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.

Regards,
Ed Kim
Practical Risk Manager

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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.

Regards,
Ed Kim
Practical Risk Manager

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Increased Risk Of Regulatory Scrutiny Of Private Bankers

Senators Baucus (D-Montana) and Grassley (R-Iowa) of the Senate Finance Committee (SFC) are seeking to place their names next to Senator Sarbanes (D-Maryland) and Representative Oxley (R-Ohio). These SFC leaders are planning new laws against offshore tax evasion.

Now offshore tax evasion is not “News” as IRS had complained about this back in 2002. According to Global Policy Forum, IRS estimated in 2002 that anywhere from 1 to 2 million Americans were evading taxes. This is a problem as old as the beginning of time as it is in human nature to abhor having to pay a levy/tax to a central body. (For you theologians, check out Able and Cain story, referencing the grain offering by Cain.)

The reason why the latest government action on tax evasion is a Private Bank risk issue is that most people identified with tax evasion are the wealthy. It is not surprising then any new regulations and law would focus on the bankers working with wealthy clients.

Even without the new regulation / law the regulators have plenty to go after bankers. With the introduction of the PATRIOT Act in 2001, Bank Secrecy Act of 1970 (BSA) and the Money Laundering Control Act of 1986 (MLCA) were strengthened. The Title III of the PATRIOT Act provides the Government with additional reach into the international arena to find and persecute money laundering. While the original intent of the PATRIOT Act was to prevent terrorism, the act can be used for any acts of money laundering, be it to fund terrorism, narcotics, or to simply avoid paying taxes.

While money laundering has been a major concern for broker-dealers, hedge funds, and investment banks, the same cannot be said for Private Banks. For centuries, the Swiss Bankers – the ones who pioneered the modern day Private Banking concept – have had the reputation of complete secrecy. This allowed the wealthy to use the Swiss Banks to hide their assets from prying eyes. Naturally, this included any enquiry from the taxman.

While most people using the Private Banking services are honest folks, there are some who try to “push the envelope” with the aid of the Private Bankers. One such Private Bank that has been flagged twice in the recent past for aiding clients in this field is UBS. In 2007, a UBS Private Banker was one of 19 arrested in Brazil for money laundering.
Then, again in 2008, two top UBS Private Bankers were indicted for aiding in tax evasion.

Given that many Private Banks have been structuring deals for their wealthy clients that could be deemed to be money laundering or tax evading, the scrutiny and pressure are mounting against the Private Bankers. Even the Private Bankers themselves know this. According to the Times article, one Private Banker in London is quoted saying "My God, we're doomed."

Perhaps. It will be interesting in the next few months as the international effort into curtailing tax evasion and money laundering intensifies. This will be especially true for Chinese nationals as China is very tough on any crime that it focuses on to prosecute. . I agree with Professor Reuven Avi-Yonah’s comment that "The whole world of private banking is full of this stuff.” Maybe Senators Baucus (D-Montana) and Grassley (R-Iowa) may be relevant in the current dragnet, or maybe not. At least, if the Senators are successful, they can put a colorful moniker for their law.

SOX is just a bad moniker. I recommend that Senators Baucus and Grassley label their effort BAG-A-CHEATE, which stands for BAucus-Grassley Amendment to Congress Headed Efforts At Tax Evaders. This would be just as colorful a moniker as CAN-SPAM and just as difficult to remember what it actually stands for. Senators, you are free to use my suggested moniker, if you wish.

Oh, for those who are curious, here is the link to CAN-SPAM. Yes, it is an actual law.

Regards,
Ed Kim
Practical Risk Manager

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