OK great, so now what??

If you’ve been reading my blog, you know that I supported the proposal (in principle). For me, the key was taxpayer protection - that taxpayers would receive an equity stake in exchange for putting their capital at risk, and that there would be ample oversight of the Treasury in implementing the plan (see A Letter to Main Street and Letter to My Senators for background). I believe that we received a decent deal with respect to the former (the equity part), but it’s unclear that the taxpayers received sufficient concessions with respect to the latter (the oversight part).

Nevertheless, it was my position that something needed to be done to stave off an imminent financial calamity, and that the consequences of inaction would be far greater than the consequences of imperfect action. So although the plan, as signed into law today, leaves much to be desired, to me, it is better than none at all.

Even so, I suggested that this plan might not be enough to solve our economic ills. In a recent post, A Letter to Main Street, I hinted that it was unclear if the plan would work and promised to explain why. I’m trying to make good on that promise now.

There are several issues with the plan that suggest that it might be a difficult one to make work. These are some of the considerations that I feel are important. Feel free to add others that I may have overlooked:

1. The plan is too small relative to the overall problem. The main issue here is that in the end $700B is not nearly enough to tackle the problem. By some accounts, in order to properly address capitalization and credit problems, an amount in the order of $2-4 Trillion is closer to reality. In this respect then, the $700 Billion may just represent a drop in the ocean. Many experts have suggested that in addition to the purchase of assets, banks will need to be further recapitalized, and it is unclear that private investors are willing to do that, even with the Treasury taking $700B of assets off bank books. What is clear to me however is that the TARP is just one of many additional measures that the Fed/Treasury/U.S. Gov’t will have to take to restore confidence.
2. You can give banks money, but you cannot force them to lend. Forget for a moment that this plan is structured as a purchase of assets. Even if this were simply a cash giveaway, you can’t force the banks to lend. Giving them money will not suddenly restore their faith in counterparties and solve the confidence problem.
3. Borrowers may be scarce. Just because banks may be suddenly flush with cash (and it is unclear that the TARP will accomplish that), and assuming banks are willing to lend, this does not mean that there will be demand from prospective borrowers. Borrowers of all kinds are sufficiently scared that they’ve already tightened their belts - deciding not to consume and/or invest. In this sense then, credit will contract irrespective of how much capital the banks have on hand.
4. Buyers of paper backed by assets against which the banks lend are on strike. If we give the banks capital and they lend, who will buy the paper? The reputation of these institutions may have been tarnished to the point that buyers might not be willing to come back into the market and buy the asset-backed paper issued by the banks. After having been burned by the banks the last time, they may lack trust in these institutions. And banks depend not only on the ability to make money lending, but also to make money selling paper and re-lending the proceeds. If buyers are not willing to buy the paper so that the banks are able to re-lend, then really all that has been created is the equivalent of the economic stimulus plan. The money gets spent once, and then the banks are stuck sitting on paper again (only hopefully better paper this time).

The approach of the TARP then, as I see it, is to attack the problem by addressing the supply side (supplying capital to the banks). Overall, it’s unclear to me that anything has been (or even can be) done to address the demand side. This is where the rubber meets the road.

While I hope for the best, my fear is that even if the TARP addresses the interbank credit problems (which it does not entirely), confidence among both borrowers and buyers will take a long time to return. The end result is still long and protracted recession. I am just hoping the plan is enough to avoid a depression.

For greater detail (in flowchart format) about the costs associated with the TARP plan, see Steve Keen’s excellent, and funny, post (Why it Can’t Work) at RGE Monitor.

I understand that you have some reservations about the proposed $700B plan for the US Treasury to buy troubled assets from the banks. I don’t blame you. And frankly, I share your concern. I agree that the bill, as most recently proposed, was inadequate. Moreover, I’m not even convinced that it would solve our credit woes (for reasons I will detail in a later post).

One objection that I have heard some express about the plan is that it bails out Wall Street at the expense of Main Street. Therefore, the argument has been that the plan should be opposed and Wall Street should be left to deal with the mess it created.

It is true that there are elements of the plan that would let the fat cats on Wall Street off easier than they otherwise would; however, let me try to explain why I perceive this situation to be so grave that Main Street would not be spared at all, and that the need for action (even if imperfect action) is absolutely critical.

