Should GM Be Saved?

Should GM be saved? From a free market perspective, the answer is clear: "Heck no!" Unfortunately things just aren't that easy...

So the members of the G20 met over the weekend, and it was pretty much as expected: A big shiny photo-op that didn’t really produce much except hot air. (If you’re wondering what the G20 is, The New York Times has created a decent primer.)

The G20 leaders said the type of things you would expect them to say – “we hope and expect and urge a swift resolution to the crisis blah, blah, blah” – but they didn’t make any truly substantial decisions.

Most notably, the group agreed to meet again on April 30, 2009 (after President-elect Obama has had time to settle in).

This really isn’t surprising. Those who thought some big sweeping change might arise from the gathering forgot one key fact: George Bush has effectively become one of the lamest-of-lame-duck presidents in all of history.

In terms of moral authority, gravitas, and all around ability to get things done, “W” functionally ceased being President the moment the November 4th election ended (with nary a hanging chad to spoil the psychological transition).

We’ll talk some more about the G20 and the Bretton Woods chatter another day.... For now, the question du jour is, “Should General Motors be saved?”

(As an aside, the topic has a little bit of a personal dynamic. Your humble editor will be flying to Detroit for Thanksgiving later this month. The Litle clan has roots in Grosse Pointe, MI and kin in Ann Arbor, MI. Though I was born in Motor City, it will be my first trip back in what feels like a decade.)

To clarify, the question “Should GM be saved?” is not a moral one. That is to say, it is not a question of fairness, rightness or wrongness as we ask it here.

Instead, it’s more a question of which will ultimately cost more – throwing tens of billions more down a rathole, or letting the rathole morph into a giant failure vortex.

Bankruptcy Basics

First let’s reconsider the case for letting GM go bankrupt – which requires a quick recap of the bankruptcy system itself.

The moral side of the ledger seems clear. In a free market capitalist system (or at least a quasi-free market system, like the one we aspire to maintain), failed businesses should go ahead and fail as a matter of principle. They should not be propped up like zombies, draining resources from taxpayers and dogging competitors with subsidized competition.

It’s just a bad way to go.

We also have a bankruptcy system in place for a reason. It didn’t take long for Americans to realize that the old school way of doing things – throwing people into debtors’ prison – wasn’t very conducive to the long-term health of a dynamic and growing economy.

Entrepreneurs and well-established companies alike need to be allowed to take risks. And that means sometimes they need to be allowed to fail. If all the risk takers were thrown into debtors’ prison, soon you would have no more risk takers (and no more dynamism). So a “fresh start” provision – the bankruptcy system – came into being to help things along.

When failure does occur, the bankruptcy system is designed to salvage the workable parts of a business. Sometimes the business is allowed to continue operations without a hitch, so that customers and suppliers don’t have to face a disruption. (You’ve probably noticed how the major airlines have dipped in and out of bankruptcy over the years without taking planes out of the sky.)

The bankruptcy process usually (and rightly) wipes out the shareholders. As investors in the failed enterprise, they willingly took that risk. The failed companies’ creditors usually take a major hit too.

When bankruptcy is declared, there is a tally of all the companies’ assets – pretty much anything that’s worth a buck. Those assets are then divvied up among the creditors on the books. The “senior” debt holders get paid X cents on the dollar first. If there is anything left after that, the next tier of debt holders gets paid... and so on down the line. (Equity shareholders are last in line, which is why they usually get nothing.)

If the business is still viable after all that, the company can get a fresh start – usually with wholly new management.

Drowning in Debt

Those who think GM should bite the bullet and go bankrupt point to the folly of throwing good money after bad. The real problem with GM is what’s known as the “capital structure” – meaning the company’s ratio of equity versus debt.

Simply put, GM has a less-than-$2-billion market cap (that’s the equity part) compared to more than $45 billion in debt (which includes pension funds and other employee obligations).

That’s an eye-popping debt-to-equity ratio of more than 22 to 1. For a normal company, a debt-to-equity ratio of a mere three or four to one would be considered speculative, because debt is a lot like leverage. (Scratch that, debt is leverage.) So a ratio of 22 to 1 is just insane. It’s like an elephant sitting in a folding chair.

What’s worse, what little remaining cash GM has in the bank is being burned up by money-losing operations. (This is why GM has warned it will go under in 2009 without a cash infusion, and why GM’s managers urged employees to participate in a letter-writing “beg congress for money” program.)

In finance terms, GM is not unlike a man with a $40K per year income and $900K in mortgage and credit card debt. A modest loan would not help such a man any more than another few billion would help GM. The money would simply be tossed into the gaping maw of the creditors. As far as long-term outcome goes, the inevitable would be delayed only slightly if at all.

