Print 19 comment(s) - last by just4U.. on May 30 at 2:01 AM

Government is playing deal or no deal, but there's no prize for the contestants

The U.S. government has delivered an ultimatum to GM's bondholders and the unions -- accept its terms or deal with a bankruptcy, which will likely be filed June 1.  Nobody questions that these parties got themselves in this mess -- the auto companies for failing to follow supply and demand, the unions for expecting exorbitant terms in bad times, and the bondholders for reaping interest while there food source slowly died.

And the government has made a strong case that it has to save GM and Chrysler, in some form.  A liquidation or long halt in production could cause several teetering suppliers to fall into bankruptcy and closure, destroying the entire U.S. auto industry, by making even the more successful companies like Toyota and Volkswagen unable to sustain production.  This in turn could very well plunge the U.S. from a recession into a depression.

However, more alarming than this precarious situation is the way the government is mismanaging it and disenfranchising many parties in the process. 

Under the current deal, Unions would receive approximately a 20 percent stake in GM, to satisfy their pension and health care requirements.  I'm not going to argue the merits of that.  It’s sufficient to leave the debate on unions and retirement benefits to the readers.

However, what stands out glaringly is this -- the U.S. government is demanding a 70 percent stake in the company, while it is demanding that at least 90 percent of bondholders exchange their debt for a stock stake equaling 10 percent. 

So what's the key problem?  The government so far has only loaned GM $19.4B USD, though it says the recovery will require "tens of billions" more.  Meanwhile the bondholders hold $27B USD in GM debt.  So the government may, in the end, loan GM slightly more than bondholders (say $40B USD total, appr. 50 percent more), but is asking for a whopping seven fold equity stake?  It’s little wonder the bond holders have rejected the proposal!

Equally strange is the bipolar nature of the government's decisions -- the U.S. Treasury Department recently indicated its willingness to forgive all of Chrysler's debt, which is will likely be in the tens of billions as well.

Meanwhile, as a GM bankruptcy becomes an increasing certainty, the company's stockholders, many of whom are small-time investors, risk losing their nest eggs due to this game of hard ball they never signed up for.

And last, but not least there's the troubling question of the future of GM, with the government taking on majority ownership.  While mild socialism has had mixed, even slightly positive results in Europe, this is a precedent setting move -- the U.S. government is preparing to take majority ownership of one of the country's largest manufacturers.  All the while, banks and financial institutions, with the exception of Fannie Mae and Freddie Mac, are largely left to do what they please, largely unfettered.  This strange mixture of selective nationalization and laissez-faire economics seems haphazard, unbalanced, psychotic, and doomed to failure.

An important distinction is that this is not a red and blue political issue -- this precedent started with Bush administration (Republican) and has continued into the Obama administration.  The push to move Chrysler and GM into bankruptcy and either take a stake in the company (GM) or forgive the taxpayer-fund loan (Chrysler) have enjoyed bipartisan support.  Only a few fiscally conservative Democrats and Republicans have voiced dissent.

And let's face it; both GM and Chrysler are the equivalents of a car crash victim on life support.  The medical services team at the hospital is the U.S. government and they've kept the companies on life support, a wise decision, assuming we don't want them to die.  However, now they're demanding a huge payment for a treatment (deal), or alternatively giving a life-threatening surgery (bankruptcy) while taking such a payment regardless.  Meanwhile the family members (bondholders, stockholders, and retirees) suffer as they find themselves on the wrong side of unfavorable financial terms, or face the death of their loved one who has supported them.

These are dire times, with few easy answers.  However, the U.S. was founded on the principles of equity and capitalism.  In the despair of this recession, one can only hope that government has a change of heart and does not lose sight of these principles, as it currently is doing

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By MozeeToby on 5/27/2009 5:43:27 PM , Rating: 4
First and foremost, thank you for putting this as a blog entry instead of a news article. Second, thank you for pointing out that all of this is happening because of people on both sides of the aisle, though the senate and house usually follow the recommendations of the treasury.

