Tag Archives: GM

I’m Back!

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As I hope you noticed I haven’t posted for over a couple weeks.  (if you haven’t noticed, spare my feelings and don’t tell me).  It was mostly a busy schedule and some health issues. But I’m back at the keyboard ranting away now.

Actually I’m also back in another way.  After way too many months of not appearing on TV, Channel 6 WLNS in Lansing, interviewed me twice this week about the GM IPO.  My ego is greatly relieved.  The long fade into complete and utter obscurity has been halted for at least another few weeks.

If you’re curious here’s the video.  In  a way it’s embarrassing what TV does you.  I have all these deep (I hope) thoughts and analyses.  Then I have the interview which usually lasts maybe 5 minutes (10 on a big topic) with camera rolling. Then I see how the editing process boils it all down to a few seconds of seemingly total banality that only serves to confirm I have a firm grasp of the obvious.  Oh well.  If you really want to know what I thought about the GM IPO, you’d probably learn more from my posts here and here.

GM, Banks, Bailouts and Incentives

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With the GM IPO having succeeded so well this past week, the critics and nay-sayers have had to change tunes.  I don’t know that I really see the government investment in GM’s bankruptcy and restructuring as a “bailout”.  I see more as the kind of strategic government intervention that helps the economy that a good government does.  But, in the interests of brevity I’ll go with the common parlance of the critics and refer to the investment in GM as a “bailout”.  To understand my position better, see my post on the GM Tale.

The critics can no longer claim the GM was a waste of money.  The government has gotten back something near half of it’s original loans and equity money. The publicly traded market has now put a value on the remaining share ownership and  while it isn’t at break even yet, it’s very plausible that within a couple years the government could recoup all and even profit. The critics claimed GM was hopeless. They claimed the UAW was too overpaid and wouldn’t cooperate. Wrong again. A $2billion profit in 3rd quarter 2010 when total auto industry sales are still down 25% from 2007 disproves that charge.  The critics claimed it was socialism.  Judging by the strong investor demand for the IPO, it’s apparently the kind of socialism that capitalists want.

But now the critics claim that the whole GM bailout experience being successful sets up the wrong incentives. They claims that more large companies will seek big government bailouts too.  They’re wrong again. What the critics are suggesting is called “moral hazard” in economics.  It’s the idea that managers or firms, if they know they will be rescued or bailed out when things go bad, will start taking excessive and unjustified risks.  Moral hazard is the kind of situation where the incentives are wrong.  It’s what you intuitively expect to happen if you tell somebody to choose their risks, then tell them that the riskier choices have higher possible payouts, and that if the risk turns out OK the chooser can keep all the profits. But if the risk turns out bad, the chooser won’t suffer at all.  Obviously this is a “heads the chooser wins, tails the chooser sticks the loss to somebody else”.  Just as obviously, it’s not a good scenario.  It leads to wild and excessive risk taking and leaves other people to clean up the mess and take the loss.

The GM “bailout” doesn’t significantly increase moral hazard at all, though.  In contrast, our policies towards the large Wall Street banks has increased moral hazard.  Why does a GM bailout not create moral hazard but bank bailouts do? Simple. Despite legal and Supreme Court claims, corporations are not persons.  They do not make choices.  Managers of corporations make choices.  For a bailout or the prospect of a bailout when things go bad to create a moral hazard situation, the decision-maker, the person making the choice must be the one to get bailed out.  That means the manager(s).  Government bailouts create moral hazard when the managers are kept safe and allowed to profit when bets decisions go well and allowed to skate without consequence when their decisions don’t work.

In GM’s case, this didn’t happen.  Senior management lost their jobs.  Both Richard Waggoner and Fritz Henderson, both long-time GM managers who rose to CEO lost their jobs and were replaced by outsiders.  Further, the shareholders of GM got wiped out entirely.  They got zip, nada, zilch from the bankruptcy and turnaround.  In fact, technically, the “old GM” is being liquidated, it’s life over.  The IPO is in fact a new company.  No rational existing manager of another company wants to go through what Waggoner and Henderson did.  They want to avoid it.  No shareholder in any other corporation is looking at GM and hoping they can do the same – get wiped out. There’s no moral hazard setup here.

Where the moral hazard of bailouts has been created is with the banks.  The big banks, particularly JPMorgan Chase, Goldman Sachs, Citi and BofA, were all saved from disaster in late 2008 by the government investing billions more money than they did in GM.  Yet, not a single senior manager of those banks has suffered negative consequences as a result.  Quite the contrary, Wall Street hit record management bonues in 2009.  They actually learned that losing other peoples’ money and getting bailed out was a good thing for them personally.  Further, no common shareholder of those banks has suffered.  In fact, the government went out of it’s way to make sure the bailout didn’t affect dilute common shareholders when the government choose non-voting preferred stock as the way to make the bailout investment.  The bank bailouts – now that’s how you create moral hazard and keep them coming back for more.

