Justice on Life Support

On March 30, 2023, Donald Trump managed to further sully American history by becoming the first President indicted for crimes -- in this first case, as a FORMER President already declared to be running to become the NEXT President for crimes committed PRIOR to his Presidency. It won't be argued here whether Trump is the first President to DESERVE such a fate - other candidates exist -- but it says something about Trump's immoral makeup that he was the first to drag the Presidency across that previously unthinkable line. Specifics of Trump's first indictment -- it seems likely there will be others in other unrelated matters -- are likely to remain hidden until his arraignment in a New York City courtroom expected on April 4. There isn't much value in speculating about the strength of the case or likely defense tactics until details of the charges become public. However, comments from those nominally in favor of this first indictment and those vehemently opposed raise troubling insights into the daily operation of justice in America -- for the privileged and the masses.

Generalities of the Case

Again, the detailed charges of the indictment will likely remain secret until Trump's expected arraignment on April 4, 2023. In general, the case under investigation involved the following events:

• a sexual affair between Trump and an adult film star ("Woman-1" or Karen McDougal) in 2006
• a sexual affair between Trump and an adult film star ("Woman-2" or Stormy Daniels) in 2006
• a $150,000 "capture and kill" deal brokered by Trump Organization lawyer Michael Cohen, Woman-1 and American Media on August 6, 2016 to squelch 1's story
• a secondary deal between American Media and a shell company created by Cohen to assign the "kill and capture" rights to Cohen in exchange for $125,000
• public disclosure on October 7 of audio recordings from 2005 of Trump stating to an Inside Hollywood feature reporter "And when you're a star, they let you do it. You can do anything... Grab them by the pussy. You can do anything."
• contact on October 8, 2016 -- one day after the Inside Hollywood disclosure -- from the lawyer for Woman-2 to American Media offering to sell the story of her sexual affair with Trump
• within a few days of October 8, Cohen negotiated a deal with Woman-2 and American Media for control of her story for $130,000 but actual payment on that deal was held up
• on October 25, Woman-2 still unpaid contacted the lawyer and editor at American Media who contacted Cohen over an encrypted phone application requesting payment urgently, at which point Cohen agreed to complete payment
• on October 26, Cohen used recently completed incorporation papers for a second shell company Essential Consultants, deposited $131,000 of funds from a separately obtained home equity account in his name, then wired $130,000 from that account to the attorney at American Media, fraudulently tagging the transfer on the wire request as a "retainer"
• on November 1, the lawyer for American Media returned a copy of the final signed / executed deal between American Media and Woman-2 for control of her story
• in January of 2017, Cohen submitted reimbursement requests for the $130,000 payment, the $35 wire fee and $50,000 in other technical support expenses to The Trump Organization, which grossed up the $180,035 amount to $360,000, added another $60,000 in "bonus" then set up an arrangement to pay the $420,000 in twelve monthly installments as income to Cohen rather than business expenses or political contributions benefiting the Trump campaign

Cohen was charged and convicted by federal officials on a variety of crimes, some unrelated to Trump the individual or The Trump Organization, but the falsification of expenses tied to Essential Consulting WAS among the criminal charges that earned convictions that sent him to prison. More importantly, Individual-1 referenced in those charges was obviously Donald Trump but he went unindicted at the time because of a long-standing internal Justice Department policy stating federal law enforcement cannot indict a sitting President.

Insight into the Hush Money Case

Once Trump left office, the parlor games began regarding additional prosecutions regarding the Stormy Daniels hush payment and related paperwork. Would the Justice Department now pursue charges against Trump mirroring the same charges applied to Cohen, now a convicted felon from the same events? If a jury understood the charges the first time and reached a guilty verdict, it would seem the only challenge left would be proving Trump's involvement was active enough to serve as direction / agreement of not just the payment but the creation of bogus accounting and masking of a financial contribution obviously benefiting his campaign. Once the Justice Department declined to pursue the case, WHY did they decline? Weakness in the facts supporting an argument Trump was a party to the criminal actions? Reluctance to use such a prurient event to drive a precedent setting case? Bigger fish to fry to drive those same weighty precedents? Or a belief that NO President should be subjected to prosecution, lest we instantly turn America into a banana republic of perpetual persecution between alternating despots?

None of those questions were answered. Merrick Garland and team essentially said NOTHING. In the meantime, state officials were investigating years of tax fraud by Trump and his operating companies involving arbitrary inflation / deflation of asset prices to INFLATE collateral for bank loan applications (bank fraud, wire fraud) while at the same time fraudulently LOWERING evaluations for tax bills (tax fraud). On September 21, 2022, New York State Attorney General Latitia James filed a civil fraud case against Trump family members and The Trump Organization itself seeking $250 million in financial penalties, ongoing state audit supervision of the firm's books and a ban on any of the Trump family operating any company in the State of New York. The investigation went back at least ten years and identified over 200 instances of fraudulent asset valuations. Obviously, many of the instances were beyond criminal statute of limitations bounds (hence the civil action) but presumably James and team saw patterns that extended to current practices and shared that information with federal prosecutors and (presumably) Manhattan District Attorney prosecutors as well throughout their multi-year investigation.

Until December 31, 2021, the Manhattan District Attorney was Cyrus Vance, Jr. Vance was leaving office on 12/31/2021 so the entire world waited for him to emerge with a decision on charging Trump in the Stormy Daniels case like Puxatawny Phil's spring forecast. After Vance left with no public decision, his elected successor Alvin Bragg met with investigators and prosecutors reviewing the material. On February 23, 2022, two of his prosecutors publicly quit in frustration, a day after an internal meeting in which Bragg had said he was not ready to proceed with a case. Bragg did not subsequently provide public clarifications regarding his thinking but reporting at the time claimed he was concerned about dependencies upon testimony from Michael Cohen in prosecuting a case requiring proof of intent in Trump's mind when Cohen's conviction would obviously allow the defense to claim Cohen was seeking retribution against his former boss.

So what has Alvin Bragg learned since February 23, 2022 that led him to indict Trump? Again, the indictment most likely will not be shared until the arraignment on April 4 so frankly, speculation really isn't productive without those details. It seems likely that Bragg's team has benefited from some of the information shared by Latitia James' team that might have identified a more consistent pattern of fraud regarding shell companies, legal fees and misstated accounting records that confirm a pattern of involvement, direction and intent directly on the part of Trump that were also used in the Stormy Daniels actions. It also seems likely that additional documents, recordings or testimony have provided confirmation not dependent upon Michael Cohen that Trump approved or even requested the actual payment explicitly to defuse a POLITICAL issue DAYS before election day (making it a campaign contribution, not just a family effort to avoid the wrath of a wife) and approved or even requested the paper shuffle to pay for the campaign contribution out of Trump Organization funds and mis-characterize the reason rather than paying out of Donald J Trump's personal checking account. As of late March 31, multiple sources are mentioning the first indictment involves "about 30" criminal charges. This quantity of charges, if accurate, would confirm investigators established a strong pattern of wrongdoing over time and different parties of which the hush money case may only be one facet.

Trump's current lawyer has essentially argued "the Edwards Defense", a reference to Democratic Presidential candidate who escaped conviction for hush payments under the guise of the payments being made to avoid personal embarrassment of his wife, rather than assisting his presidential campaign. The sequence of events above would seem to easily refute such a claim since negotiations with the second woman began ONE DAY after the Access Hollywood campaign that had temporarily paralyzed Trump's campaign and spending -- he could NOT survive a second moral blowup prior to Election Day.

Insights into American Justice

It is pointless to play fantasy courtroom for either the prosecution or defense given the incomplete picture of this first indictment but analyzing the reactions of elected officials, media and the public provides insights into more important concerns - the widening inequities in the American system of justice. One of the most curious reactions came from the editorial board of The Washington Post. On March 31, they published an opinion stating the hush money case was a "poor test case for prosecuting a former president." This argument seems focused not on the merits of the case as they stand (because no one knows those merits until charges are disclosed at arraignment) but the timing of this case versus other alternatives pending. Is the WaPo for some reason anxious about a potential history-making case being tied to something as salacious as a porn star payoff? Are they worried the complexities of this case might result in an acquittal which might make prosecutors even MORE reluctant to attempt prosecution in future cases of deserving Presidents?

That concern in fact seems to reflect a simple belief that any change in precedent regarding treatment of Presidents better involve REALLY REALLY important matters, rather than simple / stupid / tawdry stuff. But such concerns in fact would conflict with the goal of equal protection under the law. If a candidate for House or Senate had an affair, paid off the other party for silence amidst a campaign, and failed to record it as a campaign contribution and falsified other records to cover the expense, THEY would be prosecuted. If charges would be filed in some cases but not when a President is involved, then we are not providing equal protection to all citizens and we are not subjecting all citizens equally to the law for wrongdoing. THAT is the issue. Not hush money, not campaign finance and not accounting fraud.

Curiously, The Washington Post also ran another editorial on March 31, 2023 expressing frustration that this hush money case is now a state level case rather than a federal criminal case. The concern stems first from the fact that, within New York State, nearly all prosecutors and judges involved are partisan, elected officials which means a long case can result in charges being dropped or prior rulings being reversed in response to elections if participants are targeted for prior actions in a case. While making the justice system responsive to voters, it also makes justice decisions potentially more volatile in ways which cloud the clarity of precedents and create the perception of selective treatment which again is antithetical to the rule of law. A point not mentioned in that second WaPo editorial is why federal prosecutors did not essentially take the prior federal prosecution of Cohen, globally substitute "Donald J Trump" for "Michael Cohen" then hit the play button immediately after Trump left office. One would assume the exact same set of facts involving the same four parties (Trump, Cohen, Daniels, American Media) that resulted in a prior conviction would simplify prosecuting Trump as a co-conspirator already referenced in evidence that won a conviction. While the prior prosecution wasted no breath in the trial cementing the idea that Trump not only approved of the crime but directed it (since they were acting under the premise he was un-indictable as a sitting President), the actual FACTS presented did seem to make that case and they were sufficient to convict Cohen.

The reactions of the far right (Trump fans and wannabes alike) to the indictment are far more concerning. Within five minutes of the breaking news, America's despot-in-waiting, Ron DeSantis, posted a comment blasting Bragg's indictment as "un-American" and a weaponization of the legal system to advance a political agenda. More tellingly, he stated Florida officials would not comply with any request for extradition of Trump from Florida to New York if it came to that. DeSantis' comment was clearly pre-crafted for political consumption and has little likelihood of becoming an issue since Trump appears to be planning on surrendering in New York voluntarily. Besides, federal law requires every state to honor extradition requests from any other state. However, DeSantis' comment exposes his sole criteria for virtually any action he performs in office ("what's in it for Ron?") and reflects his willingness -- even EAGERNESS -- to use his powers (actual legal powers or perceived, threatened powers) for HIS political gain at the drop of a hat.

