GM

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GM Deathwatch Continues

The news from GM is either grim or encouraging depending upon your point of view regarding the efficacy of bankruptcy. If you till cling to the vision of GM’s importance and value to the overall US economy then its impending demise and re-emergence as a much diminished business will be grim indeed. If you are like me, however, and view GM as a dinosaur or a mere illusion of a going concern, then the prospect of cleaning it up and saving what can be salvaged can only bring a sigh of relief. Enough already: this is a dead company. Years of folly, bad design, declining engineering, and weak management have reduced it to a sham.

There was a time when GM stood both as a model of US manufacturing and as an exemplar of blue collar wage potential. Largely insulated from world conditions it built a business model around relatively high wages and, for the times, lavish benefits. Coupled with a massive domestic market that provided enormous scale advantages, GM became iconic as a symbol of American post World War II economic dominance.

But the model was deeply flawed. When confronted by lower cost competition, less rigid labor practices, more flexible production methods, and designs more appealing to a global market rather than a uniquely American one it was exposed suddenly as a blundering and inept business. We are well rid of it.

The demise of GM says as much about the cost burdens of the US health care system as it does about the ineffectiveness of its basic post-war manufacturing model.

I find it ironic that amongst all the factors contributing to GM’s demise its health care burden is one of the most urgent. It has become a much quoted quip to say that GM is a health care company that happens to make cars. This irony is especially delicious for those of us who have argued for a universal health care system in the US to replace its current extraordinarily fragmented and expensive semi-private system. It was GM that worked tirelessly in the aftermath of World War II to prevent the establishment of a more consolidated health care system. It was GM that devised the notion that health care was a ‘benefit’ to be supplied by employers, rather than a ‘basic service’ supplied by the community itself. GM’s original intent was to stymie the UAW by taking on the cost of the health care benefits and preventing employees being able to carry those benefits from to other employers. The objective was to build loyalty in its workforce, and to penalize those who switched to other car makers.

Build loyalty it did. In spades. Now it is sinking under the weight of all those early retirees who add no value and make no cars, but must be paid for. All those loyal retirees are deadweight being carried by today’s workforce and being paid for from today’s cash flow. Meanwhile Honda, Toyota, and Fiat all flourish with lower manufacturing costs precisely because they don’t pay the tab for those benefits.

The demise of GM says as much about the cost burdens of the US health care system as it does about the ineffectiveness of its basic post-war manufacturing model.

Meanwhile the death spiral continues.

Today’s news that the company’s creditors have rejected its final credit-for-equity swap is no surprise. The creditors long ago signaled their distaste for the fact they would end up with less ownership in the post-bankruptcy company than the UAW’s healthcare fund would. One or two of them have walked away from the negotiations, presumably in anticipation of a court fight.

As things shape up now the government will have to add even more direct aid to fund the re-emergence of GM. As a result the UAW fund will now only have about a 17.5% stake in the ‘new GM’, while the US government will own a full 70%. The rest is set aside for the creditors. Current shareholders will disappear. The UAW looks to be a key player in the future: not only will it have its 17.5% stake, but it will have warrants for a further 2.5%, it will lend about $6.5 billion as preferred stock, and a further $2.5 billion as a senior creditor of the new company.

That’s loyalty for you.

The creditors are balking at the amount of ownership the UAW comes away with. They argue, correctly, that US bankruptcy law places their claims higher in liquidation and so they should be offered a better deal. In a perverse way the cost of health care is hurting them too. Had we a universal health care system the government would not be trying to force this deal through. All those retirees would be taken care of anyway. The fate of their health, and the fate of GM would not be intertwined. So the company could fail without taking its retirees into consideration. But by tethering its retirees to its own financial well-being GM has undermined its creditors.

There will be a court fight over the bankruptcy when it is announced. The creditors have the law on their side. I doubt that will get them far. The administration has made it clear that the health care of the UAW retirees is a public priority. Even if that means flouting normal bankruptcy procedure.

Adding spice to all this is the fight that looms in Europe. The German government has taken a hard line on the future of Opel, GM’s major European subsidiary. Other European governments are reacting to what they see as heavy handed and undue bias in the way the Germans are handling the sale of Opel. The UK, in particular, is miffed because the future of Vauxhall, based in England and GM’s other large European subsidiary, is seemingly being ignored in all the fuss about Opel.

GM’s death seems more of a convulsion than a smooth transition through bankruptcy. Its directors are rumored to be meeting tomorrow or Friday to discuss ‘next steps’. In view of the looming government deadline – June 1st – and today’s collapse of talks with the creditors, there cannot be much to discuss. Bankruptcy is the only way forward.

About time too. I just wish they could have managed it better. But this is GM after all.

Addendum, May 28th 1:25 p.m.:

And right on cue: a group representing about 20% of GM’s bondholders reached an agreement today [Thursday] and thus have settled on a new deal. The creditors will end up with 10% of the ‘New GM’ with an option to buy another 15%. I doubt this will stop a bankruptcy filing, but it should help ease the way through: the court will look at the holdouts and ask why they don’t sign on for this deal too.