 

The GM Tale

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Earlier this week General Motors, the new post-bankruptcy GM, issued it’s Initial Public Offering.  Initial signs are very encouraging in several ways, which I’ll describe.  But first let’s take  a note.  Only 20 months, less than two years, The conservatives and tea party types were howling for GM to go bankrupt and for the government to not step in – just let it and Chrysler die along with what would probably have been nearly a million good U.S. jobs and the State of Michigan. Let’s revisit those events for a moment below the fold:

Continue reading →

GM: Some Bondholders Want Bankruptcy – BusinessWeek

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Business Week catches up to Econproph from last month.

The barriers to getting a deal done with GM bondholders, and negotiating away enough of that debt to strike a deal and avoid a planned, government-assisted bankruptcy, remain very big, with five weeks to go before the deadline.

…And second, some of the bondholders own credit default swaps, which amount to an insurance policy against the debt and pay them in full if GM defaults. Those bondholders actually fare much better if GM goes into bankruptcy.

Why GM will almost certainly go bankrupt.

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Right now, for GM to avoid a bankruptcy filing, it has to get concessions or “sacrifice” from the “stakeholders”.  In plain terms this means the union and the bondholders.  The union has already stepped up to the plate. It has sacrificed and offered additional sacrifice contingent on the bondholders.  So far, though, the bondholders haven’t agreed to anything. It is the bondholders who are blocking a “restructuring”.  Ultimately, the bondholders will force the company into bankruptcy.    Why?

To understand why, we need to look at the negotiation process. There are thousands of GM bondholders: some large, some small, some individuals, some banks, some are bondfunds like PIMCO, and some pension funds.  But while there may be thousands (perhaps even millions) of seperate bondholders, the vast majority have no voice in the negotiations.  Instead, there is a “bondholders’ committee”.  Who is on the committee?  The “experts” and the large bondholders: primarily banks and bondfunds.  These banks and bond funds presume to speak for all bondholders. But their interests are not in line with all bondholders.  We know that there are very large number of outstanding Credit Default Swaps (CDS) contracts on GM.  So who likely holds the CDS’s?  The very same large banks and bond funds that are negotiating.  So, in effect, if GM goes BK, then the bondfunds/big banks are hedged and get full payment via the CDS.  If they agree to a restructuring, they get less than full payout.  So there’s no chance they’ll agree.  Of course, the little bondholders (like Joe Retiree with his $10,000 of GM bonds) loses.  He’s not hedged and he has no real voice on the committee.  The little guy gets no voice until after the committee approves sending a tender offer.  Not likely to happen.

This is doubly true since AIG, the likely writer of many of those CDS’s, continues to get full bailout from the gov.

The only chance of avoiding BK for GM is if the Obama administration either:  makes a credible threat to stop bailing out AIG  –OR– the administration decides to make CDS’s null and void.  Neither is likely.

Why GM could still go bankrupt: Banks & AIG are the problem

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GM has a problem.  It’s not the cars or the union.  GM needs to get it’s costs down as required by the govt loan terms.   The union has agreed to it’s share of the restructuring.  Waggoner is now gone.  What’s left and what’s blocking GM’s turn-around are the the banks and bondholders.  They refuse to take a “haircut” to re-structure GM’s capital structure and debt costs.  Why?

Because the big banks and bondfunds have already insured themselves against GM default (bankruptcy).  So heads they get paid, and tails they get paid.  The only way they don’t get paid fully is if they agree to a restructure now.

Ahh, but you say, isn’t AIG, the “insurer” of these bonds through it’s credit default swaps already kaput itself?  Yes, but The Treasury has shown that it will make good 100% on AIG’s CDS.

GM (and all of it’s employees, dealers, and communities) is being held hostage by the banks and bondholders until the US govt pays full ransom to them.

Why, oh why, oh why won’t the govt just declare Credit default swaps null and void?

Why GM’s CEO is out, but no bank CEO is gone

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Yesterday the Obama admin forced GM CEO Rick Waggoner to resign as a condition of continued support for GM’s restructuring.  Yet, the administration has not yet demanded any of the banks change management (except AIG & Fannie last Sept), despite the banks using 18-20 times as much bailout money.

Several folks have asked me why? Why the double-standard?  The answer is that in the last 30 years, the banking industry has captured Washington.  Our Treasury Dept officials are ex-bankers and when done in DC they return to banking. The leading economic advisors (Larry Summers now, Bob Rubin and Hank Paulson in past) are either bankers or have long career ties to banking.   This is not a good thing.