Consider DeSantis' reaction from this perspective. His vow to violate federal law by refusing to direct state officials to comply with a valid (but hypothetical) extradition request isn't an off-the-cuff social media REACTION of an idiot to bad news for a fellow fear-monger. It was a PRE-PLANNED reaction, carefully crafted to stroke the desired fears and biases of a carefully curated base. In essence, Republicans are not playing mere checkers in creating chaos, they are planning chess moves of chaos and have additional incendiary ammunition staged and ready to fire no matter where the chaos crops up next.

This game of incendiary chess is being played at every level -- federal, state and local. On March 29, US House Representative Lauren Boebert (R-CO) attended a committee hearing regarding criminal codes in effect in Washington, DC after recent battles in which CHANGES to those codes were REJECTED by the House and Senate. Boebert arrived armed with a series of questions for a witness who led a team formulating the proposed changes WHICH WERE REJECTED BY CONGRESS, aiming to get him to admit that he pushed for changes that allowed public urination. Only NO CHANGES were made and HE DIDN'T DRAFT any proposal to eliminate public urination as an offense and voted FOR an altered list of changes that omitted the change she was citing. Only Boebert wouldn't hear it. She badgered the witness with false facts, repeatedly interrupted him as he tried to answer her questions while making it sound like he was rudely interrupting her (a classic tactic in obfuscation and non-communication -- pick an argument with the person you're questioning and never let them complete an answer…), and kept fixating on public urination. (Aside #1, best online coverage of this fiasco was an article in The Guardian entitled Wee the people. Aside #2, there could be a reason for Boebert's fixation on public urination since her husband was charged in 2004 with public indecency and lewd exposure at a bowling alley.) Whatever purpose the committee had in originally calling this meeting on congressional oversight of DC's finances and local law enforcement was completely destroyed by the time Boebert ended her sideshow. Mission accomplished.

In Missouri, Republicans in the legislature introduced bills in January 2023 to further restrict the ability of Missouri voters to make changes to the state constitution. Under current law, voter initiatives for constitutional amendments must collect signatures from eight percent of registered voters in the state. Under a new proposal, that percentage would go UP and that percentage would have to be reached in EACH district within the state. The state is split about 50/50 between liberal and conservative with the metro areas of St. Louis and Kansas City being "blue" and everything else being "red" but due to gerrymandering, enough of the liberal votes in St. Louis and Kansas City are bled off into red districts, creating a super-majority for Republicans in the House and Senate, despite actual voter totals being much closer. Assuming a proposal collects enough signatures, current law only requires a 50% majority to pass but bills have also been proposed to raise that majority to 60% or even 67%.

In Arizona, Republican state lawmakers have adopted the "majority majority" rule (commonly called the Hastert Rule) already adopted by US House Republicans to require any proposal to obtain a majority vote of support within the Republican caucus in order to progress pass committees for a full vote. That means in a 50/50 split, a bill proposed by 100 percent of Democrats and 20 percent of Republicans (total support of 60 percent) will still be blocked from progressing. Only bills gaining at least 50% support from the Republicans will reach a vote, essentially eliminating any legislation from passing even if a technical majority of all elected officials are in favor of a bill. Arizona Republicans claim this rule has been in place for years but interviews of prior Republican Arizona House speakers reflected no use of such a rule to gate bills reaching a vote.

Efforts are in flight in many states to impose more control on the discretion of local prosecutors via special oversight panels which can enforce desired emphasis on "favorite crimes". Again, in Missouri, state officials are attempting to use oversight rules to remove St. Louis Circuit Attorney Kim Gardner from office after a teenager visiting the city lost both of her legs in a horrific accident caused by a multiple offender who was out on bail awaiting trial due to delays in part due to Gardner's incompetence in operating her office. A perfect use of such measures. Unfortunately, the information cited by Missouri's current Republican Attorney General for justifying Gardner's removal dates back to 2017 when she entered office. The same information was readily available to Missouri's PRIOR Attorney General, Republican Eric Schmitt, who did nothing with the statistics on delays, lost paperwork, charges left unprosecuted, etc. and instead spent his time suing the Biden Administration about immigration issues in Texas and student loan forgiveness.

In Georgia, Republicans are proposing a bill that would establish a state oversight board to monitor prosecutor performance across the state and allow this board to jettison any prosecutor not meeting the board's desired standards. Of course, this proposal isn't aimed at any incumbent "Kim Gardner" type prosecutor who is failing at the basic mechanics of prosecuting crimes.. It's aimed at eliminating highly competent prosecutors such as Fani Willis who is investigating the attempts of a US President to conspire with elected state officials and administrators to alter the legitimate results of the 2020 election. The oversight board being proposed would have a Republican majority controlling it, reflecting the gerrymandering of the entire state. This would allow Republicans to thwart the legitimate work pusued by prosecutors elected in Democratic dominated areas from pursuing cases related to voting rights, civil rights, labor rights, etc. that might not be popular with outstate Republicans.

Tactics like these in Missouri, Arizona and Georgia reflect a fixation on the insulation of existing power from future majority blocs of voters. The same tendencies of Republican legislators at all levels to insulate themselves from accountability to their voters will continue spilling over to measures that will attempt to control the judiciary to protect special interests and persecute enemies. There is no concept of right and wrong or innocent and guilty driving these measures. Only winning versus losing and the preservation of power at any cost.

WTH

America's Political / Criminal Circle of Hell

Donald Trump's actions the week of March 19, 2023 have proven beyond a shadow of a doubt that America is now operating in a never-before seen circle of political and criminal hell. In a single week, Trump established two new lows for the conduct of ex-Presidents. He lashed out about his own projection of a criminal arrest and simultaneously warned of death and violence because of his arrest. But he also promoted his first official campaign rally which was held March 25 in Waco, Texas and - by doing so -- directly drew parallels between his perceived persecution by "racist prosecutors" in three different proceedings to the "persecution" of Branch Davidian cult leader David Koresh and eighty five persons killed with him by "jackbooted" government thugs after federal agents attempted to execute search warrants related to child sex abuse charges and illegal weapons violations.

Lest anyone think such a linkage is purely coincidental, a CURRENT "pastor" of the Branch Davidians (yes, the cult still exists…) responded to Trump's public comments by agreeing with them and explicitly drawing the comparison between the siege on the Branch Davidian complex and the execution of a search warrant for illegally retained top-secret documents at Mar-a-Lago. Like Ronald Reagan's choice of Philadelphia, Mississippi as the site of a "state's rights" speech in the 1980 campaign, it isn't a mere dog whistle tactic if EVERYONE can hear it a mile away.

So if it appears possible for a religious cult to survive thirty years after an apocalypse brought on itself by its own leader, what hope is there for any end to the Trump cult of ignorance, fear and hatred? Answering that is difficult without first contemplating the charges facing its leader, the tactics being used to avoid accountability for them and the larger feedback loop between political systems and criminal justice systems that are worsening the problems rather than correcting them.

In as few words as possible, the various charges facing Donald Trump are summarized below:

• an ex-President is being sued for libel stemming from a stalled lawsuit for an alleged rape in late 1995 / early 1996 that originally could have been dodged under the "no indictment of current President" rule until the same libelous comments were made a second time
• an ex-President is under investigation for violations of New York State law involving possible state misdemeanor charges of falsification of business records which may have been conducted to hide illicit use of campaign funds (a federal crime) elevating the state misdemeanor to a state felony -- the root of the issue is a $130,000 payment to a porn actor after a prior public fiasco about taped comments about sexual assault in the week prior to the 2016 election
• an ex-President is under investigation since January 2022 for possible criminal violations of the Espionage Act due to boxes of highly classified materials found missing from National Archives inventories
• an ex-President is under criminal investigation based upon a criminal referral from the House Committee on January 6 involving: obstruction of an official proceeding, conspiracy to defraud the United States, conspiracy to make a false statement, inciting and/or assisting an insurrection
• an ex-President is under investigation by Georgia state officials for his efforts made after the 2020 election to alter certified voting results to switch Georgia electoral votes to flip the 2020 Presidential election
• as a result of the missing document criminal investigation, an ex-President is also now under criminal investigation for lying to government agents attempting to recover said documents and filing demonstrably false affidavits in the process

At a minimum, one would think that any ONE of these situations would be enough to ensure the target would never enjoy one additional second of airtime or attention from anyone except prosecutors, judges and juries. Instead, the target has paralyzed legal efforts at the state and federal level with a consistent, escalating set of strategies:

• claiming permanent immunity from civil / criminal actions as a President or ex-President -- even for actions PRIOR to becoming president
• delaying proceedings through bogus claims of Executive Privilege to block sharing of information
• filing frivolous motions and objections to further delay proceedings
• churning through lawyers to further delay proceedings as new counsel ramps up
• filing demonstrably false affidavits with courts
• interfering with potential witnesses by offering financial incentives for future employment
• interfering with potential witnesses by making derogatory / threating public comments
• venue shopping proceedings with courts with a higher proportion of Trump-appointed judges
• interfering with proceedings by making public threats against prosecutors and judges

In a properly functioning justice system, these tactics would be immediately identified and halted in their tracks with immediate rejections of bogus motions, harsh reprimands of attorneys at initial use of these tactics and financial sanctions / disbarment upon repeated offenses. As these first levels of criminal tactics for defending the target were defeated, pressure would immediately focus on the many participants supporting the alleged activity to compel testimony to move the investigation or trial forward.

Of course, under normal times, one would assume at least SOME of those participants would evaluate the ethics of their actions and their immediate legal peril and provide truthful testimony that could quickly cut through any remaining fog and bring the cases to an appropriate conclusion. These are not normal times. In this case, the target has a lifetime career of fraud and racketeering-like behavior and attracted an entire paid team of Administration advisors and shadow advisors consisting of people from the far fringes of ethics and basic sanity who have no issues with using the same tactics. Months of delays were encountered as staff attempted to exercise bogus claims of Executive Privilege and other Constitutional claptrap. As of March 25, 2023, appeals courts have rejected nearly every one of these stall tactics and have finally put several key witnesses in the box in front of grand juries without even Attorney / Client privilege protections.

But frankly, even that is likely not enough to ensure justice.

We are so far beyond any norms that there is STILL no assurance these parties will provide testimony. Given their self-selecting status as being ethically diminished enough to consider acting in the target's orbit, there is a HIGH likelihood they will plead the fifth amendment -- either as a final attempt to do the target's bidding by withholding information or because they are literally a party to the crime being investigated and may incriminate themselves as well. At that point, the only lever left for prosecutors involves carefully considered offers of immunity to key players who might possess info required to definitively secure charges and convictions against others higher in the chain.

