I’m Back!

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

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

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:

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GM: Some Bondholders Want Bankruptcy – BusinessWeek

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.

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

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