Don’t get me wrong, in some ways I am glad that the bill was voted down by the House of Representatives today. It needs to be retooled and reworked. But we need to get some version of it through – hopefully with better protection for the taxpayers and more stringent oversight.

But Main Street, let me try to make this clear - this plan is just as important to you as it is to Wall Street!!

Credit markets are currently experiencing unprecented stress. When credit markets are stressed (whatever the reason), banks and financial institutions do not lend; rather, they hoard whatever precious liquid assets (cash) they can get there hands on.

So why does this matter to Main Street?

Well, in the extreme (and this borders on hyperbole for the purposes of exposition), with banks not issuing credit:

Wall Street will be affected, and almost immediately. Imagine jobs disappearing from the financial industry overnight. And who knows how many – maybe orders of magnitude of 20-30% of all financial services jobs. And maybe you think, “too bad, folks on Wall Street deserve to pay with their jobs because they created this mess.” That would be myopic. Think about what mass layoffs on Wall Street would mean for government budgets of all kinds. Without income, there is no collection of income tax. It would immediately put extreme pressure on Federal, State, and Municipal budgets. Those budgets fund services upon which we are so dependent. Moreover, think about the impact on consumer spending. Unemployed people aren’t very good consumers. This would result in stress for retailers, and an additional negative feedback effect on government budgets through the sales tax channel. This is not good for you.

In addition, our federal budget is already running a massive deficit. This would force us to borrow even more from foreigners to fund domestic needs. At what point do those foreign creditors walk away?

Think too about how much stress a complete credit meltdown would put on credit lines of all sorts. Financial institutions would be forced to withdraw credit lines from all borrowers, creditworthy or not. As a result, a whole host of real economy companies upon which you depend for your needs will find themselves without credit to fund their daily operations. For the weakest of these companies, that would force them almost immediately into bankruptcy. For firms with stronger balance sheets, it would result in a huge jump in the cost of capital, severe curtailment of operations, and additional layoffs. How many layoffs, I cannot be entirely sure, but believe me, you would feel it!

So now not only would there be mass unemployment on Wall Street, but it would be coupled by mass unemployment across a swath of industries. Imagine how much pressure such mass unemployment would put on unemployment insurance benefits, which in some states are underfunded, and even if they are not underfunded, they are certainly inadequate to meet those kinds of needs.

In addition to mass layoffs, imagine mass foreclosures (even greater than what we’ve seen thus far). Folks without jobs will not be able to adequately service their debt and will be forced to hand the keys of their house back to the bank. Even those who remain employed will have difficulty meeting their debt obligations as many with adjustable rate mortgages will find their discretionary income squeezed when those rates readjust at higher rates.

If credit dries up, imagine going to an auto dealership to buy a car only to find out that a bank cannot float you the funds for the purchase. Imagine going to a store to make a purchase only to have your credit card denied – not because you are not creditworthy, but because the bank cannot underwrite the purchase. And even if you do qualify for credit, the terms would be so onerous that it would make many purchases prohibitively expensive. If you want to buy goods therefore, you have to pay in cash. But then imagine going to a bank to draw on your funds only to find that they are unavailable

All of these effects will obviously cause a negative feedback effect on the retail industry, whose sales will drop off a precipice. Hence more layoffs, less government income, less consumption, less credit, and so on.

This is why this $700B infusion into financial institutions, while deplorable and disgusting, is absolutely critical.

And as I mentioned in a previous post (see Letter to My Senators), although I can envision the economic consequences of allowing such a credit crisis to bring down our entire financial system, I cannot even fathom the social consequences. So for those of you who are ideologically opposed to this bailout, ask yourself, “Are you really ready to live with the consequences?”

In my view then, the most important thing is not whether or not to the plan should move forward, but how best to construct the plan to protect taxpayer interests and provide strong oversight.

For me, the key is, and has been, equity in exchange for capital. Moreover, I believe that Roubini’s recommendation for capital in exchange for preferred equity is a sound one.

Unfortunately, to me this plan seems like our best/last chance to stave off catastrophe. Sadly, although it provides us a chance to address the symptoms and represents a step in the right direction, it’s not entirely clear to me that it will work. I will explain why in a follow-on post.

To be continued…

I ordinarily see our differences, and the way that they unfold in public discourse and debate, as a strength. However, our economic situation has become so fragile that I believe that there is too much at stake not to take a position and have your voice heard. The potential economic and social consequences are enormous!

