Part 7 - More on Autos, Stimulus, and the TARP

January 15, 2009
Having been distracted by some unrelated research which has been very time consuming, I will now try and catch up with a few comments about the Great Recession of 2008 (and 2009!).

Auto Sales
First, to compare latest auto sales data with some of my earlier thoughts.

Back on November 17, I commented about 2009 auto sales; "If 2009 was to average 900,000 vehicles per month, i.e. 60,000 a month higher than October 2008 sales, total sales for 2009 would be 10.8m, a further fall of 20% on 2008 sales and a reduction of 40% in two years."

I repeated my prediction of 10.8m units for 2009 in December, with my personal pick "that December sales will be no better than November of 747,000. However, the total sales for 2008 may still just scrape over 13.00m".

December sales are now available. To me, they were surprisingly better than November at 895,000 although still down 35% on 2007.

Total 2008 sales were 13.24m, down from 16.15m in 2007, a fall of 18%. However, the fall of 18% does not tell the story, as sales were severely lower in the last quarter. In OND total sales were 2.48m units, an annual rate of 9.92m units, or an average of 827,000 per month over OND.

The market has made up its own mind about the prospects for the survival of Chrysler and is voting with its feet. December sales for Chrysler were down 53% on 2007.

Amongst, the gloomy auto sales, one can note that Rolls-Royce sales in North America, were up 6.9% for December 2008 over 2007, and up 27% for the full 2008 year! However, there is probably a lead time lag here!

In their "bail-out" plans to Congress, the major US manufacturers projected 2009 unit sales as follows;
Chrysler - 11.1m
Ford - 12.5m
GM - 12.0m

GM also said it would to" seek extra back-up assistance in case adverse conditions continue and sales only reach 10.5m in 2009".

I will stick with my last November projection, for 2009 sales of 900,000 per month, that is 10.8m for the 2009 year.

Thus GM will be back for more money, as will Chrysler. Whether they get any, will be interesting!

I cannot see there still being three manufacturers by December 2009.

House values and the stimulus package
I noted the other day that the average value of a home in the US has fallen to $181,000. That is a fall of around 5% since September 2008.

Given that, as another blow to consumer confidence, the rising unemployment, and continuing share market uncertainty, I cannot see the proposed stimulus package doing any good. Most commentators are expecting it to give the ec0nomy a "shot in the arm", but my understanding is that a bullet "shot in the arm," will leave a big exit wound and a lot of damage!

The name of the game is consumer confidence, and the only real thing that will resolve that is time. Yes, job security is a factor, but if consumers receive any cash or rebate as part of the stimulus, the money will either go to pay their most urgent credit card debt, or be banked.

Bank Lending and the TARP
There is a lot of uninformed comment about banks receiving TARP money and not lending it. I have commented in previous posts about bank leverage, but will try and explain again, using a simple example.

In simple terms, banks typically lend up to ten times the value of their equity, to keep a Reserve Ratio of say 10%. Reserve ratios have to remain above certain prudent limits by law and/or by the terms of borrowing that a bank has entered into itself, when receiving funds.

1.a Thus, and call them millions or billions of dollars as you please, but a bank might then have;

Equity and retained profits invested in the bank - $10,000
Borrowings and customer deposits with the bank - $90,000
All assets (including loans to bank customers) - $100,000
With a Reserve Ratio of 10% ($10,000 equity divided by $100,000 assets)

1.b Then if the bank loses $5,000 on a major loan or investment, the balance sheet changes to;

Equity and retained profits invested in the bank - $5,000
Borrowings and customer deposits with the bank - $90,000
All assets (including loans to bank customers) - $95,000
With a Reserve Ratio of 5.26% ($5000 divided by $95,000)


At this point the bank has breached its Reserve Ratio and has two broad options.

2.a To seek extra capital or TARP money of $5000, to restore Equity and retained profits to $10,000 and Assets to $100,000 and achieve a Reserve Ratio of 10.0%

Equity and retained profits invested in the bank - $10,000
Borrowings and customer deposits with the bank - $90,000
All assets (including loans to bank customers) - $100,000
With a Reserve Ratio of 10% ($10,000 divided by $100,000)

2.b Alternatively, to reduce assets from $95,000 to $50,000 and use the $45,000 of cash to reduce its borrowings to $45,000. Thus;

Equity and retained profits invested in the bank - $5,000
Borrowings and customer deposits with the bank - $45,000
All assets (including loans to bank customers) - $50,000
With a Reserve Ratio of 10% ($5,000 divided by $50,000)

Normally, losses will not be this great in proportion to equity, and any losses will be covered by a mix of new equity and down-sizing.

But 2008 has not been normal! Relating the above to the financial sector during 2008, banks like Lehmans found that their losses were greater than the total of their equity, and no other bank was prepared to buy all their remaining assets. Thus, Lehmans remaining assets were sold piece-meal at distressed prices.

For the surviving major banks, as in the example above, the TARP money has provided part of the replacement equity to restore the Reserve Ratio to 10.0%.

However, the crux of the matter is that by restoring equity to $10,000 above, only allows the bank to retain its total assets at $100,000.

Given the financial squeeze on most borrowers, some of those existing assets will have fallen behind in their repayment schedules. Thus, any TARP cash is most unlikely to add to a bank's net positive net cash. As such there is very little scope for a bank to use TARP money to make new loans or to acquire other banks.

All that has happened, is that the bank's health has been restored, so it can continue to exist and to serve existing customers, without having to undertake a massive downsizing.

Some banks have merged with Federal encouragement and then found purchased assets were worth less than was expected, giving a new round of problems similar to the above, for example, see Banks Need More TARP Money To Save Them: Analysts