GM Bankruptcy Watch: Woe to Main Street Bondholders

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.

Comments

[casey00001:]

Rick:
What exactly is a diversified portfolio these days? Does your crystal ball tell you what industry is safe from Government Interference where the rules of law get changed. You but a debt instrument but get equity instead. Just what is a safe investment? Its not the bondholders fault. Its flat out Obama's fault for how he sliced the pie. And history has a long memory.

May 29 04:14 AM

[john s. gordon:]

the criminals on wall street (who are extremely unlikely to ever be punished) stole a bundle of vivian's money.
> jack

May 29 09:04 AM

[Fredster4:]

Rick,
You're missing the point. It's not whether bondholders were diversified or "what were they thinking" when they invested a huge chunk of their savings in GM Bonds. It's whether the rule of law is being followed in the demise of GM and dividing up the spoils. According to the law, bondholders are equal to the UAW in their claims, however are receiving far less in this process. Just because these individual bondholders did not take a classic portfolio management approach to diversifying their nest eggs, and thus have little hope in raising any sympathy in your column, simply has no bearing in the way the prospectuses for these bonds were originally written. Bondholders entered into a legally binding contract with GM where they would be equal with VEBA should GM go down the tubes and that contract is not being withheld. That should be the focus of your column, not whether what they did was prudent or if you have sympathy for them. It's irrelevant.
Fredster4

May 29 10:29 AM

[not so dumb...:]

I also own more than $100,000 in GM bonds as a part of my retirement. I bought them at close to par several years ago, and never thought GM would be an unsafe investment. The treasury gave AIG $173 billion to save wall street jobs. It should give $50 billion to GM to clear the debt for bonds and the UAW, and let GM go forward without filing bankruptcy. Bankruptcy will likely cost more than $50 billion, and no one wins except the lawyers. Obama has spent several trillion to "save/create jobs", thought this is hard to verify. Loaning $50 billion to GM to avoid bankruptcy would cost less and clearly would save thousands of American jobs. I now seriously doubt the sincerity of Obama and his save American jobs talk.

May 29 11:26 AM

[hkn:]

I am 80 years old and extremely diversified in the stock market. I have taken hits because the bankruptcy laws are not being followed. The administration is writing them as they please. I will never buy a corporate bond again no matter how good the company is. Yes, my portfolio is down, but so is everybody else. 401k's etc. It hurts to lose 25,000 of hard earned money because it is pay back time to the Unions who supported O'Bama. You haven't seen the worst of it yet. Socialism is here.

May 29 07:05 PM

[newbietech:]

This is a good article.
It is well balanced in pointing out the plight of the retail bondholders.
The two questions posed in it are quite right.
You shouldn't have too much of your assets allocated in one place. And there were umpteen opportunities to sell these bonds over the last few years. It just goes to show that you need to stay alert on what you have in your portfolio.
I don't believe socialism is here just because Obama is putting Taxpayer and worker interests ahead of the bondholders. It is clearly important to have these companies continue as going concerns.

May 30 09:21 AM

[Moon Kil Woong:]

Agree 100%. The problem is not who wins or looses, it's the erosion of the capitalist system, the rule of law, and owners/lenders rights. Rightfully, the lenders have the right to become the owners. Thus to deny them of their legal claims is to deny the company to the rightful owners.

Wake up people. Your free market system is going bye bye. Who cares about what you make on the stock market. At this rate, your legal claims to ownership may be in question as well. After all, you don't even have the real documents proving ownership. The banks do. How simple it would be to just make it all dissapear. It would be a lot easier than making the bond entitlements of very big firms dissapate into thin air.

This is an outrage not to the owners of the bonds. It's an outrage to the rule of law, the very core of the free market system. I don't own a single share of GM. Never had, never will, but to say those who bought very legal claims with legal remedies deserve illegal treatment is just not right. They deserve what they bought. Just like AIG owners deserve nothing. We have turned the system on its head. Not Obama, or Bush Jr., or Congress. We have for tolerating these obominations to our moral principals.

The uttemost deepest shame to us all...

May 30 09:31 AM

[Market Sniper:]

Just make it disappear? Might have something there, Moon! We are living in times where the sanctity of contracts no longer applies. From bondholder rights trampled by Federal authority to judicial "cramdowns" on mortgages. All debt is eventually retired one way or the other. 1) It is paid off; 2) it is bankrupted out of existence and 3) IF you are the "money" issuing governmental authority, you can print it out of existence. Since the third option leads to all manner of civil mayhem, perhaps it is time the Federal government explores Option Number Two..declare ALL debt, public and private, null and void. True, it raises all manner of moral hazard but as Option Number One is now an impossibility and Option Number Three (the road on which we are now embarked) will leave very little, if anything standing, Option Number Two maybe the only viable alternative. a radical solution, I will grant you, but perhaps preferable to the alternative.

May 30 10:12 AM

[Harry Tuttle:]

The lessons for bond investors:

1) Nothing is safe. You ignore the risks at your own peril.
2) Beware of "political companies". Government intervention may help you, as it did for Citibank debt holders, or hurt you, as it seems to be the case with GM bondholders. When push comes to shove, the government will always choose the politically powerful over the rights of a tiny minority.
3) American capitalism is neither efficient nor blind.

caveat emptor.

May 30 12:20 PM

[Larrysyr:]

GM would be worth even less if it were not working ahead of the bankruptcy filing to organize the various claims of the various stakeholders.

Let's face it. In Chapter 11, there would be no D.I.P. financing for GM except the federal government. Public money comes with public strings. Private money would come with private strings, if it were available. The outcome may or may not seem "fair", but the only alternative is to liquidate, and in liquidation, I doubt bondholders would get even 5 cents on the dollar.

The rule of law is that if enough claims are settled, the bankruptcy judge will allow the filing to proceed. If not enough claims are satisfied, the judge will divvy up what assets are available.

May 30 06:47 PM

[mac123449:]

Just took my 1979 Lincoln Continental for a spin this morning if only i had a time machine to go back in time when America was still a capitalistic system and the foreign cars were pieces of shit.

May 31 03:57 PM