The Great Deformation

by David Stockman

  The real pyramid building in the Obama stimulus, of course, was the $20 billion or so for transit and light rail. Forty-five years of mucking around with the abomination known as Amtrak proves that cross-country passenger rail can never be economically viable because it cannot compete with air travel.

  Presently, every single ticket sold on the Sunset Limited from New Orleans to Los Angeles, for example, requires a $500 subsidy—more than coach airfares on the same route. Indeed, Amtrak’s long-distance routes account for only 15 percent of its passengers but 80 percent of its red ink; that is, about $1 billion in annual subsidies go to 4 million citizens who patronize Amtrak’s hopelessly uneconomic long-distance routes. These windfalls are dispensed without regard to ability to pay, but the intended beneficiaries are not the passengers anyway; the subsidies are meant to keep overpaid, feather-bedded union jobs on the Amtrak payroll.

  The only potentially viable part of the public rail dream relates to dense urban corridors between large and nearby urban centers: Philadelphia and New York City or Los Angeles and San Francisco. Yet if there is one truism about interurban light rail it is that it must be paid for by direct users and regional transit authorities from local taxation.

  This stems from the fact that the productivity benefits to business travelers in reduced travel time are modest, if even measurable. On the other hand, the potential to overbuild, overschedule, and overman these systems to the benefit of land speculators, developers, construction contractors, railcar suppliers, transit unions, and leisure travelers is enormous, most especially when much or all of the cost consists of other taxpayers’ money.

  Federal funding of interurban rail like the dozen projects started in the stimulus bill, therefore, is a sure-fire recipe for waste of scarce fiscal resources and reduced national productivity. This truth has been proven decisively by forty years of federal operating and capital subsidies for local mass transit. Time and again, systems have been overbuilt, money-losing lines have stayed open, transit union workers have gotten way overpaid, and local politicians have been encouraged to demagogue for more service and lower fares, and to demand Washington make up the shortfalls.

  From an economic equity viewpoint, the argument for federal funding of regional light rail is especially perverse. Most of it would be built in the highest income regions of the United States—California and the Eastern Seaboard—and paid for by taxpayers in the lower income and less densely populated interior. Worse still, this redistribution of fiscal resources from the poorer regions to the richer areas would incite still another giant Washington logrolling system.

  Indeed, chronic battles over tens of billions in regional transit funding would only further dissipate the nation’s capacity for fiscal governance, even as it undermined efficiency, accountability, and care in the local management and operation of these systems. Federal funding of regional rail is thus not a productive form of public investment. It is merely another excuse for deficit spending, and another opportunity for K Street to prosper at the expense of the innocent public.

  REACTIONARY WELFARE, PROGRESSIVE STYLE

  At the end of the day, the Obama stimulus bill was a massively wasteful and unaffordable tribute to the textbooks written long ago and in a different time by the vicar’s uncles. Yet the stampede on Capitol Hill and K Street to fill in the blanks on the stimulus napkin caused Washington to give short shrift to the true and urgent task under the circumstances; namely, the need to shore up and refocus the social safety net.

  Four years after the crisis, median family income has fallen by 10 percent in real terms. Likewise, as documented in chapter 31, the number of full-time breadwinner jobs in the US economy is still down by 5 million; that is, it is more than 8 percent below its late 2007 level. In short, the Main Street economy has been failing for years, and now the massive debt deflation under way will aggravate that condition enormously, leaving millions of citizens to depend upon intermittent employment in low-paying part-time jobs or to fall back on family, friends, charity, or nothing at all.

  Yet the total amount of funding for means-tested assistance in the Obama stimulus was just $28 billion, or 3.5 percent, of the $800 billion package. Funding for unneeded bridges, interchanges, and road repair got more money than the combined total for food stamps, the earned income tax credit, and federal grants for public assistance and WIC (the health and nutrition program for women, infants, and children). This outcome was telling because it demonstrates that trapped in its Keynesian fog, the nation’s so-called progressive party cannot see that the overwhelming task of national governance for years to come will be tending and funding the safety net. The challenge will be to systematically and forthrightly address the swelling level of human needs, but to do so in a manner that is stringently targeted on means-tested programs and which does not encourage dependency and freeloading.

