Yesterday, CNN reported:
Cash-starved small business lender CIT Group said Wednesday evening that it has been told it won't be getting a government bailout anytime soon.
There is "no appreciable likelihood of additional government support being provided over the near term," the company said in statement. The CIT board and executives are evaluating alternatives.
In the preceding days, there had been discussions between the federal government and CIT concerning a fresh round of federal assistance for the troubled small business lender. Had assistance been rendered, it would have stretched the federal government’s “too big to fail” doctrine beyond its implied purpose of preventing events for which the fallout could lead to the failure of the nation’s financial system. Instead, such a decision would have indicated that the “too big to fail” doctrine, already laden with moral hazard, had evolved into one in which it is politically unpalatable to allow even smaller entities to fail. Then, political connections, not the size of the firm or the risk it posed, would become the arbiter of whether a firm’s survival would essentially be guaranteed by the federal government. Such an outcome would further erode market discipline.
CIT Group is much smaller than the financial firms that were propped up by massive federal assistance. In its March 31, 2009 quarterly balance sheet, CIT reported $75.7 billion in assets. In contrast, assets held by Citigroup amounted to $1.9 trillion at the end of last year. Bank of America had assets of $1.8 trillion, and AIG’s assets amounted to $860.4 billion. Simply put CIT Group was nowhere near the class of firms that posed systemic risk.
Furthermore, were CIT’s to fail, it would not become the largest failed financial institution. When Washington Mutual Bank was shut down by the FDIC, it held assets of $307 billion. Additional banks with assets of $10 billion or more that were closed down were IndyMac, Downey Savings & Loan, and BankUnited Federal Savings Bank.
Rather than stretching the “too big to fail doctrine” into a de facto policy that exacerbates moral hazard, two viable alternatives exist:
• The FDIC could close down CIT Group and use its normal resolution process to dispense of CIT’s assets. CIT had previously registered as a bank holding company.
• The federal government could leave CIT to find such financing that it needs from private sources. Failing that, it could leave CIT to file for bankruptcy. Considering the FDIC’s need to conserve cash for the additional bank failures that are likely in coming months, the second option of leaving CIT to file for bankruptcy is probably the more attractive choice.
Either course would indicate to wary taxpayers that the federal government will not provide assistance to firms that are not too large to fail. Instead, extraordinary federal assistance would be confined to those entities that pose systemic risk. That, in turn, would limit the probability of the development of more widespread excessive risktaking in the future based on expected federal bailouts to preclude firm failure. Currently, moral hazard elevates the risk of such practices on account of a de facto federal guarantee that has been affirmed and reaffirmed for firms that pose systemic risk since the 1970s.
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Showing posts with label moral hazard. Show all posts
Showing posts with label moral hazard. Show all posts
Thursday, July 16, 2009
Wednesday, July 15, 2009
Automotive Prices Lead Core Producer Price Index Higher
During June, headline producer prices surged 1.8%. Excluding the typically volatile food and energy components, the producer price index rose at a tamer, but still brisk 0.5%. Leading this rise was a climb in producer prices for light trucks and passenger cars.
The Bureau of Labor Statistics explained:
The index for finished goods other than foods and energy increased 0.5 percent in June after inching down 0.1 percent in May. Accounting for most of this upturn, prices for light motor trucks climbed 3.4 percent following no change in the previous month, and the index for passenger cars rose 2.0 percent in June after edging up 0.1 percent in May.
At this time, it remains to be seen if a trend in which new vehicle production costs rise faster than core producer prices becomes established. The fact that monthly producer prices for passenger cars have increased faster than core producer prices for 5 of the last 7 months and producer prices for light trucks have exceeded the change in core producer prices in 6 of the last 7 months is a worrisome indicator. A six-month moving average for the core producer price index and the two new vehicle components also indicates that costs in the automotive sector may be starting to rise faster than overall producer prices.
A trend in which automotive producer prices rise persistently faster than the core producer price index could indicate that the restructuring of the automotive industry, including the bankruptcies of Chrysler and General Motors, is slow in increasing competitiveness even as the debt burdens of Chrysler and General Motors have been pared substantially.
Should the automotive sector grow less cost-competitive in its production costs, the automotive sector could be confronted with the challenge of trying to pass on its higher costs to consumers or continuing to face financial pressure. Already, the six-month moving average of new vehicle prices indicates that new vehicle prices are rising faster than either headline or core consumer prices.
Although it is too soon to determine whether that trend will be sustained, much less fully diagnose its causes, at least three factors could be contributing to the possible emergence of an unfavorable trend in new vehicle prices.
