Why Does Money Cost So Much today?

FEBRUARY 7, 2011 BY GEORGE LOVATO JR
What Does a Rising Rate Really Mean?
I listened to a friend recently predicting gloom and doom about rising bond rates. The fact is a little increase in the U.S. bond rate is good. Too much and could adversely affect the economy which we all know is fragile in its current condition. What does a rising rate really mean? First better yield on parked funds. Second, lending institutions will have a better basis to forecast a base rate to lend by in simple terms. And increased yields on invested money can mean more money to lend. In short it is not the end of the world.
I can recall a time when Wall Street Prime was a reasonable reference point for the cost of money. That has gone out the window. Rates are pretty much all over the board now. There does not seem to be a clearly defined interest rate pinpoint. LIBOR was also a reference. But that too is unreliable these days. What is a good bellwether? U.S. treasuries used to be and should become again the standard. But they first must stabilize and next they must be priced attractively. So at a time when we are all searching for anchors on a sandy beach, maybe a little increase in the U.S. bond market is not a bad thing. What Bernanke is doing now and how he is managing the course is in my opinion sound. Create demand.
Time and the Cost of Money Marches On
I recently had a discussion with a client on the cost of money. His reference point was his previous loan rate which was established seven years ago. It just happened to be five and one quarter percent. He wanted to renew his loan at the same rate. When I informed him that it was going to be in the mid to upper sevens he was shocked. He could not fathom the increased cost. His position was he had been performing on the loan and all should have been left unchanged. He did not see the reason why he should pay more. After some time I explained all that has happened in the last four years outside his bubble and he was astounded. What happened he wondered? How could what happened out there affect me? Well the reality set in and he then was more accepting that what he had seen in the news did in fact have an impact on him. What a surprise. Well time and the cost of money marches on.
I hear that same argument from a lot of my clients. Why does money cost so much these days? There are a host of reasons, much too long for this blog but suffice it to say a lot has changed. Losses from lending institutions must be absorbed. Risk must be accounted for in the cost of money. The cost of management of lending must be adjusted just to mention a few reasons. Do not be so shocked when you see the proposed interest rate. It is going to cost more. Pure and simple.
The Cost of Capital
There is a story in my upcoming second book (Due out in May) about this very subject. You can find my first book here. It speaks of the cost of capital in its varying forms. Commercial bank debt costs less than semi-regulated debt. Equity is far more expensive than both of those forms and the list and prices goes on. Cost of capital is volatile in today’s market. We must plan for it along with all the associated costs that accompany debt or equity. It has now become a cost to contend with. Long ago it was by most standards inconsequential. Today it is measurable and significant. In the story I mentioned in my upcoming book it relays an incident where the interest on a loan went from six percent to fourteen percent in a matter of a few months. This increased cost was never projected nor anticipated (variable loan rate combined with default covenants added to the loan) and as a result the client went out of business in the process. Lesson…allow for the varying and increased volatility of the cost of capital.
Everything Has Changed
Some of us feel we are unaffected by what goes on in the world around us. Others feel that as long as we are unchanged so is the manner in which we do business. The fact of the matter is that many things have changed in the world of finance in the past few years. So much so that even some of the rules that guided some of our decisions are non-existent or so radical is the paradigm shift it is hard to even comprehend. Suffice to say if we are in business, we must be more observant and mindful of the changes in our world, economy and in finance. Don’t listen to opinion but search for the facts and patterns. Open your mind as well as your ears. Most of all, we know now that everything has changed and that includes the cost of money.

GMAC Again?