Now, as far as the government asking for a 7 fold equity compared to the bond holders. The bonds that the bond holders have were purchased for one price, that doesn't mean that is what they are worth today. With GM teetering on the edge of bankruptcy, they are worth significantly less than what they were purchased for.

I'm not saying they're worth 1/7 what they were, but it does need to be taken into account when we talk about how much stock they deserve to get in any deals.

RE: Risk
By JasonMick on 5/27/2009 6:00:51 PM , Rating: 5
Thanks for the comment.

In response to this:
Now, as far as the government asking for a 7 fold equity compared to the bond holders. The bonds that the bond holders have were purchased for one price, that doesn't mean that is what they are worth today.

I would point out that they *are* worth that much today, though I think you're implying that if GM liquidated, the net worth retrieved would likely be less than this. A bond is like a loan -- unlike stock, bonds can't lose value (other than monetary loss from inflation) unless the other party defaults due to bankruptcy or other extreme cases. (AFAIK)

I think the main problems here are:
1. The government taking majority ownership of GM
2. The government hanging bondholders out to dry.
3. The government committing to an expensive bankruptcy (at taxpayers' expense) which could be avoided by a fairer deal.

As a final note, the government says a GM bankruptcy could cost $50B USD. Why not just pay off all the bondholders and be done with it, if they are really going to spend that much? (Sure, this might not be kosher by the bond terms, but the gov't would have an easier time forcing this fairer deal..)

At least that way the bondholders would get back what they put in, GM would have a fresh start and the government could still have some money and power to micromanage GM outside bankruptcy and steer it in the right direction without directly taking the company over, like they do under the current plan. While I agree there are some questions surrounding this kind of micromanagement, I still believe it to be better than a blatant gov't takeover.

As things stand, we have a rapidly worsening mess.

RE: Risk
By MozeeToby on 5/27/2009 7:39:35 PM , Rating: 2
Although GM still owes the full amount of the bond given, if the bondholders were to try to find a third party to sell the bonds to, they wouldn't get full value because everyone would be assuming the bonds won't be paid in full. The bonds have a market value and that's what I mean when I say the bonds are worth less now than when the bondholders bought them.

Loans (in the form of bonds) are an investment in risk, that is why they pay out interest in the first place, because there is a chance the loan won't be paid back. Now it's true that maybe the risk rating attached to those bonds was incorrect, but the same could be said of the liar loan bonds that started the housing mess.

As for the government taking majority ownership of one of our largest manufacturers, obviously this is at best a risky idea, and at worst goes against some of the very foundations of our country. And I don't deny that there are better and fairer deals possible, only that the bondholders aren't necessarily getting hung out to dry.

RE: Risk
By JasonMick on 5/27/2009 9:23:27 PM , Rating: 3
That's a good point too, but the thing that's missing from that picture is that under normal circumstances, a company like GM would go bankrupt, and the bondholders would try to recover as much as they could by forcing the liquidation of the company's assets.

In this special case the government is saying liquidation is off the table. What it is saying is that bondholders cannot collect what they normally *could* and instead much settle for a much smaller pittance, while it enjoys much sweeter terms.

While I can see some validity in the government's argument that letting GM die/be liquidated might result in a national depression, I think this abuse of investors and ill-though-out nationalization is an equally poor idea. The government shouldn't be taking ownership of the nation's businesses, unless something has changed about our government's fundamental foundations which I somehow missed.

The government from the Bush administration to the Obama administration has looked consistently and hopelessly lost and unprepared, blindly charging ahead and trying to carry the economy to the next day, while failing to think about the long term impact in weeks, months, and years. I don't think all the decisions have been bad, but overall for the last several years we've been headed down a bad path economically, and the gov't appears to be continuing on its merry way.

Forgive all of Chrysler's debts at the taxpayer's expense? Take over GM and make it a state-run company? There's a word for that -- madness.

