Tuesday, May 26, 2009

The Other Shoe - California's Belated Economic Collapse

In Grapes of Wrath, John Steinbeck told a story about how folks migrated to California to find hope within The Great Depression. We are now in what Time Magazine calls "The Great Recession" but California is not going to be a place to find economic hope.

The "other shoe" is about to drop in our Great Recession. California is hosting a "belated" economic collapse. Of course, no one publicly calls it that because no one wants to see it. But the boring statistics are available.

In the first quarter of 2009, "California had the most mass layoffs with 115,014 workers let go, followed by Michigan with 46,817, Illinois with 41,887 and Texas with a more modest 33,005," according to an article in Forbes. More than Michigan? After all, the same article reported that in Detroit "57 mass layoffs snuffed out 14,781 jobs in the first quarter of 2009." But California had 2.5 times the number of mass layoffs than Michigan.

We could comfort ourselves with the fact that California has 3.6 times the population of Michigan. But thing is, Michigan lost 285,000 reported jobs between April 2008 and April 2009. California lost 543,300 jobs in that same period. Most significantly, California lost 428,400 of those jobs in the first quarter of 2009.

In October 2006 when things had recovered from the "dot com bubble" burst, California had 857,500 folks on it's unemployment rolls. In March 2009, the Employment Development Department reported 2,091,800 unemployed.

By February of 2009, the state Unemployment Insurance Trust Fund ran out of money. According to a Sacramento Bee article published at the end of January, California will "rely on a $1.84 billion federal government loan to pay benefits through March." Of course, that's old news.

The State of California should have filed for bankruptcy in March, not because the Unemployment Insurance Trust Fund is empty, but because the General Fund is overdrawn.

There aren't many old enough to remember when during the depression, along with banks going under, state and local governments including schools started paying vendors and employees with "warrants" which were IOU's based on the hope that someday enough cash would come into the treasuries to cover them.

The State of California is about to start massive layoffs beginning with about 6,000 employees in the next month with the initial largest layoffs in the Department of Corrections (yes, prison guards).

While most Californian's don't see the magnitude of the problem, the State and local governments of the world's 8th largest economy will suffer a financial shock over the next 6 months. I mention local governments, because the State is considering "borrowing" property tax revenues and will be unable to remit sales tax revenues to local governments because the State is again getting low on cash. The State's deficit is now 25% of the State General Fund and rising.

State spending on everything from cars and computers to food and toilet paper is going to have to be cut by a minimum of 15% (although it should be double that number). This is a surprisingly large amount of money that is going to cease to enter the private sector. The ripple effect in the national and world economy will be noticed by the economy's statistics keepers.

It's just the way it is unless Congress decides to intervene to bail out another poorly managed "too-large" economic entity within the American economy in order to reduce the impact on the world's economy. The Los Angeles Times, in discussing the likelihood that private investment in California's economy will dry up, noted:

"We lose competitive advantage by being the state that can't solve its problems," economist Stephen Levy said. "Regardless of what we think the solution is, the fact is we can't find a solution."

The budget crisis threatens to further weaken the state's job market, which lost 63,700 more jobs last month, according to figures released Friday. The state's overall unemployment rate actually fell slightly, to 11% from 11.2%. But new job losses could prolong the vicious cycle in which the California economy is now trapped, with rising joblessness reducing consumer spending and delaying a housing rebound, thus leading to more layoffs.

Business Week called California a "basket case" in an article noting that 47 states face budget gaps. Writer Christopher Palmeri explained:

The California state legislature will now have to consider many more cuts. They'll range from relatively smaller items—a $4 million-a-year poison-control hotline that gets 900 calls a day—to sweeping cuts in health-care spending that will reduce coverage for 2 million poor state residents. "These are folks who may go to the emergency room, but they'll face the bills afterward," says Anthony Wright, executive director of advocacy group Health Access California. "If you're trying to lift yourself out of poverty, that won't help you."

California legislators had already passed $16 billion in spending cuts and $12 billion in fee hikes to tackle the current fiscal year's budget. Schwarzenegger says his own office has been reduced by 27 positions, to 147 people, and remaining staffers are taking a 9% pay cut. State legislators, though, say the governor's decision this week to stop pursuing short-term borrowings came as a surprise to them. Noreen Evans, a Democrat who chairs the budget committee in the State Assembly, says she was against borrowing more money to begin with. She thinks the fix lies in a number of spending cuts and tax increases—everything from putting a sales tax on tickets to sporting events to the $750 million a year that could be gained from taxing oil production in the state. "We should think about taxing oil producers before we cut health care coverage to 200,000 children," she says.

Some see California's fiscal crisis as an opportunity to address structural problems with the state's government....

