GM Bankruptcy Watch: Woe to Main Street Bondholders

| About: General Motors (GM)

One of the saddest stories emerging from the GM bankruptcy drama is the plight of “Main Street” bondholders. Most of the investors holding $27 billion in GM debt are big banks and institutional firms, but apparently Mom and Pop-type investors hold about $7 billion in GM bonds.

Unlike the big firms, they’re generally not secured: They can’t demand collateral if GM defaults, and for the most part they didn’t buy financial insurance to hedge against the risk of losses. So in bankruptcy, they go to the back of the line, where they’ll be lucky to recover even a small portion of their investment.

Bloomberg ran a story mentioning Vivian Floyd, an 80-year-old woman in Celebration, Fla. who could lose up to $100,000 on GM bonds she owns. She has no lawyer negotiating with GM or the U.S. government. Her only advocate is her son Jim Graves, who used to work for GM. CNBC has been running segments with other retirees about to to lose a bundle on GM. The Wall Street Journal ran a recent piece by Dennis Buchholtz, a Michigan retiree who owns $91,000 worth of GM bonds and insists that “GM bondholders are people like you and me.”

All of this is illuminating. And scary. The financial crisis has brought all sorts of surprising practices to light, and after a moment of sorrow on behalf of the Main Street bondholders, my next impulse is to ask: What were they thinking?

First question: Do people still gamble a big chunk of their savings on a single company? Really? Mutual funds have been around for nearly 50 years, and one of the very important things they do is limit the risk of a single catastrophic failure that wipes out your whole portfolio. Newer investment products like exchange-traded funds offer an almost endless variety of choices for people who want to shop around.

I know, I know, many of these bondholders are older investors who came of age in the era of the Benign Corporation. They’re comfortable (or were comfortable) entrusting their livelihood to a single huge institution. Sorry, but they should have known better. Or somebody else should have been looking out for their interests.

Second question: Why are they riding GM bonds all the way to the bottom? GM’s fortunes have been declining for a decade. If you use the stock price as a measure, it’s been falling steadily, with few upticks, since 2000. For the last few years, the automaker has been losing Hummerloads of money while promising one “restructuring” after another that never materialized. Granted, it was hard to predict bankruptcy a few years ago, but it was starting to look possible, then likely, by 2008. Did the unsecured bondholders figure some white knight would ride to the rescue

We’ve relearned a lot of vital lessons over the last year that we knew once, then forgot. Apparently it went out of style for awhile to have a diversified portfolio. Guess what. It’s back in style.