But again, these are not "normal" criminal actors in normal times. These are "exceptional" criminals in abnormal times. Many of the actors could reject any plea deal for immunity, take their chances in a jury trial and bet on obtaining a state or federal pardon after the next election for Governor or President. Any leverage prosecutors have with plea deals is being ACTIVELY subverted by Republican politicians at the state and federal levels who are denigrating the prosecutors and judges involved with these proceedings, strongly hinting any convictions would be tossed out if the balance of power shifts back to Republicans. In Georgia, state politicians are scheming to create a new state-level review board that would have the power to remove any prosecuting attorney at the state / county level. Republicans previously OPPOSED such a panel when Democrats proposed a similar mechanism in response to the delayed prosecution in a prominent racially motivated murder so their sudden support of such a measure after the election of numerous minority women as prosecutors in 2020 seems HIGHLY suspect.

Analyzed as a set, all of these circumstances reflect a never-ending feedback cycle between flawed politics and criminal behavior:

• what started as a political problem (a balkanized electorate voting for a known racist, misogynistic fraudster)
• created epic political problems (an impeachment involving the extortion of an ally Ukraine in exchange for political dirt for use in an upcoming re-election campaign)
• then created unimaginable criminal problems (conspiracy to overturn an election and incite an insurrection thwarting the transfer of power)
• which triggered unprecedented political problems (a second impeachment)
• then petered out with more unprecedented post-term criminal problems (Espionage Act violations and lying to government agents about handling of national security documents)

We have traversed the circle multiple times and landed again upon…

….a political problem.

In the end, the duration and depravity of this American nightmare stem from the implosion of the Republican Party at the emergence of the Tea Party faction. The Republican Party was balkanized prior to February 2009 but outward political success allowed the internal divisions to be masked from outsiders, making the party appear to be operating as one large block of ice floating in the political sea with an appearance of plausible policies and tolerable behavior of its members. After losing the Presidency in 2008 to a black Democrat, Republican leaders organized IMMEDIATELY to create an internal strategy for blocking ANYTHING that black Democratic President would propose and that private leadership strategy became a public strategy under the "Tea Party" name within a month of inauguration of "the other guy."

At that point, older, traditional "country club" Republican leaders began retiring, further reducing any moderating forces in policy and conduct. After the re-election of a black President, the illusion of a unified "iceberg" of Republicanism was split into separate "ice cubes" floating around the Sea of Right. The preferences, fears and hatreds of those in the biggest single surviving ice cube "bloc" of the party exactly matched those of Donald Trump, a lifelong racist, misogynist and financial fraud.

While that bloc might not have been mathematically a majority of the party, because it was the largest single bloc of the party, it allowed Trump to gain momentum during 2016 primaries and no Republican leaders had the courage to publicly condemn such a fatally flawed human as their party candidate. Instead, decades of us-versus-them policymaking created a Republican bench that failed to yield a single candidate able to argue against Trump from a position of sanity and moral authority. All of his competitors bowed out and the entire Republican Party rallied around their candidate despite a sexual scandal of PROVEN epic proportions a week before the election and managed to win an electoral college victory to put him in the White House.

Regardless of what happens in the coming weeks in FOUR different ongoing court venues, the only viable solution that can ultimately eliminate the cancer of Trumpism lies in the political realm, not the criminal realm. As long as political forces continue rewarding politicians who threaten judges and prosecutors and allowing politicians to appoint corrupt judges willing to ignore CENTURIES of precedent while lying about it in their confirmation hearings, criminal proceedings are not a reliable means for curing these ills. The only solution is a mass exodus of voters who currently identify as Republican who are NOT part of the MAGA cult. As long as they continue to vote or act under the Republican brand, they are allowing an authoritarian / fascist minority to leverage a minority position of a party operating in a structurally flawed two-party system to impose grossly undemocratic policies upon an entire country.

WTH

Do You Smell Smoke?

On August 12, 2007, I posted an analysis (Financial Markets Running on Empty) of an odd statistical blip within financial markets that seemed to be overlooked (purposely ignored?) at the time but proved ominous in hindsight. The Dow had dropped 279 points on Monday, August 6, then jumped back 469 points by Thursday, August 9 only to drop 381 points on Friday, August 10. A discussion of the factors causing those jitters on the PBS NewsHour struck me as odd at the time. Two notable figures in economics explained away the wild oscillations as a perfectly logical result from a sudden shift in the "risk spread" between the cost of "safe" money versus the cost of achieving higher returns as markets realized the risks taken to earn those higher returns were in fact much larger than previously understood.

Ah, makes perfect sense, I said at the time. Nothing to see here, move along…

Except that discussion happened to mention a dollar figure involved with the funds "injected" by the Federal Reserve into financial institutions on Friday, August 10 to stabilize the markets. $38 billion dollars. That struck me as a rather large number. I did some digging to compare normal daily Federal Reserve "injections" with the $38 billion dollar figure and came away dumbstruck, leading to one key rhetorical question… Did the events of August 10, 2007 feel like the events of September 11, 2001? The Fed's intervention on August 10 dwarfed that of the interventions after September 11, 2001 despite market uncertainties after 9/11 that were obviously astronomically high. That raised another critical question… Assuming the Fed doesn't commit tens of billions of dollars for nothing, what risks were seen on August 10, 2007 that were WORSE than those after markets re-opened after September 11, 2001?

More disconcerting than the basic dollar amounts involved was another subtle change in Federal Reserve strategy undertaken with the intervention on August 10, 2007. On that day, the Fed not only initiated purchases of Treasure bills -- normally viewed as near-zero risk for all parties involved -- they began buying up corporate bonds and mortgage backed securities, the very investments underlying the crash that -- in hindsight -- was essentially beginning that day on August 10, 2007 and cumulated in the 2008 meltdown.

The key point of that analysis was that ANY time the Federal Reserve is required to inject RECORD amounts of cash to provide liquidity between banks as they settle their books each night, bad things are afoot. When the Federal Reserve also has to devise new mechanisms for stuffing cash into the pockets of banks never previously used or contemplated, really bad things are afoot.

---

Fast forward to the events of the week of March 13, 2023.

The public was already spooked by the failure of Silicon Valley Bank on March 10, 2023 triggered by its narrow focus on providing merchant services (payroll / accounts payable) services to bubble-funded startups and its incompetent strategies for hedging risk from interest rate fluctuations. That failure was bookended by the failure of two other institutions, Silvergate and Signature Bank, which had exposure to risks in crypto markets and firms betting on crypto assets. After Silicon Valley slipped under the water, markets began looking for other institutions that might be similarly challenged by swings in long term interest rates and a new victim was found -- First Republic Bank. Analysis of the bank's depositor profile showed 68% of accounts over the FDIC's limit of $250,000. The bank's credit rating was downgraded on March 15 by Fitch's and Moodys.

As the stock price of First Republic continued falling the week of 3/13 in response to these disclosures, private discussions between regulators, the Fed and initially JPMorgan Chase concluded "something must be done." A collection of uber-banks (the TBTFs) and wanna-be-uber banks (the "tbtf" regionals) organized a plan to inject $30 billion dollars into First Republic by transferring balances of their depositors over to First Republic. At the same time, the Fed devised a new means for floating money to banks. In an attempt to even out short term panics triggering fluctuating valuations for Treasuries prior to maturity, the Fed will now loan dollars to banks by holding Treasuries owned by the bank for 12 months in exchange for the cash value the bank paid for the Treasuries, even if the current market price on that T-bill is LESS. This avoids the impact of having to raise cash by selling Treasuries prior to maturity and taking exaggerated losses -- the sequence of events that tanked Silicon Valley Bank.

Receiving far less attention was the fact that the events of the week of March 13, 2023 generated another wave of massive liquidity intervention on the part of the Federal Reserve. How massive? Larger than the interventions at the peak of the 2008 meltdown.

https://www.investopedia.com/federal-lending-to-banks-eclipses-2008-crisis-7368374

In addition to $11.9 billion being lent in the first week of the Fed's new one-year lending program, overnight lending via the Fed's "discount window" to banks settling their books each night skyrocketed. In the week ending March 10, discount window lending totaled $4.5 billion. For the week ending 3/17/2023, discount window lending totalled $152 billion dollars. In comparison, discount window lending in the worst week of the 2008 crisis totaled $110 billion dollars. Inflation from 2008 to 2023 totaled about 29.6% so in 2023 dollars, the 2008 lending peak would be $142 billion.

Again, the question must be asked. Do the events surrounding the failure of three banks in 2023 appear to be anywhere near as consequential as the meltdowns in 2008 triggered by years of fraud with mortgage backed securities and credit default swaps and retail mortgage origination fraud?

As was the case in 2007, perhaps the insiders talking their book by telling Average Joe and Jane to sit tight and leave their money where it is know something -- or many things -- the public does not. It's not like there are shortages of risks facing financial systems worldwide:

• Credit Suisse undergoing a pre-emptive merger into UBS at the urging of the Swiss Central Bank and Swiss regulators, concerned its tanking equity might trigger a failure similar to Silicon Valley Bank or the fate just dodged by Republic One in the US.
• Massive strikes in France related to imposed changes in retirement ages driven by massive increases in costs due to declining birth rates and longer lives, all of which could ripple into France's financial system.
• Looming debt ceiling charades in the United States that have technically already put the Treasury beyond the current debt ceiling, only to be delayed by manipulations of accounts across the federal government -- manipulations whose incremental freed cash could vanish in an instant if the Treasury has to respond to another banking crisis.

WTH

The Origins of Current Financial Failures

The problems being experienced in the worldwide financial industry stem from two key failures -- the failure of banks and their customers (individuals and businesses) to accurately / consistently contemplate all of the components of risk in their financial decisions and the failure of governments and central banks to consistently enforce meaningful regulations that stop the feedback loop of ever-larger dumb corporations requiring ever-larger dumb banks to hold ever-larger concentrations of wealth.

Unique Factors Driving the SVB Failure

Initial reporting on the failure of SVB attempted to emphasize unique factors that contributed to SVB's insolvency and takeover by the FDIC. Understanding these factors at face value is worthwhile for what they say about management decisions made by SVB executives and those of its customers. The basic narrative behind the failure is that SVB incurred a spike of withdrawals from some of its largest startup customers which required cashing out significant numbers of longer term bonds held by the bank to raise the cash, which forced the firm to take losses on those bonds due to rising interest rates set by the Federal Reserve.

Note that THIS round of withdrawals itself did NOT cause the complete failure. A few more days of iterative actions and reactions were required.