And so why, the bailout critics ask, should taxpayers give GM more cash just so that GM’s inept managers can hand that cash over to long-standing creditors – especially when 1) the company dug its own hole, 2) saving GM in its present form is “mission impossible,” and 3) this kind of thing is exactly what the bankruptcy system is for?

Not That Easy

So it’s decided then... let GM fail, right? Let the free market sort itself out and the bankruptcy system do its work? Unfortunately, it’s not that easy.

We know that throwing money down a giant hole is generally a dumb thing to do. What we don’t know is whether GM could become another Lehman Brothers.

Lehman Brothers, one of the top five investment banks in days of yore, filed for the biggest Chapter 11 bankruptcy in U.S. history (over $600 billion) back in September. Given the circumstances, Lehman certainly “deserved” to fail in the free market sense. It made its bed of leverage, and the Treasury and the Fed let the company lay in it.

Unfortunately, it was the aftermath of the Lehman failure that proved breathtakingly disastrous.

When market historians look back at the panic of 2008, I believe they will widely agree that letting Lehman fail outright was one of the biggest mistakes the Fed and Treasury could have made given the circumstances.

It is this type of risk we run repeating with GM.

Trust Evaporates

Before Lehman Brothers, there seemed to be a logical pattern to Uncle Sam’s crisis efforts. With the Bear Stearns rescue, it seemed clear that the government would allow equity shareholders to be wiped out, but holders of counterparty risk – the third-party actors who had contract dealings and accounts with Bear Stearns – would see their assets shielded.

When Lehman was allowed to fail point blank, shielding no one from the fallout, that’s when Wall Street (and by extension the world) went into deep freeze.

This is because Lehman was deeply intertwined in both the hedge fund world and the credit default swap market. By letting Lehman fail outright, the government allowed hundreds of billions worth of third-party assets to be thrown into limbo – frozen solid by bankruptcy proceedings.

This bone-headed move on the government’s part – the equivalent of yelling “Surprise! You’re screwed!” – caused trust in the financial system to evaporate. All of a sudden nobody, and I mean nobody, knew what the government would do next (or who was in danger). No counterparty felt that their assets were safe. Seemingly no investment bank (or regular bank for that matter) could be trusted.

It wasn’t just that hundreds of billions in third-party assets were held hostage by Lehman’s Chapter 11. It was that now, all of a sudden, anybody’s assets could be subject to the same out-of-the-blue fate.

And thus it was this sense of total uncertainty as to what would happen next – a terrifying lack of clarity as to what the “rules” were in a time of turmoil – that caused the global financial engine to seize up completely.

(You may recall, too, that the first AIG bailout came hard on the heels of the Lehman failure. Hank Paulson barely had time to pat himself on the back for letting Lehman “get what they deserved” before having his face shoved into humble pie.)

The Risk of Lehman Redux

So getting back to GM... the risk in letting GM fail, as odious as it might feel propping it up, is that GM could become another Lehman Brothers in terms of creating a new “run on the banks.”

Except in this case it would be more of a “run on Motor City” – and all the industries associated with it.

Wilbur Ross, a distressed assets investor dubbed “The King of Bankruptcy” by Fortune, says a GM bankruptcy would be “a total mess.”

In an interview with Bloomberg, Ross voiced his view that, if the overall environment were better, a GM bankruptcy “wouldn’t necessarily kill” the auto industry. But with things looking as bleak as they are, a fallen GM could cause the other big automakers to topple like dominoes.

On top of that, there is the real risk that GM wouldn’t be able to continue operations. As we’ve seen with the airlines, large companies often keep their doors open while going through bankruptcy. Most who assume a GM bankruptcy is the best route further assume the car maker wouldn’t have to shut its doors.

But a company’s ability to keep the doors open in bankruptcy requires access to financing and the prospect of a reasonably bright future – two things GM just doesn’t have right now.

So if GM’s doors were to close, we don’t know when they might open again... if ever... and we don’t know how devastating the blowback would be for all those auto industry suppliers hanging on by the skin of their margins.

And again, on top of the vast Motor City supply chain, what would happen to Chrysler and Ford (F)? What about the homes, the restaurants, the small stores, and the tens of thousands of other unrelated businesses indirectly supported by auto industry employees? How would the country deal with mass shutdown on such a scale? Would the state of Michigan itself need a bailout? Would other states then line up?

We just don’t know.

What Will Obama Do?

President-elect Obama knows that the choices in regard to GM amount to bad and less-bad. He laid out his thoughts in a TV interview on Friday.