Simon Johnson, ex-IMF chief economist, has written analysis of the problem that, while long, is very worthwhile read. He calls the financial industry’s capture of our government’s policy a Quiet Coup.

I have some key excerpts below the fold, but it’s worth checking out the whole article. Continue reading →

Surprise: Bush sort of does the right thing for GM/Chrysler

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I’ll admit I’m surprised.  My inner cynic suspected the Bush administration would try a pre-packaged Ch. 11 bankruptcy for GM or Chrysler, or that they would dither and play Hamlet so long that the Chrysler, GM, or some big Tier 1 would end up in bankruptcy anyway for Christmas.

Instead, GM/Chrysler get their bridge loans.  See NYTimes (registration reqd) or FreePress.

The good side is that the package includes restrictions and a March 31 deadline that will enable the companies to play hardball with their debt holders (especially the banks), as well as dealers and the union.  The union has already shown a willingness to help & play,  but contrary to what some Republican Senators and Wall Streeters believe, the problem now isn’t so much the union contract as the debt-laden capital structure.  The banks haven’t shown a willingness to play yet.  Maybe now they will.  With the fed gov money getting priority over all other debt, a fed gov decision in late March that the restructuring hasn’t happened will greatly raise the risks for current debt holders.  The balance of power in the game of chicken between firm and banks just changed.

The downside is the timing and amounts. See the FreePress.  It seems Bush/Paulson want to tempt fate.  There’s no slack here folks.  That’s tight.  If the economy takes another surprise hit in the next 40 days, this might not work.

Industry Matters: Why Chap 11 Bankruptcy Won’t Help GM

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The NFL should watch out.  Armchair quarterbacking while watching football on TV is being challenged by a new couch potato activity: armchair management. It seems that nationwide people, pundits, Wall Street analysts, and even U.S. Senators have the solution for GM and the U.S.-headquartered auto industry:  file chapter 11 bankruptcy and “re-structure”.  It worked for airlines and others they say!

No! say the defenders (?) of the Big 3.  A Chapter 11 bankruptcy would immediately turn into a Chapter 7 liquidation because customers won’t buy cars from a bankrupt automaker.

NOTE for Students: “Chapter 7″ and “Chapter 11″ are different parts of the U.S. bankruptcy code.  In ch.7, a firm is liquidated – it shuts down operations, all the assets are sold, the creditors are paid what money is left, and the company is no more – it is a “late company” in Monty Python parlance.  In ch.11, a firm is allowed to continue to operate and the court protects it against claims from earlier creditors. The court then negotiates/forces the creditors to take less then than what’s owed them.  The court can also tear-up an re-write union/employee contracts. Eventually, the firm “emerges” from ch. 11 as a financially restructured company.

The truth, like always, is more complex than these simple soundbites.  In my opinion, chap 11 bankruptcy is not a viable option for the Big 3, but the reasons are more complex than just “customers won’t buy from a bankrupt automaker”.  Let’s look at why chap.11 won’t work and why a ch. 11 would quickly become ch.7 and a cascade that brings down other automakers.  But in fairness, we’ll also look at what benefits ch.11 would bring.

In addition to the customer reluctance argument, there are four other reasons why ch. 11 won’t work for autos, even though it “worked” for airlines and some others. All of them involve the economics of the auto industry as compared to other industries.  The auto industry has high hard fixed costs, it has a long product development cycle with large sunk costs, purchased components are a large part of value, and it’s a credit-based business.  Airlines and other firms that have successfully navigated ch.11 don’t have these characteristics.

