs and benefits, (c) method of measuring and reporting on the progress (transparency), (d) have built in contingency plans to work around potential problems that may occur, and (e) have a clear and easily measurable action plan for achieving best possible outcome.

The previous administration completely bumbled in implementing the first half of the TARP. There was no clear “Exit Strategy” for the $350 billion funding as the TARP did not did not have a clear and easily measurable action plan, method of measuring progress, or even contingency plans to work-around potential problems.

The complete ineptitude of the previous administration’s handling of the TARP was laid bare by The Congressional Oversight Panel (COP) report, which came out a few days ago (actual report here; and news article here). The Congressional Oversight Panel lambasted the previous administration’s shortsightedness of purpose, poor planning, fumbled execution, lack of transparency, and bad deal making by asking the Treasury in December 2008 the following 10 questions:

1. What is Treasury’s Strategy?
2. Is the Strategy Working to Stabilize Markets?
3. Is the Strategy Helping to Reduce Foreclosures?
4. What Have Financial Institutions Done With the Taxpayers’ Money Received So Far?
5. Is the Public Receiving a Fair Deal?
6. What is Treasury Doing to Help the American Family?
7. Is Treasury Imposing Reforms on Financial Institutions that are taking Taxpayer Money?
8. How is Treasury Deciding Which Institutions Receive the Money?
9. What is the Scope of Treasury’s Statutory Authority?
10. Is Treasury Looking Ahead?

The Treasury should have had answers to these questions PRIOR to releasing the first $350 billion of the TARP. Even now, it appears that the Treasury is still unwilling (or unable) to address these basic issues, which only heightens the risk that the remaining $350 billion will be squandered yet again with no measurable benefit.

Since the Treasury was unable to answer any of the 10 questions, it would be very interesting to hear what the new Treasury Secretary Geithner will say next week. Whatever it is, I doubt that any of the questions posed by the Congressional Oversight Panel would be answered. The problem lies not only with the Treasury Department but also with President Obama. The Administration needs clearly state that lax accounting, poor planning, and insufficient results will not tolerated and, going forward, there will be strict performance and reporting requirements associated with the bailout. Without these directions, the risk of additional $350 billion being wasted is great.

Ed Kim
Practical Risk Manager

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Wednesday, November 19, 2008

Future Of The U.S. Auto Industry

With the current debate focused on whether to bail out the U.S. auto industry or not, the U.S. is in danger of missing the “Big Picture.” The Big Picture here is transportation. Our love with cars began with the idea of having the freedom of movement. The ability to just hop in a car and go anywhere helped to spark the growth of the interstate system and solidified our car-centric culture (click here for a list of popular songs about cars).

A Bit Of History
As our love with cars grew, so did our desire for it to go faster and further while providing ever-increasing level of comfort and safety. How many of us actually remember when cars did not have passenger-side rear view mirror or without remote lock system? While our love of cars grew, we did not pay a lot of attention to the cost of ownership, especially the cost of fuel. With the aftermath of the 1973 oil crisis, did we pay attention to the fuel cost? This paved the way for the Japanese cars to enter the U.S. market with their inexpensive and fuel efficient cars. (It also helped BMW to solidify its foothold in the U.S. market with its fun, fuel-efficient, and sporty 2002.)

The U.S. auto industry, facing its first crisis with the 1973 oil crisis and the influx of inexpensive Japanese cars, shifted gears rapidly to produce more fuel-efficient cars. While their initial efforts were pitiful, such as the Ford Pinto, AMC Gremlin, AMC Pacer, and GM Vega, the U.S. auto industry moved quickly to counter the “Japanese auto invasion” and try to meet consumer’s demand for fuel-efficient cars.

The aftermath of the oil crisis led to the U.S. government establishing the Corporate Average Fuel Economy (CAFE) regulation in 1975. This was an attempt at forcing the U.S. automakers into making more fuel-efficient vehicles and thereby reducing our dependence on OPEC. After another crisis in 1979 with the Chrysler bailout, it would appear that the U.S. auto Industry had learned its lesson: quickly adapt and survive or die.