  In fact, however, the de facto policy of the Obama stimulus and subsequent renewals has been to throw money at non-means-tested programs, particularly extended unemployment benefits and Social Security disability. Since September 2008, approximately $300 billion has been spent on unemployment insurance benefits but upward of one-third of that has gone to affluent workers laid off from jobs in finance, real estate, and other white-collar occupations or to two-earner families with high combined incomes. At the same time, there can be no doubt that ninety-nine weeks of benefits have been a deterrent to reemployment, even if in part-time jobs or lower-paying positions.

  Likewise, since the official end of the recession in June 2009 there have been 3.5 million new cases on the disability benefits rolls, a figure which towers over the 200,000 breadwinner jobs restored during that period, and which is nearly double the caseload growth rate prior to the crisis. In short, the disability benefit has become a backdoor safety net, and in the process is encouraging millions of desperate citizens to abuse the program and become permanent dependents of the state.

  Rather than retargeting resources through the earned income tax credit (EITC) or converting food stamps into a proper means-tested cash transfer system, however, the progressive policy agenda remains ensnared in a time warp; it digs Uncle Sam ever deeper into debt with stimulus boondoggles, and even justifies massive supplemental funding for grossly inefficient social insurance programs as a stimulus to consumer demand. Yet in the context of today’s crisis of fiscal solvency, these measures to bolster the macroeconomy rather than transfer societal resources directly to needy citizens and families are reactionary.

  The old-time New Deal–like initiatives revived by Bernanke’s false depression call, in fact, have mobilized special interest lobbies to feast at the public trough like never before. Consequently, Washington has been dragged ever deeper into fiscal paralysis and incapacity to perform functions that are actually needed, such as funding an adequate national safety net. Worse still, all these misbegotten depression-fighting measures have destroyed what remained of an honest fiscal culture.

  CHAPTER 30

  THE END OF FREE MARKETS

  The Rampages of Crony Capitalism

  in the Auto Belt

  THE BAILOUT OF CHRYSLER AND GENERAL MOTORS (GM) WAS UTterly unnecessary and did not save any auto jobs; it just reshuffled them from rising plants in right-to-work (red) states to dying plants in the UAW (blue) states. But the auto bailouts were more than just another policy error which emerged from the BlackBerry Panic. They were, in fact, the final crushing blow to free market capitalism.

  The auto bailouts corrupted political discourse beyond repair, elevating official mendacity and crony capitalist deceit to a new level. And as Washington plunged into a sweeping rearrangement of both the nation’s largest industry and its financial overlay, it was a Republican administration which led the bailout bandwagon, thereby leaving the public purse vulnerable to crony capitalist raids for the permanent future.

  The auto bailout was initiated by the nation’s bailout crazed de facto president, Hank Paulson, based on the specious claim that a million jobs w
ould be lost from an industry which, according to the Bureau of Labor Statistics (BLS), employed only 750,000 workers. At the time it was self-evident that the real issue was job allocation, not job loss. Up to half of this BLS figure for manufacturing jobs in the “motor vehicle and parts” industry was in the new auto belt of Kentucky, Tennessee, Mississippi, Alabama, Georgia, and South Carolina. It was absolutely the case that the auto OEMs involved—Toyota, Nissan, Hyundai, BMW, and Mercedes-Benz—would have gained sales and jobs had Chrysler and GM been allowed to meet their maker in bankruptcy court.

  So the bipartisan embrace of the auto bailout changed everything. The pieces and parts of the national economy would now become fair game for a perpetual Washington food fight. Yet a government which is responsible for every bob and weave of the entire national economy will quickly succumb to pure crony capitalism, a régime which cannot avoid eventual fiscal insolvency and the destruction of any semblance of a free market economy.