For this reason, I am sharing excerpts from a letter I drafted (edited to correct grammatical mistakes and read more smoothly) to my senators last evening. I hope this is the only time I will ever feel compelled to make a political point on this blog.

—————————————-

Esteemed Senator XXX,

I am writing you because I am deeply concerned about the fragile state of our economy. In no uncertain terms, our financial system is on the brink of collapse, and it is effectively insolvent.

However, rather than rushing this TARP [Troubled Asset Relief Program] through and giving the Fed a blank check for about $700B of taxpayer money, we should make sure that we get this legislation right. In order to do that, any plan that includes putting taxpayer money at risk should be accompanied by a recapitalization of our financial institutions, at the expense of current shareholders. That is, if we are not going to let institutions fail, then they must be held accountable in other ways. This is the only way to address the moral hazard problem. This also provides the best protection for taxpayers since making them effective owners of the banks allows taxpayers to participate in any upside in bank performance. The intention, obviously, would be to re-float the banks back in the public markets once they are in better health, and at a gain for taxpayers.

If a recapitalization of this sort were to occur, this would represent a quasi-nationalization of the banking system. I know that this is not the ideal solution. After all, we live in a “supposed” free market economy, so taxpayers should not own banks, but if we do not address moral hazard, we WILL have accomplished nothing, and we WILL be in this situation again. Also, since banks will need to be recapitalized anyway, I believe that this is the best solution.

PLEASE, PLEASE, PLEASE do not let Paulson and Bernanke fleece the American people and congress by allowing them to scare everyone into signing the blank check. Make sure that check comes with conditions!

For now then, I urge you to please sign no bill UNLESS a recapitalization plan is in place.

Also, I should point out that I am paying very close attention to the deliberations and how my senators comment and vote. The future of our economy is at stake.

Sincerely,

Robert Salomon

—————————————-

Please, now is not the time for partisan politics. I know that there are those who ideologically oppose any government intervention into private sector in general (and the banking industry in particular). However, as a concerned citizen and a taxpayer, we stand to lose whether the government acts or not. And I believe the consequences of inaction are far greater than the consequences of imperfect action.

For example, let’s assume we allow a complete systemic financial meltdown. The government will have to step in to protect depositors at many (if not all) of our banking institutions. Once all the funds at the agencies that insure those deposits are exhausted (and it will happen quickly given the FDIC balance sheet), taxpayers are on the hook for the rest.

And that is just the monetary cost of financial meltdown. I cannot even begin to estimate the social cost.

We (taxpayers) lose either way. I don’t know about you, but I would rather pick up the costs ex ante, while providing taxpayers some potential to recoup their investment, than to let financial institutions fail only to pick up the pieces and watch our economy come to a grinding halt.

The time has passed to allow institutions to fail just to prove a point to the few idiots who got us into this mess in the first place.

So I ask you to think carefully about the repercussions of allowing our system to fail and ask yourself if you are prepared to live with the consequences.

Allowing a complete meltdown of our economy would be catastrophic not only from a financial perspective, but from a social perspective as well.

This is why we need to get this bailout, although deplorable and disgusting, right.

I found an article about executive compensation in China that appeared in last week’s issue of the Economist especially fascinating (see False Options). As the article explains…

How executives are rewarded is one of the many mysteries of China’s increasingly powerful companies. Unravelling it is important, not least because it should help to explain corporate China’s transformation from a state-controlled to a consumer-driven creature.

Research on this question has been surprisingly sparse. A new study by Zhihong Chen and Yuyan Guan, of the City University of Hong Kong, and Bin Ke, of Pennsylvania State University, casts a rare beam of light.

…Senior executives’ cash pay [at 83 large companies operating in China but trading in Hong Kong] was low by global standards: $180,000 a year on average. Almost every firm awarded stock options, worth an average of $140,000, giving bosses healthy top-ups as well as equity stakes—if those options were exercised. Remarkably, a lot never were. At more than half of the firms, no options were exercised within four years of vesting.

The authors of the study pose the following question:

“What forces make them [executives] throw away money [in the form of unexercised options] on the table?”

The article goes on to conjecture that the reason that executives in China do not cash out their options is likely cultural. I agree that there is a large cultural component to the differences in behavior between Chinese and American executives with respect to cashing out in-the-money options.