For the auto industry to completely collapse would be a disaster in this kind of environment,” Obama told 60 Minutes. “Not just for individual families, but the repercussions across the economy would be dire.”

Unfortunately, “bad and less-bad” are the kinds of choices one is left with after allowing a problem to fester for decades.

Will pulling the plug on GM be any easier a year from now than today? Hard to say (but probably not). Will GM be able to stagger to the Jan 20th finish line in time for the Obama administration to throw a lifeline? Or will emergency action be pulled off before then? Guess we’ll see.

The bottom line is, saving GM has no longer become a matter of right and wrong. It’s become a matter of choosing the lesser of two serious evils. It’s another form of payback for our past excesses – the need for government to apply “necessary” stopgap provisions that have great long-term cost themselves.

Obama’s interview touched on long-term costs too, if only by accident... “We shouldn't worry about the deficit next year or even the year after,” the President-elect said.

If only our foreign creditors would show such patience.

Sound Off!

So what’s your opinion on GM? Should it be saved? If your answer is a firm “yes,” why? If a resounding “no,” what about the risk of letting the rathole turn into a mass failure vortex?

Or maybe you don’t have a firm opinion either way – which is fine too – and just want to rant about how badly the whole thing sucks. All comers can weigh in here: [e-mail] e-mail address is being protected from spambots. You need JavaScript enabled to view it .

Don’t Forget Consumers

Last but not least, in regard to the just-mentioned President-elect...

On another somber note, President-elect Obama has an even more pressing concern on his plate than GM. He is going to have to wrestle with the decline of the U.S. consumer.

Here is the issue in a nutshell: U.S. consumer spending has long accounted for two-thirds of U.S. GDP (the traditional measure of the nation’s output). Thanks to an indefatigable joi de vivre – or rather joi de shopping – the U.S. consumer has acted as the de facto “engine of growth to the world” for roughly the past quarter century.

In that time, Americans bought more crap – er, stuff – than anyone else in the world, and they mostly bought it on credit. Now the cycle of ever-greater consumer spending has hit bottom... and a new cycle of saving and frugality has begun. This is a huge, HUGE shift. The impact can hardly be understated.

That’s why we here at Taipan Publishing Group think of it as something called the “Consumer Shockwave.” The Consumer Shockwave will have an ongoing ripple effect, and countless areas of the U.S. economy will be impacted (or already have been impacted).

Zach Scheidt (a.k.a. Cash McDash) and I have just wrapped up pre-production on a Free Web Summit (length thirty minutes, give or take) on the Consumer Shockwave topic.

We’ll talk about what it is, specific impacts it will have, and how it could have a dramatic impact on your investments. We’ll also talk in terms of industries and sectors, focusing on big losers and big winners from the Consumer Shockwave phenomenon.

And, last but not least, we’ll give away some free trading and investing ideas too. This Free Web Summit airs this Friday, November 21st, at 11 a.m. Eastern Time. I hope you get a chance to tune in!

Comments

[ButWhy:]

Let's pretend Detroit gets the money.

Who is going to buy the cars? Who can get credit?

Where I live, more often than not, when you see a person driving a domestic, it means they have a poor credit score. It means the dealer sold them a car that wouldn't have gone off the lot, otherwise. These poor people are paying 15% or more for that loan. The value of cars has fallen dramatically....people are upside down on their loans. Is Congress going to bail out the little guy?

So how are we going to fix that little problem? It's kind of like the housing crisis, no? Are we going to MAKE people buy Detroit autos? How do you fix that problem? Give people a tax credit for buying Detroit? How does that help the American taxpayer assembly worker who puts together a Honda? Why punish her?

Detroit cranked out too many cars for a shrinking market because they had to pay the union worker. It is an unsustainable model, and it needs to be fixed. Get rid of the Unions. Sure, that will hurt. But with all the pundits out there telling the taxpayer "things are gonna hurt", let's put the hurt on the parasite that killed the host.

2008 Nov 19 09:31 AM

[Cracked:]

American car makers are finally getting what they dished out for years to the consumers. We all have heared "Sorry sir that's not covered under your warranty" "But the car only has 2000 miles on it" "Sorry". Hey this is why very few Americans are buying American these days. It's not the unions like they keep claiming it's there engineering and deisgn department that are told to design automobiles that have certain weak points that will require service. Look at General Motors and Ford for example what they make in there service department compaired to Honda or Hyundai. How is it a Korean company can offer a standard warranty that blows the doors off these guys and yet make money? It is really sad that this big business attitude has ruined these companies. They're asking for help now but with no plans for management change, why should we the tax payers help these thieves? CHANGE OR GOODBYE!

