The desperate circumstances of publicly traded AutoNation in October 2008 were not only indicative of the plight of the entire auto dealer sector, but also were a microcosm of the financial deformations that had been visited upon much of domestic business by the explosion of borrowing after 1994. In the final analysis, what became “bailout nation” when the lucre from TARP and the Fed’s alphabet soup of credit lines was spread far and wide had actually been born and bred during the Fed’s two-decade-long régime of bubble finance.
AutoNation had followed the usual script during this period, beginning with an M&A spree in the latter 1990s which assembled more than two hundred car dealerships representing the entire spectrum of domestic and imported brands. Built on a diet of heavy debt, the company sold about $20 billion of new and used cars annually, from a $2 billion vehicle inventory financed by “floor plan” loans, and sported brand new showrooms and lots financed either with operating leases or balance sheet debt.
Based on debt and M&A deals, AutoNation’s sales grew explosively, rising from $5 billion in 1996 to $20 billion in 1999, but already it was an accident waiting to happen. In typical fashion, AutoNation massively overpaid and overinvested in its dealerships, and was therefore eventually required to take a giant $1.8 billion write-down of goodwill and franchise assets in 2008. As a result, during the six-year period between 2005 and 2011 when it sold $85 billion worth of cars, parts, and service, its cumulative net income of just $50 million amounted to a rounding error. In other words, all of the positive net income it booked during the period was cancelled out by the value destruction represented by its huge asset write-offs.
MIKE JACKSON: CRONY CAPITALIST PITCHMAN
Not surprisingly, AutoNation’s longtime CEO, Mike Jackson, has been a pitchman for every raid on the US Treasury that the auto industry has concocted, including the bailouts in 2008–2009 and the absurd waste of taxpayer money called “cash for clunkers” in 2010. During October 2008 especially, Jackson gave voice to a hysterical view on the potential impact of the Wall Street meltdown on the auto industry and Main Street generally.
Sitting on $4 billion of debt at the end of 2007, AutoNation could not afford even a brief slump in the rate of car sales. Its entire inventory of cars was hocked to floor plan lenders, and the real estate and showrooms from which its two hundred dealerships operated were also each encumbered with multi-million debt obligations.
So when the new car sales rate plunged to about 10 million units for a few weeks after the Lehman events, Jackson raced around in Chicken Little fashion yelling that the sky was falling. The reality, however, is that it was an apparent air pocket in auto sales that wasn’t real.
In another of the great deformations engendered by the Fed’s cheap-money campaigns, the new car sales rate had been vastly inflated for more than a decade. Indeed, the 16–17 million SAAR (seasonally adjusted annual rate) that the industry and AutoNation desperately depended upon included 3–4 million units that were literally being stuffed into the economy with cheap debt.
The most egregious aspect of this was the 40 percent of auto loans that went to subprime borrowers, most of whom couldn’t afford new cars in the first place and would soon default in large numbers. But the market distortions actually extended to the entire auto financing system. Millions of new cars were sold each year on lease, for example, but the “residuals” assumed at the end of typical three-to five-year leases were way too high. This meant that monthly rental rates were artificially low and deeply subsidized.
Likewise, car loans which traditionally had three- to four-year maturities had been steadily extended to upward of seven years. This caused loss rates to soar, since cars depreciated far faster than loan balances were repaid. Yet auto lenders were able to absorb these losses without charging punitive interest rates to their customers because their funding costs were effectively subsidized by the Fed.
In the same manner, rental fleet companies bought upward of 2 million vehicles per year that sat idle most of the time in airport parking lots. Thanks to high leverage and cheap credit, however, this asset-wasting business model was artificially profitable most of the time, thereby spurring additional uneconomic demand for new vehicles and seconding to auto dealers a steady supply of (lightly) used cars.