After selling some of its holdings at a loss, SVB executives decided they needed to raise cash and chose to do so via selling stock. The sequence of events here is what actually triggered the bank's demise.

1. SVB executives chose to raise the equity via TWO separate actions -- a typical common stock offering and a distinct offering of preferred stock. Common stock provides the stockholder voting rights in the company's decision making while preferred stock provides ZERO voting rights but provides a higher prioritization of dividend payments as compensation for the lack of voting influence.
2. In an attempt to calm public concerns, SVB executives publicly announced their two-tiered equity plan so depositors, current shareholders and regulators could all relax knowing they had a plan.
3. In fact, SVB's public announcement not only conveyed the size of its shortfall (the offers totaled $1.8 billion dollars), it confirmed ALL of the dollars the firm stated it needed would not be all available at the same time. Funds from the preferred stock offering would be delayed by at least a half day in order for the firm to complete the extra legal paperwork required for such an offering.
4. This timing gap convinced many depositors that their funds would still be at risk for at least another entire day so depositors lined up the next morning to continue draining money from SVB accounts.
5. The FDIC saw the continued run and stepped in to take over the bank.

It isn't clear if a unified common stock offering executed in a single step would have saved SVB but the decision by its management to split the offering and inject a delay in obtaining the full $1.8 billion it publicly said was required GUARANTEED a run and the bank's failure.

Besides this tactical error that proved to be existential (at least for SVB's original management team), SVB reflected a multitude of unique factors that made the risk of failure a near certainty.

• geographically concentrated commercial customers
• high share of young start-up firms facing separate headwinds leading to high cash withdrawals
• high share of customers (commercial and individual) above the $250,000 FDIC protection limit
• investment decisions chasing higher returns on long term Treasures in a period of rising interest rates
• a vacant Chief Risk Officer positions for most of 2022

The first two bullets above merged into one bigger problem. The number of start-up firms in the same geographic region and similar industries magnified existing group think tendencies that kick in during financial crises. Higher interest rates made venture capital funding harder to obtain, making existing start-ups more dependent on existing cash on deposit. Firms seeing their prospects dimming might have required cash for severance payments, etc. Having a concentration of firms served by a single bank magnified those pressures and SVB lacked the diversification across industries and geography to act as ballast against those draws.

That original problem then triggered unique fears due to the profile of SVB's customer deposits. While the FDIC officially limits deposit protections to $250,000 (more on this later…), it is common for a larger bank (i.e. a regional or national) to have accounts above that limit. Presumably, the assumptions made in these cases by both the bank and the depositor are

• the customer knows those dollars are unprotected
• the customer enjoys the convenience of drafting payroll checks and paying vendors from a single bank
• the customer does NOT want to manage N different accounts to avoid crossing the $250,000 limit
• the customer assumes they'd recognize signs of trouble to find alternatives before their chosen bank fails
• the bank enjoys the extra cash to use in its quest for returns elsewhere

Note - it isn't clear if banks pay FDIC insurance for ALL of their deposits on hand or just the portion of balances under the $250,000 limit. If they only pay for the balances under $250,000, then essentially the deposits in excess of the $250,000 limit cost them LESS, given them an incentive to continue accepting the excess deposits. A gigantic moral hazard.

Here's what the histogram of a typical bank's account balances might look like.

The key point from this illustration is that the majority of assets (the area in green) lie BELOW the FDIC limit. In this environment, none of the depositors under the FDIC limit have any need to panic amid trouble so they don't and the dollars in the accounts over the limit are not a majority of deposits. As such, the vast majority of the bank's cash isn't subjected to a run.

In contrast, SVB's account histogram reflected VASTLY greater risk. Conceptually, it looked more like this, though this scale doesn't reflect the HUNDREDS of millions present in many of SVB's accounts -- the $250,000 FDIC cutoff line would have been a blip at the bottom at that scale.

At SVB, an astounding NINETY FIVE PERCENT of the bank's deposits were over the $250,000 FDIC protection limit. Many of those accounts over the limit had amounts that were ORDERS OF MAGNITUDE over the limit. Examples: Circle ($3.8 billion with a B). Roku ($487 million). Block-Fi ($227 million). Roblox ($150 million).

When rumors about a bank with THIS depositor profile begin swirling, the vast majority of the bank's deposit accounts lie ABOVE the FDIC cutoff, meaning ALL of those customers face immediate risk of losing their cash and have EVERY reason to withdraw their money, and they do - IN DROVES. In the case of SVB, the initial triggering event prior to the big trigger was the sale of $21.billion of securities to raise cash for withdrawals that incurred $1.8 billion in losses. The $1.8 billion shortfall represented a small portion of the total liabilities but each individual depositor had no way to know if their account might get caught short so depositors attempted to withdraw another $42 billion before the FDIC closed the bank.

Operating a bank with this depositor profile itself is a catastrophe waiting to happen. It appears SVB compounded this risk with additional strategic failures. With a "traditional" retail bank with a mix of individual and commercial accounts, accounts are likely split between checking accounts and "time deposit" accounts like savings accounts and certificates of deposit which limit withdrawals per month or have fixed maturity terms which tend to make the money "sticky" and less subject to flight. At SVB, a large portion of its biggest accounts were commercial accounts used primarily for payment processing (payroll, accounts payable, etc.). Such accounts have ZERO "stickiness" and are VITAL to firms' daily operations. SVB executives failed to imagine how the behavior of such customers might differ in uncertain times from traditional depositors and reflect a higher likelihood of flight as those firms worried about keeping their own businesses afloat. This profile essentially narrowed SVB's margin of error and should have triggered more conservatism in its strategy.

It appears this profile actually magnified SVB's risk as the firm used the piles of cash to chase higher returns by locking up cash in longer term, higher interest Treasuries. Since SVB's customers were not necessarily expecting high returns (at first) on essentially checking account money, this at first proved lucrative for SVB. SVB's year over year revenue increased 22.8% in 2022, 47.65% in 2021 and 15.6% in 2020. However, once the Fed began raising interest rates to combat inflation after COVID stimulus and disruptions, more customers began expecting higher returns on SVB deposits but SVB already had large chunks of cash locked up -- at lower rates. There are entire courses in finance theory taught in business schools that likely sail over the head of most individuals (and most depositors) but understanding yield curves and impacts of changes in short versus long term interest rates is a requirement of anyone operating a bank filled with other people's money.

It isn't clear yet how much SVB executives understood these risks and reacted to them but one fact is quite damning in hindsight. The position of Chief Risk Officer at SVB was vacant between April and December of 2022. The previous occupant, Laura Izurieta, vacated the position in April but technically didn't leave the company until October 2022 according to proxy filings. Those filings don't reflect the circumstances behind Izurieta's departure but the 6-month delay before final separation is frequently seen in cases where at least one of the parties is not happy about something and they agree to disagree on the specifics while keeping quiet about any conflicts. Did the firm find the CRO failed to steer them away from risks posed by the changing yield curves? Or did the CRO flag the looming problems and request strategic changes only to be ignored by the CEO and board?

A final factor that likely played a role in SVB's demise was the archaic nature of its own internal IT systems. Despite being in business for 40 years and despite operating in the heart of Silicon Valley amid hundreds of high tech firms who acted as customers, SVB's internal systems were in fact woefully out of date. Its systems presented unique challenges to the flows required to accept PPP payments from the government and to the load imposed by thousands of commercial users attempting to use its online tools to handle those payments. One CEO customer of SVB (David Selinger of Deep Sentinal) stated the company's back-office system locked up as thousands of its commercial customers attempted to use its online banking tools to manage incoming PPP payments and map them for payroll and accounts payable functions. Customer-facing systems that poorly perform in good times do not inspire confidence in bad times, triggering more fear and doubt that contribute to a run.

If basic self-help portal functions for customers were antiquated, perhaps it is too much to expect much of the more critical core systems supporting senior management. What types of analytics did SVB generate against its account and customer profile data each day? How did they analyze inflows and outflows by customer segment to spot worrisome trends? Did they have warning threshholds for the number of accounts exceeding FDIC limits or the total dollars exceeding FDIC limits? Did they review the bank's investment portfolio for sensitivity to changing interest rates? Did they define limits on the duration of Treasuries and bond maturities in light of their own customer cash demand patterns to avoid getting caught short? Of course, these types of questions tie into larger questions about similar peers and the larger industry.

Shared Factors Driving the SVB Failure

One thing is common with all financial failures. From the Asian Crisis of 1997 to the post 9/11 recovery in 2001 to the 2007-2008 meltdown to the present failure, public statements at the beginning of each crisis from banking leaders, politicians and regulators follow an identical script:

The (_____) failure is an unfortunate but unique circumstance. Officials have carefully reviewed the situation and have crafted a series of actions to protect the larger system. We have spoken with leaders of other major institutions who are confident similar issues will not occur with their firms. The (______) public can operate as they normally would. Now is not the time to panic.

Uh huh. In times like this, here are the questions the public should be asking:

Is the situation at SVB unique? Absolutely not. Backoffice systems at most megabanks formed from mergers of mergers of mergers likely date from the mid-1990s, making them difficult to maintain and expensive to enhance to offer new capabilities for customers or new insights for management that could improve risk management. SVB is also not likely to be the only bank managing large numbers of accounts exceeding FDIC protection limits. (See the next section on systemic risks for insights into why.)

Do bank executives and regulators have the proper "telemetry" to identify similar looming problems at other banks? It's already clear SVB's systems were woefully antiquated, making it likely they failed to devise metrics that could have set limits that would have prevented them from getting burned by shifting yield curves. Do other banks have better systems? Virtually all banks faced the same audit requirements after Dodd-Frank and the same financial climate to drive their priorities for investing in their back offices. It is safe to assume many banks have no better telemetry in place. Why bother crafting new alarms when you are tagged as TBTF? If telemetry improvements are skipped and things go well, the money that would have been spent on tools can be distributed to executives and stockholders. If things go poorly, well, TBTF, the government will bail us out. Why spend the money?

Assuming the required telemetry is available, do other bank executives and regulators have the willpower to ACT upon the telemetry to correct problems and avoid them going forward? There's no way to factually answer this hypothetical question but the past is likely to be prologue. A wide range of financial institutions have a decades long track record of operating for their own short term benefit, even in direct conflict with fiduciary obligations to their customers, be they wealthy individuals, large commercial accounts or fellow institutions. Given the distorted moral perspective created by TBTF status, it is highly likely executives are eager to avoid acting on news of POTENTIAL risks as long as profits continue flowing for the current quarter.

