Posted by: Randy Allgaier | November 23, 2008

The ’08-’09 Interregnum: History, Challenges and Benefits


We are in that nether land – the last throes of the disastrous Bush administration where he and his administration can neglect many things that they choose to punt to the next administration and cause mischief in other places (burrowing, regulation changes and pardons) and before the dawning of the Obama age. Could there be a more difficult place to be, is this like the Catholic concept of Limbo? Could there be a period in history that is stuck between such stark contrasts of aptitude and world view?

In 1932 — a comparison that’s been coming up uncomfortably often these days — there were four months between the election of Franklin D. Roosevelt as president and his inauguration on March 4, 1933. It was a long, cold, leaderless winter, part of what one historian has called an “interregnum of despair.”

As a result, the country enacted the 20th amendment, moving Inauguration Day up to January 20. But from developments at the moment, it’s clear that even two months can be an awfully long time.
And as Paul Krugman pointed out in his column in The New York Times, these days things — especially bad things — can happen very quickly.

1932 was not the first difficulty in the transfer of power. Following most elections, this interregnum has been of little consequence. In 1800, however – the first time in our republic that one party gave way to another – the four months between Election Day and Thomas Jefferson´s inauguration were tense indeed.

Yet no interregnum was as volatile as in the secession winter of 1860-61, when Abraham Lincoln was elected president even as the Union began to dissolve. For Lincoln even more than Roosevelt, the four months between victory at the polls and Inauguration Day would be traumatic.

Whereas another person in Lincoln´s position might have assembled a professional staff, Lincoln depended on two young secretaries, John Nicolay and John Hay, who would serve throughout his administration.

Lincoln´s most immediate task was to form a Cabinet, and he was determined that it would represent the power centers of the new Republican Party as well as key geographic regions. He made only one bad choice: Simon Cameron, a Pennsylvania power broker who would prove to be a dreadful secretary of war.

He also erred in not naming someone to represent him in Washington, where political observers assumed that secretary of state-designate William Seward would be the “premier” of the new administration.

On Feb. 11, 1861, Lincoln, following the custom of the day, undertook a slow journey through scores of whistle stops from Springfield to Washington. As the party traveled east, the news became more ominous. Representatives of one state after another deserted Washington, and Jefferson Davis was inaugurated president of the Confederacy.

Lincoln´s odyssey ended on a sour note. Warned of an assassination plot in Baltimore, he agreed to travel through that city incognito and in disguise – a decision that inspired many cartoons and one Lincoln would come to regret.

So with an interregnum that will last another two months- what are we to do?

Krugman writes:

Is economic policy completely paralyzed between now and Jan. 20? No, not completely. Some useful actions are being taken. For example, Fannie Mae and Freddie Mac, the lending agencies, have taken the helpful step of declaring a temporary halt to foreclosures, while Congress has passed a badly needed extension of unemployment benefits now that the White House has dropped its opposition.

But nothing is happening on the policy front that is remotely commensurate with the scale of the economic crisis. And it’s scary to think how much more can go wrong before Inauguration Day.

Economists expect to see a continuing series of dismal economic reports on GDP, employment, corporate profits, etc. Behind the statistics will be more disappointing events, a veritable shoe store of shoes getting ready to drop. Here’s a list of coming attractions offered as perspective on what may be in store.

On the front burner, obviously, is a required “resolution” to the U.S. auto industry’s decades of mismanagement. The money’s running out and the party’s about over. Their problems include legacy costs (the pensions and health care of retired workers), high cost union contracts, uncompetitive products, and “bad management” such as having too many product lines or too much overhead costs
.
Congress and the new administration are coming to understand – as even the board of GM is now admitting – that many of these problems have legal bases which essentially require a bankruptcy proceeding to clean up. But Chapter 11 could be especially daunting for a huge car company for many reasons, not least being questions it would raise in the minds of future potential customers. Therefore, it appears that the government is moving toward providing some sort of debtor-in-possession financing to GM and perhaps Chrysler as part of a plan that I hope will include dramatically revamped operations, new management and new directors.

