The Case Against the Obama Taxes

Yesterday, President Obama proposed a tax plan.  George Shultz has replied: “rich people and large companies like General Electric Co. are the beneficiaries of a complicated tax system.”

“It’s wealthy people and the GEs of the world that know how to manipulate these preferences and get their tax rates down,” said George Shultz, an economist and former dean of the University of Chicago’s business school. “The average Joe doesn’t have access to those lawyers.”

George Shultz, also former United States Secretary of the Treasury and Secretary of State, made this statement in an interview with Bloomberg press when arguing for a complete change in the tax code to reflect the realities of the 2010s. (http://www.bloomberg.com/news/2011-09-20/shultz-says-it-s-time-to-clean-house-with-u-s-tax-code-to-boost-economy.html)

One could also say the same thing when referring to the ability of “wealthy people and the GEs of the world” to handle the inflationary environment created by governments that are aiming to sustain “high levels of employment” as designated by the full employment objectives of the United States and many other western nations. 

The wealthy and the large corporations can protect themselves or even benefit from inflation.  The “average Joe” cannot do this.  In fact, the “average Joe” ultimately “gets screwed” from inflationary policies aimed at keeping him employed.  Having under-employment rates in the 20 percent plus range is not what was planned as policies of credit inflation dominated the past 50 years. 

Furthermore, credit inflation creates a wonderful stage for financial innovation, shifting jobs from manufacturing and production to financial services and other support industries…like the legal profession.  We can only look at the shift in jobs in the United States over the past fifty years to see the consequences of this development.

The financial innovation of the last fifty years points to another change in the world that not only allowed the financial innovation to take place but provides insight into the world of the future.  The change I am writing about is the advent of the Age of Information.  Financial innovation thrived upon the new technology and the new technology was underwritten by the growth of the financial innovation. 

“Wealthy people and the GEs of the world” (along with the JPMorgan’s, Goldman-Sachs, and others) are able to use this technology “to manipulate” things so as to benefit themselves as much as possible.  They have the tools.  Why did GE come to earn two-thirds of its profits from its finance wing?  And, the same can be said for General Motors and many other “manufacturing” companies. 

And, people are concerned about the fact that over the past fifty years the income/wealth distribution of the United States became so skewed toward the rich.  The credit inflation and social policies of the past fifty years created the conditions for those that could “manipulate” things and get their tax rates down and profit from the inflationary environment that was created by the politicians. 

The “average Joe”? 

The “average Joe” could do little or nothing.  If he “stayed employed”, kept the job at which he was already working, he fell behind.  The “average Joe” needed to become educated, needed to become more technologically savvy, needed to find the “lawyers” and financial advisors to “manipulate” the system.  But, that was not the way the incentives were aligned!

Unfortunately, the objective of the politician does not mesh with that of “the average Joe.”  The objective of the politician is to get elected and then to get re-elected.  Consequently, laws and regulations aimed at keeping “Joe” fully employed in his current job have been crucial.  Empathy with “Joe” was good politics.  The fact that “Joe” was constantly falling behind was not the issue.

The world has changed.  Yet, we can’t seem to get away from the same election strategies that have been followed over the past fifty years.  In my mind, we are going through a cultural shift that is painful and disturbing.  It is a shift that is going to take place, one way or another, and just pursuing the same goals over and over will only exacerbate the pain and the disturbance over time.  And, the constant advancements of information technology will just add to this.  

Shultz is arguing that the “Tax Reform Act of 1986” needs to be revised and reformed, not extended and made more complex.  He argues that “a simplification of the code would allow Congress to lower rates on a ‘revenue-neutral’ basis, while economic expansion would boost tax receipts.

“You’ll get a gusher,” Shultz said. “If you get this kind of stimulative tax policy and other things into effect, there will be a response and revenue will come in.”

 It seems as if “wealthy people and the GEs of the world” will play ball with you when they feel that they are not being singled out and picked on.  Otherwise, out will come the lawyers and the financial advisors and we get results similar to the ones described above.  The problem is that in proposing these changes in the tax codes as Obama has done or creating an environment of inflation, things just don’t stay the same. 