The authors of the study then add:

“If executives in general do not exercise stock options, how can the option scheme align executives with the interest in shareholders?”

Actually, I think that having management in place that does not exercise in-the-money options is, in some ways, a good thing for shareholders. After all, once executives have exercised their options and cashed out, their interests are no more aligned with those of the shareholders than if they never had shares at all. If executives are forced to hold in-the-money options, they have every incentive to continue working in the shareholders’ best interests to maximize share price. This not only makes their options more valuable, but more importantly for individuals from collectivist cultures such as China, it avoids the the public humiliation that would result from a drop in the share price.

I believe the point that the authors of the study were trying to make, however, is that if executives do not consider options a potential income-generating mechanism ex ante, then options provide no incentives ex post. If executives treat those options as if they don’t exist and never intend to act on them, then in theory, they could care less whether they have options in the first place.

But if the explanation for why Chinese executives are less likely to exercise in-the-money options is truly cultural, then the incentives likely still work as intended. It’s simply that executives are reticent to exercise the options on the way up for fear of how they will be perceived if they do so, and incentivized to continue to keep the share price above the strike price for fear of public humiliation if they do not. In my opinion then, they still serve a purpose.

So in this respect, shareholders of American corporations might be better served if their executives followed the example set by their Chinese counterparts.

For more on executive compensation and options, see my earlier posts A New Approach to Executive Compensation? and Is Restricted Stock the Answer to Executive Compensation?

You see, according to Terry Lanni, the CEO of MGM Mirage Casinos, newspapers stand to learn a fair amount about change from Las Vegas.

The chief executive of the world’s second-largest casino company told newspaper editors Monday that he wished them the best in embracing change in the journalism industry, and said Las Vegas casinos have required reinvention to remain profitable.

MGM Mirage Inc. chief executive Terry Lanni…offer[ed] insights on responding to change and connect[ed] journalism’s current challenges with the transformation of Las Vegas — from a gambling-only town to a resort destination with many other amenities.

That’s what happens when an innovation (in this case, the internet) poses a fundamental challenge to your entire business model. Your options are to stick to your knitting and risk going the way of the dodo, or to change, and maybe still meet the same fate.

The problem with change in the face of such a crisis is that it is extremely costly for management to undertake, and even if they do, there’s no guarantee of success. Changing to a new business model or diversifying into new businesses is not only costly, but often stretches the firm beyond its capabilities. It’s really a double-edged sword.

But this dilemma is not unique to the casino industry or the newspaper industry. It is universal, part of a normal pattern of industry evolution. Every so often, industries experience upheaval. This is referred to as a punctuated equilibrium model of innovation (industry evolution) in the management literature. Industries experience long periods in which technologies do not change all that much, and competition is relatively stable. Then some radical innovation appears (either coming from within the industry itself, or from a complementary industry - such as the internet in this case) that upsets the apple cart.

In the aggregate, this is generally a good thing for economies. It is called progress. But at the micro level, for individual firms, industry upheavals of this sort can cause a lot of pain.

Lanni recognizes that and expressed it eloquently in his comments:

“Suffering through the turmoil of change is never easy. But as (then) U.S. Army chief of staff Gen. Eric Shinseki said, ‘If you don’t like change, you’re going to like irrelevance even less,’”

Now it might have been a bit of a stretch for Lanni to compare the type of change currently being experienced by the newspaper industry to that experienced by casinos in Vegas (in my opinion the latter experienced a much less radical challenge to its business model/value proposition). But I have to admit, it was nice of Terry to let what happened in Vegas get out of Vegas for once.

1. In addition to the U.S. consumer struggling at home, consumers across the globe (especially in Japan and Europe) have begun to feel strain, resulting in decreased foreign demand for U.S. goods and services.
2. The U.S. dollar has rallied significantly in recent weeks impacting the foreign sales of U.S. firms.

Janet Yellen (President of the San Francisco Fed) echoed this sentiment in a speech she gave yesterday in Salt Lake City (see The U.S. Economic Situation and the Challenges for Monetary Policy, hat tip CR):

…export growth alone contributed one-half of the total real GDP growth [3.3%] registered in the second quarter. This element has been an important source of strength in our economy for over a year, being buoyed by strong growth abroad and by the weakening of the dollar. However, as I discussed, in recent months the dollar has risen somewhat and economic growth in many of our industrialized trading partners has slowed or even turned negative, suggesting that we can no longer count on exports as an important source of strength.

