"The New Normal? Some Consequences, Not All Intended or Expected"

Sydney M. Williams

Thought of the Day

“The New Normal? Some Consequences, Not All Intended or Expected”

January 6, 2011

I no longer fly as much as I once did. However in the past two months, five flights - two on American and three on United - have had five things in common: the number of flights has declined; fares have risen; the planes are full; service has declined; extras cost...extra. Departures are less frequent. No longer can one spread out with an empty middle seat; attendants no longer come by offering a pillow or blanket; anything more substantial than a bite size snack or a can of soda/juice costs extra, and the airlines no longer accept cash. (Charging $1.79 to your Amex card seems ridiculous.) And, for all this we have the opportunity to pay a little more.

Warren Buffett once remarked that the airline industry, in the years since Orville Wright first went airborne in Kitty Hawk, North Carolina in 1903, in the aggregate, never made money. But tough times make for tough decisions. Thus an unforeseen consequence of the credit collapse-induced recession (unforeseen by most investors and probably all policy makers, but likely not by business) has been that a number of industries have been placed on sounder financial footings.

The airline industry may well descend into its previous profligate ways, but perhaps not. Low cost carriers such as Southwest and Jet Blue had already made important inroads and the bigger airlines have responded by buying up competitors, thereby reducing competition. The retirement of planes and schedule reductions were obvious means of reducing costs and increasing load factors. As a customer, I miss the amenities of an earlier time, but also as a customer I feel more comfortable that they will have more money for maintenance where some of the savings hopefully will be spent. The truth is I always felt a little queasy about air carriers losing money when so much (and so many) depend on their adhering to strict maintenance and safety rules.

The auto industry is another that for years has made little or no money. Unions successfully negotiated egregious hourly raises, too-generous pension benefits, unaffordable healthcare plans that effectively denuded shareholders, but not management who managed to wring generous contracts from their compliant boards of directors. As the past recedes, it will become difficult to recall those hectic months two years ago when General Motors and Chrysler went bankrupt. In spite of the fact that bondholders got reamed during negotiations with the auto companies two years ago (contract lawyers must have spun in their graves!), it may finally be shareholders time; though investors should be cautious. Despite the obviousness of the link between Wall and Main (pension and retirement funds are the largest single holder of equities), there persists among liberals in Washington a feeling that all stock holders are cigar smoking, top hat-wearing insensitive capitalists. The enemy, as “Pogo” might have put it, is us.

Yesterday the auto industry reported industry sales in the U.S. of 11.6 million units versus a 27 year low for 2009 and, remarkably, the industry returned to profitability. Estimates for sales in 2011 are expected to expand to 12.2 million units. Assuming that target is reached, it would still be 23% below the average annual sales of 16.8 million units for the years prior to the recession, and would, in fact, be the third lowest in the past eighteen years! That American manufacturers have been able to return to profitability speaks volumes for industry changes. However, one should keep in mind that bankruptcy permitted extrication from billions of dollars in debt, and pension and healthcare obligations. Should the latter reemerge (the former will), losses will follow.

For decades following the end of World War II, the “big three” (GM, Ford and Chrysler) dominated the American automobile industry. Now, according to yesterday’s Wall Street Journal, the “gang of seven” (those three plus Toyota, Honda, Nissan and Hyundai) will split the spoils. Thirty years ago GM captured almost 50% of US auto sales and had trouble making money. By the end of 2008 GM’s stock was lower than it had been fifty years earlier. Labor had done well and so had management, but not so the owners of the enterprise - the shareholders. Last year GM captured 20% of a smaller market and was profitable. Necessity, as I wrote recently in a different context, becomes the mother of invention.

Commercial banks represent a third industry that has benefitted through difficult adjustments to tough times - again mainly self inflicted. (Investment banks, in contrast, have benefitted from the get-go of the credit crisis, as most were awarded commercial bank status, allowing them to borrow from the Fed’s Discount Window at 0.50% – so they can use the money – your money and mine! – to speculate, for example as Goldman did earlier this week in purchasing one percent of Facebook for $500 million – at twenty-five times revenues – providing little risk to Goldman, but almost no return to the lender – the taxpayer.) Reductions in mandated interest rate charges for poorer credits have caused banks to sever relationships with less credit worthy clients, improving the bank’s charge-offs, but forcing the borrowers into the arms of pawn shop owners and unregulated check cashers, both of whom often charge usurious rates. The amount needed to be held in checking accounts to qualify for free checking has risen five to ten fold. And, thanks to the Dodd-Frank Bill, an effective 84% reduction in debit-card merchant fees is causing banks to consider imposing annual fees on their use – an ironic response to a nation and a people trying to undo three decades of an unsustainable growth in credit card debt.

As a nation, we lived beyond our means for years, borrowing from the future to satisfy today’s hedonistic desires. This has been particularly true for politicians who ingratiated the electorate, especially state and local union members, by providing benefits in return for votes – knowing full well that the road had to come to an end. It now has. Businesses had done much the same in the post war years, but decades ago realized that pipers need to be paid, as most switched their pension plans from defined benefit to defined contribution plans. Reform, when it comes, is never easy. It takes time to adjust. Tony Blair, in his book, A Journey: My Political Life, speaks to the progress of reform (He is speaking of tuition reform in the U.K.): “The change is proposed; it is denounced as a disaster; it is unpopular; it comes about; within a short space of time, it is as if it had always been so.” In my opinion, we have not yet accepted the changes that will be forthcoming; nevertheless, necessity is dictating that eventuality. In the case of the U.S., investing for the future, whether it is in education or industry, must replace today’s culture of immediate gratification.

Whether this is part of the new normal envisioned by the bond gurus at PIMCO, I could not say. But businesses, like people, survive however they can. And it looks like these three are attempting to do so. If my being squeezed into a two foot square space for a four hour flight to Denver is the worst I will suffer, then I should consider myself lucky. But the consequences of rising airline fares, costlier cars with more onerous financing charges and tightening credit conditions for the neediest may not meet the expectations of millions who voted for Mr. Obama in 2008. They may have hoped to keep the good times rolling, digging the hole deeper and to hell with the consequences.