The New GM: It Should Do Well With No Debt

The new GM reported a profit of $2.5 billion for the second quarter of 2011. This compared to a loss of $15 billion in the same quarter of 2010.

Indeed, the new GM appears to be doing a lot of things right. It has reduced its labor force from 263,000 to 208,000. It operates fewer plants. It made slightly more cars, and it has reduced its buyer incentives.

The Obama administration will use this success story as his major economic achievement. He saved GM with the government’s $50 billion bailout. He did not save the shareholders of the “Old GM.” They lost everything.

There is one fact missing in this optimistic story. The $50 billion bailout wiped out $40 billion of GM debt. It is a lot easier to make a profit if you have no debt payments.

In the second quarter of 2011, GM had no interest expenses. Ford, which borrowed money to stay in business, has around a half billion in interest expenses each quarter. The government bailout, in effect, gave GM a huge competitive advantage over its rivals. Without the bailout, GM would be paying more than $2 billion a year in interest costs.  Its second quarter profit would have been $1.7 billion instead of $2.5 billion.

GM now faces an increasingly bleak third and fourth quarter. If its profit drops to, say, $800 million, virtually all of that is due to the bailout of its debt.

Is GM the success story we are told it is?

A Tale Of Three Thefts: China, Russia, And The U.S.

The denial of the rule of law for the few may affect the economic actions of many.

Russia 2006 
In December of 2006, Gazprom, the Russian energy monopoly, "accepted" control of Sakhalin-2 from Royal Dutch Shell (RDSA - news - people ). Sakhalin-2 is a drilling venture off Sakhalin Island in Russia's North Pacific. Shell negotiated the offshore drilling rights with the Russian government to be Sakhalin-2's owner and operator along with its two Japanese partners. In return, Shell agreed to invest $8 billion. Shell's deal was unusual because it included no Russian partner, but it was approved at the highest levels in 1994. As the end of 2006 approached, Sakhalin-2 was ready to go into production. Shell's investment had grown to $20 billion

.click to continue reading on Forbes.com

Rhode Island Is Smarter Than Everyone Else

A new Rhode Island state law places bondholders before other creditors in the case of bankruptcies of municipalities.

The town of Central Falls declared bankruptcy recently, but its bondholders are scheduled to be paid in full. The pensions of retired city workers will  suffer a cut of one third.

Why did Rhode Island take this unusual and politically-costly approach?  A Rhode Island official explained it as follows: “We do not want bondholders to think this state was not a good place to put their money.” He also noted that without this law, Rhode Island municipalities will have to pay higher interest rates for its borrowing.

How is it that such economic rationality trumped politics in Rhode Island? Why could we not have had such rationality during the federal debt limit debate?

Municipalities in states borrow in highly competitive markets. They must compete against 49 other states. If the state’s investment climate is inferior to others, they cannot attract lenders. If you wanted to buy municipal bonds, would you buy from Rhode Island or California?

The federal government faces less competition, and the competition it faces is weak (such as European and Japanese sovereign debt).  Our federal government believes it can sell its debt not matter how badly it misbehaves.

The recent Standard and Poor downgrade may change this way of thinking.

The NYT Says What Obama Cannot Say: Raise Everyone’s Taxes

The New York Times Sunday editorial reveals point blank the liberal agenda. According its the editorial writers, we cannot cut spending in any significant way without curtailing core liberal programs. Hence, “there is no economically sensible or politically honest way to address the deficit without also increasing revenues and reforming the tax code.”

Even more remarkable is their candor with respect to taxes. Contrary to Obama’s promise not to raise taxes on the middle class, the NYT calls for raising taxes on just about everyone. 

I supply their blueprint for taxation during the second Obama administration without comments:

1). Let the Bush tax cuts expire at the end of 2012 for those making $250,000 and above.  The other tax cuts could expire at the end of 2013. The middle class should keep their tax cuts for a year to prop up consumer demand. The expiration of all the tax cuts would “save” $3.8 trillion over the next decade.

2) Tax reform should not touch breaks for home ownership and retirement saving, but they should be targeted only to help low and middle-income tax payers. Capital gains should be taxed at 35 percent. Tax breaks that subsidize profitable industries like oil must be ended. If the ending of tax breaks permits, tax rates could be lowered generally.

3) We should use a value-added tax or carbon taxes to raise “needed revenue for deficit reduction, and for what government provides” so that all additional tax revenue need not be squeezed from income taxes.