The politician is subject to the same fallacy that is faced by the economist conducting his deductive reasoning.  It is the problem of “ceteris paribus”, the assumption that “all else stays the same.”   When you change the tax code or the inflationary environment, all else does not remain the same.  As a result, you often find yourself facing the problem of “unintended consequences.”  You get results that you didn’t intend to get.  In the case of the economic policy over the past fifty years, you get higher levels of employment and under-employment than you wanted and greater inequality in the distribution of income/wealth. 

The current Obama tax plan is a journey into the past.

Merger Trend Heats Up

For the last 18 months or so, I have believed that one of the most important factors affecting the American (and world) economy would be a growing number of mergers and acquisitions. Individuals at Credit Suisse Group AG estimate that “The value of global takeovers may increase 15 percent to 20 percent this year, extending a 27 percent rebound in 2010.” (http://www.bloomberg.com/news/2011-03-30/new-deal-rush-pushes-takeovers-to-most-expensive-since-lehman.html) Not only is the economy growing (however modestly) but the better off corporations have lots and lots of cash assets, borrowing costs are exceedingly low, and there are lots of other corporations that are not so well off and whose best outcome is to be acquired by someone larger and healthier. Last week the AT&T and T-Mobile deal was announced. Recently we have also had deals announced by Duke Energy Corporation and Deutsche Boerse AG. And, yesterday, Canada’s Valeant Pharmaceuticals International put out a hostile offer for Cephalon, Inc. General Electric has engaged in a string of acquisitions, the most recent one was just announced, a $3.2 billion deal for GE to acquire the French company Converteam. And, there are many others. Deals are also taking place in the commercial banking industry. Although there were 157 banks closed in 2010, the number of banks in the industry fell by 310 indicating that lots of acquisitions were going on behind the information relating to the regulatory closures taking place. And, the big companies are getting bigger. The prices of an acquisition are rising. In the first quarter of this year, the price of an acquisition reached the highest level since before the collapse of Lehman Brothers Holdings, Inc. There are three aspects of this activity that are important for our future. First, consolidations are taking place across virtually all industries. There are many targets “out there” and companies with lots of cash and lots of borrowing power are “on the prowl.” This activity will have two effects on economic growth. In the short run, consolidations slow down economic growth because they lead to a rationalization of industry where plants and offices are closed and people are let go. Over the longer run, productivity increases as organizations become more efficient and effective producers of goods and services. Second, companies that have built up too much debt are in the process of deleveraging and, at the same time, are spinning off some of the subsidiaries they acquired with the debt. Thus, firms are getting back to more manageable levels of debt in their capital structure and they are also returning their operational focus to their core businesses. Both of these moves will also tend to keep economic growth from speeding up in the near future. The reduction in the debt of these companies will not be replaced in the near future and this will moderate the increase in bank lending and other corporate borrowing. Furthermore, the return of companies to their core businesses tends to result in the closing of plants and offices and the reduction in the number of people these companies employ. Third, investors will have the opportunity to participate in the restructuring of the economy that is now taking place. However, investors must be careful because not all acquiring companies are equal and not all acquisitions will turn out well. The current merger and acquisition boom is still in its early stages. As such, premiums received by selling companies are low, “the lowest since the third quarter of 2007.” Premiums are always low at the start of an M&A boom! Yet, not all deals are attractive to investors. Whereas AT&T stock has climbed 7.6 percent since it disclosed the T-Mobile deal and Valeant Pharmaceuticals stock jumped 15 percent late yesterday on the news of its bid for Cephalon, other transactions have not fared so well. If there is a chance to participate in this investment swing, it is now, when the purchase premiums are low. These will rise, and in the typical cycle, the rise will approach a level in which all new M&A deals are suspect. How soon the rise will occur is, of course, problematic. With so much cash on company balance sheets and the Federal Reserve holding market interest rates so low, one could imagine that the bidding could become pretty hot. But even if the bidding becomes “hot” this will not do much good for the economy in the short run because consolidations and the rationalizing of companies will result in plant and office closings and the laying off of people. It will also result in big companies (and big banks) getting bigger.