That would be true, of course, if Californians were able to switch their fundamental political orientation back to the social compact of the mid-1950's when they attempted to tax themselves sufficiently to provide governmental services and infrastructure for all. But there isn't time to avoid an overall collapse of the economy within the state.

California's economy is too large for the federal government to ignore. But things may already be out of hand. Before California became the state with the most mass layoffs in the third quarter of the 2008-2009 budget year, the Legislature working with the Governor put together a budget that included $15 billion in spending cuts, $12.4 billion in borrowing, and $12.8 billion in tax hikes. But tax revenue continued to drop dramatically, costs for programs like unemployment, MediCal, and health care for children climbed, and the voters overwhelming turned down ballot measures that were needed to balance that budget. Within 48 hours after the May 19 election, State Legislative Analyst Mac Taylor placed the deficit at $24.3 billion and growing.

What we all know is that a realistic take on the 11% unemployment rate reported this month is that it is more likely an 18% unemployment rate because of those who have fallen off the bureaucratic radar with another 7% of workers who became underemployed in the last 18 months.

As the State reduces its purchases of supplies, equipment, and services from the private sector and starts laying off employees whose families stop spending, the multiplier effect will put more private sector workers on the unemployment roles. This will result in reduced sales tax and income tax revenue which will increase the State budget deficit.

Actual cash income from property taxes will drop as people miss their payments. Local government will begin to face cash shortfalls. The problem is that the State has already experienced one cash crunch when it had to delay paying it's bills this fiscal year and will likely experience a similar problem again soon. So the State is not going to solve the problem for local agencies. In fact it will worsen the problem, for that last budget included borrowing $692 million from cities, $960 million from counties and $330 million from special districts which supposed has to be paid back over the next three budget years, beginning in July with the budget year 2009-2010 which is impossible.

As things started getting bad in 2008, the Legislature and the Governor cut school funding by $7.9 billion claiming that the state's education finance formulas the money doesn't require the money to be repaid in future years. School groups such as teacher's unions disagreed arguing that the schools were owed $1.4 billion from the 2007-08 fiscal year. Argue all you want, it is a moot point.

These issues cover current cash flow only which is only part of the picture. The budget proposal for the 2009-2010 fiscal year includes "accelerating" collection of $2.3 billion in personal income and corporate taxes which would have accrued in the following budget year, taxes that are at least 30% overestimated. And there are issues like $48+ billion the State is behind in contributions to cover health and dental benefits for retired state workers, a picture that sounds ominously like GM and Chrysler.

Some said the recession in California got going in earnest in 2008. Not really. It started to ramp up to earnest in November 2008. The real picture looks like this "monthly new unemployment claims" graph:

California's Great Recession likely will begin "in earnest" in July 2009. And unfortunately for the Obama Administration and the world, what was the world's 8th largest economy will drag everyone else down with it.

California will need to reorganize as a bankrupt entity. It would be wise to seriously consider the Three Californias Proposal.

Monday, May 4, 2009

Your Tax Money, The Players You Don't Know and The Inadvertent Outsourcing of Our Auto Industry

While I have been a supporter of the Obama political and social movement, I have concerns about the Obama Administration's handling of the American automobile industry crisis. At his last prime time news conference the President said: "I don't want to run auto companies...."

I don't want him to run them either. But I want him to find a person with a "big picture" view and a significant far-more-than-financial knowledge base to oversee them for him in order to achieve goals that protect North American workers and the American economy in the long term.

Reading about Fiat's U.S. government supported move to own a significant interest in Chrysler and acquire some or all of GM Europe is troubling. GM purchased a 20% stake in Fiat in March 2000 with a much lauded goal to get some mid-size vehicle front drive technology. GM never used the technology and by 2005 it ultimately cost the company $2 billion to get out of the deal. It is clever dealing like this that make one wonder if American car manufacturers shouldn't just be allowed to flounder and die using their own skills (or lack thereof).

Fiat's proposal to create a separate auto division out of it's European brand names (not including Ferrari) as well as GM Europe brands and Chrysler products is disturbing on many levels as the company appears to be looking at Eastern Europe to reduce labor costs.

But what most people aren't aware of is a company like Magna International, self-described on it's web site as follows:
We are the most diversified automotive supplier in the world. We design, develop and manufacture automotive systems, assemblies, modules and components, and engineer and assemble complete vehicles, primarily for sale to original equipment manufacturers (OEMs) of cars and light trucks in our three geographic segments - North America, Europe, and Rest of World (primarily Asia, South America and Africa).