This is one of the effects that I spoke of in my previous post. However, it goes further. I would submit that not only will exports from the U.S. suffer, but the foreign sales of U.S. multinational affiliates will likewise suffer. Again, they will be impacted by the slowdown in the demand in the countries in which they operate, thereby decreasing profit. They will likewise be adversely impacted by the strengthening U.S. dollar as they repatriate income and report consolidated earnings in U.S. dollar equivalets.

For these reasons, and more, I am not seeing a rebound in corporate profitably for U.S. domestic or multinational firms in the 2nd half of 2008.

I think that this deal is destined to fail.

…For Tata, while bold, the deal just doesn’t make much sense. Aside from several luxury brands, an increased global presence, and some notoriety, I’m not sure what Tata gains. For example:

1. Where’s the synergy? Can Tata and Jaguar/LR share components, design, production, dealerships, or management? On its face, the synergies are just not there. But perhaps the investment was made for learning purposes, with Tata hoping to use Jaguar/LR capabilities to improve the quality and/or image of their existing automobiles. Possibly.
2. Can Tata rationalize Jaguar/LR’s production to make them more profitable? Actually, they cannot. They made pledges not to cut staff or close plants. And it’s unlikely that they would be able to reduce costs substantially by sourcing parts and supplies from India.
3. Can Tata right a ship that larger, more experienced, more formidable competitors had been unable to? In Jaguar and Land Rover, Tata is inheriting pieces of the old British Leyland Motors (Jaguar, Rover, Austin, Morris, etc.) that all tolled experienced (and continues to experience) more than 40 years of uncompetitiveness and underperformance. Quite simply, they are inheriting a lot of baggage (see Riding the Elephant for more background on British Leyland). It will be difficult for Tata to overcome this tremendous inertia.

Some analysts have argued that Jaguar and Land Rover were purchased on the cheap (at $2.3B minus $600M that Ford is throwing in to offset pension liabilities), and at the right time - when both Jaguar and Land Rover have a stable of new models about to hit the market (e.g., the Jaguar XF and the Land Rover LRX). These analysts point out that if these new models hit it big, it will make Tata’s acquisition look like a steal. However, this assumes that Tata can revive flagging sales at Jaguar and Land Rover in the middle of a downturn. Likewise, it assumes that Tata, by simply owning the brands, will not dilute their image. Finally, it assumes that the Jaguar and/or Land Rover brands can be revived after years of neglect and consumer dissatisfaction, and that consumers will once again be interested in buying relatively expensive, gas-guzzling cars and SUV’s (especially in the case of LR).

For all these reasons, I remain skeptical.

A recent article in The Economist echoes some of these concerns, but expresses some hope (see Now it’s Personal).

In the first quarter of this year JLR [Jaguar Land Rover] rang up profits of $421m.

But life has since become much harder for makers of large, powerful cars. In America, where petrol at $4 per gallon means big sport-utility vehicles have suddenly fallen from favour, Land Rover’s sales fell by 31% in the year to July.

So far, booming demand in Russia (up by 106%) and China (up by 151%) have more or less plugged the gap. Land Rover’s overall sales are only 2.7% lower year-on-year than in 2007. But JLR’s new boss, David Smith, acknowledges that the second half of the year will be much tougher. Land Rover’s production is being scaled back by 25-40%, depending on the vehicle model.

MY COMMENT: And it looks like things will be even tougher with global demand (even in places like China and Russia) slowing quite a bit.

A further worry for JLR is tightening environmental rules in most of its big markets. In Europe carmakers with fleets averaging more than 130 grams of CO2 per kilometre (g/km) are likely to face financial penalties by 2012. JLR is particularly exposed. Its best CO2 performer is the diesel Jaguar X-Type, which emits 154 g/km. Its worst is the Range Rover Sport which, in supercharged V8 form, chucks out 374 g/km.

MY COMMENT: JLR has a long way to go on emissions. It is not clear to me that Rover (given its portfolio of offerings) is anywhere near competitive.

One of the nice things about this article, however, is that it begins to detail JLR’s strategic plan for the next several years.