In the fall of 2008, this whole house of automotive cards came crashing down. Retail consumers pulled back sharply, but that was a healthy correction because American garages were overparked with too many unaffordable cars bought on cheap credit. Indeed, the number of vehicles per household had soared by 50 percent during the previous two decades, while real incomes had advanced by barely 10 percent. Likewise, subprime auto loans dried up, which was a healthy development, and sales to lease and rental fleets also plummeted because their customer lots were already chockablock with idle vehicles.
The central source of Jackson’s hair-on-fire panic, therefore, was that American households finally went on a buying strike in response to the plunging stock market—especially the top 10 percent of households which are the predominate source of demand for luxury vehicles. Not surprisingly, one-third of AutoNation’s new car revenues and an even larger share of profits come from luxury brands including Cadillac, Lincoln, Mercedes, BMW, Lexus, Porsche, and Land Rover. Unless the affluent classes could be quickly coaxed back into the showrooms, therefore, Jackson’s $4 billion pile of debt would have soon crushed the company’s crippled cash flow.
Jackson’s subsequent all-out campaign to conscript the American taxpayer into the rescue of the credit-swollen auto sector thus had an obvious purpose; namely, to get buyers of its whole stable of brands back into his empty showrooms. Accordingly, through the auto dealers’ associations Jackson became one of the chief cheerleaders for TARP, the auto bailouts, and the Fed’s radical program to cut interest rates to zero and pump liquidity directly into the auto finance market.
So it wasn’t the hapless production-line workers at GM’s Lordstown, Ohio, plant alone that Jackson had in mind when he urged Congress to “hold your nose on principles for the greater good.” Likewise, it wasn’t just rust belt wage earners he was thinking about when he forecast Armageddon if Congress didn’t pass TARP, hysterically warning that the nation would face “a systematic shutdown of the entire US auto industry, millions of jobs lost, a depression and 20 percent unemployment.”
The jobs Jackson really wanted rescued were also in Stuttgart, Germany, and Toyota City, Japan, the sources of the high-profit luxury vehicles that actually kept his debt-ridden confederation of Sunbelt auto dealerships solvent. Still, the nauseating hypocrisy of Jackson’s agitation for a Detroit bailout did powerfully illuminate the true depth of the deformations stemming from Greenspan’s bubble finance.
The truth of the matter was that cheap credit and the Greenspan Put had created a hair-trigger economy, and especially so in the complex and lengthy auto supply chain. Most of the key linkages—suppliers, dealers, fleet customers, retail consumers, even the Detroit Big Three—were so dependent upon massive debt extensions that any interruption in the pace of output and sales threatened calamity.
In effect, the Fed’s prosperity management policies have stripped the free enterprise economy of its shock absorbers and capacity to adjust to changed conditions; that is, they have crippled the very features that give markets their vast superiority over state-managed economies. Trying to foster and force prosperity artificially, the central bank has invited the nation’s business enterprises to gorge themselves on cheap debt, thereby eviscerating the resilience and flexibility ordinarily possessed by firms on the free market. And it has turned their executives and owners into desperate pleaders for bailouts and state intervention.
CHEAP DEBT: ANOTHER GIFT TO THE 1 PERCENTERS
In this respect, the fundamental financial template of AutoNation vividly illustrates the manner in which Fed policy had turned business enterprises into debt zombies and the Mike Jacksons of American business into bully-boy claimants to government subventions. In a phras
e, it isn’t so much the devil of statist ideology as it is the demon of debt that makes them do it.
After three years of so-called recovery, for example, AutoNation remained heavily leveraged. During 2011 its total debt of nearly $3.6 billion amounted to 7.2X free cash flow (EBITDA less capital expenditure). Yet, notwithstanding this mountain of debt and the extreme risk implied by its high leverage ratio, the company’s entire after-tax interest expense was just $68 million. Obviously, a massively leveraged company in a highly volatile and cyclical industry like auto sales could not borrow at this microscopic 1.9 percent annual rate on an honest free market.