Will there ever be a time when regulators or politicians will tell the public to move deposits out of harm's way? Uhhhhh, obviously not. Leaders and experts will ALWAYS say "this is not the time to panic, just sit tight." That doesn't mean that won't be the appropriate action nine out of ten times but it means leaders and experts will NEVER clearly state depositors in a specific bank need to take their ball and go home. Depositors with balances above FDIC limits will be on their own to understand their own risk tolerances and the risks posed by the banks they choose to use. This requires a substantial boost in financial literacy. This sounds odd to state in relation to people in control of large sums of money but the SVB failure made it clear THOUSANDS of customers (individuals and companies) operated with tens and hundreds of millions of dollars without FDIC protection.

Regardless of one's account balances, every depositor needs to understand EVERYONE they encounter in the financial sphere is talking their own book and is dispensing advice one hundred and eighty degrees out of phase with the interest of individuals situated outside the 0.1%. Indeed, Jim Cramer appeared on CNBC on February 8, 2023 describing the firm as a good play on the bounce back occurring with a collection of tech stocks which had tanked in 2022. He correctly identified the bank as concentrated in the "merchant bank to startup firms" sector and stated "private equity investors aren't going anywhere." On March 9, 2023, Cramer's story was different. "SVB was getting killed on its bond portfolio each time the Fed raised interest rates. The bank didn't signal that it had too many bad loans that were backed up in stock of startups that hadn't been able to come public because there's no appetite for IPOs when the Fed is tightening aggressively. They should have been raising money like CRAZY for MONTHS like some of the other banks out there." For those outside the 0.1%, education, skepticism and vigilance are the only viable defenses.

Systemic Factors Driving the SVB Failure

So far, it seems clear that SVB wasn't a one-off. There were two other failures (Silvergate and Signature Bank) bracketing the SVB failure. As of March 16, 2023, a collection of uber-banks (the capital TBTFs?) including JPMorgan, Citigroup, Bank of America, Wells Fargo and additional sub-uber banks (the lower-case tbtfs?) announced a plan for a total of $30 billion dollars to be infused (no better word, really) into First Republic Bank. Why? Officials stated it was intended to convey their collective confidence in the banking system but investors were selling off First Republic Bank stock, raising fears a dive in the stock price would trigger a run similar to SVB which the bank couldn't survive.

Clearly, there are immediate forces at work creating acute conditions for marginal institutions. There will likely be other failures as part of this "wave." It is more important to understand the systemic factors that are creating SERIES of failures over time, seemingly like clockwork, ten to fifteen years apart. What are those factors?

Forgetting Prior Disastrous Teachable Moments -- The US created a firewall between retail and investment banking via the Glass-Steagull Act in 1933 after massive losses in investment banking contaminated retail accounts, tanking the entire economy. Politicians were convinced by financial experts that technology cured the system of such risks, leading to the passage of the Commodities and Futures Modernization Act of 1999, which eliminated the investment/retail firewall requirement which led DIRECTLY to the 2008 meltdown. The failure of banks to accurately valuate their derivative investments led to recurring "stress test" requirements under Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) whereby banks had to prove they could support worst case deposit draws even under extreme market conditions that might materially reduce the value of their assets. Banks and clear majorities in both political parties voted to eliminate those tests for all but the biggest banks only eight years later via the Economic Growth, Regulatory Relief and Consumer Protection Act (bitterly ironic name, huh?) of 2018. The relaxed rules eliminated stress tests for all banks with under $250 billion in assets. The 2018 changes were supported by CEOs of many regional banks, including the CEOs of SVB and Signature. SVB's CEO provided testimony to Congressional committees as far back as 2015 pushing for the relaxed rules and Signature Bank donated heavily to key Democrats who served as co-sponsors of the 2018 legislation.

Predatory Self-Dealing -- Also coming to light in the SVB incident is a familiar pattern of even larger financial institutions contributing financial advice that may prove to be completely incompetent at a minimum or perfectly hedged to generate outsized profits for the advisor at the expense of the advised. SVB obtained investment advice from Goldman Sachs regarding its portfolio and Goldman was one of the institutions who gobbled up some of the securities SVB unloaded as part of its $20 billion dollar fire sale to raise cash. Goldman made a quick $300 million off those trades. Sound familiar?

Lack of a Corporate Death Penalty -- Justice officials and bank regulators alike in multiple countries seem completely unwilling to impose a "corporate death penalty" upon financial institutions involved not only with heinous crimes in their own right (arms trafficking, money laundering for terrorists, etc.) but crimes and incompetence which impair the bank itself with all of its TBTF interconnections that could trigger larger failures. As of March 16, 2023, Europe is facing it's own "unique" basket case in the entity Credit Suisse. Credit Suisse has been labeled as one of the 30 largest systematically critical banks in the world and provides wealth management services for entrepreneurs and the uber-wealthy worldwide. The bank has seen a 75% decline in its stock price over the last year and industry experts and regulators are quick to state its immediate problems as of March 16, 2023 are totally unrelated to the problems reflected in Silvergate, SVB, Signature Bank and Republic Bank. Instead, Credit Suisse has demonstrated a pattern of criminal behavior over decades that has resulted in CEO churn, a series of investment bets on behalf of large sovereign wealth clients that resulted in large losses, and more recent losses based on rising interest rates lowering valuations of its existing portfolio. Despite being "unrelated", failures of US banks trigger a hunt for other weak victims across the globe whose books might collapse from an unexpected draw down of cash or an unexpected loss in its portfolio. Credit Suisse obtained a $54 billion injection from the Swiss central bank as a means for calming global fears but not all watchers are convinced that is enough. The plight of Credit Suisse is also generating speculation that Deutsche Bank will encounter similar rough seas for similar reasons.

Key Learnings (So Far)

Banks and the incompetent politicians they own materially misrepresent what constitutes a "small" bank. Banks managing less than $250 BILLION dollars are not "small banks" by any definition of the word. SVB had about $208 billion in assets as of late 2022. Any bank managing $208 billion or $150 billion or $50 billion in assets still has to settle its books with overnight loans to/from other banks or the Fed. When MILLION dollar amounts have to slosh back and forth between banks every night, ANY sudden perception of existential risk can trigger ripple effects between dozens of banks. Tiny local banks can do little to solve a liquidity problem at a mega-regional or mega-national bank which ensures ANY problem at one tier can ripple laterally within a tier or vertically up to other banks instantaneously.

Banks continue growing larger and larger for a single related reason - the failure to adequately enforce anti-trust regulations. At one level, failing to enforce anti-trust limits on banks themselves means fewer minds impact more assets so a single bad action (whether by incompetence or active malfeasance) can impact an ever-larger pool of assets. Banks argue they MUST get bigger because their business customers are getting larger. A bank with a mere $200 million under management cannot handle the payroll of a single company whose biweekly payroll for 40,000 workers is $120 million dollars. A bank with $3 billion under management cannot handle a commercial account that has $1 billion in retained earnings in its treasury. But that cannot be a logical argument for allowing unlimited growth for banks. Consolidation of entire sectors into near-monopolies not only creates systemic economic risks for the same reasons (fewer unique minds controller larger pools of assets), it is already stifling innovation as the megacorporations focus on protecting existing products rather than inventing something better.

Governments repeatedly push stimulus dollars primarily through banking channels on a top-down basis where the public stimulus is diverted for private gain by the exact parties and practices that produced the failure being mitigated. On March 14, 2023, PBS' Frontline program aired an insightful two-hour report entitled The Age of Easy Money that presents a convincing unifying theory regarding the cause of the current financial dilemma facing the US. The program can be viewed online at Frontline: The Age of Easy Money

The thesis of the program is basically this:

The Federal Reserve offered freakishly low interest rates for ten years after the 2008 meltdown. At first, they were required for a few years but after roughly 2012, they were not strictly necessary. The Fed continued them thinking both governments and corporations would take advantage of them to invest in critical infrastructure (roads, bridges, chip plants, new assembly lines) that would provide long term boosts to productivity in the economy. Instead, they continued past 2016 and instead of passing infrastructure bills, Congress passed tax cuts for the uber-wealthy and corporations borrowed BILLIONS of dollars at absurdly low rates and used the cash to buy back their stock and boost bonus metrics and options payouts for executives, further funneling trillions into the 0.1%. This magnified wealth inequality and did NOTHING for productivity. When the Fed attempted to take the crack cocaine away with initial rate hikes in 2018, markets screamed and Jerome Powell cowered and reversed the rate hike, adding another two years to the party. By the time the COVID lockdown hit, adding another $2.3 trillion of cash stimulus to the economy put all those distortions into overdrive.

After watching the program, an obvious question comes up. If stimulus for the COVID lockdown could not reliably transmitted through banks, what alternatives could have been considered?

Here's some fun with numbers and math and the concept of simplicity:

• the CARES Act providing COVID stimulus in 2020 spent $2.2 trillion dollars
• of the $2.2 trillion, $300 billion went directly to taxpayers, $800 billion went to business owners as part of the Payroll Protection Program (PPP) and $1.1 trillion was injected into banks through Fed purchases of corporate bonds and other financial instruments
• in 2020, a total of 157,494,242 tax returns were filed
• those 157,494,242 tax returns reflected a total of $12.533 trillion adjusted gross income
• that's an average of $79,577 income per tax return
• an average income of $79,577 equates to $1530 in weekly income
• at the time, everyone thought a shutdown might last 8 weeks
• sending a check replacing 8 weeks of "average" income for all tax filers would have cost 8 x $1530 x 157,494,242 or $1.928 trillion dollars

If you skip payments to the top 1% of earners, that could be approximated by just ignoring the 1,574,942 returns with the highest income, reducing the payout by $19.28 billion. The exclusion cutoff point can slide left or right as fairness dictates. All the math could have been done with 2018 tax year data which should have been available by April 2020 (many 2019 filers would just be submitting returns in April of 2020).

How would the impact of this distribution scheme differ from the actual approach chosen? It would have bypassed all the fraud encountered with the Payroll Protection Program component (nearly $80 billion dollars of fraud as of 2023). Wage earners with incomes below the average $79,577 would receive a proportionately higher pandemic payment which would actually reflect the disproportionate risk facing lower income workers during an economic emergency. The distribution of dollars into banks would have exactly mirrored the existing allocation of consumer accounts across the retail banking system rather than allowing resources to funnel to existing TBTF banks. Small business wouldn't have to worry about meeting payroll since their workers would have their equivalent net income deposited directly to their account or sent to them by check with zero middleman fraud.

Financial Literacy and Risk

The American public has suffered through financial failures only to see protections enacted then rolled back (Glass-Steagull then the Commodities and Futures Moderization Act then Dodd-Frank then the 2018 bill...). It's clear individuals are failing to achieve a base level of financial literacy required to reject the pleas from the rich and powerful talking their own book looking for "regulatory relief" that privatizes obscene profits and socializes obscene costs of failures. The worldwide public needs a crash course in the basics of financial operations, ranging from accounting, audits and regulatory capture and corruption but most urgently, the public needs a more complete model for understanding financial risk and the use of interest rates as a catch-all indicator of risk.