Discipline, Especially Related to Financial Discipline, is a Bad Word

What appears as the lead in the Huffington Post this morning?

“What a Waste: Companies Using Piles of Cash to Buy Back Stock, Not Generate Jobs!” This headline points to an article in the Washington Post: http://www.washingtonpost.com/wp-dyn/content/article/2010/10/06/AR2010100606772.html?hpid=topnews.

It was the lack of discipline that got this country where it is now. The recipe that some people are pushing for is “more of the same!”

The United States has been a show case for the “lack of discipline” over the last fifty years. The credit inflation initiated by the federal government has grown and expanded to almost every sector of the economy. Almost everyone, public and private, has leveraged up to the hilt over this time period.

The question remains: did we reach levels of debt that were unsustainable and had to be reduced?

Other questions follow: Have we misdirected resources in ways that have left one out of every five people of employment age untrained for employment in today’s workforce? Have we, like Japan, created surplus capacity in industry through fiscal stimulus and excessively low interest rates? Have we provided incentives that the wealthy can take advantage of, which the less-well-off cannot?

And, the problems swirl around us.

Elizabeth Warren pointed to the 3,000 commercial banks in the United States that are seriously in trouble and face enormous pressures due to the commercial real estate loans that are coming due or re-pricing over the next 12 to 18 months.

There have been numerous articles over the past week or so about the fiscal woes that cities face. (See the New York Times article “Fiscal Woes Deepening for Cities, Report Says”: http://www.nytimes.com/2010/10/07/us/07cities.html?ref=todayspaper.)

“The nation’s cities are in their worst fiscal shape in at least a quarter of a century and have probably not yet hit the bottom of their slide,” states a report by the National League of Cities.

What about the financial health of the states? “Right now there isn’t really anywhere to turn” as many states are now cutting aid to cities, says Christopher Hoene, one of the authors of the report. “The state budgets are in a position where they are more likely to hurt than to help.”

And, this doesn’t get into the problems individuals are having holding onto their jobs or homes.

Who seems to be doing well and positioning themselves to move into the future? Well it seems as if large companies and large banks are doing all the positioning at the present time. (See my post http://seekingalpha.com/article/228507-corporations-are-hoarding-cash-and-keeping-their-powder-dry.) Corporations buy back stock to better position themselves for future moves in the acquisition area. A higher stock price gives them more bargaining power when they are negotiating a “for-stock” transaction.

We are just seeing the tip of this iceberg. In August, acquisitions were unusually high in the manufacturing area for this time of year. We have not seen the September figures yet, but we are seeing lots of movement.

How can one doubt this movement with headlines like this one that appeared this morning in the Wall Street Journal: “GE Goes On Binge For Deals” (http://professional.wsj.com/article/SB10001424052748703735804575535872986083474.html?mod=ITP_marketplace_0&mg=reno-wsj).

In the article, John Krenicki, chief executive of GE Energy is quoted as saying, “This is another sign we’re playing offense.” There are “lots of choices organically and inorganically to grow the business.”

The article goes on: “GE Vice Chairman John Rice said last month the company has the firepower to spend about $30 billion on acquisitions over the next two to three years.” He added, however, that “we’re not going to run out and buy something just for the sake of buying it.”

But, this is not going to add jobs to the economy and it is not going to produce a lot of investment expenditures, both of which would help to spur on an economic recovery.

The United States is re-structuring. It appears as if more discipline is being exercised by those in a position to move forward. It also appears that those that are “under water” are scrambling to get their lives back under control.

The correction will not be comfortable or easy. But, calls for people and businesses to forget their efforts to bring discipline back into their lives will just postpone the fact that discipline will, at some time, have to be brought back into their lives. In fact, we may have reached the point where there is no going back…the thrust of the last 50 years may not be able to be sustained…and discipline will be re-established.

