As Goes GM, So Goes U.S. Government Credit

Includes: GKM, GM
by: Rakesh Saxena

Recent statistics show that 64% of the global currency reserves are held in US dollars. But if the Treasury’s latest guidelines on the auto industry bailout process are any guide, the Euro might well become the reserve currency of choice this year; 27% of currency reserves are currently in Euro-denominated assets.

If the hastily-packaged emergency funding for General Motors (NYSE:GM) was not enough, the government has now lent $5 billion of tax-payer dollars at an 8% interest rate to General Motors Acceptance Corporation (GMAC), which lost billions in 2008 and which still holds $100 billion-plus in subprime, questionable mortgages through its subsidiary ResCap. Then, on Wednesday, the Treasury indicated that it would provide money to any company deemed important to making or financing cars.

There are two related but distinct issues which cause concern when auto-part suppliers like Delphi (which has filed for bankruptcy) become eligible for government assistance. Firstly, bailouts or otherwise, the overwhelmingly credit-driven manufacturing-to-sales Detroit business model is in dire straits, unsustainable and even counterproductive; the foundations of Deutsche Bank’s early-November call of “zero” value for General Motors remain intact. Secondly, the Treasury’s obvious expansion of its own Depression-influenced definition of “systemic” risk to now include the broad auto sector is more than likely to damage perceptions of US government risk.

This all-encompassing definition of systemic risks will push credit default swap spreads for 10-year US treasuries, last quoted at 60 basis points, to 100-120 bps within weeks, particularly as international investors realize that the Detroit Plan is turning into a disaster; already, central bankers outside the US are concerned by the lack of transparency in the utilization of $350 billion of tax-payer money for rescuing Wall Street’s elite financial institutions.

Who exactly is buying General Motors above $3.60 and why? GM’s stock may not get to zero in a hurry, given that vested political interests in Washington will inevitably generate another bailout package when the weaknesses within the temporary fix are exposed later in this quarter. But any move higher from Friday’s close represents one of the safest short bets in a long time. And for good reasons.

General Motors has announced a 0% financing option for car buyers; but the sharp 2008 decline in GM’s car sales has nothing whatsoever to do with interest rates. What American households are struggling to achieve is a semblance of rationality in their balance sheets, in the face of a dramatic erosion in wealth; the last thing they are worried about at this juncture is a new automobile. In fact, the overall size of the car market has contracted, and will continue to contract as the recession turns nastier during the course of this year. The need of the hour is lower production, lower inventories and, yes, lower union-related and legacy costs; in other words, a comprehensive restructuring under a bankruptcy umbrella.

In the meanwhile, it will be interesting to see how the Treasury responds to the crisis which is threatening the viability of GM’s suppliers and dealers. Already, property developers and insurers are lining up for bailout funds; the widespread consensus is that the government will end up supporting both sectors despite lawmakers suffering from a “shy bride” syndrome today. The sheer quantum of the bailout exercise ($8 trillion by last count) was already causing concern; today, more importantly, questions regarding the qualitative implementation of the exercise have also begun to surface.

Those trading General Motors shares should be aware that, though credit default spreads for Ford (NYSE:F) and Ford Motor Credit, General Motors and GMAC have narrowed through this week, they continue to represent a significant risk of default.

Standard & Poor’s has downgraded GMAC to “selective default”; this reinterpretation of credit-worthiness definitions (to include “stand-alone” and “issuer credit”) by the rating agencies is further complicating the bond pricing matrix. The new multi-tiered rating structure is a direct consequence of the challenges facing the economy. It is the flawed response to those challenges which will adversely impact the “full faith and credit” of the US government.

Disclosure: Author holds a short position in GM