In fact, an enterprise bearing that much credit risk would likely pay a free market interest rate on the order of 10 percent, and under a neutral tax code it wouldn’t be deductible. The mathematical implication is that virtually all of the profits that AutoNation has posted since the 2008 crisis do not reflect earnings on the free market, but essentially measure the absurdly cheap after-tax cost of debt under current government policies.
This kind of policy-induced windfall is especially perverse because it fuels precisely the kind of financial engineering games previously described. In this case, AutoNation’s stock is 67 percent owned by two hedge funds and management insiders. Accordingly, during 2009–2011 they used the taxpayer-financed reprieve of the auto bailout not to pay down debt and get out of harm’s way but, perversely, to amp the company’s leverage even higher in order to fund massive share buybacks.
During those three years alone, the company spent $1.2 billion on share repurchases, or nearly double its net income, notwithstanding that the latter was itself entirely an artifact of cheap debt. But this feckless raid on its own treasury accomplished the intended purpose: the share count was reduced by 20 percent, thereby goosing per share earnings, even as the maneuver added heavily to the company’s existing debt burden.
Not surprisingly, Jackson was a frequent guest on financial TV, castigating opponents of the auto bailout and cheerleading the Fed’s money-printing campaign while touting an earnings rebound which was completely phony; that is, it was mainly an artifact of massive share buybacks. AutoNation’s fiscal 2011 net income, in fact, was down 43 percent from 2005.
Still, on the strength of the share buybacks, the company’s stock price quadrupled from a post-crisis low of $10 per share to nearly $40 per share by the end of 2011. Once again, its hedge fund owners and option-holding insiders made a killing from this orchestrated stock market ramp.
Indeed, this miracle of a booming stock price in the face of performance failure was essentially a gift of state policy to the 1 percenters. Under the honest free market interest rate (10 percent) and neutral tax policy scenario referenced above, AutoNation would have earned the grand sum of $0.20 per share in 2011. The hedge fund scalpers who had climbed on board after the auto sector bailout were thus winning huge because the stock was being valued at 200X its true economic earnings.
The AutoNation scam was repeated again and again in the aftermath of the bailouts. Businesses should have been belatedly cleaning up their balance sheets in order to preclude another perilous squeeze like the one in late 2008. Instead, insiders and their Wall Street accomplices plundered balance sheets further to fund record share buybacks and other financial engineering games.
Indeed, too many of the nation’s CEOs have embraced the same corrosive crony capitalism as practiced by Mike Jackson; that is, they have become financial TV pitchmen for stocks medicated by buybacks and cheap money. At the same time, they insist almost without exception that full-throttle state action to goose the economy after the Lehman crisis was justified to prevent an economic Armageddon.
Needless to say, if the American economy really stood that close to the economic abyss in September 2008, the fact that not one net dime of free cash flow has been applied to business debt reduction in the four years since the Lehman event begs for explanation. In fact, the US business sector balance sheets carried $11.8 trillion of debt at the end of 2012—$600 billion more than when Jackson and others were braying that the sky had fallen.
This astonishing truth has materialized for one overwhelming reason: corporate CEOs have not reduced their debt because they are being given profoundly false signals by the Fed’s obsessive pursuit of financial repression. Indeed, after-tax interest rates are so stupidly low that executives have come to believe that it would actually be foolish to pay down their debt.
The Fed’s destruction of market-pricing signals for both investment-grade and high-yield corporate debt has also tranquilized top financial managers with respect to refinancing risk. The middle and long end of the yield curve has been so brutally flattened by the central bank bond buying that it has triggered the greatest rally in corporate debt prices ever recorded. Accordingly, there has been a corporate refinancing boom that is as far off the charts as was the home mortgage “refi” boom of 2002–2006.
In the United States alone, issuance of investment-grade and high-yield bonds during 2010–2012 totaled $3.2 trillion, or 40 percent more than was issued during the comparable period of the last business recovery (2003–2005). Moreover, since the overwhelming purpose of this record issuance during the current cycle was to refinance existing debt, business executives have learned a profoundly dangerous lesson: that debt carries no risk and that “extend and pretend” is a perpetual option.