RE: Risk
By arazok on 5/28/2009 9:07:23 AM , Rating: 5
My hands are twitching as I write this, but Jason is correct regarding the bond holders. They are getting shafted in this deal, big time.

Bond holders are among the first in line to get compensated in a bankruptcy. Under this deal, the government is essentially forcing it’s way to the front of the line, and picking the pockets of the bond holders along the way.

The rules of bankruptcy are clear, and people invest based on the expectation that the rules will be followed. Bond holders loan money in exchange for interest, AND the knowledge that if the company goes bankrupt there is a good chance they will recover some or all of their money. Just as equity holders invest knowing that they will probably get nothing in the company goes bankrupt. The message being sent to future investors is that the government will not honor the rules. Who would ever want to buy the bonds of a major auto manufacturer after this? In the end, it hurts the car companies, because investors will be reluctant to buy their bonds.

What I don’t understand is why doesn’t the government just lift the pension obligations off the car companies books, and pay it themselves? Giving the unions ownership wreaks of political payback for election support. The unions have no business owning any portion of the companies – it’s a huge conflict of interest.

It looks to me like America has forgotten the values that made it #1 in the first place. Hard work, and the rule of law has been replaced with a sense of entitlement and exploiting short term gains.

RE: Risk
By Ringold on 5/28/2009 9:28:47 AM , Rating: 1
You beat me to it.

I'm amazed that business and investors are so fearful of Obama that almost none dare speak out or fight back. I mean, I read the details of whats going on with Chrysler, that's Banana Republic-level shenanigans there, not what one would expect to see in a civilized, stable, Western republic. It's something I'd expect to read about going down in Russia or Venezuela, or in ancient history when some group helped install a new Emperor in Rome who then turns around and dolls out spoils to supporters.

RE: Risk
By Ringold on 5/28/2009 9:19:24 AM , Rating: 4
Although GM still owes the full amount of the bond given, if the bondholders were to try to find a third party to sell the bonds to, they wouldn't get full value because everyone would be assuming the bonds won't be paid in full.

Jason's right, though he's skirting around it a tad I think. It doesn't even matter what the market value of the bonds are right now. What matters is the capital structure and law, and there the face value of bonds doesn't change. Secured bond holders come first, if there are any, I know there were in the Chrysler bankruptcy (who got bent over a barrel and absolutely raped, with only the Indiana State Treasurer daring to stand up to Obama). After that, generally, all should be equal. Ceteris paribus, don't know why any one group of bond holders should get more or less then another -- unless of course there's social engineering, favoritism, etc going on.

RE: Risk
By monkeyman1140 on 5/29/2009 4:38:06 PM , Rating: 2
Lets be clear though, bond holders accepted risks when they invested. Corporate bonds are not guaranteed by the government, the FDIC or anyone else for that matter.
If they are hung out to dry, thats capitalism. I don't like to see the government stepping in spending taxpayer dollars bailing out private interests.

By Screwballl on 5/28/2009 10:27:44 AM , Rating: 2
this precedent started with Bush administration (Republican) and has continued into the Obama administration.

One thing you failed to mention is that it was NOT the Bush administration that started this, it was the liberal Democrat majority Congress (while Bush happened to be in office) that started this mess. Too many liberals love pointing out various things blaming it on Bush when the man was obviously not smart enough to start something like this. It was started and continues to fall into the hands of the left leaning majority in Congress.

Atlas Shrugged, here we come!

RE: political
By captainpierce on 5/28/2009 12:24:49 PM , Rating: 3
If I recall correctly, Congress did decide not to give taxpayer money to GM or Chrysler. Mr. Bush misused his authority by authorizing the Treasury to use TARP money. It was unconstitutional. The President cannot spend money without the approval of Congress. TARP was not supposed to be a slush fund that the government could selectively use to bailout politically favored industries.