The NYT ends with its reading of public sentiment: “The public is open to new taxes, and the economic facts are clear. Until tax increases are considered in equal measure to spending cuts, there will be no budget fix.”

I imagine this editorial is not being greeted with enthusiasm in the White House. It lays bare the fact that Obama’s core supporters do not want to cut spending. Instead, they propose massive tax increases on middle- and low-income families.

If Obama were to publicly embrace these proposals in his upcoming campaign, his chances of reelection would shrink virtually to zero. Republican candidates should keep this editorial ready for use.

It’s Not the Tea Party Stupid: Why the Bond Market Does Not Like What It Sees

Those who blame the kamikaze, hostage-taking tea party for ruining the U.S. credit rating do not see what the bond market sees. The last-second budget deal, which was really about nickels and dimes, underscored two things:

 First, it again revealed a political system unable to address the big issues. And if it tries to address them, it is likely to make things worse.

Second, it shows a nation that is no longer able to grow itself out of fiscal difficulties.

Experts know that the deficit and debt figures tossed around in public discussion are only the tip of the iceberg. The real iceberg is the unfunded liabilities of Social Security and Medicare. Their unfunded liability is how much money we would have to set aside to meet the future obligations of these two programs.  Our national debt, which may soon reach the size of GDP (say $17 trillion), is dwarfed by the unfunded Social Security and Medicare liabilities that may have already reached $100 trillion!

The bond market is looking at our deficits and our unfunded liabilities, and it does not like what it sees.  Moreover, it sees that any and all serious attempts to deal with these fiscal problems impose huge costs on potential reformers.

As examples, I would cite:

The savaging of George Bush’s attempt at the start of his second term to reform Social Security via partial privatization.

The demogoging of Paul Ryan’s plan to salvage Medicare and Medicaid by turning it into an insurance grant program.

The passage of Obama Care under the fig leaf of a deficit reduction plan, with all parties understanding it raises unfunded liabilities.

In the past, we have been able to ameliorate deficits and unfunded liabilities by economic growth. There is now doubt as to when or whether we will return to healthy growth. We have an economy that does not lend, does not take risks, does not buy, and is strangled by regulations. We have an administration that is perceived as anti-business and more interested in redistribution than growth and efficiency. If we are doomed to European-style growth, our fiscal woes will grow worse and worse and worse.

The S&P downgrade speaks to all these concerns. It surely did not help that the Obama administration ordered the free coverage of a wide variety of women’s health costs in its latest administrative guidelines for Obama Care. As more of these administrative rulings come out, the colossal unfunded mandates of Medicare will be better understood.

If things are so bad, you might ask, why is our federal government not already paying higher interest rates? The answer is that although things are bad here, they are worse elsewhere. It is like a marathon with some of the world’s slowest runners. We are running very slow but others are slower.

That’s not the way to win a race – by relying on the ineptitude of others.

Only in Putin’s Russia: Prosecute a Dead Man!

On November 16, 2009, lawyer Sergei Magnitsky died in a Russian prison. He was jailed for alleged tax evasion, but his mains sins were representing Hermitage Capital’s case against the Russian state and for blowing the whistle against crooked Russian officials. In prison, he was denied medical attention despite repeated requests and died in custody.

Magnitsky case became an international incident. The U.S. State Department has issued a list of Russian officials involved in the case whom are to be denied visas. Russian justice authorities cleared the prosecutor who handled the Magnitsky case and even awarded him a medal. Russian authorities are preparing a list of U.S. officials to be denied visas to Russia.

In a possible Kremlin rift, President Medvedev named a human rights commission to look into the case. They concluded that Magnitsky’s arrest contravened the European Human Rights Convention, the case against him was fabricated and pursued by the same Interior Ministry officials he accused of a $230 million theft from the Russian Treasury, and he was beaten immediately before his death in custody. The Russian interior ministry rejected these findings.

On August 5, the Russian Interior Ministry announced they plan to prosecute  Magnitsky for alleged tax evasion, although  he has been dead for twenty months. They justified this bizarre action as a humanitarian move to give Magnitsky’s family the satisfaction of a chance to clear his name. This  claim was rejected by Magnitsky’s mother, who said: "To put a man on trial after he was killed, when he can no longer defend himself, is an evil and base act. It goes against all human morals, and law."