Our capabilities include the design, engineering, testing and manufacture of automotive interior systems; seating systems; closure systems; metal body & chassis systems; mirror systems; exterior systems; roof systems; electronic systems; powertrain systems as well as complete vehicle engineering and assembly.

We have 240 manufacturing operations and 86 product development, engineering and sales centres in 25 countries on five continents as of December 2008.
In their own words, Magna is a manufacturing outsource alternative for auto manufacturers that currently services 75+ auto brands including every American brand:
For many years now, automobile manufacturers have increased their outsourcing of components, assemblies, modules and systems. The primary factors driving this outsourcing have been the need by OEMs to reduce costs, minimize the time required to bring a new vehicle to market, capitalize on the technical and engineering expertise of suppliers and minimize capital expenditures. This has increasingly resulted in OEMs outsourcing production of larger assemblies and modules to suppliers including Magna. With our broad and deep capabilities in design, engineering, testing, manufacturing, program management and system integration, we are well positioned to continue to capitalize on the outsourcing trends.
An example is offered in a graphic on Magna's web site:

Now they've formed a significant new partnership with the only U.S. non-government-owned auto manufacturer, Ford:
AURORA, ON, Jan. 11 /PRNewswire-FirstCall/ - Magna International, the world's most diverse auto parts supplier, announced today a vehicle-development partnership with Ford Motor Company to introduce a zero-emission lithium-ion battery electric vehicle (BEV) to be delivered to market in 2011.

The electric vehicle, which Ford announced at this year's North American International Auto Show in Detroit as a key vehicle in their electrification strategy, will be a small car with an expected range of up to 100 miles without using a drop of gasoline and without compromising customer performance expectations. The Ford BEV is expected to offer consumers a familiar driving experience - it will operate similar to a conventional vehicle, but with smoother acceleration, less noise and zero emission.

"This vehicle adds an important piece to Ford's product lineup with a zero-emission vehicle that will be both affordable and meets customers' needs," said Don Walker, co-CEO of Magna International. "In addition, the joint partnership demonstrates valuable OEM/supplier collaboration by sharing in the expertise and investment that the auto industry now requires for new advancements in energy independence and reduced CO(2) emissions."

"Our collaboration with Magna on a Ford BEV is the result of a shared vision of the potential of electrification in transportation," said Derrick Kuzak, Ford's group vice president, Product Development. "This partnership leverages the technical expertise of two global companies to achieve a common goal, delivering a no-compromise, zero- emission, battery powered car for the retail market."

Magna will be responsible for providing critical components that make-up the powertrain and battery modules in the vehicle. In addition, Magna will also play a key role in the engineering required to integrate the electric propulsion system and other new systems into the vehicle architecture.
Simply put, the best we can expect is that at least some of the "critical components that make-up the powertrain and battery modules" will be manufactured in the U.S. and Canada. The company has been acquiring technology as can be seen from these news releases:

AURORA, ONTARIO, Canada, October 23, 2008 – Magna Electronics, an operating unit of Magna International Inc., announced today the acquisition of BluWāv Systems LLC, a developer and supplier of electric and energy-management systems for hybrid electric vehicles, plug-in hybrid vehicles and battery electric vehicles. BluWāv is located in Rochester Hills, Michigan.
BluWāv will enhance Magna Electronics’ position in developing and supplying components and systems to the emerging automotive market for electric and hybrid vehicles.
“BluWāv provides technical leadership in multiple product areas for Magna Electronics as well as our other operating units,” said Carlos Mazzorin, President of Magna Electronics. “In addition, this acquisition will allow Magna to bring innovative electric/hybrid-vehicle systems to market faster, while simultaneously developing the next-generation systems for tomorrow’s hybrid and electric vehicles.”
“As a leader in advanced electric propulsion and energy-management systems, we look forward to joining the Magna family and contributing a competitive edge in advanced systems for hybrid and electric vehicles,” said Kevin Pavlov, President and CEO of BluWāv Systems.
About BluWāv
BluWāv Systems LLC, is based in Rochester Hills MI and is a developer and supplier of electric propulsion and energy management systems for Hybrid Electric Vehicles (HEV), Plug-in Hybrid Electric Vehicles (PHEV), and Battery Electric Vehicles (BEV). BluWāv focuses on incorporating advanced technology into its products in each segment and creating an optimal combination of products to form complete propulsion systems. BluWāv’s products are grouped into three distinct segments that together provide more than 80% of the propulsion system content for an HEV, PHEV, and BEV. BluWāv is truly “changing the way the world moves™”.
SAILAUF, Germany and SENNWALD, Switzerland, March 4th, 2009 – Magna Electronics, an operating unit of Magna International Inc., and BRUSA Elektronik AG, a developer and supplier of high-efficient power electronics and electric motors, announced today a collaboration on electric and hybrid vehicle applications. This collaboration enhances both companies’ positions in developing and supplying components and systems to the emerging global automotive market for electric and hybrid vehicles.
“With this collaboration, Magna Electronics has another strong partner in the field of electric and hybrid vehicles,” said Matthias Arleth, Vice President Magna Electronics Europe. “In combination with Magna Electronics’ years of experience and know-how in industrialization and production, we remain a trusted partner to manage future serial orders. Within the network of our competence centres we offer system solutions from concept to production.”
"For more than 20 years, BRUSA has been developing key technologies and components for electric vehicles, which now bear a very high degree of maturity,” said Josef Brusa, President of BRUSA Elektronik AG. “Now the time has come to turn these innovative technologies, together with a strong partner, into competitive volume products in order to support the market breakthrough of electric vehicles."
BRUSA Elektronik AG, is a Swiss Company with actual 50 employees, which develop and manufacture innovative power electronic and drive technology for electrical Vehicles. In focus are the research and development department of the Automotive manufacturer as well as innovative Small Companies and Start Ups in the range of Electrical Vehicle. Long years of experience and high Innovation strength makes it possible to offer customers High-Level-Technology in every case, from the E-Motor over the partial components like Motor-Controller, DCDC-Converter, Charger, etc. till the whole system Vehicle drive. www.brusa.biz