There is no question that this re-structuring is going to be very, very hard on some people. But, that is why one needs to be disciplined in what one does, even in the go-go years. Getting back the discipline is always hard. Perhaps the hardest part is to realize is that some, in the go-go years, were pushed to go beyond what they could really achieve at the time: these individuals were given incentives to put aside their discipline with the impression that their lack of discipline would not come back to haunt them.

The lesson that apparently needs to be learned over and over again is that, ultimately, a lack of discipline catches up with you. Discipline then has to be re-established. Re-establishing discipline is painful. But, there is no such thing as a free lunch.

Households and the Debt Problem

The Federal Reserve released new data on the financial condition of the household sector of the United States. Like other sectors of the economy, the financial condition of this sector has deteriorated over the past year.

The value of household assets dropped about 15% falling from $77.3 trillion to around $65.7 trillion. Most of the decline came from the fall in housing values and in their stock market portfolios.

In terms of household holdings of stocks, the value of the stocks households owned, mutual funds that were held and funds in retirement plans, the loss was $8.5 trillion. That is, the value of stock holdings fell from $20.6 trillion to $12.1 trillion.

Although mortgage credit fell during the year, total household liabilities stayed roughly the same at about $14.2 trillion. This means that debt as a percentage of assets rose from around 18% to 22% during the year (or net worth as a percentage of assets dropped from 82% to 78%).

Mortgage credit at the end of 2008 was $10.5 trillion so that other household liabilities totaled around $3.7 trillion, with consumer credit making up $2.6 trillion of this latter number. Mortgage credit fell during the year, but not because the household sector was trying to get out of mortgage debt. The primary reason for the decline was foreclosures and the reduction in the willingness of financial institutions to lend.

What this means is that households took on increased leverage during the year, not because they wanted to in order to grow their balance sheets, but because of the decrease in the value of their assets and because of the need to borrow due to lower incomes. The increased leverage was a result of the collapse of the mortgage market, in particular, and the economy, in general. The increased leverage just happened—it was not planned.

In order to protect themselves in the face of these changes, households moved assets into cash and cash equivalent accounts. Banks deposits held by households were at about $7.7 trillion at year end.

This is important information for understanding the state of the economy and the contribution the household sector might make toward turning the economy around. The household sector was in free fall in 2008 and was reacting to events, not leading them.

Households took three major shocks last year: first was the decline in housing prices; the second was the rise in unemployment; and the third was the fall in the stock market. Not only was their cash flow significantly hurt, but the value of their assets fell precipitously. They borrowed in an effort to hold on and they became more liquid so as to be prepared for that “rainy day.”

The year 2009 does not look any better than 2008. Housing prices continue to plummet. The stock market has dropped since the first of the year. And, unemployment has ratcheted up. That is, one can assume that the direction observed in the balance sheets of American household in 2008 will continue to be followed this year. Even if the stock market were to stabilize or rise through the rest of the year consumer spending, I believe, will continue to be weak. Even if housing prices stabilize. Even with the implementation of the Obama stimulus plan.

According to the best information we have there are three further shocks looming on the horizon. The first two have to do with the mortgage market: over the next 18 a large amount of Alt-A and Options mortgages are supposed to re-price. Given the weakness in employment that is expected to continue and the lower household incomes, this event could be devastating. And, on top of that credit card delinquencies are rising and these are expected to grow given the financial condition of the household sector.

Consumers will continue to withdraw from the marketplace as they add debt where they can in order to maintain at least a part of their former living standards. Also, consumers will continue to try and become more liquid so that they can be prepared should they need to need cash to tide them over a rough time. Any improvement in the stock market will be met with households selling more stock so as to move the funds into more liquid assets, the rise in the market making it easier for them to get rid of stocks—even at a loss.

And where are the funds going to go that come to households from the Obama recovery plan? My guess is that a good portion of them will go into liquid assets, or into paying down debt. Households are scared right now. They are going to use whatever they have as conservatively as possible. This even goes for those that have some security in their employment condition.