The majority of individual consumers loosely equate interest rates with inflation and assume one is a direct reflection of the other. A minority of people may have a vague recollection that central banks use interest rates they set as a lever to try to manipulate inflation rates to optimize economic growth and employment. Extreme levels of infation (high or low) can be problematic and unexpected changes in inflation levels can damage the economy so many understand interest rates reflect those risks. But at a more conceptual level, "interest rates" reflect multiple dimensions of risk at work in the economy, not just risks associated with inflation. What are those dimensions?

Time Risk -- The time value of money is the most foundational component of interest. It reflects the fact that every rational human values X units of a thing in their hand TODAY more than they value the same X units of the same thing at any future point in time. Intuitively, this makes sense and holds true in most situations (***). With X in hand today, there is no risk that X won't be delivered at some point in the future or that each unit of X won't change in value so now always has more certainty over "eventually." In theory, even if all other risk categories could be "solved" and reduced to zero, lenders would still demand SOME interest payment solely to compensate them for deferring an amount into some future period.

*** In certain market conditions (such as a massive, temporary drop in demand) it is possible for people to prefer more at a later point in time than now if they are short of storage facilities, etc. The temporary negative prices for oil during the initial pandemic lockdown is an example of this phenomena.

Monetary Risk -- Lenders face monetary risks when they agree to accept future payments for a loan denominated in a fiat currency whose quantities are managed by a third party (typically, a central bank or government treasury). Any time the supply of fiat money grows FASTER than "real" growth in output of the economy, the future value of each unit of that fiat currency is reduced. If a central bank "prints" money at a 7% growth rate when the economy is only growing at 3%, lenders come to believe they are being paid back with inflated bills and will demand a higher interest rate on a loan to make up for that inflation. Millions of pages and blogs have been written about the interrelation between inflation and monetary policy which won't be re-debated here. Suffice to say there is one school of thought that believes all inflation stems from manipulations of monetary policy by central banks and governments. Others believe some inflation can simply reflects market forces correcting for imbalances in supply and demand -- for labor, raw materials or actual final goods and services -- and can have little to do with what a central bank is doing. As an example, if healthcare costs are a key part of the market basket used to measure inflation, a sudden event like a PANDEMIC that drives tens of thousands of healthcare workers OUT of the field in frustration will drive up healthcare costs as hospitals pay higher wages chasing a smaller pool of workers but this increase in prices has nothing to do with monetary policy.

Borrower Risk -- Each borrower poses unique risks based on their trustworthiness as perceived by the lender and factors that might limit or completely eliminate the borrower's ability to pay back a loan at some future date. If a bank is considering a 4-year loan to someone operating a roofing firm, there might be less risk lending money to a twenty seven year-old roofer than a fifty eight year old roofer who might face a higher chance of a workplace injury that could end their ability to work.

Industry Risk -- In addition to borrower-specific risk, there can be risks specific to an industry that could stem from technology changes, regulatory exposure, etc. that might increase or reduce the overall risk of payback by the borrower. A single lender looking at two potential borrowers for the same loan amount and term and similar individual credit histories might view a borrower in an industry with a long track record of income stability more favorably than a borrower in a high-tech industry that has only existed five years and has twenty start-ups attempting to be the next Google of that field when only two will even reach IPO. The lender might also attempt to analyze the risk of looming regulation or changes in government incentives as a factor of the interest rate on a loan.

Geopolitical Risk -- Geopolitical risk covers the possibility of world events (wars, coups, shifts in political leanings for countries or regions) impacting the operations of the borrower and their ability to pay back a loan. With all other factors being even, a lender considering loan requests from an oil refinery company in the US and Ukraine would obviously demand a higher geopolitical risk premium from the Ukrainian firm, even if the two firm's track records for soundness were identical prior to February 2022.

So is this concept really useful? No and yes.

This concept is NOT useful in the sense that borrowers will never see their overall interest rate offered by a lender broken out into these factors. In fact, in many individual and small business lending scenarios, lenders are PREVENTED from setting interest rates per client as part of discrimination protections. If five borrowers approach a bank on the same day with five slightly different credit histories and business proposals to pitch requesting the same loan amount and term, rather than all five getting loans at five unique interest rates, it could be that only three get a loan -- all at the same rate -- and two others simply get declined.

The concept IS useful however when analyzing collections of customers and strategies selected by banks when setting lending criteria and investing depositor money. If a bank was considering four loan applications for identical amounts and identical terms from four different clients, their component scores might look like this in table format:

More numerate types might be able to digest those numbers and discern that the Ukrainian firm represents the highest risk but the raw numbers still wouldn't intuitively convey the exact degree or how they compare across dimensions with the other firms. Imagine instead the numbers are graphed in "radar graph" format as shown below:

The area of each polygon directly reflects the total risk of each borrower and the stretch in each dimension immediately conveys the extent each dimension contributes to the total risk.

The same "radar" technique can be used to compare dimensions of behavior between types of accounts within a bank or quantifiable characteristics of customers (dollar amount exceeding FDIC limit, payroll, angel investor capital, revenue, etc.). Banks should be conducting this type of analysis to identify how market shocks might trigger collections of customers to act in concert in ways that could exhaust capital on hand. The events between March 9 and March 16 of 2023 make it clear most banks are giving this type of analysis lip service or are not doing it at all. Obtaining these insights is deemed unimportant because they've identified easier ways to maximize bank profits when things go well and are assuming divine intervention will protect them as too big to fail when things go wrong.

Is this concept valuable for individuals? Yes. By thinking of "interest rates" in terms of these components, individuals deciding where to put their savings or where to house a checking account with large sums of money can look at interest rates offered by a bank then ponder how those rates reflect all of these components. Remember, in a savings scenario, essentially the DEPOSITOR is the lender and the BANK is the borrower so all of these factors still apply, only the party in the driver's seat changes. Some examples:

Why is Bank of America only paying 0.04% on savings accounts and First Bank of Hollywood is paying 2.9%? Possibly because FBOH is viewed as a small bank with limited assets and thus considered a higher risk and has to offer higher interest rates to savers to compensate them for the risk of not putting their money in BOA, viewed as too big to fail.

Why is First Bank of Podunk paying 4.3% while equally small First Bank of Hollywood is only paying 2.9%. Possibly because FBOP is located in a rural community dependent upon crops and their region has been inundated with flooding, raising the risk of many of its deposits getting withdrawn and many of its borrowers becoming unable to pay back loans. To continue attracting deposits, they have to offer a higher rate to compensate the depositor for the risk.

Why is Mutual of Miami issuing a new round of 10-year corporate bonds at 7.3% when Mutual of Montana is only paying 4.9% and 10-year Treasuries are only paying 3.39%? Possibly because Mutual of Miami's insurance business is subject to vastly larger risks from hurricanes, flooding and tornados than that of Mutual of Montana whose customers only have to worry about droughts and blizzards which typically don't do much property damage requiring payouts.

In short, individuals cannot just go chasing high yields without understanding the risks signaled by those higher yields and understanding if those risks are appropriate for the tolerances of the individual. if rates in general are 4% and an opportunity presents itself offering 9%, there's a reason for it.

WTH

Red Barchetta Blues

In 1981, rock band Rush recorded a now-classic song with a story line combining themes about independence, central authority, vast changes in technology and automobiles. The song describes a world of both great technical sophistication but matching authoritarian controls on technology, specifically technology related to automobiles -- an automotive dystopia with highly sophisticated but boring, passionless cars and stifling restrictions on their use. The protagonist of the song, presumably a teen, still has the urge to get out and "elude the Eyes" but must resort to Sunday trips to the country where he can rip around the countryside in a machine from yesteryear, carefully preserved by his uncle, "a brilliant red barchetta, from a better vanished time."

Rush's Red Barchetta seems to be an apt musical encapsulation of the funk being experienced today by both automakers and consumers. In fact, it is eerie how appropriate the themes from a progressive rock song of 1981 match the problems of 2023:

• a century of old, familiar technologies (internal combustion engines) causing global problems
• competing technology solutions to mitigate or eliminate traditional ICE problems
• competing regulatory pressures pushing specific technology solutions
• multi-national corporations attempting to select replacement technologies requiring multi-billion dollar bets
• massive, square wave changes in labor and supply markets brought about by a worldwide pandemic
• enormous uncertainty in customer demand for core drive train technology alternatives
• enormous uncertainty in customer demand for feature technologies (infotainment, safety, self-driving)
• longstanding manufacturer / dealer dysfunction

Metaphorically, both makers and buyers are temporarily stranded in a no-man's land far removed from an old-technology world whose economics and customer demands were understood and a new-technology world requiring billions of synchronized investments across multiple industries (manufacturing, energy production, energy distribution, retail) in which there is no single, obvious, correct strategy over the next ten to fifteen years. Those existential problems are further complicated by economic / demographic problems with buyers and longstanding dysfunction in the automotive retail ecosystem which are now stretched to their breaking point as all parties attempt to recover from distortions created by pandemic shocks.

How are these transitions going? About as well as one might expect in a capital intensive, risk-averse industry creating products that combine complex safety and environmental demands with fickle, often pointless fixation on electronic gadgetry.

Competing / Conflicting Regulation and Incentives

Every manufacturer and every government now viscerally understands the need to improve energy efficiency, reduce hydrocarbon emissions and optimize the ecological impact of new cars across their entire cradle to grave life cycle. Favored solutions for doing so still vary widely between countries and as a result, between manufacturers. Japan's government has, up until now, had a core contingent that thought hydrogen fuel cells were a viable path, leading Toyota among others to invest significant resources for trials in that area which have yet to prove remotely practical. Over the past twenty years, most countries just focused on raising MPG-equivalent ratings of fleets and tossed in rebates to customers as incentives. Over that period, consumers have generated consistent demand for such hybrid vehicles and several makers have developed reliable drivetrains with this technology and sold millions of vehicles.

Over the past three to five years, many governments including the United States enacted much more aggressive fuel economy targets and goals for carbon emission reductions, goals which CANNOT be met with any existing V8, V6 or I6 engine designs and likely not with V4 or V4 hybrid vehicles. Manufacturers have taken that as a clear sign that investments in redesigns for full electric cars MUST be made IMMEDIATELY. The flux in strategies for the makers resulting from these regulations is discussed in the next section.