RE: political
By Ringold on 5/28/2009 4:58:45 PM , Rating: 2
Doubt it was unconstitutional, these bills have holes large enough to fly a Death Star through. Bush, I'm sure, would say GM and Chrysler are "troubled assets," maybe with a wink.

As for it being a slush fund, that's exactly what it was billed as -- except the only industry that was really talked about was finance & banking. GM does have a stake in GMAC, Ford and Chrysler I imagine have relationships with their own credit divisions, was that the vector through which money flowed? I'd have to look up specifics.

RE: political
By captainpierce on 5/29/2009 8:38:28 AM , Rating: 2
It is flat-out unconstitutional when the Congress says no and then the president defies them and does it anyway. It's amazing so many in the media and on the left who despised Bush would not take note of such a flagrant misuse of power.

TARP would never have passed if it were billed as a slush fund. Its explicit purpose was to purchase toxic assets and get them off bank balance sheets. Because the law gave the Treasury secretary wide latitude, he was able to reverse himself immediately and use it to recapitalize banks instead of purchasing the assets. At that point, it did become a slush fund but that was not the premise under which the TARP program was sold.

I could say a few words about whether it's even lawful for Congress to delegate that kind of power to the Treasury. But we had a crisis!! We had to do something!!

Moral Hazard
By captainpierce on 5/28/2009 7:22:57 AM , Rating: 2
A liquidation or long halt in production could cause several teetering suppliers to fall into bankruptcy and closure, destroying the entire U.S. auto industry, by making even the more successful companies like Toyota and Volkswagen unable to sustain production.

No one knows what would've happened if the government would've refused to help either one of these companies. I hear these doomsday scenarios all the time. Just like with the financial system. They may have temporarily avoided a major disaster but they have set a horrible precedent, which will cause much more serious problems down the road.

I wish they would just be honest. If the leaders of this country want the United States to be socialist they should just say so. Although I would argue that this is more like fascism than socialism. The government hasn't taken over all the means of production...yet.

RE: Moral Hazard
By kattanna on 5/28/2009 11:26:21 AM , Rating: 2
i have to agree. we keep saying by doing this that people, and companies, are not responsible for their actions.

if a company cannot weather the storm, they should be allowed to fail to make room for those who can.

RE: Moral Hazard
By just4U on 5/30/2009 2:01:28 AM , Rating: 2
What I don't quite understand is the part about it turning from a recession into a depression if they don't help. Is this something that could actually happen?

I'd like to see more clarification on that point alone which effects just about everyone. I don't live in America but if you guys were dragged into a depression you'd take us (Canada) in with you.. (kicking and screaming ofcourse)

We are on the verge of giving GM Canada 10Billion dollars.. as well..

it's obvious which car obama wants the keys to...
By johnsonx on 5/28/2009 6:45:13 PM , Rating: 2
The government has clearly decided they want to run a car company, and that company is GM. Why? GM is the most politically incorrect of the two available for takeover, but also has the earth-saving Volt project coming along. So they can 'fix' GM by getting rid of all the evil trucks and SUV's, and transform it into a earth-conscious seller of electric and hybrid vehicles.

By Skunkbeard on 5/28/2009 10:13:15 PM , Rating: 2
Maybe the president wants a fully armored escalade with 24" rims on it? Or better yet, an H2? I know those can be uparmored, I've seen them.

Interesting related article
By mattclary on 5/27/2009 6:48:29 PM , Rating: 3

The dealer closings were not ordered by the bankruptcy judge but by the White House. This puts a whole new light on how the dealers to be closed were chosen and, more importantly, who did it.

truer words....
By mattclary on 5/27/2009 6:44:23 PM , Rating: 2
...have never been spoken.

This strange mixture of selective nationalization and laissez-faire economics seems haphazard, unbalanced, psychotic, and doomed to failure.

"You can bet that Sony built a long-term business plan about being successful in Japan and that business plan is crumbling." -- Peter Moore, 24 hours before his Microsoft resignation

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