Bankruptcy does not mean "Going out of Business"

Today, President Bush offered the U.S. automobile manufacturers bailout loans so that their management would not be forced into bankruptcy.  He said that he offered the loans because given the bad economy, it would be improper to allow the auto manufacturers to go out of business. But, bankruptcy does not necessarily mean that companies disolve with no buyers. 

Companies are forced out of business when their market disapears. For example, there was no demand for buggy whips after people started buying automobiles. But there is nothing on the horizon to replace the automobile and U.S. manufacturers have more than 40% of the U.S. auto market. World wide, GM sold more cars and trucks than Nissan did in 2007 - but, GM lost money while Nissan had good earnings. The U.S. auto manufacturers are losing money because of the UAW and various state laws that prevent them from getting rid of unwanted dealers and manufacturing lines.  The added cost due to these union and state law problems has been estimated as adding approximately $1,500 to the cost of earch car. Imagine how many more cars GM et al would have sold, and how much more profitable they would have been, if they didn't have these problems. 

Gigantic layoffs in the automobile sector following bankruptcy is a scare tactic used to defend the UAW and (or) to save the jobs of U.S. automobile management. Waves of layoffs have been occuring in many different industries due to economic weakness. If the U.S. automobile companies go into Chapter 7 (sell off the assets) would any company be willing to buy the manufacturing lines, management and other parts of a business without the employees necessary to make them work? If bankruptcy in Chapter 11 (reorganization) allows them to pay their suppliers at a rate of 10 cents for each dollar - would any company treat their suppliers that way knowing it would mark the end of any relationship with them? Sanity, anywone?

Fed rate cut to near zero - Good or Bad Tactic?

The Federal Reserve cut the overnight bank rate yesterday (called the federal-funds rate) from 1% down to 0% to 0.25%.  Clearly, there is very little room left to cut. But, is it likely that this latest rate cut will improve economic conditions? 

The current round of interest rate cuts began in August, 2007. Clearly, these cuts have not stopped the current economic deterioration. The stock market and the economy started to sink in November 2007. Real estate prices have tumbled, there are record levels of foreclosures and,  just yesterday, the Labor Department reported a 1.7% drop in consumer prices in November for the biggest such decline since February 1947. 

The Fed cut rates during the last recession in 2001 to 2002, but economic conditions did not improve until President Bush proposed a tax cut in April 2003 that took effect later in the year. GDP growth for the 4th quarter of 2002 was only 0.2% and just 1.2% in the 1st quarter of 2003. But once the tax cut looked like it was going to pass, look what happened to economic growth: 

• 3.5% in the 2nd quarter 2003
• 7.5% in the 3rd quarter 2003
• 2.7% in the 4th quarter 2003
• 3.0% in the 1st quarter 2004
• 3.5% in the 2nd quarter 2004

Economic weakness did not start to appear until the 3rd and 4th quarters of 2006 and the 1st quarter of 2007 when the GDP growth was 0.8%, 1.5% and 1.0% respectively. The first economic contraction occured in the 4th quarter 2007 when GDP lost 0.2% - just as the stock market started to sink.

Bad Economic Data But The Stock Market Goes Up

Over the last couple of weeks, there have been a couple of occasions when the stock market has gone up despite being presented with awful economic news. This is a very bullish sign. After all, the stock market is a pricing mechanism for future economic growth. Since October 10, all three major stock indexes have moved sideways. This pattern, called a "base" by traders, is frequently preparatory to a bullish change in trend.  What does the stock market "know" that newspapers are ignoring?

• On December 5th, the stock market zoomed up 4% following reports of record home foreclosures in the 3rd quarter and a loss of a half-million jobs during November.
  
• The stock market gained 1% on Friday, December 12th after Thursday's report of a 26-year high in unemployment claims and Friday's report of falling retail sales.

Not all of the news from the retail front was bad, however. Retail sales fell 1.8% in November but excluding cars and gasoline, sales increased by 0.3%. This was the largest increase since June and the first since July.  Reduced sales figures from gasoline stations is also positive because it reflects the dramatic drop in energy prices.

Unemployment has increased recently in the face of massive corporate layoffs. This is bad news, but it is also a lagging economic indicator. Companies don't layoff workers at the first whiff of financial trouble because it is time consuming and expensive to rehire workers. Likewise, when financial conditions start to improve companies wait to rehire until they are confident that the upward trend will continue.