What's missing in many countries -- certainly the US -- is an equal focus in government at the federal and state level on modernizing the electric grid to homes and essentially building out a charging station infrastructure equivalent in its ubiquity to existing gas / diesel stations. That infrastructure is so pervasive it is invisible to most Americans, even if they pass three stations on a single corner on their way to work. They're just there cuz they've always been there.

Of course, what's also missing -- PARTICULARLY in the US -- is a larger rethinking of our car culture in general. America had fantastic train service between many cities and useable urban mass transit in many large cities until after World War II. At that point, federal, state and local policies changed nearly overnight in ways that encouraged urban sprawl and destroyed mass transit systems. Today, America's car culture worsens urban sprawl, raises costs and lowers standards of living for younger workers increasingly unable to afford $40,000 vehicles with $3.50/gallon gas, 50 mile round trip commutes and inflated rent / mortgage expenses resulting from that same urban sprawl and NIMBY zoning restrictions limiting new home construction.

Technology / Drive Train Whiplash

As governments adopt new restrictions and incentives for autos, makers are experiencing whiplash in their choices of underlying drive trains and general feature technology used in vehicles. Government mandates for higher fuel economy have led most makers to stop making ANY cars with V8 engines entirely and many makers have even abandoned standard ("naturally aspirated") V6 / I6 engines. The dilemma they face is what to adopt to replace those older, tried-and-true designs. Just a smaller standard 4-cylinder? A turbo-charged 4-cylinder? A 4-cylinder+electric hybrid? A turbo 4-cylinder hybrid? Or a pure electric motor?

What's the problem, buyers might ask? Just pick a couple of technologies, bet on those and if one clicks, dump the other one and go with the winner, right? Not exactly. The underlying chassis of an ICE vehicle, hybrid vehicle or pure electric vehicle is different because of the center of gravity, paths for electrical conductors, heating logistics for the cabin and the batteries, etc. If a vehicle is designed for a V4/hybrid and later the maker decides to go pure electric, that vehicle's chassis will likely require a complete redesign. Now ponder the unanswered questions facing makers.

• Will pure electric vehicle demand hit a wall due to regional grid issues?
• Will pure electric vehicle demand hit a wall due to inadequate investment in retail charging locations?
• Will designs for smaller turbo-charged V4 and V6 engines encounter reliability issues that cause customer demand to plunge?
• Will mileage optimizations for smaller ICE/hybrid combinations prove too incrementally inconsequential, causing customers to shun hybrids and just go EV?
• Will hybrid and EV manufacturing hit a wall with availability of lithium and other rare earth metals?
• Will makers sticking with ICE find electric technologies solving most of their supply chain and grid concerns, causing demand for traditional ICE powertrains to vanish?

These are NOT easy decisions with guaranteed answers with guaranteed payback intervals for car companies. Think of the decision paralysis makers went through adopting simple stuff like airbags, anti-lock brakes and collision avoidance systems. Decision making has not been any car maker's forte.

In-Car User Experience Whiplash

Consumers have over thirty years of experience in adjusting to "user experience" whiplash in PC software, cellphones and even household appliances like TVs and Bluetooth-enabled washing machines and refrigerators. Some of that frustration is the natural result of new technologies that logically supplant older approaches for collecting user input or displaying status. More recently, consumers have grown suspect that much of the change experienced in products year over year is merely change masquerading as innovation. In other words, the hated concept of "model years" applied to software running inside cars used as a means to incent customers to dump the old and buy something new.

The idea that a similar approach of "change for change's sake" with "auto OS" platforms may also be suppressing demand for new cars, for multiple reasons. First, the fact that functionality one has become habituated to could be relocated or re-sequenced (or removed) without prior consent is bad enough. Second, most companies do a horrible job at providing help content online so having user interface behaviors change and attempting to document those changes online ("to switch traction mode, press Home, then swipe down to display the control panel screen, then click on the tire icon, then choose the boulder, the beachball, the ice cube or raindrops for rocks, sand, ice or mud traction, then click the OK button, then save it to your driver profile…") is fraught with the likelihood of customer dissatisfaction.

The most important concern with this "user experience churn" is its potential impact on actual safety. Sure, the average owner MIGHT adjust to this madness on their own vehicle after a month or two of driving. But hundreds of thousands of drivers rent unfamiliar new cars every day at airports. No one wants to sit in a rental parking lot for an hour delving through touch screen menus on an unfamiliar vehicle to figure out how to enable fresh air mode. They want to get in the car and head to their hotel or meeting location without delay and are likely to to be in traffic at a point where they need to use some function whose implementation is NOTHING like their own vehicle.

Labor Market Issues

Concerns about continual changes in "user experience" lead directly to labor market issues in ways many might not expect. Newer cars not only have vastly more complicated "user experience" software systems but vastly more complicated "drivetrain control systems" as well. Makers have attempted to tag such complexities as a feature to buyers since improvements CAN be made by simply pushing new software without physically altering the vehicle and -- in some designs -- without having to visit a dealer.

Old-school automotive engineering assumed designs could not change on the fly without vast expense upstream and downstream so the level of effort applied to human factors, design and manufacturing was much higher. With software-based features, absent changes to physical touch screens, GPS sensors and cameras, most functions can be changed as quickly as new code can be loaded onto EPROMS or memory chips. Isn't this a good thing?

Well...

Software has been present in vehicles since the introduction of electronic ignition and has grown more complicated as logic was used to alter timing / enrichment for performance and emissions. Software engineers within the automotive industry had similar backgrounds and skills to software engineers working on control systems in other disciplines like aviation or manufacturing involving telemetry, feedback loops, etc. that controlled machinery but weren't critical in driving human interactions via screens or input devices. Software engineering for consumer applications like PC software, smartphone apps and appliances and electronics has adopted vastly different paradigms for prioritizing feature work over fix work and timing new releases and bug fixes. These paradigms are focused primarily on marketing and branding goals of being first to market or assuming the first to launch will be able to win new users even if the first release falls short of perfection. Most criteria are thus based on user experience and are largely subjective.

As an example of how these newer "beat the calendar" tactics differ from older "get it right or people die" tactics of yesteryear, here are two approaches adopted in many development teams who deliver web portals, smartphone apps or PC software.

minimum viable product -- An approach aimed at avoiding getting beaten to the marketplace by a potential competitor by identifying the smallest set of functionality required for a product to gain adoption and only delivering those functions in early releases. Full functionality gets delivered incrementally over a longer period with subsequent releases which might be weeks, months or quarters apart.

canary releases -- An approach for exposing small incremental changes to functionality to a subset of existing users and carefully monitoring their behavior for signs of success or failure. This essentially uses existing live customers as guinea pigs for testing of new features and bug fixes, usually without their consent. Many organizations use this approach because they are unable / unwilling to spend the time and money required to devise internal test mechanisms to generate all of the input scenarios or high load the software might encounter in the wild.

As an owner of a vehicle, the idea of the behavior of your vehicle changing at the whim of the manufacturer without prior notice should give pause. The idea that the maker has bought into "continuous delivery" to add functions you might not want / need but risks the stability of the existing car with each new patch should also raise concerns.

Treating automotive design and support as a giant software problem with continuous releases poses a different labor problem as well which involves these expectations of a $60,000 vehicle:

• Cars need to remain operable for 15-20 years to justify the skyrocketing prices
• Cars must function in weather extremes that are never applied to "indoor" stationary appliances
• Cars have historically been tweaked slightly every model year to spark sales and justify ever-increasing prices -- that tweaking now includes changes to infotainment functions and other cabin functions
• Proliferating "auto OS" platforms across makes, models and model-years fragments the code base for such systems, requiring retention of more developers and testers to maintain each version for the entire lifetime of the vehicle -- which could / should be 15-20 years

Corporations already have trouble retaining engineers to support systems that are merely five or ten years old. Developers want to work on new products with new software tools. No developer wants to be stuck maintaining COBOL code in Southwest Airlines' scheduling app and no developer is going to want to be stuck writing security patches for a 2021 Chevrolet Tahoe in 2031. This has already been a problem with many software systems but the risks might have been mitigated by the code operating on a single processor in a non-networked environment. The software may eventually encounter a defect but the defect cannot propagate to other nearby devices or be used to propagate malware to unrelated systems on the same network.

Those mitigating factors do not exist with vehicles that may use BlueTooth or wifi to access your home network to monitor electric consumption so the vehicle doesn't charge when you are running your oven and AC or when it needs to check for nightly software updates. As a result, these new control systems MUST remain running but will CONTINUE being exposed to security risks requiring continual patching for the lifetime of the car. Have governments considered regulations dictating the minimum support life of vehicle software? Have car makers pondered how their designs will reflect those support life needs and how their hiring practices will adjust to meet those regulations?

One thing that IS certain is that makers are concluding their ranks of ICE veterans are too high and are taking steps to address it. On March 9, 2023, GM announced a new buyout targeting any US managers with more than five years' service and any global executives with more than two years' service. GM has set aside roughly $1.5 billion to cover the expenses for any that take the offer. This follows a prior buyout around 2018 that targeted 18,000 salaried workers, leaving GM with roughly 81,000 workers as of 2023. The offer is only one month salary per year of service with a limit of twelve months payout so it is essentially an offer of up to one year's salary. Assuming an average salary of $150,000, the $1.5 billion earmarked would cover another 10,000 employees.

Of course, Ford made a major shift on March 2 of 2022 by splitting its books between ICE platforms and electric platforms. This change not only has impacts for cost allocations of design and manufacturing but for the structure of sales channels through dealers and/or directly to customers. At the time of the announcement, Ford stated it was NOT planning to spin off one of the two divisions because they needed to be able to work together yet Ford also said the ICE division ("Ford Blue") needed to focus on profits and the electric division ("Ford Model e") needed to focus on new software and manufacturing techniques for high growth and that these goals couldn't achieve the required focus in one entity. The more cynical observer might still conclude spitting the books early will simplify an eventual write-off / sell-off if Ford succeeds at milking enough profits from Blue to fund where they need to go with "Model e" then immediately cut Blue loose if ICE demand tanks.

Both moves seem to indicate neither GM or Ford feels confident predicting what their workforce of the future needs to look like but both are confident it is SMALLER and has far fewer staff who cut their teeth on ICE platforms.

Supply Chain Strategy Failures

By themselves, the technology shocks around drive trains and "auto operating systems" have been challenging enough but the worldwide COVID pandemic exposed an unrelated strategic flaw in every high volume automaker that created cashflow problems in the short term and is triggering other ripples in maker / dealer sales chains that will be addressed later. The flaw stemmed from a fixation on "just-in-time" procurement of critical components and other non-auto market forces that took the auto industry's turn in line once it panicked and cut its orders. Most are familiar with the story…

During initial lockdown, travel restrictions led rental companies to halt all ongoing new car purchases and -- with no clear sign of when flying would return -- sell off nearly 100% of their existing fleets. That distorted the new car market via two paths. It cut fleet sale volumes from manufacturers to rental firms overnight. It also reduced retail demand by flooding used car markets with fleet vehicles at fire sale prices. Manufacturers processed those two inputs and immediately zeroed out purchases of some of the most EXPENSIVE components in any car -- the Engine Computer Units (ECUs) and customized integrated circuit chips used throughout vehicles.