The data that are coming out confirm the strength of the problem that the policy makers face. The United States has a tremendous debt overhang. This debt problem is going to have to be worked off. Economists talk about “the paradox of thrift”, the problem that consumers are not spending at this time and probably will not spend much in the near future, even though if everyone opened up their pocketbooks and spent, everyone would be better off.

This situation is like a “Prisoner’s Dilemma” game. If everyone else increases their spending reducing their savings and, willingly, increasing their debt and I don’t follow their lead, then I will be a lot better off that all these other people. But, if everyone else believes as I do and doesn’t reduce their savings and doesn’t increase their debt, then I end up losing big to everyone else. So, as in the “Prisoner’s Dilemma” everyone defaults to the decision to save more where they can and to pay off their debt. The consequence of this will be that consumer spending will remain weak and much effort will be extended, where possible, to work themselves out of debt.

The overall problem is that there is too much debt outstanding. The policy makers are focusing upon stimulating the economy by increasing spending. If the debt overhang is truly too great, then the stimulus package will only have a small multiplier effect on the economy as households try and get their balance sheets back in some kind of order.

Such behavior will not have much affect on the economy, and it will also not have much affect on the stock market. Government policy makers must direct more attention to resolving this debt problem. It seems to me that this is what the financial markets are trying to tell them. As Citigroup and Bank of America claim they are showing some signs of profitability. As General Electric survives a reduction in its credit rating, meaning that GE Capital has more of a chance to re-structure itself. As General Motors indicates that it has reduced costs sufficiently to rescind the request for another $2 billion from the government in March. And, as other financial institutions seek to repay to TARP money they had received last fall, the stock market rebounds.

It is the debt problem that is the big concern of the financial markets. In my opinion, as long as the government policy makers put their primary focus on stimulating spending, the financial markets—and the economy—will continue to flounder. When they refocus on the more crucial problem they will find that the financial markets will be more supportive of what they are doing.

The Citigroup "Rally"

The performance of the stock market today, March 10, 2009, I believe, provides us with a clear indication of what is predominantly on the minds of investors. The major concern of investors is the value of the assets that are carried by companies on their books, and especially on the asset values on the balance sheets of financial institutions.

I say this because Citigroup has been the “poster child” of what most investors feel is wrong with the financial markets and the economy. The perception is that Citigroup is so weighed down by assets that are not performing and that must be written down that there is little or no hope for its survival outside of a full takeover by the United States government.

Focus has been so strongly focused on the “asset problem” that other institutions, like Bank of America and JP Morgan Chase & Co., have also been affected with concerns about the value of their assets. As a consequence, the stock price of these and other financial institutions have declined drastically due to the uncertainty as to whether or not they are solvent.

The stock market took off right from the opening bell this morning. The cause—a memo written by Vikram Pandit, the chief executive officer of Citigroup, to employees of his organization indicating that Citigroup had been profitable for the first two months of 2009 and was likely to turn a profit for the first quarter of the year. If this happens it will be a sharp turnaround in performance for the company, a move to the black after five consecutive quarterly losses.

There was no indication about any special write-offs or credit losses, but the memo gave hope to the idea that Citigroup, even after such write-downs, would post a profit for the first quarter.

The hope that was forthcoming, I believe, is the hope that Citigroup will now be operationally in the black going forward and that this kind of performance would give them the time and cushion to continue to work off bad assets and take more modest charge-offs against profits in the future.

The hope is certainly not that Citigroup is “out-of-the-woods.” That would be too much to hope for. To me, what is captured in the market response is that Citi may still have time and not be forced into some precipitous governmental takeover action.

Now, let me say that this was just one day and just one piece of action released by someone that needs, in the worst way, to give some sort of encouragement to his troops. Tomorrow is another day and there will be more information and more market maneuvering in the future. But, it was a day in which there was a possibility for hope—no matter have small that hope might be.

The problem had been that investors had perceived asset values declining with no bottom to be seen. And, there was no one or no event in sight that might put a stop to this decline.

This is why I believe that the financial markets have not been giving President Obama and his team “good grades” on their efforts to craft an economic policy and a bank rescue bill. The economic recovery plan was proposed and passed by Congress, yet there was no “bounce” in the market due to this program. So far, any bank rescue bill talked about or outlined has been deemed a dud.

