Perhaps that’s what you think when you read Money Morning each day.
But anyway, today we’re referring to something sent in by a reader.
Money Morning reader Paul sent us an email on Saturday saying, “Here we go again…” followed by a link to a Sydney Morning Herald article titled “GM to pay $A3.9b for auto financier”.
We share Paul’s thoughts, here we go again…
Or kind of. Except we’ll make the point that what Paul refers to never really stopped. By that I mean excessive leveraging. As we’ve written many times before, the so-called deleveraging in financial markets and household balance sheets has been a massive lie put about by those who want the borrowing gravy train to continue.
A cursory look at the statistics will show you that even where there has been a small decline in borrowing in one sector it has been more than made up for by borrowing in another.
But I encourage you to read the article for yourself. To be fair to the SMH, the paper has just syndicated an article written by the Associated Press, so we can’t really blame them for the journalistic, er, quality of the article.
But we can blame them for running such tosh.
I mean, take the opening paragraph:
“General Motors Co. will buy AmeriCredit Corp. for $US3.5 billion ($A3.93 billion), a deal that allows the automaker to expand loans to customers with poor credit and offer more leases, key areas where GM must grow to accelerate its car sales.”
When we read that your editor’s head literally slumped into our open hands. Expanding loans to customers with poor credit is a “key area” for GM? Oh Lordy! But it gets better, or is it worse? Anyway, read this:
“Only 4 percent of GM’s sales come from subprime buyers, which the company hopes to expand with its AmeriCredit acquisition. ‘If you just had a modest increase from 4 to 5 per cent, that’s a significant number it its own right,’ Liddell [GM's chief financial officer] told reporters.”
Because of course GM would stop when it gets to 5 per cent. That’s right, there wouldn’t be a temptation to increase it to 6, 7 or 10 per cent would there? No, of course not.
If you recall, General Motors had to be bailed out by the US government to the tune of nearly USD$60 billion less than two years ago.
Why did it need the bailout money in the first place? For many reasons. But chief among them were company killing retirement and redundancy funds.
On top of that it was building crappy cars which it then had to bribe customers to buy using the incentive of zero percent finance.
But even that wasn’t generating enough cash to keep the company solvent. Even that incentive couldn’t encourage enough chumps to stump up the cash for its crappy cars. So it had to provide incentives to those with low credit scores too.
How could that possibly fail? As we’re told repeatedly by the mainstream press, interest rates are never going up again so the increase in household debt won’t be a problem. Similarly, with a zero percent interest rate for the life of a car loan, it must be impossible for anyone to default because there is no interest rate risk for the borrower.
It didn’t happen like that though did it. Hence the USD$60 billion bailout.
But as I’ve mentioned above, the fact that GM is hoping to increase its exposure to subprime borrowers isn’t new, it’s just ramping things up a little further.
It goes to show you that despite the massive bailout, and despite the ‘cash for clunkers’ programme, the auto industry is a terrible business to invest in.
It shows you that without massive intervention by governments and without taking on company-busting risks, car companies live on wafer thin margins.
Even the Ford Motor Company [NYSE: F], which didn’t receive direct government handouts – but which did benefit indirectly thanks to the Obama ‘cash for clunkers’ programme – could only manage a USD$2.7 billion profit for the last financial year on the back of a massive USD$116 billion of sales.
Yet despite that it’s been enough to see the Ford share price more than double this year! We’d go as far to say that it’s become one of the darlings of the American stock market.
And now it seems the Australian auto industry is on the verge of getting yet more handouts.
Has Australia ever subsidised an industry more than it has the likes of Toyota, Ford, General Motors and Mitsubishi?
The latest ruse offered by Australia’s first unelected female prime minister is for a $2,000 taxpayer funded rebate for anyone who trades in a pre-1995 car in order to buy a fancy environmentally friendly car.
No prizes for guessing what’s going to happen to the price of used cars over the next couple of years.
Of course there are plenty of conditions attached to the handout. Such as you need to have been the owner of the traded in car for at least two years, and the car you buy has to meet a minimum ‘green’ standard.
There could be a nice little earner here for scrap yards to offer a warehousing service. Pay them a fee and they’ll store a crappy car for you, registered in your name for two years. Then when you ‘trade it in’ for a new car you’ll get the rebate.
But anyway, we’re sure the handout will be fully maxed out before long, with $2,000 of your tax dollars going straight from your wallet into the hands of your friendly neighbourhood car dealer.
However, it’s all for a good cause because apparently, according to the Australian Financial Review it’s going to “cut carbon dioxide emissions by 1 million tonnes and save $344 million in fuel costs in the next 10 years”.
Naturally that sounds like a lot. 1 million tonnes less of a gas which is unproven to be environmentally unfriendly, and $344 million in fuel savings.
But when you compare it to Australia’s total CO2 emissions as of 2007 of 374 million tonnes, the amount saved isn’t even a drop in the ocean. In fact it’s a paltry one quarter of one per cent.
