GM: The Bailout vs. Bankruptcy Meme 12 comments
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There's a bailout vs bankruptcy meme going around with regard to GM -- a choice which makes me want to tick "none of the above". I've seen it in dozens of places of late, but since it comes with the imprimatur of Paul Krugman, let's look at the argument of Jonathan Cohn:
GM can't build cars without parts, and it can't get parts without credit. Chapter 11 companies typically get that sort of credit from something called Debtor - in - Possession (DIP) loans. But the same Wall Street meltdown that has dragged down the economy and GM sales has also dried up the DIP money GM would need to operate.
That's why many analysts and scholars believe GM would likely end up in Chapter 7 bankruptcy, which would entail total liquidation... [cue visions of millions of newly-unemployed workers and hundreds of billions of dollars in losses]...
Those are among the reasons most analysts and economists, however reluctantly, have concluded that a better solution would be another government bailout.
At heart, this argument is simple. There's no available DIP financing for an orderly Chapter 11 bankruptcy, and Chapter 7 liquidation would be disastrous, therefore we need a bailout which avoids any kind of bankruptcy at all.
But I don't see why a government bailout must, ipso facto, avoid any kind of bankruptcy. GM alone has $35 billion in long-term debt, most of which is trading at about 20 cents on the dollar. That might only be a drop in the bucket compared to its total liabilities of $193 billion, but it's a good place to start: If bondholders took an 80% writedown while the government pitched in $12 billion of preferred equity in the post-restructuring entity, that's a $40 billion improvement to GM's balance sheet right there. And of course bankruptcy would give GM the opportunity to renegotiate onerous contracts with its dealers, as well as other real and contingent liabilities.
This is what I've been referring to as a "bail-in", and it makes quite a lot of sense on its face. Let the government provide the necessary financing, but ensure that bondholders share some of the pain as well, especially since doing so would simply ratify the mark-to-market losses they've already taken.
Such a plan would involve working out the details of a bankruptcy in advance: There are large dangers involved when a company the size of GM enters bankruptcy without any clear conception of how it might exit. So there would need to be serious negotiations between all of GM's stakeholders and the government -- negotiations which, I'll concede, would be all but impossible during this uncomfortable interregnum between the election and the inauguration. Even if GM can somehow muddle through until January, it can hardly expect such negotiations to be concluded in a matter of weeks. So there's a timing problem here, given that the present administration has demonstrated zero inclination to help out Detroit.
But I still think that it would be useful to stop thinking of a bailout as an alternative to bankruptcy, and start thinking more imaginatively about the different mechanisms, including both government funds and bankruptcy, which could help put Detroit on a more sustainable footing.
Update: Ryan Avent seems to be thinking along similar lines, in a blog entry entitled "Chapter Something Else":
If Congress can pass a special, tailor-made rescue bill for the automakers, then certainly it can also pass a special, tailor-made bankruptcy bill for them.
I guess my only question is what's wrong with Chapter 11. Why create a whole new class of automaker bankruptcies, if a pre-packaged Chapter 11 would work fine.
Disclosure: no positions
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This article has 12 comments:
In addition to the usual people hurt ..... you have to take into consideration that GM was long considered a "widows & orphans" stock. Retirees, pension plans and others with no direct connection to GM stand to loose a considerable portion of their savings.
This bankruptcy would be felt at WalMart as bad or worse then Wall Street.
The whole 'psychological damage' aspect of GM's declaring bankruptcy is ridiculous - as if talking about how GM is losing billions of dollars, and is not viable, is somehow better. If done right, it would probably be a net plus to Gm's image - people in general, and investors in particular, love it when there's a plan, especially one that makes sense, moves in a new direction, and is optimistic. A straight bailout to GM is like morphine to a cancer patient.
In a perfect world of Capitalism only the strong survive and business takes care of itself. But those are not the ground rules we have been playing under. The government has controlled and mismanaged the credit markets with the introduction of the Community Reinvestment Act and followed it up with deregulating and miss managing Fannie Mae and Freddie Mac to the point that our credit system almost collapsed.
Add to that the deregulation of the futures market that allowed oil to hit $147.00 per barrel and started a consumer driver recession. It is the governments fault, they caused the problem and they should stand good to fix it. Gm has been in a restructure program for the last several years that should reach a majority of it’s goals by 2010. I’m talking about moving the legacy cost of the retirees to the UAW, which with other cuts and changes would drastically improve Gm’s underlying cost
per vehicle. Some say that GM built gas guzzler SUV’s and trucks that the public didn’t want, but that was untrue, an out right lie. They were built due to demand for such vehicles, look at your local Toyota lot and see the number of full size V-8 trucks and SUV’s. Toyota saw the demand and was trying to tap into that large market.
It was $4.00 a gallon gas that killed it in less than a month and no company can change production over in less than 6 months and retool especially with the availability of loans gone. Another government screw up. We pay more to other countries in the form of aid to help with our security. Those opposed to helping out our manufacturing base
survive the screw ups of the government should ask themselves who will build the tanks and planes the next time we need them. It makes me sick to my stomach to see supposedly grown men and women play these political games and argue over the fate of millions of workers future when they caused the problem to begin with. It’s time for our elected officials to get off their he said she said politically driven backsides, accept the responsibility that they know is their’s and fix this short term problem. For the rest of you generating an income off of the volatile market ups and downs and enjoy profiting from a company crashing, get a real job and contribute to society and quit being the vultures you have become.
Mitch Mayberry
What if "the last day" is sometime in December 2008? One more coupon or 20% of your money back isn't much of a choice, but neither is hoping your bonds are worth what you paid for them. Bondholders in LEH didn't get much for their so-called secured obligations.
You may wish to reconsider while you still have options.
Remember that WaMu bondholders didn't get a chance to salvage their "fully performing" bonds before they were shafted either.
The gub'mint has shown it will change the rules on a whim and anyone who gets in the way can wind up with nothing. Keep that in mind.
Some combination of a pre-packaged bankruptcy with federal assistance (whether in the form of DIP financing or something else) is the only way out that makes sense.
Federal dollars without restructuring only buys time, and probably not a whole lot of time at that. Bankruptcy without explict support risks a death spiral and liqudation, with fairly dire consequences.
Hope someone in Washington is listening...
1) Adjustments in pay - union and white collar
2) Strict control over management's salaries and bonuses
3) A massive, but rational, reduction in legacy responsibilities
4) A 100% loss for all common and preferred shareholders
5) At least an 80% loss for bond holders, other than GMAC holders, to be paid for with new common stock
6) An infusion of the People's funds in the form of preferred stock with "business-like&qu.... parameters, such as 10% dividends, a very healthy option to convert into new common, and a serious number of long-term warrants to purchase new common
7) Reduce obligations to suppliers by 30% with the reduced amount paid in new common
The above is a good starting-point of discussions
Michael Z.
Sherman Oaks
dmzfinancl@aol.com
mikiesmoky@aol.com