It is this latter failure that the financial markets have been reacting to. To the financial markets the concern over asset values has dominated everything else. The recovery plan does not address this issue and so does not provide any confidence to investors over possible bankruptcies and takeovers related to institutions that are insolvent due to the bad assets on their books. Expenditures on infrastructure and education and health care and so on are one thing, but a stimulus package like the one that passed Congress cannot prevent a collapse of the financial system as the value of assets plummet and are recognized.

And, so the memo relating to the two-month performance of Citigroup hit the market and gave investors some encouragement that there might be some possibility that the problem related to asset values maybe…just maybe…could be worked out. And this attitude spread to other companies and other areas in the stock market.

We see that the stock of Bank of America Corp. rose 28 percent, the stock of JPMorgan Chase & Co. rose 23 percent, and the stocks of PNC Financial Services and Morgan Stanley increased by double digit numbers. Of especial interest is that the stock of GE rose by 20 percent reflecting the spillover of the positive attitude given to the banks was also given to GE and the concern over the fate of GE Capital.

Again, all of these companies have seen the price of their stocks decline in the past six months or so because of the concern over the value of their assets.

As mentioned, stocks rose from the opening bell, seemingly responding to the contents of the Pandit memo. But, the market responded to other news that they interpreted in a positive manner.

Fed Chairman Ben Bernanke gave a speech that reinforced the “good news” coming out of Citigroup. In this speech, Bernanke discussed the need for moving onto a new regulatory system. The part of his statement that market participants focused upon was Bernanke’s claim that the accounting rules that govern how companies value their assets needed to be changed. The Fed Chairman was careful to say that he did not believe that the mark-to-market accounting rules should be changed. Still he did talk about how asset values should be treated and investors reacted to this in a positive way. Again, the focus of the market was on asset values and little else.

There was one other bit of news that the financial markets reacted to in a positive way and that was the comment of Barney Frank about the “up-tick” rule. This statement, although important in itself, was only a side-show in the movement of the stock market today. Its just that when the good news is poring in, look out!

The important take away about the performance of the stock market today is that the major focus of the investment community is on the value of the assets on the balance sheets of banks and other organizations in this country. This message should be read loud and clear by the Obama administration. Spending plans are fine, but the recovery of the country depends very heavily on what is done about the value of the assets on the books of banks and other organizations and how losses in value are going to be worked off.

This is important too because of what is on coming in the future. It seems as if the credit problem is going to accelerate as the defaults rise on credit card debt, as interest rates need to be reset on Alt-A and option payment mortgages over the next 18 months or so, and the looming bust in the commercial real estate market. The asset value issue is not going to go away soon.

So, we got a rise in the stock market. We may get several more in the next week or so. I don’t believe anyone can predict the movement in the stock market over the coming six months. There are still too many uncertainties. And, even if the stock market were to rise over the next six months, my bet is that the asset valuation problem is still going to be with us. And, in all likelihood it will still be with us next year at this time.

A Case Study in Unknown Asset Values: A. I. G.

My blog of March 1, 2009, “Uncertain Asset Values and the Stock Market” (http://maseportfolio.blogspot.com/), was written before the most recent news surfaced about the continuing bailout of A. I. G. I believe that the example of A. I. G. represents a perfect ‘test case’ for what was presented in that post.

The March 1 blog contended that the major uncertainty facing the investment community…and the Federal Government…is the value of assets on the books of many of the nations businesses…especially many large and important firms that are “too big to fail.” The argument is that this uncertainty has to be cleared up as much as possible before the economy is really going to have a chance to regain its health.

The problem now is that not only are companies withholding information from the investing public…but the government is also withholding information from the investing public. Specifically, companies…and the government…are afraid to release information on who they are dealing with…the “web of counterparties”…because of their concern that the release of these names would cause a panic leading to deposit withdrawals or the cashing in of insurance policies and so forth.