  Most importantly, it means a fatal corruption of political democracy. Ironically, President Obama did not earn reelection in 2012. He bought a second term with taxpayer dollars in the auto precincts of Ohio, Michigan, and Wisconsin, and did so under the cover of a GOP-endorsed bailout. But the terrible lies about the bailout’s necessity, repeated over and over by the Democratic campaign, constituted far more than partisan cant. In fact, they represented the fundamental confusion about economic events and conditions which have arisen from the Fed’s destructive régime of financial repression and financial markets manipulation.

  THE HOARY LEGENDS OF THE GM BAILOUT

  The hoary urban legend that General Motors could not get a debtor in possession loan (DIP) at the time of the Wall Street meltdown is a dramatic illustration of the ill effects from the Fed’s destruction of interest rate price signals. True enough, GM could not get bankruptcy financing at 5 percent. But under the conditions which existed in December 2008, the job of the free market was to treat financial train wrecks like GM with stringent terms and interest rates commensurate with their risk.

  As it happened, however, any memory of the function of free market interest rates among policy makers had long ago vanished. So after the Senate had properly rejected aid to Detroit, Paulson struck again, on the apparent theory that if GM couldn’t get cheap financing fair and square in the marketplace, then it was the taxpayer’s job to step into the breach.

  As he himself made clear in his own telling of the episode, GM was never asked to scour the earth for DIP financing, even if available terms were onerous. In fact, Secretary Paulson never even asked GM to prove that it had tried.

  For all practical purposes the US Treasury Department, armed with the massive firepower and open-ended authority of TARP, had staged an economic coup d’état. Paulson had just returned from a ten-day trip to China where he had been mesmerized by the miracles of Red Capitalism, and was not about to see the stock market in general, and Goldman’s stock in particular, take another beating.

  Never mind that GM was a veritable fount of corporate incompetence and long-standing financial scams, and that it could no longer dodge the harsh and messy resolution of the marketplace and bankruptcy courts. The US economy was now being run by the writ of a “can do” power tripper who had no clue that deal making Wall Street style was a frightfully dangerous way to make public policy, and a lethal blow to the integrity and resilience of free market capitalism.

  So without the benefit of any analysis whatsoever, the hapless lame duck in the Oval Office wolfed down a hot dog for lunch while his treasury secretary instructed him to “sign here” on a $13 billion TARP check to GM. It thus transpired that the most important test of free market capitalism in modern times was cancelled for the ephemeral reason that the treasury secretary did not want the stock market to open the next morning—Friday, December 12, 2008—on a down note.

  Paulson’s rendition of this Rubicon moment is downright embarrassing in its myopic lack of perspective. If the Bush administration didn’t rescue Detroit from its own folly, “the GOP risked being labeled the party of Herbert Hoover,” he prattled on, implying that the nation’s taxpayers existed for the political convenience of the party in power.

  Worse still, Paulson’s memoir reveals a neurotically obsessed and self-appointed economic czar who had unilaterally suspended any and all free market rules until further notice. Washington would take over the auto industry for the stunningly superficial reason that the country was “in the midst of a financial crisis and deepening recession.” Accordingly, it would be inconvenient for GM to “declare bankruptcy [because] they would be doing so without advance planning or adequate financing for an orderly restructuring.”

  From that moment on there was no turning back—not just from the GM loan but, more profoundly, from a permanent régime of bailout capitalism. The TARP funds allegedly provided GM with a three-month bridge loan, yet once the Bush White House blinked it was a foregone conclusion that GM would not get an honest DIP loan and that the TARP funds would become a “bridge” to a full-scale federal intervention.

  The eventual, rule-shattering $50 billion bailout of a single company, which had only 62,000 US hourly workers, was thus set in motion by a Republican administration stumbling around in a spree of seat-of-the-pants interventionism. Only after the fact did the perpetrators and beneficiaries of this horrid abuse of state power invent the pretext that GM’s continued existence was threatened by a total shutdown of the financial markets.