Even this “solution” is fraught with risks. Will the new plan and/or the new management effectively allow the reorganized company to compete successfully or will it fall into Chapter 7? Will a domino effect on suppliers – and perhaps competitors – hurt many other companies? Will too many people be thrown out of work? Wouldn’t it take several years at least to see good results? In other words, the ripple effects from any G.M. resolution may have unintended consequences and may take a good deal of time to play out.

In the short term perception is reality. I suspect that when a specific re-organization plan for GM is agreed upon there may be a rally in stocks as investors and the public are relieved that strong steps are finally being taken to resolve a very long smoldering infirmity in the American economy.

Dubai is one of seven quasi-independent United Arab Emerites. It has little oil. Instead it embarked on a business strategy of developing a global financial center combined with high end recreational real estate – sort of an adult Disneyland. The idea was that Europeans and Asians would vacation and establish business and financial operations in a Trump-esque “world-class” new Middle Eastern city. Features like an indoor ski center and a man-made island in the shape of a palm tree became world famous.

A new reality has come to Dubai of late including low oil prices, few Europeans or Asians taking
expensive vacations, a dry spell for international financial deals. So the new high rise concrete in Dubai – financed mostly with debt from abroad, by the way – is looking like the “see-through” buildings of past U.S. real estate busts. Deals are starting to crater and lenders are starting to panic.

So it’s possible that Dubai could go down the tubes and that low oil prices could make a rescue by Dubai’s more highly oil-endowed brethren seems less feasible. I have no idea what implications a Dubai debt default might have for any non-UAE financing entities. But if we have learned anything about financial melt-downs during the past year it is that major disasters in one place have a way of infecting many parties around the world who might not have seemed like obvious candidates for infection.

Private equity has bought huge numbers of businesses around the world using highly leveraged capital structures provided by banks that are now looking nervously at the repayment schedules and not signing up for further rounds – or deals. A global slowdown implies that many highly leveraged businesses will require more capital infusions. Will new equity step up or will there be wholesale bankruptcies among P.E. financed companies? Some of the deals are already looking questionable include the Cerberus financing of Chrysler and the Blackstone purchase of Sam Zell’s commercial real estate empire.

Real estate investment trusts, whether public or private make leveraged acquisitions, just like private equity does, but they specialize in real estate obviously. What a wonderful formula for a depression economy: leverage and real estate. After all, commercial real estate, whether it is space for retailing or distribution or offices experiences reduced demand and lower prices during times of economic decline. Add leverage to the mix and you have a potential disaster as a recent report in the Wall Street Journal notes. One analyst recently predicted that by the time the current downturn completes its damage there will be no solvent REITs and the entire industry will vanish. I doubt that, but I don’t doubt that there will be great damage to and from real estate investments.

The impact of problems in private equity and REITs is both direct and indirect. The immediate impact is the hit taken by employees and equity holders of the portfolio companies. They then pull back from other economic activity. Then comes the echo effect on the banks that provided the leverage. The loan losses reduce credit availability and banks’ liquidity which then impacts other businesses that need credit.

Everyone is anticipating problems in these standard lending markets. The problems have not yet become acute because the crisis itself is only a few months old. It takes a slightly longer time for problems in a given lending market to be felt by the banks. It took several years of crazy sub prime lending before anyone recognized the problem. But the likelihood of substantial defaults in credit card,
car loans, and commercial loans is considered to be quite high.

Russia could be close to economic collapse. According to a report in The Guardian recently, ” Russia faces possible devaluation of the rouble and a severe drop in living standards next year.” I read similar reports in the press about Hungary and Pakistan. Clearly Pakistan is in deep trouble militarily and politically as well as economically. It could be a very loud shoe dropping. To the extent that other countries become more troubled, U.S. problems are also increased.