Mr Smith claims that JLR has a new nimbleness which allows it to exploit its smaller size. Strategy is set by a board consisting only of Mr Smith, Mr Tata and Ravi Kant, the head of Tata’s automotive business. Tata is committed to supporting the business plan until 2011, but the intention is that JLR should operate as a more or less independent, self-funding entity.

MY COMMENT: I’m not sure operating as an independent, self-funding entity should be Tata’s purpose with this acquisition. The best use of JLR is not to treat it as if it were a portfolio holding of Tata’s, but for Tata to exploit synergies with JLR - either reducing overall cost structure by sharing operations, parts, components, etc. AND/OR by using JLR as a means to learn - to help Tata develop up-market vehicles and learn about selling/manufacturing cars in developed markets.

Mr Smith’s strategy consists of three main elements. The first is improving customer service. Jaguar is already rated highly in America by J.D. Power, a consumer-research firm, but Land Rover “is not there yet” says Mr Smith.

The second is to recognise that, although JLR cannot compete across the board with the likes of BMW, Mercedes and Audi, it can be the best in its chosen segments. Land Rover, he says, has “benchmark products” in all its segments, and the XF, rated by several car magazines as superior to equivalent German cars, has shown what Jaguar can do. A new small Land Rover, based on the LRX concept-car displayed at car shows this year, seems certain to get the go-ahead, and Jaguar’s big saloon, the XJ, will be replaced next year with something sportier and more modern-looking. Mr Smith sees both Jaguar and Land Rover going even further upmarket, pushing into territory occupied by the cheaper Bentleys and Aston Martins.

MY COMMENT: This will be difficult for JLR to accomplish. One of the reasons JLR has a tough time competing effectively with the likes of BMW, Audi, and Mercedes is precisely because they don’t offer “across the board” models. They specialize in up-market saloons and SUV’s. BMW, Audi, and to a lesser extent Mercedes have a distinct advantage over JLR in their ability to spread development costs across models by using a single platform across multiple offerings (cars and SUV’s). This makes it difficult for LR to compete on cost with the likes of BMW, Audi, and Mercedes. Moreover, does JLR really believe it is in a league with Bentley and Aston Martin??

The third element is to reduce emissions. Jaguar is already a leader in lightweight aluminium construction and Mr Smith expects a 25% improvement in fuel efficiency over the next few years just by refining existing engines. But JLR is also investing $1.5 billion in new hybrids which will come on stream from 2012. Land Rover’s “e-terrain” technology, a diesel-electric hybrid powertrain with an electric rear-axle drive system, should give future Land Rovers even greater off-road ability while cutting emissions by 30%.

MY COMMENT: That is not enough. JLR does not currently manufacture one car that meets the European environmental standards that take effect in 2012.

And if all that were not enough, on top of all the strategic issues that JLR faces, for Tata there is the added difficulty of managing/coordinating operations across borders and cultures - i.e., an Indian firm managing a largely British operation. In cross-border deals, corporate culture needs to be integrated in a context complicated by differences in national culture. That is no easy task.

For JLR and Tata’s sake, I hope JLR survives to see 2012. But even if it does, there is no guarantee that it will turn into a profitable investment.

So I remain unswayed. I still think this is a bad deal for Tata.

At first I was flattered. It was a nice gesture, and it certainly feels great to be recognized as one of the top bloggers in the field.

But after thinking it over, I can’t help but wonder - Are there really 50 business professors who have blogs??

So while I thank the MBAExplorer for recognizing this blog, I must conclude that my blog most likely qualifies for the list by default

But seriously, they have compiled a nice list of blogs by business school academics. I encourage you to take a gander at what some of my colleagues have been writing.

…we should think carefully (and critically) about why some firms performed well…especially those that used improved foreign sales as an explanation for such performance.

If consumers continue to struggle in the US and it turns out that the improvement in…performance was a result of a temporary improvement [exchange rate induced] in the repatriation of foreign profits, we can and should expect…a long road to economic recovery.

Two things (not unrelated) have happened since then that make that prognostication look more and more like a reality:

1. In addition to the U.S. consumer struggling at home, consumers across the globe (especially in Japan and Europe) have begun to feel strain, resulting in decreased foreign demand for U.S. goods and services. For an excellent summary of economies currently in (or slipping into) recession, see Nouriel Roubini’s recent post The Perfect Storm of a Global Recession.

