Bailouts drive Chapter 11 out of fashion

When Robert Reich published Supercapitalism: The Transformation of Business, Democracy, and Everyday Life in 2007, the U.S. economy was growing, the financial sector was intact, and the housing bubble had just begun to leak. Although that now seems like decades ago, the former Secretary of Labor’s core argument still has a decidedly clear ring of truth; indeed, perhaps now more than ever. Reich is currently professor of public policy at the University of California at Berkeley’s Goldman School of Public Policy.

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Now I read a fantastic interview S+B's Ed Baker had with Reich... Excerpts -

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"Why should Wall Street executives, shareholders, and creditors come out any better from this taxpayer-supported bailout than they would under a typical Chapter 11 reorganization, where they would get relief from a portion of their debts and bad loans, but not all of them, and they would have to restructure compensation, management, and governance procedures? Despite the bailout — and the relatively easy course that Wall Street has enjoyed — Main Street is still suffering: People are losing their homes at a faster rate than they did before. Small businesses can’t get loans, creditworthy car buyers and others are seeing credit lines shrivel and disappear. So from the standpoint of average Americans, the bailout has had no positive effect whatsoever.

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Frankly, I don’t quite understand why Lehman didn’t go into Chapter 11. Now, maybe it was too small, or it wasn’t prepared to go into Chapter 11. But in general I don’t see why Wall Street firms are in any greater danger of Chapter 7 liquidation when they can’t pay their bills than any company in the real economy. Even Citigroup: Presumably it is worth more alive than dead. Its creditors would much rather that it stay afloat to pay off its loans than disappear completely. And it has a lot of assets — not necessarily physical assets, but a very strong customer base and a lot of talent. No one would support that it would cease to exist if it chose Chapter 11.

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S+B: So you see the contours of the bailout as little more than a successful marketing effort?

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REICH: It’s a giant public relations campaign. But I’m not sure that anyone consciously regards it as such. The Treasury Department traditionally has been Wall Street’s embassy in Washington. Treasury secretaries traditionally are closely allied with Wall Street. I’m sure Hank Paulson views Citibank or Morgan Stanley or his old hunting ground, Goldman Sachs, as profoundly different from a manufacturing company or another major services company. The funny thing is, I think that Paulson would be aghast to think of what he did as industrial policy. But of course that’s exactly what he did.

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[On reviving Big Three from Detroit] - Today, the management of the Big Three seems to believe that if they can only get through the recession, they’ll be fine. They view their challenge as primarily cyclical. They may be right technically, but they’re wrong over the long haul. Their challenge is structural. They’ve been losing market share for years, they’ve been producing cars that the public doesn’t want. Few young car buyers would ever think to buy an American car anymore. The Big Three have to come up with an entirely different vision of their industry and of their operations, and I hope that that is part of any bailout.

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S+B: Why has it taken Detroit so long to get this message, when it’s so obvious to so many people?

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REICH: The culture at the Big Three is very insular, for one thing. The invasion of Japanese carmakers into the U.S. to make vehicles shook up Detroit, and in response, the Big Three have made substantial improvements in quality. But management and labor are still living in a different age. They haven’t been shaken up nearly enough. Labor understands the situation probably better than management. The new UAW contract recognizes the need for substantial changes. Young workers will be coming into the Big Three with wage and benefit packages not all that different from what American workers are getting from the Japanese automakers. But there’s still a long way to go on the management side.

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Superb insights. Hope Obama and Tim Geithner read this before they push more bills to the Congress :-)

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Fishing for VCs

Throw a line into the Thames and likely you could net a VC.

VCs in UK warn hundreds of tech companies could shut shop if the government can’t come up with a £1bn ($1.4bn) fund of funds to support the sector.

As stock markets are in effect shut for initial public offerings, it adds pressure on venture capital firms. They must rely on trade buyers to achieve an exit from their investments, or finance them for longer. More than a third of UK venture capital groups expect to write off at least three investments this year due to lack of follow-on funding, a survey by Populus of 80 members of the BVCA found.

The survey said that 86 per cent had found it hard to raise secondary rounds of finance for their companies in the past six months. A similar number said portfolio companies still in product development stage would survive less than a year on cash reserves.

In San Francisco, earlier it just took a walk down the Sand Hill Road to land a VC. In UK, you need a boat and little fishing break is all it takes; you may not land the money though :-)

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The cut runs deep

So the US congress have agreed upon an economic stimulus plan. Now comes the real rocker - how to value bonds that have no takers?

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Getting this right will not be easy.

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The wild variations on the value of many bad bank assets can be seen by looking at one mortgage-backed bond recently analyzed by a division of S&P, the credit rating agency.

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The financial institution that owns the bond calculates the value at 97 cents on the dollar but S.& P. puts it at 87 cents, based on the current loan-default rate. It could be worth 53 cents under a bleaker situation if say, the defaults double. But even that might be optimistic, because the bond traded recently for just 38 cents on the dollar, reflecting the even gloomier outlook of investors.

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Both Washington and Wall Street ecognize that there are no current market prices for these toxic securities. But bond dealers say most kinds of securities can be valued and are being traded, but trading has slowed as sellers and buyers disagree about what that the price should be.

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The value of these securities is based on the future cash flow they provide to investors. To determine that, traders have to make assumptions about the housing market and the economy: How high will the unemployment rate go in the coming years? How many borrowers will default? What will homes be worth?"

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To them normally one would suggest go by the realizable value of underlying assets. But even that is a problem if the bond is backed by 9,000 second mortgages used by borrowers who put down little or no money to buy homes. Nearly a quarter of the loans are delinquent, and losses on defaulted mortgages are averaging 40 percent. The security once had a top rating, triple-A.

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Holy Fuck !!!