And as for the $344 million in fuel savings. Savings for whom? According to the AFR the so-called Cleaner Car Rebate scheme will cost taxpayers $394 million.
So the fuel “savings” will actually be an additional cost to the tax payer of about $50 million.
It’s the old robbing Peter to pay Paul story that’s so typical of government interference.
Besides, who says the scheme will cut any emissions at all?
We’d like to know how the 1 million tonnes in CO2 savings has been calculated. Has it been calculated on a like for like replacement? In other words, based on the assumption that the owner of the spanking new Toyota Camry hybrid will drive the car exactly the same way as the crappy pre-1995 bomb.
From personal experience we’ll say that’s unlikely.
Prior to trading in our 1996 Hyundai Lantra Sportswagon (and very sporty it was too!), we would only drive the thing to work in Fitzroy from home in Frankston two or three times per week.
And each time we made the 40km journey in each direction, we did so in the knowledge that we were never sure we’d make it home without the help of the RACV. Every day was an adventure… hill starts especially!
But after we traded the bomb in for a spanking new hip-hop red (that’s the manufacturer’s description, not your editor’s) Hyundai Getz, guess what that’s done to our driving patterns?
Yep, you’ve guessed it, we now drive to work every day, and have only used public transport less than a handful of times since then.
And based on the so-called CO2 savings you’ll get from buying an eligible car such as the Toyota Camry hybrid, it won’t take that much of an increase in driving patterns to wipe out the CO2 savings.
Because according to the Toyota website:
“Hybrid Camry’s 2.4 litre engine produces 142 grams per kilometre of carbon dioxide. This is equivalent to a small car with a 1.3L engine. Compare this to petrol-engine cars in its class which produce up to 60% more CO2 per kilometre.”
So to put it simply, it’d only take a 60% increase in vehicle usage to completely offset any of the supposed gains. If your editor’s new car experience is anything to go by, the actual carbon dioxide savings are likely to be negligible.
Look, let’s admit it, we are in the middle of an election campaign. The whole point it seems of election campaigns is to outspend your opponent.
But hats off to the PM for coming up with a policy that combines savings, increased government expenditure, and a green policy all in one.
It’s the Holy Trinity of election policies. Forgive us if we don’t yell Hallelujah!
Cheers.
Kris Sayce
For Money Morning Australia
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bb – it’s not in a lenders interest to write bad loans, and there are laws against doing that knowingly.
In my experience most bad loans are as a result of deliberate misinformation provided by borrowers.
In short many borrowers lie to get a loan, and sometimes those lies are difficult to detect. If anything the laws are heavily weighted in favour of the borrowers with a lot of protection built in. Nevertheless some loans will go bad, but with an arrears rate of just 0.6% for home loans in Australia, accuracy rate of 99.4% is not bad.
What is your accuracy rate???
Drew – You are quite correct, of course. Such a situation would dampen and possibly kill any further upward movement in prices. What I was focusing on was that such a thing by itself would not mean that underwater borrowers, or their creditors, would be forced to eat debilitating losses, which was something that Faber’s argument seemed to have missed in connection with the risks of being heavily leveraged against property at a time when the market moves against you.
He seemed to lump property leveraging in with Margin Loan type leveraging, but there is a vast material difference between the two in that in the latter you do get hit with margin calls that put you under severe strain, whereas in the former case you do not receive margin calls, and you can simply continue servicing your loan and keeping your property whether you are underwater or not.
Hence, his simplified argument that appeals to the limiting cases of a wide and rich spectrum as regards leveraging and its dangers in times of market volatility, while successful at illustrating an important point, it is also misleading in its over-simplicity, and particularly where leverage against real estate is concerned, and especially concerning home ownership, where the only realistic avenue for the vast majority of people is to borrow upfront, and pay down the debt, bit by bit, over time.
This appears to be a major oversight in that entire interview on his part, especially since he uses it as a specific example of how one should not invest. I fundamentally disagree with that position. To recap: Firstly, only by using leverage do most people stand a realistic chance of ever owning their own homes. Secondly, residential mortgage products do not represent the sorts of risks he attributes to them due to market volatility. Thirdly, the vast majority of people would have Buckley’s chance in hell putting aside enough for their retirement without making use of some sort of leverage. Lastly, I would venture as far as saying that hardly anyone who has in fact managed to save enough to be self-sufficient in retirement would have done it without making use of some sort of leverage.
But, again, if one is to use leverage, then it should be of the safer kind, like in the form of a residentially secured mortgage. Otherwise, must employ tight loss limiting strategies, like stop loss orders. Also, leverage should not be excessive so as to put one right on the edge, but should be taken on with a degree of room to move if things get tight for a while. And finally, one should try to pay down the debt at the fastest realistic rate possible, something pointed out by Nick a while ago. And really really lastly, one should definitely not leverage oneself to the teeth like crazy, because such a thing is a sure recipe for being caught out. I probably repeated myself with that last one, but there you have it.