What is of concern is that this Ford partnership with Magna represents the failure of the American auto industry. Why didn't Ford buy BluWāv in 2008? Magna is foreign owned. Engineering, and therefore the licensing revenue, for the very innovations we seek in our auto industry will be paid to a company outside the U.S. And BluWāv not only is an American company under foreign ownership, now on January 9 it announced that "the recently-passed Fiscal Year 2008 Omnibus Appropriations Bill directs $1.2 million to the company to accelerate its research and develop an energy storage system for hydrogen based and hybrid vehicles."

But at least the manufacturing of some of the parts may occur at BluWāv in Michigan and at Magna Powertrain in Troy, Michigan. And we'll still have final assembly done in automated robotic assembly plants here.

Magna is competing against Fiat regarding a possible partnership/acquisition in GM Europe. From Bloomberg:
OAO Sberbank, Russia’s biggest lender, and OAO GAZ, its second-biggest carmaker, are joining Magna International Inc. in a bid for a stake in General Motors Corp.’s Opel unit, a German minister involved in the talks said.
A takeover proposal for Opel from North America’s largest auto-parts supplier is being supplemented by offers from Moscow- based Sberbank and Nizhny Novgorod-based GAZ, Juergen Reinholz, economy minister in the German state of Thuringia, said today in a phone interview, declining to elaborate.
Eastern Europe is hungry for jobs that could result. I understand the need, but is that what the partnerships between Chrysler, GM, the UAW, and the U.S. taxpayers was intended to accomplish?

The problem with the Obama Administration is what the New York Times reported:
The Obama administration decided not to have an independent car czar, as was proposed in a House bill late last year. Instead, the administration chose to use a task force, giving President Obama the ability to be more directly involved in seeking solutions to the auto industry’s problems.
Instead, the Administration is leaning on "one of the most politically connected investment bankers on Wall Street, Steven Rattner," according to the article:
Mr. Rattner, a well-known media banker, is playing a central role as car czar lite, traveling to Detroit to visit plants, meeting with the automakers’ bankers, unions and bondholders, and advising the White House on which companies seem salvageable and how. If he succeeds, he may get a chance at a larger job in the administration.
In my mind, this does not bode well for America.

The critical issue here is not how the taxpayers ought to invest in order to get their money back ASAP. It's how to build an revitalized auto industry within our national boundaries even if we don't get our money back directly for 30 years. Our economy has been demolished by the ownership society "short-term return" attitude in the investment banking industry. Let's don't extend that attitude into the attempt to restructure and rebuild our manufacturing base.

Yes, we don't want the government to own or the President to run an American auto industry. But maybe that is needed in order to, in the long run, have an American auto industry beyond a few accountants keeping records working with a few technicians who run automated robotic assembly lines putting together parts, all designed and manufactured elsewhere.

That's what happened in our clothing industry. Levi Strauss & Co. used to be one of our largest clothing manufacturers. Now it's a warehouse and accounting business keeping track of orders to and shipments from fabric and finished clothing manufacturers in other countries, temporarily (hopefully) warehousing some of the products in the U.S., and shipping and keeping track of sales to retailers. Levi Strauss & Co. manufactures nothing, like too many American businesses.

There is no point in using taxpayer funds to save an auto industry if that is what it will resemble.