  1. A significant number of customers won’t buy from a bankrupt automaker, unlike airlines.  It doesn’t matter if some customers, or even most customers, would continue to buy.  If you run a high fixed-cost business, any significant drop in volume will doom your operation and necessitate liquidating plants.   Despite what advocates of ch. 11 argue, it’s perfectly rational for consumers to fly a bankrupt airline and not buy a car from a bankrupt automaker.  A plane ticket is a service that’s delivered over a few hours.  I only need to know that the plane is safe (I know the FAA & insurance is watching) and that the airline won’t shut down during the time I’m flying.  That’s a risk most people will take since it’s low probability.    A car from a bankrupt automaker is a different thing.  I’m buying a large asset (second largest asset I’ll likely own).  My “investment” depends not only on whether I think the automaker will be there for parts in 2-3 years, but also whether future buyers of my used car will think the parts/service is available.  The safety (recalls) are dependent on the automaker, not the FAA or an insurance company.  In buying a car, I’m buying a relationship with the company & dealer for several years.  Yes, some car fanatics will buy anyway and maintain it themselves, but even if only 20-30% are scared off, it’s doomsday for the automaker.
  2. Autos have high “hard” fixed costs, unlike airlines.  In ch.11., it’s normal that sales volume declines somewhat.  For any business, the risk to profitability/viability of a sales decline depends on whether costs are fixed or variable.  High fixed costs = trouble when sales decline.  High variable costs mean costs come down with the sales decline.  I define a “hard” fixed cost as some cost that can’t change easily regardless of sales  volume.  A “soft” fixed cost is more like a step-cost.  Opportunities exist to lower the costs.  It’s fundamentally a question what size a “chunk” of capacity is. Airlines are often thought of as high fixed costs, but in reality they have soft, step-fixed costs.  An airline essentially has three major costs:  lease on the plane (hard fixed), the fuel for each flight, and the labor/maintenance.  Airlines can reduce costs in small chunks – if there aren’t enough tickets for the Chicago-Albuquerque flight, cancel it. You save the fuel costs and possibly some of the labor costs.  GM, on the other hand, can only realistically cancel an entire plant or a whole model line – these are permanent shutdowns.
  3. Autos have to plan ahead, airlines don’t. Under the best of conditions and the most flexible automakers, what’s on the showroom floor has been in planning, development, and production for at least two years.  To do a significant “re-structuring” requires planning ahead.  In airlines, reaction is a lot faster.  Witness how fast airlines adjusted to fuel cost changes in 2nd qtr 2008 or traffic declines in 4th qtr 2001.  Can’t do that easily with autos. In autos, if you start reducing costs today in 2008, you lower the cost of the car available in 2011.  2009′s costs are largely set already.
  4. Purchased components & the supplier network. A bankruptcy court can tear-up a union contract.  It can force a bond-holder or bank to write-off part of their investment and take a loss.  A bankruptcy court CANNOT FORCE a supplier to make and sell parts.  Without parts, no car. Without a car, no sales, and no automaker.  70% of the value of a car is parts/components purchased by the Big 3.  It’s not just a question of whether customers will buy from a bankrupt automaker, but also will a cash-strapped supplier sell and deliver parts to a bankrupt automaker.  There’s not much evidence to indicate they will.  What’s worse, is even if 95% of suppliers are willing, the 5% that might not can shut down the whole thing.  For most auto parts and components, the tooling is unique to each model.  It takes months, even years to switch the supplier of a particular part.  For an automaker to survive Ch. 11, ALL the suppliers need to be involved and taken care of.  Not likely to happen.  In airlines, on the other hand, the airline needs fuel.  If Exxon won’t sell it, BP can easily substitute. Different industry.
  5. Autos are built with credit, airlines fly on cash. An automobile is really a credit vehicle.  The automaker buys the parts on credit. The tier 1 supplier buys on credit.  The dealer buys on credit. The customer buys the car on credit.  Nobody gets paid until and unless the car gets sold and GMAC, FoMoCredit, the credit unions, the banks, etc deliver the money.  In chapter 11, the certainty and risk of being paid changes drastically for everybody.  A bankruptcy court can easily tear-up existing contracts, but it can’t force customers, suppliers, or dealers to enter new ones on credit.  A bankruptcy court also can’t supply credit.  And in the current 2008-09 environment, it appears the banks can’t/won’t either.  Airlines, however, pay cash or near cash for the only really large purchased production component:  fuel.  Customers also pay cash (or do their own financing with Visa/MC). Different industry.

A chapter 11 bankruptcy for automakers would have one positive effect.  It would make it easier and cheaper to break and re-negotiate the contracts with the dealer networks.  This would allow GM and Chrysler to skinny down the dealer network  -  a critical element for long-term survival.  Right now, this is a tough task because a patchwork of state laws and anti-trust court decisions makes it difficult for the automaker to unilaterally cut dealers.  Today, automakers have to essentially buy-out dealers with a $ carrot to get rid of them.  Presumably (I am not a lawyer), a federal bankruptcy court trumps state dealer franchise laws.  Again, even here, the contrast to airlines is stark.  Airlines don’t have to “buy-out” an airport or travel agency in order to stop doing business with them.

If the GM or Chrysler end up going chapter 11, I don’t see anyway that survival is possible in any practical form.  Instead, a chapter 11 will really be a chapter 7 with additional paperwork and attorney’s fees up front.  And a disorderly liquidation of any one of them, puts key Tier 1 suppliers at risk and the risks production at Ford, Toyota, Honda, Kia, Hyundai, etc.

Unfortunately, it seems that our economic policy leaders are touched with the Wall Street disease:  armchair management.  They don’t understand how the business works and don’t want to learn, but they want to prescribe management policy anyway.  I don’t have a problem with people (or their elected representatives) wanting to prudently put limitations on their investments (and that’s what the auto loans should be), but we need fact-based, intelligent analysis, not simplistic soundbite solutions that don’t won’t pass Econ 101 or Mgt 201.