2008 Nov 19 09:36 AM

[MSmailbox:]

GM must "repent," before it can be "saved."

2008 Nov 19 09:36 AM

[Cracked:]

It's people like "ButWhy" that think the unions have ruined the american auto industry with not a clue at all! I am not part of any union but do understand the need for them. How would you like to work for a company the size of GM or Ford and have the schooling and training but told there going to pay you $10 a day? Honestly could you afford to live on $10 a day? Do these union employees make more money than you? Aren't they entitled to make a normal living wage? These wages they are payed aren't anywhere near the wages the CEO'S of these big companys make. Look at AIG in 2007 the CEO who makes 600K a year received a 21 million dollar bonus. So I am sorry a guy making 50k or 60k a year is not breaking the bank here.. With that kind of thinking you should move to taiwan or china and enjoy all the lead paint they have to offer!

2008 Nov 19 09:43 AM

[earthman2008:]

The best scenario, of the bleak possible outcomes from this article, seems to be, let them fail. Then and only then, infuse government backed credit at reasonable rates to help them recover and collect the money back over time as they build steam. The issue seems to hinge on whether, after filing, GM would have enough access to credit to continue on its path to retooling and competitiveness in the auto market. That way the money is not going down the rathole it is invested in a fighting chance. Does this make sense? Responses welcome.

2008 Nov 19 09:43 AM

[KEEGS:]

Just wondering...if the government bails out the auto industry...what next? A Pandoras box is opened and everybody will want a quick fix from the government. And, if that is the case, the Government bails out the auto industry, then when can I expect my money? Honestly, if the government wants to get things moving again, pump some of that 700 billion our way. Quit paying billion dollar salaries for CEO's and high paid bosses. Common sense America....common sense! DO NOT BAIL OUT AUTO INDUSTRY. THEY ARE GETTING WHAT THEY HAVE DISHED OUT....A LOT OF PAIN!!!!

2008 Nov 19 09:56 AM

[Dave O.:]

There is no accountability for this mess on either side; Management claims its the fault of the capital markets, labor claims they have given concessions and is no longer to blame.

For 25 years (since the Chevy Vega, Ford Pinto, Dodge Omni) these companies have given us shoddy products with a take-it-or-leave-it attitude.
There was a time when we had no choice. Now we do, and the paybacks are painful.

GM and F carry $billions on their books as 'goodwill' or invisible assets.
GM and F have negative goodwill, their names are a liability and the situation is more dire than the lousy GAAP numbers suggest.

"Its not my fault" is an excuse given by adolescents when they want something after being proven they're not responsible enough to handle it.

GM is not Rick Wagoner, and its not the UAW. The company should be saved. Get rid of the deadwood. All of it. And start over.

2008 Nov 19 10:00 AM

[BrokenDreams:]

I see someone on these blogs finally has some common sense. However, common sense is not so common these days.

In the less appreciated words of Rev. W. "the chickens have come home to roost" !
Unions have always been a big part of the problem for business. It's why the price of our goods continues to increase. The business has to provide so many "rights" in its wages that the workers can't even afford to buy the products even they themselves make.

American Dream is now an American Nightmare, and
I'm not buying it.

2008 Nov 19 10:10 AM

[uh, duh:]

Why is it that the gooberment doesn't simply contract $25-$XXX billion dollars worth of vehicles (police cars, ambulances, school busses, army vehicles) to be built new over the next X years. I mean a national upgrade of our service vehicle fleet. This will both keep a lot of US auto workers employed, and give taxpayers value for their investment. And ease burden on state budgets who pay for much of this now.

Or even more radically, contract the auto giants to produce an efficient car for every American family over the next 5 years. How's that for a tax credit.

Answers are there, if they look - instead of just writing blank checks. IMHO

2008 Nov 19 10:13 AM

[mswilkinson:]

The union workers are over paid for the work they do.
The Auto Industry management is overly egotistical and mired in antiquidated thought and business processes.
Just as was the case with the US steal industry
That combined with their benefits (UAW and Sr Management) has been a drag on the US auto industry for decades.
Just as it was the case with the US steal industry.
Already the UAW has come to the front showing their true colors and stating that they will not give anything up in this dire time.
The US steal industry demanded protection from the US government for DECADES but eventually all the tarrifs in the world couldn't protect the US steal industry from the fact that their cost were to high and their methods to antiquidated to compete in the modern world.
Throwing cash at the US auto Industry to "Save" them will only enable them to continue to stumble on bloated and non competitive until their innevitable downfall.
Get rid of the unions. Put caps on the executives salaries and bonuses
Modernize the plants.
Kill off the dead end products (Like the ford Excursion and Flex, The GM Hummer, and all the sub standard quality cars).
Develope competitive products at competitive prices.
Then they will survive.