• Automobile manufacturers are trying to “catch up” with the recent increase in their production costs relative to producer prices. In doing so, they are trying to pass on at least a share of those costs to consumers.
• Automobile manufacturers have assumed that demand for new vehicles will increase as an economic recovery takes hold. Under such a scenario, they figure that there might be an opportunity to pass on at least some share of the recent increase in their production costs that would not exist were the economy to continue to contract.
• Moral hazard is beginning to play out. Given the enormous taxpayer assistance that has been provided to the automotive industry and to automotive parts suppliers, the industry believes that additional downside risks from a stagnating of new vehicle sales or even a further decline are relatively minimal. Instead, the federal government would be prepared to render additional assistance under such a scenario. Under such a risk assessment, the automotive producers could assume that they can take a greater risk at increasing their prices in the face of soft economic conditions that they might otherwise have had to forego in the absence of expected additional federal assistance.
Overall, a situation in which the automotive industry’s production costs rise relative to the core producer price index could have profound consequences for the troubled U.S. automobile industry. In a market in which competition is global, more cost-competitive foreign producers could gain additional market share. That development could weaken recovery prospects for the U.S. automobile industry. It could also inhibit the domestic industry’s ability to invest in research and development relative to their international competitors, potentially creating an environment of further decline relative to global producers. It could render the U.S. automotive industry less capable of addressing potential future challenges brought on by the emergence of disruptive technologies that could dramatically alter the industry landscape in terms of such variables as cost, design, and fuel consumption.
&&
The Bureau of Labor Statistics explained:
The index for finished goods other than foods and energy increased 0.5 percent in June after inching down 0.1 percent in May. Accounting for most of this upturn, prices for light motor trucks climbed 3.4 percent following no change in the previous month, and the index for passenger cars rose 2.0 percent in June after edging up 0.1 percent in May.
At this time, it remains to be seen if a trend in which new vehicle production costs rise faster than core producer prices becomes established. The fact that monthly producer prices for passenger cars have increased faster than core producer prices for 5 of the last 7 months and producer prices for light trucks have exceeded the change in core producer prices in 6 of the last 7 months is a worrisome indicator. A six-month moving average for the core producer price index and the two new vehicle components also indicates that costs in the automotive sector may be starting to rise faster than overall producer prices.
A trend in which automotive producer prices rise persistently faster than the core producer price index could indicate that the restructuring of the automotive industry, including the bankruptcies of Chrysler and General Motors, is slow in increasing competitiveness even as the debt burdens of Chrysler and General Motors have been pared substantially.
Should the automotive sector grow less cost-competitive in its production costs, the automotive sector could be confronted with the challenge of trying to pass on its higher costs to consumers or continuing to face financial pressure. Already, the six-month moving average of new vehicle prices indicates that new vehicle prices are rising faster than either headline or core consumer prices.
Although it is too soon to determine whether that trend will be sustained, much less fully diagnose its causes, at least three factors could be contributing to the possible emergence of an unfavorable trend in new vehicle prices.
• Automobile manufacturers are trying to “catch up” with the recent increase in their production costs relative to producer prices. In doing so, they are trying to pass on at least a share of those costs to consumers.
• Automobile manufacturers have assumed that demand for new vehicles will increase as an economic recovery takes hold. Under such a scenario, they figure that there might be an opportunity to pass on at least some share of the recent increase in their production costs that would not exist were the economy to continue to contract.
• Moral hazard is beginning to play out. Given the enormous taxpayer assistance that has been provided to the automotive industry and to automotive parts suppliers, the industry believes that additional downside risks from a stagnating of new vehicle sales or even a further decline are relatively minimal. Instead, the federal government would be prepared to render additional assistance under such a scenario. Under such a risk assessment, the automotive producers could assume that they can take a greater risk at increasing their prices in the face of soft economic conditions that they might otherwise have had to forego in the absence of expected additional federal assistance.
Overall, a situation in which the automotive industry’s production costs rise relative to the core producer price index could have profound consequences for the troubled U.S. automobile industry. In a market in which competition is global, more cost-competitive foreign producers could gain additional market share. That development could weaken recovery prospects for the U.S. automobile industry. It could also inhibit the domestic industry’s ability to invest in research and development relative to their international competitors, potentially creating an environment of further decline relative to global producers. It could render the U.S. automotive industry less capable of addressing potential future challenges brought on by the emergence of disruptive technologies that could dramatically alter the industry landscape in terms of such variables as cost, design, and fuel consumption.
&&
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