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

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

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

Calling All Suckers: Big Banks Pull off the Ultimate Bait & Switch

Market manipulation is alive and well on Wall Street.  Calling all suckers:

Submitted by Rolfe Winkler, CFA, publisher of OptionARMageddon

We’re not quite as healthy as we thought we were. Oops. (WSJ)

J.P. Morgan Chase Chief Executive James Dimon said…that March was a little tougher than the first two months of the year….Bank of America…CEO Kenneth Lewis also said that March had been a tougher month for his bank. [Convenient that they decided to dump this information on Friday afternoon, and at the close of a very good week].

Readers may recall that a few weeks ago, those two CEOs—along with Citi’s Vikram Pandit—said the first two months of the year had been very good:

Continue reading

Change? Looks like same ol’ same ol’ to me.

Excellent but long post by Edward Harrison at Naked Capitalism.

This post describes what’s happening with the “Geithner Plan” for revised bailout of banks/ dealing with toxic assets in the context of an earlier bailout:  the Mexican currency crisis in 1994-95.  It”s many of the same folks involved:  Summers, Geithner, and a populist sentiment in Congress that the powers that be decided to go around.

Good read for both the current crisis and to review the Mexican currency crisis.

I’m just sayin’…real reason Ford’s not taking FedGov $

Ford’s talking about the future marketing benefits of not taking the Federal Govt bridge loans like Chrysler and GM.   Yeah, that’s true and possible – there probably could be a small market share gain to be had eventually by being the US automaker that “pulled itself up by it’s bootstraps”.

But there’s probably another reason.  Any FedGov loans involve reporting to the new “Car Czar”.  Right now that Car Czar will be SecTreasury Paulson.  Paulson’s an ex-banker (actually there are no ex-bankers –  once a banker, always a banker in thought).  Ford has a two-tier common stock structure.  One class for the family (can’t be sold outside) and one class for everyone else (read bankers, pension funds, and regular investors). The family class is a small $ portion of the company (sticks in my mind as around 5% -but don’t quote).  But the family class gets way more votes – effectively around 40%.  That’s how the family still controls the company.  Banks, pension funds, and others have long wanted to end the two-class stock system at Ford.  My guess is taking FedGov money would put it in jeopardy.  The family doesn’t want that to happen.  So Ford says no to govt $.  Fortunately for Ford and the family, they appear to have enough cash to do it.

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

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

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.