Mexico is at risk because it depends on oil exports for financing its federal budget but its oil production is declining rapidly, as I have frequently discussed. It has temporarily helped itself by having hedged its entire oil export revenue through 2009 at $70 a barrel. There are many bulls on Mexico because the country combines a fairly sophisticated infrastructure with low labor costs and close access to the huge American market. Nonetheless, Mexico is very much at risk of an extended period of low oil prices combined with declining production. The Mexican shoe could fall in another year and it would have substantial U.S. impacts.

As the above list makes clear, nearly all the shoes that may drop have bad implications for banks. Banks are the institutions at risk in defaults whether such defaults occur abroad or domestically, whether they are industrial or real estate loans. Whether they are credit card, car, or commercial loans. All the pressure ultimately devolves onto the banks.

Keeping U.S. banks solvent and functioning is the top priority of Paulson’s Treasury Dept. Concerns about the risks of substantial numbers of U.S. bank failures is clearly evident at Treasury, which has the best information on the subject. Treasury has subordinated all other priorities for the $700B TARP funds to the task of saving banks. It has used half the TARP funds to inject money directly into banks and insurance companies and it is keeping the second half of their powder dry because, I believe, they think they may well need more big guns to bear on further weakness.

Last week U.S. banking regulations were changed to create the ability for hedge funds and other capital pools to directly buy banks. As the Financial Times notes, “The move comes as regulators brace for a growing number of bank collapses following 20 failures so far this year.” It is clear (to me, at least) that the reason Treasury eventually changed its mind on TARP to put the funds directly into nine large banks was in large part to facilitate those banks’ ability to buy up smaller banks that get in trouble.

Treasury has apparently determined that the next administration and Congress is tasked with propping up the failing economy. The job the Bushies have reserved to themselves is to make sure there is no banking crisis. I hope they will be successful and believe they will. But it is clear that the steadfastness of their resolution on this matter can only be caused by their perception of the size of the risk.

Make no mistake, the most difficult problem we can face would be deflation. It is a virus in the economy that seizes upon the public mind and causes a vicious cycle of reduced spending, reduced production, and reduced profits. As Krugman noted, the deflation of the 1930’s came about during the interregnum between Hoover and Roosevelt. None of the downturns since the Depression has included deflation. Let us hope this one does not either.

Meanwhile, to end on a positive note and provide a more balanced perspective, there are some benefits to our present situation. Low oil prices are helping consumers have more funds to spend on other things which is good because 2/3 of the money we in the U.S. spend on oil products is shipped overseas. To be sure, low oil prices also depress oil service and exploration businesses with resulting negative impacts on steel production and capital goods makers and alternative energy producers. But on balance low oil prices are somewhat positive.

In terms of foreign policy low oil prices help the western democracies in their contests of will against such oil exporting countries as Russia, Iran, and Venezuela. That may not impact the economy directly, but it might possibly help to allow the next administration to focus more directly on the economy and perhaps less on certain political problems.

It’s going to be a long 2 months!

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Responses

  1. […] The ‘08-’09 Interregnum: History, Challenges and Benefits We are in that nether land – the last throes of thedisastrous Bush administration where he and his administration can neglect many things that they choose to punt to the next administration and cause mischief in other places (burrowing, regulation changes and pardons) and before the dawning of the Obama age. Could there be a more difficult place to be, is this like the Catholic concept of Limbo? Could there be a period in history that is stuck between such stark contrasts of aptitude and world view? In 1932 — a comparison that’s been coming up uncomfortably often these days — there were four months between the election of Franklin D. Roosevelt as president and his inauguration on March 4, 1933. It was a long, cold, leaderless winter, part of what one historian has called an “interregnum of despair.” As a result, the country enacted the 20th amendment, moving Inauguration Day up to January 20. But from developments at the moment, it’s clear that even two months can be an awfully long time. And as Paul Krugman pointed out in his column in The New York Times, these days things — especially bad things — can happen very quickly. 1932 was not the first […] […]


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