2008 Nov 19 10:43 AM

[John Sherman:]

What all the economic talking-heads fail to consider is; for example, for most people their vehicle related expenses are second only to their housing costs; as a result, letting the United State major auto industry fail will help to reduce the United States standard of living for the average worker more; it follows, by confirming the United States should just match and continue to strive for manufacturing wage rates the are equal to or less than other countries that its people have lower standards of living than ours yesterday and get paid less for their work results. Let's just see how big and entangled the United State financial economy if the auto industry begins to default, fail, and gone tomorrow?

So, my thoughts are already contained within other comments already made:
"If auto industry fails, then a new equilibrium?" available at:
community.thenewstribu...

2008 Nov 19 10:54 AM

[zzyzx:]

I'm driving a 1996 Chevy Van. It has 190k miles on it and runs like new. Doesn't burn oil. Repairs to date: New Transmission at 100k, new starter motor at 150k.

I travel and rent cars 30 weeks a year. I get full size domestic and foreign cars assigned to me most of the time. My conclusion: I like the Chevy Impala the best.

2008 Nov 19 11:04 AM

[User 301477:]

Bail them out with another loan they will not payback . Give the money to the( taxpayer ) . If the government is going to give out money I would like my million for the holidays

2008 Nov 19 11:22 AM

[c10seth:]

I made a comment the other day. At that time I thought GM going under would be the worst thing that could happen. Now, after some thought, GM just does need to fail. The unions need to go away, quality needs to be reestablished, new management needs to be found, and the money...our money that the government would "loan" GM could be used more effectively somewhere else...like giving it back to us!

The unions had their purpose during the industrial revolution and they were a good thing then. That is the past and times have changed. people should not be expected to be paid like an engineer to bolt cars together. That's stupid. What that does is it rewards people for the wrong things...kinda like the government. And that has too stop!

Quality is another issue with GM. The only thing that is quality on a GM is vehicle is the drive train and that's it. Hell, a low end BMW or Mercedes is a nicer ride than higher end GM product. Another individual commented on the warranty issues and I think they are correct. A cheaper foreign car will have a better warranty than a GM product. And this all comes right back around to management and the unions.

Thank you for taking the time to read! I enjoy reading all these comments.

2008 Nov 19 11:45 AM

[Kia in Detroit:]

I was laid off on Friday as a result of the big 3. I can honestly say No, don't bail them out. Its for the best of the country. I was making $14 an hour to sit on my butt all day. Its just a quick way to make a buck. Now I get to spend more time in school and with my son.

2008 Nov 19 12:24 PM

[tiredofyourbs:]

Wall street is bunch of crooks they got us into this mess and have the audacity to turn around and say GM is not a well run company.

I am an Auto worker. Should GM fail? Sure why not? Even US should fail. Nothing is fail proof. We will get on with our lives.
But I am tired of the broken record. Auto companies are trying to come out of their problems on their own. Wall street does not like it never liked it.

GM has poured biillions of dollars back into society - paying the workers. That means wall street thinks its a socialsit model and hates it.
Yes the pendulum has swung to the other side and UAW needs to slow down. Auto companies have been trying to get along with UAW so that wall street does not come crashing!

Guess what, may be its time shoot yourself into the foot. WE should go bankrupt and let Wall-street save the economy.

Oh and by the way Let Wall street build defence systems in Taiwan because we will not have manufacturing base. All the technolgy, reserach, experience, innovation will be lost over next 10-20 years and we will be like the Arabic nations who cannot build anything.

2008 Nov 19 12:34 PM

[Longinvestor:]

Incredible genius, you are!


On Nov 19 10:13 AM uh, duh wrote:

> Why is it that the gooberment doesn't simply contract $25-$XXX billion
> dollars worth of vehicles (police cars, ambulances, school busses,
> army vehicles) to be built new over the next X years. I mean a national
> upgrade of our service vehicle fleet. This will both keep a lot of
> US auto workers employed, and give taxpayers value for their investment.
> And ease burden on state budgets who pay for much of this now.<br/>
>
> Or even more radically, contract the auto giants to produce an efficient
> car for every American family over the next 5 years. How's that for
> a tax credit.
>
> Answers are there, if they look - instead of just writing blank checks.
> IMHO

2008 Nov 19 01:00 PM