That brings us to the present
The crux of the two crises that the U.S. auto Industry faced in the 1970’s should have made them stronger, in the vein of Nietzsche’s famous quote: “What doesn't kill us makes us stronger.” However, it appears that another adage is more appropriate for the U.S. auto industry: “You Can Lead A Horse To Water, But You Can't Make It Drink.

Facing a global recession and high cash burn rate, the U.S. auto industry is now begging the U.S. Congress for a $25 billion bailout. But, should they be bailed out? I will leave that debate to the academia and the pundits, as this risk manager thinks that the issue is beyond moot. Once again, the focus should be on the big picture. But first, some facts to set the stage.

First Some Facts
The facts are simple.
Fact 1: Oil is a non-renewable resource that is fast depleting.
Fact 2: Two countries that account for about 50% of the world’s population, India and China, will continue to increase their consumption oil products.
Fact 3: OPEC nations controls two-thirds of the world's oil reserves
Fact 4: U.S. imports nearly 50% of its daily oil consumption (imports 10 million barrels/day and consumes 20.68 million barrels/day).
Fact 5: Transportation accounts for 70% of all oil use
Fact 6: U.S. Consumers use about 9.3 million barrels of gasoline/day
Fact 7: Corporate Average Fuel Economy standards for passenger cars have remained stuck at 27.5 MPG since 1990.
Fact 8: Japanese cars’ average CAFE is approximately 32.2 MPG, or 17% more efficient (calculated using the Japanese cars’ domestic MPG figures for each manufacture and weighting Toyota at 50%, Honda at 30% and Nissan at 20%).
Fact 9: Tesla Motors is producing electric cars that have been EPA-certified at 227 MPG equivalent.
Fact 10: Tesla Motors only needed $105.5 million in private financing to get started.

The Big Picture
If Tesla Motors can produce a street legal sport car that gets 227 miles per electric charge with only $105.5 million in private investment, then why can’t the Big 3 U.S. automakers produce something equivalent? After all, they have billions to burn. Moreover, if the Japanese automakers are producing cars in the U.S. that averages 32.2 MPG, then why can’t the Big 3? After all, the Japanese automakers are employing U.S. workers and making the cars in the U.S.

The U.S. automakers are dinosaurs that will not change the way they conduct business. It is as if the spirit of Henry Ford’s infamous quote lives on: “Any customer can have a car painted any colour that he wants so long as it is black.” This inflexible mind set is the death of the U.S. auto industry.

We, the American consumer, still desire powerful cars with all the “bells and whistles.” However, in the era of high fuel prices, we also desire high fuel economy. Tesla Motors have pioneered the way to satisfy this need. While their initial 248 horsepower electric sports car is expensive at $109,000, with proper funding, it is easy to modify their design, step down the cost, and make it affordable through mass production.

After all, the first automobiles were too expensive for common folks. Only through the mass production genius of Henry Ford could the regular American afford a car. Much in the same way, Tesla Motors have clearly demonstrated that electric cars are viable, efficient, and fun to drive. The next step is to make the same technology affordable so that the middle class could afford one.

Conclusion – the Dawning of the New Automobile Society
The newly elected President could be the catalyst to push the U.S. auto industry into the new era. The days of internal combustion engine are limited. Along with that, the days of the parts manufactures. The electric cars have simple motor design, making them more reliable. Plug, charge, and go.

Gone also will be corner gas stations and many auto repair shops. Yes, there will be job losses but that is inevitable. The positives far exceed the negatives: Cleaner air, lower green gas emissions, no more ground water contamination from gas stations and auto repair shops. One can simply “fuel up” at any electric plug.

Let the trucks and buses idle their engines. There is no more harmful fumes or soot. Yes, we will still be burning fossil fuels to generate electricity but with 85% efficiency of an electric motor, as opposed to 25 to 30% efficiency of a gas-burning engine, we will reduce our consumption of fossil fuels, overall, while being able to drive 300 miles on a single charge.

I can see a day when we would be looking back and asking ourselves: “How many of us actually remember when cars did not have built-in GPS or used ‘gasoline’ to get around?” I see the day when all cars will be electric and have solar panels (for recharging the batteries) and an emergency hand crank (for those times when you run out of ‘juice’ in the middle of nowhere at night).