PF – That may be true, but you must excuse people being cynical. After all, none of that prevented USA subprime, where loans were being pushed by lenders and their agents, just so long as they twitched a little. This is undeniable, recorded history.
Was it in the banks interests to do that? Arguably, it was. The securitisation industry made a packet while the party lasted, and when the music stopped, they chief perpetrators knew that they had the best politicians money can buy right in their pockets for the greatest wealth transfer in history directly to them, in recompense for the greatest financial disaster they themselves have engineered.
Now, the question for us here, Downunder, is this: What is it to stop the very same scenario being repeated here?
agreed cb. Thanks for the clarification.
CB, am I on the wrong track to suggest that a highly leveraged margin position on which a bank takes a significant loss could have an impact on a mortgage customer of the same bank? I can understand the basic forward engineering that gets mew to that point; however you seem to look at the two independently. After watching the video, that’s the point that I thought Faber was making.
The whole idea that leveraging through mortgages is a fail-safe method of saving for retirement is not an immutable law if you ask me because we don’t understand the future environment well enough going forward. Personally, I think mortgage expenses should be treated as an expense. History teaches us that it is an expense that reaps benefits in the future. That probably won’t change, but you can’t necessarily take it for granted.
JC – I do think that you highlight a legitimate point, but which I do not think formed part of Faber’s argument. If a bank’s trading losses, or losses on mismanaged margin loans bring it to the brink of failure, it might conceivably try to call in its residential loans as a means of staying afloat. But, in fact, as PF pointed out, that would be quite counterproductive to do at a time when prices were in the gutter, as the recalls would only imperil the bank’s balance sheet even further. Selling an underwater home is no way to improve an already sick balance sheet.
So, again, I do not believe that this formed, or could plausibly form, part of Faber’s argument. Rather, I think that he simply missed to differentiate between different types of debt and leverage. He was clearly thinking of the types that had margin calls attached to them, and missed the fact that there are others that do not have that feature.
We, of the older generations, are all prone to have our senior moments, so that is what might have happened in this case. But even otherwise, at a time when too much debt is wrecking lives, it is all too easy to fall into an extreme frame of mind and declare all leverage to be dangerous. But, while true, it is no more true, in my view, than the fact that all driving is dangerous.
Of course it is, but whether one should sit behind the wheel should not be decided exclusively on the basis of dangers present in drink driving, which would be analogous to how Faber’s argument was made against using leverage as part of wealth creation. Wouldn’t you agree?
CB, all valid points but I still believe that the individual mortgagee is exposed to losses that may eventuate from significant margin call shocks, bank runs, and stock price collapses. Furthermore, mortgage lending does not operate in a bubble (excuse the pun) but there must be a connection to the wider macro-economic environment and financial shocks. History proves that. Perhaps I misinterpreted Faber’s perspective but it made sense to me in the context of inter-connectedness.
I respect Marc Faber but I often consider his perspectives as “markers,” not gospel truth. I would imagine that his clients are privy to more strategic information that what we don’t see on the internet. Furthermore, Faber has a huge client base among the mega-wealthy in Asia. With 30 years of experience working in Asia, Faber has been able to observe what you term as “using leverage as part of wealth creation” from a completely different angle.
cb @ 33 – I both understand and share that cynical response. In fact humans are always doomed to repeat their errors. Isn’t that what history teaches us.
But not for a while…..
JC – Yes, sure. Did you notice, but, a rather interesting line of argument Faber employed when he argued the poor prospects of any longer term investments in bonds? He pointed out that he knows many people who have become wealthy through investments in property, stocks, resources, etc., but not a single person who has become wealthy through investments in bonds. He used that argument to make a point, and a very good one, I thought, at that.
But now, I am going to repeat the same argument with regard to the use of leverage in wealth creation. All the people I am aware of that have created wealth of any consequence, have done so through the use of leverage. None, absolutely none of them have done it through sheer savings alone from current income. Now, admittedly, my personal knowledge and experience is extremely limited. I will bite the bullet, all the same, and challenge for demonstrable examples that will falsify my tentative hypothesis that this is most likely to be the rule, rather than the exemption.
CB, your point about creating wealth is well understood. I remember Faber once talking about how the most successful Chinese businesspeople have traditionally built businesses. They will focus on those businesses until they have paid for themselves and they are profitable. Only then will they begin on the next project. It’s a far cry to how we behave in the West (particularly in the Anglo-Saxon countries).
As for Joe building his wealth through leverage, historically I guess you’re right, particularly since post WWII. However, the purchase of a house or a stack of rentals doesn’t necessarily lead to instant wealth creation. In fact, I believe that the future could see the hollowing out of the investor base (particularly in the Anglo-Saxon countries), unless, of course, we return to serfdom (which cannot be ruled out entirely). I shudder to think what that could to our economy in the long term.
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