The semiconductor fabricators responded by swinging capacity to other demands which spiked at precisely the same time -- demand for chips related to video conferencing gear, audio conferencing gear, new laptop computers for millions of workers who needed to work from home with a laptop rather than a desktop PC, etc. Chip making capacity was also booked by a spike in demand for specialized GPU chips used for advanced video games and complex data calculations used for cryptocurrency mining. Once those new contracts were signed, the ENTIRE auto industry found itself at the back of the line for new ECU chips. Even Toyota, which had invested in a backlog of such chips and took much longer to burn down its internal stash, eventually hit the same wall as other makers and began having problems shipping vehicles by late 2021.

Distorted Product Mixes

The chip based supply issues across all makers reinforced another problem for makers and dealers alike. Assume a maker offers seven different lines ranging from commuter econoboxes, family sedans, entry level sports cars, SUVs, trucks, luxury sedans and luxury trucks. Assume unit volumes in normal times were slightly skewed to the lower and middle price ranges. Now in a market with a 30% shortage of chips that control EVERY vehicle, if the maker can only make 70% of the prior UNIT count, they are better off ensuring they have a chip on hand for every high margin vehicle before bothering to make any econoboxes. And that's exactly the decision nearly every car maker made. The same logic applies to allocations of battery capacity. Do I make 15 econoboxes or one F-150 Lightning with my limited supply of lithium ion batteries? I make $25,000 on each Lightening and only $500 per econobox so my choice is $25,000 in profit or $7500. Let's make the ONE Lightning.

Since the higher end cars are purchased by higher income customers with less price sensitivity, allocations have shifted heavily towards the most expensive vehicles and prices on those vehicles have skyrocketed. Manufacturers and dealers have the exact same incentive -- which hurts consumers. Manufacturers want to maximize their revenue against a smaller unit base. Dealers have their own fixed costs to cover each month and would rather sell a $70,000 vehicle than a $35,000 vehicle. Even as manufacturers push new technologies, this dynamic is prioritizing use of limited resources on expensive, HEAVY, niche vehicles which reduces the number of econoboxes that can be produced to accelerate actual emissions reductions.

Remember emission reductions? The GOAL of this whole exercise?

Distorted Retail / Wholesale Pricing Behavior

Like larger car culture in general, the dynamics of the retail and wholesale car markets within the US have existed for so long, the original motivations for their structure and their unique behaviors are a mystery to most, including those within the industry. Retail new-car markets are structured in most states to require consumers to purchase new vehicles from independent dealers rather than directly from the manufacturer. This two-tiered flow can create perverse economic effects when manufacturers eager to report aggressive unit sales / revenue targets to THEIR stockholders maintain production and "stuff" cars into dealers who might not be able to sell that quantity without lowering prices or eating higher floating interest expenses for the vehicles on their lot. To some extent, manufacturers can do this to dealers because in many cases, dealers do not get to choose which vehicle models / trim levels are allocated to them to sell. If they push back on having new vehicles stuffed onto their lot in tough times, the manufacturer can reduce allocations during better times or give them the vehicles with the least popular colors and options as (not so) subliminal punishment.

Manufacturers typically set suggested retail prices on vehicles but even in normal circumstances, those numbers are often only accurate within plus or minus ten to twenty percent. In pre-pandemic times, popular cars might sell at sticker with $300 or $700 in extra "destination" charges tacked on by the dealer. Average cars might typically sell at 2-5 percent under sticker based upon the battle of wits between buyer and seller. Less popular cars would often sell for prices far under list via a variety of financial tricks. A truck listing at $70,000? How about a manufacturer's rebate of $5000? How about $10,000 off sticker? How about $10,000 below sticker AND keep the rebate? How about $14,000 for a fourteen year old trade-in with a blue book value of $7000? Did that customer just pay $55,000 for a $70,000 truck? Or did they just pay $48,000 for a truck that was never worth $70,000 to begin with and will be worth $45,000 by the time they get it parked in their garage?

Three years into this post-pandemic auto market meltdown, dysfunction between manufacturers and dealers appears to be worsening. As one example, Ford seems to have solved its chip supply issues, allowing it to complete more vehicles. Wholesale units grew from 1,104,000 to 1,147,000 for the last quarter of 2022 and from 3,942,000 to 4,231,000 for the full year from 2021 to 2022. Ford's earnings report referenced lingering supply issues that kept those 4Q production trends from improving further which -- in hindsight for Ford -- is probably a good thing. During 2021 and much of 2022, dealers had virtually no stock on their lots but that has changed DRASTICALY in the past few months. Dealers are now AWASH in vehicles that are remaining on their lots for MONTHS.

Understanding the dysfunction is easier by stepping outside the normal perspective of new car dealers and consumers and adopting the vantage point of used car dealers. In the pre-pandemic era, new / used car markets evolved an economic balance that optimized the flow of new and used sales based upon "normal" market conditions. Those conditions boil down to the following:

• try to keep new car prices as close to MSRP as possible
• make exceptions above MSRP only for extremely hot models and do it with local surcharges rather than raising then lowering MSRP as conditions evolve
• hide discounts against MSRP from consumers by inflating trade-in values
• in reality, limit trade-in values paid to new car buyers at or below reference prices in Kelly Blue Book or NADA bibles

Under "normal" market conditions, this modus operandi ensures any discounting from MSRP remains difficult for consumers to detect which can create more downward pressure in actual selling prices for new vehicles. This regime also ensures incoming used cars at trade-in enter the flow well BELOW their nominal market value. This gives dealers a chance to quickly flip the newer used cars in good condition for a quick profit or unload them at wholesale to second-tier used car dealers without tying up money in them waiting for them to sell.

In pandemic conditions, new car supplies plummeted, jacking new car prices up and restricting used car supply, causing those prices to skyrocket as well. In reality, the majority of consumers who bought cars during this automotive famine were buyers with higher incomes with less price sensitivity to pandemic surcharges. Since the supply chain woes continued for at least 30 months, dealers grew accustomed to relying on those surcharges to cover their operational expenses and inefficiencies. Unfortunately, 30 months has been enough time for buyers who have the income and desire for a new car to get one and they are out of the market. The buyers remaining do NOT have high incomes and CANNOT afford the surcharges dealers have added. Those buyers are sitting on the sideline, NOT BUYING. But dealers are doing everything in their power to ignore that market signal.

Because dealers borrow money for any inventory on their lot (new or used), any vehicle physically sitting on the lot more than two or three months becomes a BRIGHT RED FLAG to the dealer to do whatever it takes to unload it. This tactic is more typical for used cars which can be unloaded via existing wholesale auctions already set up for that purpose. However, dealers are also using that auction process for NEW cars, which seems to reflect a lack of understanding of the basic concept of object permanence understood by most toddlers. Dealers' thinking seems to be: If I have a vehicle on my lot not selling at a $70,000 MSRP but I'm worried that if I lower the price to $60,000 on VIN=a, then when I get another identical $70,000 car with VIN=b, I won't be able to sell THAT car at MSRP either. Instead of discounting the car I physically have, I will drive it forty miles away to an auction and sell it THERE for $60,000 and somehow, my retail buyers will never see that and the next guy might come in and purchase the next vehicle VIN=b for the full $70,000.

On the surface, this fixation on inventory turn in a slow market doesn't make sense. If you have vehicle A on the lot for $70,000 creating interest charges at 5%, unloading THAT vehicle A only to replace it with identically priced vehicle B also listing for $70,000 with 5% interest rates doesn't change the monthly interest being incurred. To the extent that a "November 2022" F-150 is identical in functionality and value to a "February 2023" F-150, dumping the "older" unit at auction doesn't seem to make much sense. Clearly, it makes more sense if you have a "November 2021" F-150 from the 2022 model year and it is now 2023 -- having the 2022 model on the lot can make customers question the desirability of your 2023 product and act as a lever to pull down your 2023 prices and sales.

This MIGHT work for ONE vehicle among hundreds of dealers with hundreds of thousands of cars. It DOESN'T work when all of the dealers are doing the exact same thing and THOUSANDS of identical vehicles are selling at 16-20 percent discounts and those figures are being shared with Kelly Blue Book, NADA and state tax authorities. Even if buyers aren't sophisticated enough to review wholesale prices, BANKS definitely look at these indexes and will not loan more than the wholesale price. To the extent dealers can somehow keep prices up, this means BUYERS right now are likely buying cars that are already well "under water" by chipping in much more cash as a down payment. If those buyers encounter financial difficulty and have to sell the car, they will instantly realize a much larger loss than what is normal for the normal cliff encountered when driving a car off the lot.

Supply Issues for Car Owners

Supply chain and labor woes don't only affect those considering BUYING a new or used car. The same issues affect repair and collision work on existing cars. As one notable example, Tesla owners who become involved in accidents are finding collision repair delays lasting up to six months. Even if insurance coverage provides some rental car coverage, it's unlikely policies cover rental costs for MONTHS. In the case of Tesla, it isn't clear how much of these delays are due to availability of parts versus availability of factory certified repair shops. Anecdotally, one independent mechanic in Chicago operates a repair shop in an industrial park and his diagnostic test drive route through the park is adjacent to a firm he calls the Tesla graveyard. The firm has 20-25 vehicles with varying degrees of damage parked outside which haven't moved in months awaiting repairs.

I imagine similar issues are being encountered with other parts needed to repair other new vehicles with esoteric batteries, unique touch screen head units, etc. These owner expenses are likely to compound in the short term and drive up insurance rates on ALL vehicles, further impairing affordability for typical buyers and adding more demand uncertainty to the market.

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Clearly, the auto industry is living through interesting times. However, it also seems clear that the square wave shocks encountered since 2020 have not worked their way through the ecosystem. They are still bouncing back and forth inside the industry which is creating additional uncertainty with buyers about what they want and with makers on where they place their bets. In the short term, it seems like makers have priced new vehicles out of affordability for much of the current buying market and may be stifling demand from the smaller number still able to afford vehicles at current prices. Guessing how makers will emerge from this strategic fog over the next fifteen years is already impossible. Imagining how some could survive if the industry experiences another shock like a pandemic, war or similar disruption is impossible. The margins of error are already too thin.

WTH