JANUARY 12, 2011 BY GEORGE LOVATO JR
A Look forward – But First a Look Back
So here we all sit watching General Motors make another bold move. But first before we talk about the latest and greatest let’s look back. Years ago GM sold off the GMAC unit to a third party. The proverbial cash cow is tossed to the wind. Many in the industry said that was foolish due primarily to the fact that it was such an integral part of the overall business model. Nonetheless it was sold. General Motors continued to operate ineffectively after that transaction. They continued to receive criticism from the observation gallery about the transaction. The dealer body thought it was a stupid move as well.
Fast forward. GM purchase a second rate subprime finance company recently. All of a sudden someone at the helm begins to awaken. Next GM decides we need our venerable GMAC unit back. “Let’s get back in the business of finance!” What genius will get credit for this one? When I read about the purchase of the subprime unit I was not surprised but a little dumbfounded. They got kudos from Wall Street like this was a revelation. Now Wall Street is amping the volume up again about the latest revelation that they need to enhance the finance arm. To this I say hogwash! The business model should have never excluded them from the finance business to begin with.
Rewarding a Pencil Pushing Wunderkind
Now some pencil pushing wunderkind will be touted around the company as the next Bill Gates for coming up with this new and “fresh idea”. They will be given some notable bonus and the clock will continue to tick away. We as shareholders will continue to wonder who is at the helm and what map they are looking at. I say never reward stupidity. I know I have never been rewarded for it because if I ever was I would be a billionaire by now.
Because of my role in the development of AutoStar, I keep abreast of automotive industry matters. Next I have the good fortune of speaking with dealers all over the country. I speak frequently to the displaced General Motors dealers as well as the survivors. What I can tell you is Ally Bank is doing a poor job at servicing and managing the opportunity they have in providing financing to the dealer body as a whole.
Ally Bank?
GM needs a replacement service. Ally is just not what the industry needs. There are too many inexperienced poor quality field managers that do not understand, let alone execute, the much needed wholesale financing service the average dealer needs to remain competitive. I hear every day how they are fumbling the ball. I even have been in some negotiations with the “boys” from Ally and I am surprised in some cases that they were even picked to do the job on the first place. They continue to toss perfectly good clients under the bus. The credit qualification standards are archaic. Their overall approach is crude and very unprofessional. Simply they need to be jettisoned out of the picture. They have no vested interest in this industry. They do not care and thus they can destroy the industry from within at a critical time.
Cartographers Who Can’t Read Maps
But back to the cartographers at GM. I say you read the map wrong years ago. No you should not be rewarded for doing what you should have been doing all along and that is to provide a captive finance source. Read the map boys! If you have to, go back a couple of decades and read the annual reports. GMAC was part of your original mission! If you are going to put it back together put in a floor plan program with modern management mechanisms. Put in consumer lending products that meet the market demands. Provide what will work! Do not provide something for the sake of Wall Street. Pay attention to your dealers! They are your lifeblood. They are not a disposable asset which is how you have been treating them. They too have been around as long as you have. And oh by the way, don’t buy a percentage buy control or all of it! Get back in control of which way this ship is headed.

I’m Saddened By What The Government Did

DECEMBER 8, 2010 BY GEORGE LOVATO JR
I Guess The Government Dodged That Bullet
Well the cat’s out of the bag…the Federal Reserve loaned money to foreign banks. This is not new news. The long and the short of it is that these are different times than in ’08. This was a full blown crisis of epic proportions. As you all know I am a real fan of Chairman Ben Bernanke. I think he is always the smartest guy in the room. If you all recall the United States was being blamed for creating risky junk investments to which we conned the European banks to invest in. I know that is an exaggeration but that was the tone and tenor at the time. Politically I am sure the Chairman was under a mountain of pressure. Well most of the money has been repaid. Whew! I guess the government dodged that bullet.
Carte Blanche Lending to the Loudest Banks?
However I think it would be wise and prudent to analyze history and the events of years past. My first question is how much true analysis went into who, how much, for what reason and the potential of payback of the potential borrowers. Was this carte blanche lending to the loudest banks? I hope not. But the question needs to be asked. What was the criteria? Who made the calls on who got what? We need to know. Now insofar as frequency goes that is another story. Morgan Stanley borrowed over 200 times. You mean to tell me a bank could not project its actual liquidity needs? Jamie…shame on you.
The Golden Pen
Then there is the issue of hedge funds getting assistance. What? Since when did they qualify? I would like to have been the fly on the wall when that decision was made. I feel that was a huge mistake. They are in the risk business. They should have never received the golden pen from the Federal Reserve. I am disappointed in that decision. As you all know I think the automotive industry should have never received the golden pen either. I am on record that it should have been survival of the fittest. We broke a rule of commerce on that one. I am appalled about lending to a British bank that buys the very same assets from a failed American institution we allowed to fail to begin with. We should have saved Lehman! There is the proof in the pudding.
We Must Stay Within Our Own Boundaries
I hope we learn from history. We are bankers and we have to follow our own rules. We must be prudent but forward thinking. We must be aggressive but controlled in order to stimulate and complement the needs of small business. We must be disciplined for all concerned and conduct the business we are educated and trained to conduct. In other words stay within our own boundaries. We must look to the past and learn. We must use those lessons for the benefit of commerce.
I Am Saddened By What The Government Did
The cat is out of the bag and the cat is laughing. I am saddened about what I know now about what our government did. I wish they had not done some of the things they did. I am disappointed in some of the behavior of some of my fellow bankers. In the end we need to follow our own rules of commerce and capitalism and never allow our government to use the golden pen like that again. Are we better off for what was done? We will never know. We can only speculate.