Likewise, the Wall Street “risk on” casino fostered by the Bernanke Fed has severely compounded the debt propensity of corporate CEOs. Every time cash flow is applied to share buybacks and other financial engineering maneuvers, hedge fund speculators reward them with higher share prices and more valuable stock options. In Pavlovian fashion, therefore, American business leaders bang the lever again and again, whenever they can allocate cash flow to financial engineering or borrow more to fund it.
Accordingly, the American economy has not alleviated one bit the hair-trigger condition that spawned the Mike Jackson–style panic and the resultant bailout and money-printing sprees of late 2008. In fact, the Fed’s announced policy to retain ZIRP for six full years—through the middle of 2015 as of this writing—almost guarantees that the free market is only a few short years away from total suffocation under a crony capitalist–style statist régime.
The fatal driver is the fact that the collective memory of free market interest rates is being extinguished and along with it the political will to tolerate them. Yet if interest rates are not allowed to periodically soar in order to purge financial deformations, like AutoNation and General Motors were in September 2008, one-sided markets and reckless gamblers will run unchecked. Eventually, the latter will mortgage and deplete the entire economic system in an irreversible descent into financialization. Along the way, petulant crony capitalists like Mike Jackson will continue to extract billions in ill-gotten rents.
CHAPTER 31
NO RECOVERY
ON MAIN STREET
AFTER THE US ECONOMY LIQUIDATED EXCESS INVENTORY AND labor and hit its natural bottom in June 2009, it embarked upon a halting but wholly unnatural “recovery.” The artificial prolongation of the Bush tax cuts, the 2 percent payroll tax abatement and the spend-out of the Obama stimulus pilfered several trillions from future taxpayers in order to gift America’s present day “consumption units” with the wherewithal to buy more shoes and soda pop.
But there has been no recovery of the Main Street economy where it counts; that is, no revival of breadwinner jobs and earned incomes on the free market. What we have once again is faux prosperity. In fact, the current Bernanke Bubble is an even sketchier version of the last one and consists essentially of the deliberate and relentless reflation of financial asset prices.
In practice, this amounts to a monetary version of “trickle down” economics. By September 2012, personal consumption expenditure (PCE) was up by $1.2 trillion from the prior peak, representing a modest 2.2 percent per year (0.6 percent after inflation) gain from the level of late 2007. Yet half of this gain—more than $600
billion—reflected the massive growth of government transfer payments, and much of the rebound which did occur in private consumption spending was concentrated in the top 10–20 percent of households. In short, the Fed’s financial repression policies enabled Uncle Sam to fund transfer payments for the bottom rungs of society at virtually no carry cost on the debt, while they juiced the top rungs with a wealth effects tonic that boosted spending at Nordstrom’s and Coach.
The Fed’s post-Lehman money printing spree has thus failed to revive Main Street, but it has ignited yet another round of rampant speculation in the risk asset classes. Accordingly, the net worth of the 1 percent is temporarily back to the pre-crisis status quo ante. Needless to say, successful speculation in the fast money complex is not a sign of honest economic recovery: it merely marks the prelude to another spectacular meltdown in the canyons of Wall Street next time the music stops.
DEFORMATION OF THE JOBS MARKET:
THE ECLIPSE OF BREADWINNERS
The precarious foundation of the Bernanke Bubble is starkly evident in the internal composition of the jobs numbers. At the time the US economy peaked in December 2007, there were 71.8 million “breadwinner” jobs in construction, manufacturing, white-collar professions, government, and full-time private services. These jobs accounted for more than half of the nation’s 138 million total payroll and on average paid about $50,000 per year—just enough to support a family.
Breadwinner jobs also generated more than 65 percent of earned wage and salary income and are thus the foundation of the Main Street economy. Yet after a brutal 5.6 million loss of breadwinner jobs during the Great Recession, a startling fact stands out: less than 4 percent of that loss had been recovered after 40 months of so-called recovery.
The Great Deformation Page 86