The argument for some time had been that although domestic demand was stagnating, global growth would keep the U.S. economy (and the performance of its firms) chugging along, with increased exports substituting for domestic consumption. With a global consumer now struggling, and global growth quickly slowing, that reasoning looks tenuous. Re-coupling seems to be the order of the day.

2. The U.S. dollar has rallied significantly in recent weeks (by about 10% in DXY terms). This is a trend that I see continuing for awhile.

In my opinion, the explanation for the dollar’s strength has to do with the fact that now that many economies outside the U.S. are struggling, it is becoming increasingly clear that foreign countries will not only NOT be able not to raise interest rates to curb inflation, but will eventually HAVE to lower interest rates to address their own domestic weakness. This change in expectations for foreign central bank interest rates is U.S. dollar supportive. Add to that the flight to quality that generally occurs when foreign economies weaken, and we have a recipe for a sustained U.S. dollar rally. Mish has provided some excellent insight on the dollar in recent weeks (see U.S. Dollar Rally Continues, Currency Intervention and Other Conspiracies)

Should the U.S. dollar continue to strengthen vis-a-vis foreign currencies (and I expect that it will), it will put additional pressure on the earnings potential of U.S. multinationals that benefited from favorable exchange rates. A strengthening dollar not only makes U.S. goods and services more expensive for foreign consumers to purchase in their own currency, but it lowers earnings via the repatriation channel - the consolidation and reporting of foreign profits in U.S. dollar equivalents.

Taken together then, in addition to a struggling U.S. consumer, U.S. corporations face several additional headwinds moving forward: Foreign consumers that are now struggling - not willing, or able, to purchase U.S. goods and services - and less of a repatriation windfall as well.

Ouch!

As I mentioned in a previous post, 225 bankruptcies would fall far short of the 289 bankruptcies from 2000 and 383 in 2001. I do not think we will reach 289 this year (even if my prediction turns out to be optimistic). However, I would not be surprised to see 2009 challenge the 383 mark from 2001.

Below you can find a list of what I see as the “noteworthy” bankruptcies of 2008. New additions since June appear in RED (please note that this is not an exhaustive list):

• Aloha Airlines (airline)
• AMERICAN COLOR GRAPHICS (newspaper)
• ASCENDIA BRANDS (retail)
• ATA (airline)
• Bear Stearns (banking)****
• BLUEPOINT RE (insurance)
• Blue Water Holdings (auto)
• BOSCOV’S (retail)
• Buffets Holdings (restaurants)
• Education Resource Institute (insurance)
• Empire Land (real estate)
• Eos Airlines (airline)
• Fashion House Holdings (retail)
• Fortunoff (retail)
• Friedman’s Jewelers (retail)
• Fred Leighton Holdings (retail)
• FREMONT GENERAL (banking)
• Frontier Airlines (airline)
• GEMINI AIR CARGO (air delivery/freight)
• Goody’s (retail)
• GREEKTOWN HOLDINGS (casino)
• INDYMAC (banking)
• JHT HOLDINGS (trucking/transportation)
  
• LANDSOURCE (real estate)
• Legends Gaming (casino)
• Lillian Vernon (retail)
• Linens n’ Things (retail)
• Kimball Hill (real estate)
• Landsource Community Development (real estate)
• Matrix Development Corporation (real estate)
• MERVYN’S (retail)
• MORTGAGES LTD. (banking)
• PIERRE FOODS (food services)
  
• PRC LLC (business services consulting)
• Propext (textiles)
• Quebecor World (USA), Inc. (office services/printing)
• Red Envelope (retail)
• Sharper Image (retail)
• Silverjet Airlines (airline)
• Sirva (moving services)
• Skybus (airline)
• STA RESTAURANTS - BENNIGAN’S (restaurants)
• Steakhouse Partners (restaurants)
• STEVE AND BARRY’S (retail)
• SYNTAX-BRILLIAN - OLEVIA (electronics)
• Tropicana (casinos)
• WCI (real estate)
• WHITEHALL JEWELERS (jewelry)
  
• Wickes Furniture (retail)
• Vicorp (restaurants)
• Ziff Davis (media)

Most of these bankruptcies have occurred in industries that are close to the struggling consumer. That is no surprise. But again, I expect bankruptcies to become more broad-based as this recession continues to spillover to the broader economy.