This is the old “after-the-fact” problem. I used to be a part of “information sessions” for journalists to help them understand banking and the issues that surrounded the banking industry. One of the concerns that always came up at these sessions was about what responsibilities “the press” had in reporting on troubled banks. That is, if a journalist “knew” that a bank was in trouble…what responsibility did that person have to report that the bank was having problems…and thus, perhaps, cause a “run” on the bank.

This is an “after-the-fact” problem. The bank is already a troubled bank…now what do I do?

One of the arguments I made was that journalists should keep up closely enough with banks to report when banks were starting to experience difficulties. By making this information public, the press could help prevent the bank getting too far into a mess because it would want to avoid the bad publicity and work to rectify the difficulties before they got “out-of-hand.”

This, of course, was very difficult because of the insufficient reporting requirements applied to banks and the secrecy surrounding the regulatory examinations. And, if banks knew that they were being scrutinized that closely by “the press” they would certainty make it just that much more difficult for the “outsiders” to obtain information.

So, investors and communities had little information on financial institutions that were important to them and had to “trust” the regulatory agencies to apply the appropriate oversight to the banking system. Of course, the regulatory agencies did not always have “full information”, especially as the financial conglomerates began transacting in very sophisticated derivative securities and taking many assets “off balance sheet.”

I believe that the company A. I. G. is a striking picture of how this scenario played out. A. I. G. is a holding company that began as an insurance company and then diversified itself into a financial conglomerate that included a hedge fund and other “black box” investment vehicles. Their primary regulators were the state insurance regulators (and some international regulatory requirements) and the state laws caused the subsidiaries to be highly segregated so as to ensure the safety of those the insurance subsidiary had insured.

The rest of the company was not regulated to any degree. As a consequence, A. I. G. was able to build up a huge financial conglomerate that could engage in untold transactions that were both un-regulated…and un-disclosed! The accounting and reporting rules were such that investors…and the public…and the government…and even other areas within the company did not have any idea about the risk exposure of the holding company or the “spider-web” of relationships that made it a potential “carrier of contagion.”

And, we…and the government…still don’t know what the potential damage could be from this dismal situation!

As a consequence, the probability of a fifth (this last bailout was the fourth return to A. I. G.) is a lot higher than we would like it to be. And a sixth? And a seventh?

With the government owning almost 80% of the company it would seem like any additional funds would be relatively small.

But, that is the problem…we don’t know! No one seems to have a handle on the value of the A. I. G. assets!

And, as I argued in “Uncertain Asset Values and the Stock Market”, this problem exists throughout the economy. What about the assets of Citigroup? What about the assets of Bank of America? Again, to quote the earlier blog, “It is not altogether clear that even the people running a large part of this economy have any idea about the value of their own assets.” Again, I take A. I. G. as the example.

And, then we have General Electric…and the problems of GE Capital. Again…we have another conglomerate with few pieces that go together. For years, GE Capital carried the rest of General Electric. And, what happens if you have one subsidiary making up for the “not-so-good” performance of other subsidiaries? You put more and more pressure on the performing subsidiary to produce exceptional results. And, how do you do that? You take riskier assets into your portfolio and you increase leverage. Simple!

Now, GE Capital is suffering along with other financial companies that attempted to extend “exceptional” returns. And, with GE Capital failing to perform…the spotlight is being focused on all the other subsidiaries that were only mediocre performers. Consequently, General Electric must face the value of ALL of its companies and determine what are the asset values under its umbrella.

This, to me, is the picture that is unfolding…and the problems we face are not going to be resolved until we get a better grasp on asset values. But, we need to do this quickly because…and this is the problem of bad assets…the value keeps dropping if the difficulties are not resolved. This is true of bad assets in an individual institution…I saw this over and over again in the banks I helped turnaround…and it is true with the financial and economic system. In fact, that is the problem with a contagion…bad assets tend to play off of bad assets…and the difficulties cumulate. This is all the more reason for attempting to get a handle on asset values as soon as possible.

A $787 billion economic recovery plan is insufficient to overcome the possibilities of a multi-trillion dollar write-down of assets!