Friday, May 29, 2009

Government Motors vs. Goner Motors....

What an amazing run it's been for the US auto industry. The first model T's rolled off the assembly line in Detroit in October 1908. Roughly 100 years later, an industry built on innovation and cheap petroleum is suffering as both GM and Chrysler are going through bankruptcy (presumably GM will file on Monday).

While the markets might cheer this and some people are foolishly still trading GM's stock, a couple of things are clear. The pain that this bankruptcy will cause will be severe but probably not severe enough. Dealers are being cut from both Chrysler and GM, these dealers are drastically lowering prices to blow out inventory. The result is that normal demand for vehicles that might have shown up in 2010 or 2011 is being pulled forward. I think that by trying to soften the pain of a GM bankruptcy we've actually made things worse for GM in the future. Unfortunately, for you and I, we are going to be the primary losers in this scenario because we own GM.

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There have been some serious cracks showing in the treasury market (this is where the government sells our debt). Here's a quick, overly simplistic view of the treasury market - when treasury prices dip, interest rates rise. Why does this matter to Joe the Plumber? For one, the higher the interest rate the government has to pay, the more taxes you are ultimately going to be liable for - notice on the US debt clock that INTEREST is over $100 billion already this year. The second and more immediate impact is on mortgage rates. Mortgage rates are based on the interest rate on the 10 year note. This interest rate has gone vertical in the past couple of days and mortgage rates have soared closing in on their highest levels of 2009.

The mortgage market has seized up as a result and is likely to hamper any meaningful rebound in housing.

From a mortgage focused blog:

"Mortgage Operations Turmoil…Kick out the Dead Loans Now

As I noted yesterday [see Mortgage Market Locks Up], a rate spike this large results in chaos. Weeks/months of purchase and refi loan applications will be lost. Mortgage operations centers are parsing through thousands of loans focusing only on locked loans and purchases mitigating potential losses. The rest are dead wood.

Rates are all over the map as lenders assess the damage and price cautiously. Now, it is a mad dash to only focus upon the loans that are locked and have a chance of funding. If the locked loans are not funded quickly and the interest rate complex continues to experience this extreme of volatility, serious losses can occur. In a nutshell, they are kicking aside everything that is not locked or not a purchase in contract."

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Finally, I've noted that there are some interesting things going on in the oil market. Demand remains relatively weak for the end product but traders are moving into commodities as an inflation hedge and China continues to build reserves. Also, the economic crisis has severely curtailed new refinery construction which, while not an issue today, may be an issue in the very near future. Consider this news story that hit the wires late last night.......

"Saudi Arabia warned oil prices could spike to beyond the near $150 record high of 2008 within two to three years.

Energy ministers and officials at the Group of Eight energy summit in Rome are meeting as oil prices hover at a six-month high of over $60 a barrel, but below the $75 a barrel level producers say is needed to spur investment in new production.

Saudi Arabian Oil Minister Ali al-Naimi said the world was heading for a fresh spike after the current phase of faltering demand and lower prices, which reflected the global economic downturn rather than an indicator of things to come.

"However, if others do not begin to invest similarly in new capacity expansion projects, we could see within two-to-three years another price spike similar to or worse than what we witnessed in 2008."

Admittedly, Saudi Arabia has a vested interest in talking up oil prices, but I tend to agree with the premise that even if the US remains stuck in economic quicksand for the next 10 years, Chinese and Indian demand is likely to spur higher prices and we are not addressing the issue because gas is still under $3/gallon. If you pull up to the pump in 2012 and gas is $6.25/gallon you might want to question why we didn't address the situation when we had the chance.

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