Should Governments Bail Out GM?

The Wall Street Journal article GM's Shares Tumble on Rising Cash Concerns (subscription required) is one of several in the financial press that discusses the likely demise of a once great and proud company, General Motors Corporation (GM).

General Motors Corp. stock fell to its lowest level since 1946 as concern intensified that the auto maker could run out of cash and be forced to file for bankruptcy protection.

The stock's decline came as several analysts issued dire reports about GM and the company acknowledged in a government filing it could be at risk of violating the terms of some of its debt if it doesn't steady its deteriorating finances by year's end.

A violation of the debt covenants, GM said in the filing late Friday, would give lenders the right to demand repayment of $6 billion, a sum that potentially could cripple the car maker's ability to stay in business.

I shorted GM at nearly $40 per share back on 17 January 2003, nearly six years ago. I wish I were able to say that I saw all this coming. The reality is far different. Back in January 2003, West Texas Intermediate (WTI) oil price was a whopping $33.88 (see Energy Information Administration spreadsheet on historical WTI prices). I thought that if oil prices rose in the future, GM would be in difficulty. However, I never foresaw prices going beyond $100 per barrel. Had I been asked in 2003 the maximum price that western economies could tolerate, my guess would have been $60 per barrel.

In reviewing the GM share price chart (courtesy of Yahoo!), you will note that for much of the time I was underwater.

Click through on the above chart to reveal a larger version.

Later, I was doing well until Kirk Kerkorian and Jerry York of Tracinda Corp. came along, around 2006. Their involvement created excitement and buzz in GM. Rick Wagoner, GM's chairman and chief executive, successfully fought off Kerkorian and then ran his own show. Oil prices went into the stratosphere and the housing bubble collapsed. And here we are now—the stock closed down Monday nearly 25 percent to $3.36. Should GM file bankruptcy shortly, it will be a rather sad dénouement.

Various pundits are out in force telling all those that will listen how poorly managed the big three auto companies are. I disagree. While I believe GM should not have relied so heavily on its large vehicles—that was my initial premise for shorting GM—very few people foresaw this eventuality, where oil prices would remain stubbornly high and we would endure an unprecedented financial crisis around the world. In reality, I think Wagoner has done a remarkable job.

Should governments bail out GM? In all honesty, I do not know. If GM is allowed to fail, what are the repercussions? How far does it spread in terms of employment and loss of business activity? How far do GM bonds reach, and what are implications of default?

If the governments pump money into GM, how much money is required and what is the direct purpose? By purpose, what will the money be used for? Will the initial injection be enough? Can any amount of money make the company a strong, viable competitor again? Will other national governments pump money into their car companies too, further increasing competition?

If GM is allowed to fail, then shortly thereafter I believe it would be reconstituted in a much different form. Existing union contracts would, of course, be history. Existing pension and health care benefits would be gone. The number of models would be greatly reduced. Many more white collar jobs would be gone, and much of management would be replaced. And with that, GM would begin anew. That is not to say that it would be successful, but rather, it would undergo massive changes before it began producing cars again.

My initial short position was small as a percentage of my portfolio. Of course, that percentage is much smaller now. I am content to watch this scenario play out. My guess is that the governments will assist GM and that GM common stock goes to zero or nearly zero.

Disclosure: short GM.

Comments

[33Nick:]

"Various pundits are out in force telling all those that will listen how poorly managed the big three auto companies are. I disagree." Hum, I disagree but mostly because any business that mostly, if not only concentrates on a certain type of product, such as SUV and pickup trucks, is akin to putting all its eggs in one basket. It is a dangerous path. A company with no contingency plans, especially one as big as GM, Ford and Chrysler makes anyone wonder at the management style. GM would have been better managed had they produced fuel efficient cars along with SUVs, instead of lobbying and suing states who asked for better fuel economy.

It's hard to argue for and against pumping money into companies. however, it should come with enforceable strings attached, such as deliver. In the meantime, it's darned if you do, darned if you don't.

2008 Nov 11 04:11 PM

[mwclark:]

If tax dollars are pumped into the domestic automakers, they'll burn through it the same as they have their own cash. A dollar is a dollar, regardless of where it came from. I'm not willing to donate the tax money i pay to carry a business(es) that is(are), in effect, the last dinosaur to become extinct.

2008 Nov 11 04:59 PM

[PacificGate...:]

ONLY VERY DRASTIC ACTION WILL SAVE DETROIT

Congress: Here is a radical, but common sense and workable plan -

pacificgatepost.blogsp...

It is this, or bankruptcy. The American Auto industry should be saved but under new conditions.

Do not leave it to the likes of Paulson or Congress to come up with a creative plan resembling interest in taxpayers' wellbeing.

There is much creative talent hidden inside the Big 3 that has been smothered by mismanagement and the UAW.

2008 Nov 11 11:59 PM