Until then, I will watch the unfolding of the U.S. automobile industry bailout drama while being reminded of another Henry Ford’s famous quotes: “I will build a car for the great multitude. It will be large enough for the family, but small enough for the individual to run and care for. It will be constructed of the best materials, by the best men to be hired, after the simplest designs that modern engineering can devise. But it will be low in price that no man making a good salary will be unable to own one — and enjoy with his family the blessing of hours of pleasure in God's great open spaces.” – My Life and Work (1922), Chapter IV.

Ed Kim
Practical Risk Manager

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Friday, November 7, 2008

The Worst Is Not Yet Over…But Happy Days Can Come Again

With the recent massive injection of capital by the Feds and other governments around the globe, one would think that the worst is nearly over. After all, with nearly $1.2 trillion spent and earmarked alone in the U.S., it would seem that the worst is over and all that remains are localized events and global cleanup. Well folks, the worst is not over. In my opinion, the worst is yet to come and it would seem that we are nearly out of bullets.

The rationales for my assessment are as follows:
1. We have yet to register the losses to come from the credit card write-offs.

2. We have yet to account for the increased burden to the state and municipal governments from increased spending toward unemployment, welfare, and other social services benefits

3. We have yet to prepare ourselves for the substantial reduction in consumption, which will lead to further losses and contraction

4. We have yet to understand the long-term effects of the massive bail out of financial institutions

Was it the right move to spend / earmark for spending nearly $1.2 trillion to bail out the U.S. financial institutions? To me, the answer is clear “No.”

The purpose of the massive cash infusion into the banking industry was to “prime” the lending activity. In my view, this money was wasted by putting it into the financial market that allocates nearly 50% of revenue toward compensation and general administrative purposes. An apt analogy would be a donation to an organizations setup to help the less fortunate.

Which would be a wiser investment of funds?
1. To donate vast sums of money to an organization that uses only 2 to 5% of the donations toward administrative and salary and funnels 95 to 98% to where the money was really needed or,

2. To an organization that uses 45 to 55% of the donations toward administrative and salary and funnels the rest to “future” spending?

The answer to this is obvious, except for the Wall Street Firms who think nothing of taking billions of American Taxpayers dollars and still pay their senior managers millions of dollars in compensation.

Economists and risk managers, I include, scoffed when, earlier this year, Congress approved Mr. Bush’s $168 billion economic stimulus plan as being a misguided policy. They just do not get it; and for us to expect them to do so would be our fault.

So, where should the government inject its cash stimulus?
We could take a page from the Roosevelt era’s “New Deal” and put the money into rebuilding our infrastructure. President elect Obama is the right person who can, in the mold of FDR, put the government stimulus packages toward those projects that would help to put money into ordinary American citizen’s pockets, help to revive and modernize the manufacturing bases of the rust belt states, while helping to stabilize the financial markets.

One of the places for the right stimulus would be our crumbling highway system. Put the Federal funds toward re-building the Interstate system, this time with the addition of light-rails, high-speed rails, and cargo-rails as a part of the Interstate highway system. By doing so, people would be hired to build the system all across the U.S., manufacturing companies will have to rehire, ramp up, and seek capital to remodel or expand their facilities. Wall Street firms will lend to those companies involved in the rebuilding efforts, as the Federal Government would implicitly guaranty the income stream of these companies. Other places for a right stimulus would be our crumbling Electric grid system and our overburdened and antiquated Air Traffic Control Systems.

Even if President-elect Obama and his administration just focused on these three areas, our economy would:

1. Quickly revive through increased productivity and added jobs, which would increase the tax revenue to local, state, and Federal governments,

2. Benefit from lower overall fuel consumption as more people would travel on high-speed rails on shorter distance travel and air travel becomes more efficient,

3. Spend less on energy and fuel resulting from more efficient electric grids that lose less power along the way from generation to use

4. Experience faster recovery as innovations in services and manufacturing, resulting from the rebuilding of our infrastructure, would lead to creation of new industries and jobs,

5. Grow Growth from new capital investments made by investors into projects and companies involved in the rebuilding of America.

Happy Days will be here again. This risk manager is hopeful that President-elect Obama will take the right actions toward this better future.

Ed Kim
Practical Risk Manager

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