  That was unspeakably false. Even a moment of calm reflection would have revealed to Paulson and his posse that GM had massive amounts of pledgeable assets. Accordingly, it needed to be told in no uncertain terms never to bring its tin cup to Washington again, but instead to market its massive collateral pool to potential DIP loan investors anywhere on the planet, no matter how unpalatable the terms and interest cost might be to the moguls in Detroit.

  Such a mission would have readily succeeded because at the end of 2007, General Motors reported a giant pile of assets worth nearly $150 billion on a book-value basis. While this total was offset by an equal amount of liabilities—mainly debt, retirement obligations, and trade payables—the whole point of the US bankruptcy code under exactly this circumstance is to permit a new court-protected lender to “prime” any and all of these existing liabilities.

  Stated differently, any DIP lender would have had first dibs on the entire $150 billion asset litter. This included a first lien on billions’ worth of machines and tools, trucking fleets, massive factories and industrial sites, foreign subsidiaries in Brazil and China that were worth billions, brands such as Cadillac and Chevy that had not yet been ruined by generations of incompetent management at GM (despite their best efforts), and much, much more.

  None of GM’s financial liabilities mattered to a DIP lender—not lawsuits by injured dealers, not the contract-waving UAW labor bosses at Solidarity House, not the underfunded pensions that would be dumped on Uncle Sam, not the $25 billion that GM owed suppliers, and certainly not the $45 billion in long-term debt that GM owed to banks and bond fund managers who unaccountably still held its clearly worthless paper. In short, all of these claimants would have gotten in line behind a DIP lender had GM been forced into ordinary Chapter 11 where it belonged.

  $100 BILLION OF FROZEN LIABILITIES:

  WHY GM DIDN’T NEED UNCLE SAM’S CREDIT CARD

  In fact, GM didn’t need a taxpayer bailout at all. The real meaning of the incantation that GM couldn’t get a DIP loan is that it could not get one with single-digit interest rates, and appropriately so. General Motors was a colossal dinosaur owing to self-inflicted harm over decades. After the turn of the century, its financial statements had “shoot me” written all over them.

  There is no other possible way to explain the company’s staggering losses: $85 billion during the five years ending in 2008. Indeed, losses of this magnitude were almost incomprehensible, since GM’s worldwide sales during that period were just shy of $1 trillion. Yet these monste
r sales totals, which represented the cumulative shipment of more than 35 million cars and trucks, could not even remotely cover GM’s massive costs and endless write-offs.

  Accordingly, its financial crisis was not owing to a temporary plunge of auto sales in the fall of 2008. GM’s problem was terminal, and could only be solved through a massive downsizing and dismemberment under regular-way Chapter 11. As will be seen, to conduct an extended, court-protected campaign of cost restructuring and asset liquidation, GM actually needed only a modest-sized DIP loan—one that could have been readily obtained at an interest rate commensurate with the risk, say, 15 percent or even 25 percent.

  This was true because the Detroit auto business had a dirty secret. The latter was never disclosed by President Obama’s so-called auto task force when it inherited Paulson’s bridge; namely, that in the context of bankruptcy protection, GM did not need much fresh cash (i.e., a huge DIP loan) to operate a reduced cohort of viable plants and car lines. The Big Three business model, in fact, was to pay suppliers slowly and collect from dealers fast, thereby generating a huge float of working cash.

  Indeed, GM’s vast complex of suppliers was the industrial equivalent of indentured servants: their factories were filled with GM-owned tools, and in the short run billions’ worth of supplier production lines were useless without these tools and GM parts orders. Accordingly, GM was able to delay payment to its suppliers for parts and materials for forty-five days after GM was invoiced, in effect using its supplier base as a $25 billion payables “bank” to finance its production cycle.