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Quick GM Update

Just a very short note on GM: rumors are now flying that the administration is set to push GM into bankruptcy at the end of next week. All the pieces are coming into place. The company has reached an agreement with the UAW to cut health care and other benefit costs dramatically. While some have argued that this could enable GM to survive without bankruptcy, I see it as a precursor. With the union on board the government can now push ahead with a similar plan to the one used with Chrysler. The biggest remaining obstacle to progress will be the creditors, and I expect the administration to employ the same heavy handed tactics in the GM case that the used before. The two situations are not identical: the GM creditors have more strength, but the best way to force progress is to go to court.

Look for this to happen next week.

Addendum – Tuesday May 26th:

GM’s bonds are now trading at all time lows. Clearly investors are now expecting bankruptcy. Those bonds have fallen to extraordinarily low prices: they are now selling at just five cents on the dollar. Next stop zero?

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GM and Credit Default Swaps

Don’t you wish you’d never heard about credit default swaps? I do. Somehow they have become inextricably linked in my mind with AIG and our great financial crash. Now I bet that GM also wished the darned things would go away.

Lenders buy credit default swaps to insure themselves against loss when a company they have lent to defaults on its loan obligations. To my ear that sounds a lot like an effort to avoid taking risk, while at the same time benefitting from the profits that risk taking bestow upon lenders. But that’s another story.

GM’s problem stems from the fact that many, if not all, its various creditors have purchased CDS protection against the possibility that it might default on its debt. Which, of course, it would do were it to enter bankruptcy.

Now, GM, as we know, is hurtling towards bankruptcy as we speak. It might well touch down there by the end of this month. If we are to believe all the dire pronouncements coming from its CFO and CEO they would like to enter bankruptcy soon so they can restructure the company and thus have a shot at survival in the new harsh world that will be the auto industry post recession.

In order to restructure GM has drawn up a plan similar in many ways to that of Chrysler. It involves securing government money to fund the restructuring, extracting concessions from the UAW, selling off assets like its European operations, and negotiating with its creditors to get them to swap their debt for equity in the ‘New GM’.

It was this last part – the negotiation with creditors – that proved to be the most fraught part of Chrysler’s bankruptcy process. So it seems to be with GM.

Only with that CDS twist.

The point is this: because many of its creditors have insurance against default, through their CDS purchases, GM is finding it very difficult, if not impossible, to get them either to swap debt for equity, or to take a ‘hair cut’ on their debt. They’d be better off if the company defaulted and fell straight into bankruptcy without having a plan agreed beforehand because their CDS insurance would cover them dollar for dollar.

So the hedge funds and other folks who lent to GM see no reason to go along with its plan. They seem to be just fine with default.

And that, as we say, throws a mammoth wrench into the works.

It also explains why creditors have been oddly indifferent in recent years to the performance of the companies in which they invested. They didn’t give a hoot. Instead of being motivated by the risk of their investment and therefore anxious to make sure the company avoided default, they actually welcome it. How perverse is that? Risk takers who are so risk averse that they take none, yet want to be paid for taking the risk they assiduously avoid.

Wonderful.

Come to think of it, this sounds like a great new scam, I mean investment strategy: set up a hedge fund specifically to buy debt in distressed companies, e.g. the US auto maker of your choice, rake in the above average yields that distressed debt inevitably pays, and then watch as it defaults so you can get your money back. Guaranteed. Oh, and that guarantee is based on the full faith and credit of the US taxpayer since the CDS business is dominated by banks that are ‘too big to fail’. As long as the arbitrageurs don’t eliminate the margins in the scam, you’re golden. And they won’t because they also work for the same ‘too big to fail’ banks that sell the CDS.

This doesn’t sound very much like the Schumpeterian vision of the ‘creative destruction’ of entrepreneurial capitalism I was taught, but it is an insight into the games being played by our banks.

Nor does it explain why GM’s shareholders were so compliant for so long as the company’s mangers destroyed shareholder value with a ruthless efficiency they were not able to match on the shop floor. Clearly institutional investors aren’t driven by the textbook version of capitalism either. I am not sure Hayek, Schumpeter, and the others would necessarily include the words ‘supine’ or ‘compliant’ in their descriptions of the virtues of a typical red meat capitalist. But institutional investors are both. And they don’t even have CDS coverage to explain away their indifference.

Meanwhile back at GM headquarters in downtown Detroit [and I hear they want to move to warmer climes as part of the bankruptcy plan] someone is ruing the day that Credit Default Swaps were invented.

Aren’t we all?

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Auto Industry News

It is a sure sign of the times that the best news about the auto industry comes from a bankruptcy judge. Are we really that low? Unfortunately, yes. Both GM and Chrysler are doing their part to take attention away from the ludicrous spectacle the Treasury Department has put on during ‘stress test season’. More about that later, but first the auto industry.

The good news is that the judge presiding over Chrysler’s bankruptcy hearing stomped on a motion by the dissident creditors that would have prevented the sale of assets to Fiat. So it appears as if the message that we need a quick resolution to the company’s re-organization has been heard. The quibbling by the dissidents has been overridden at every turn so far. From the perspective of an interested party – you and I are now unwilling investors in the shambles that was Chrysler – it can only be good news when the judge orders the company’s plan to move ahead. The sooner it emerges from bankruptcy the sooner we find someone to take our shares off our hands.

And, frankly we need the money.

Why?

Because the real struggle in the auto industry will be fixing GM, and that lovable old elephant is lumbering right towards us.

Well, maybe not lumbering. Staggering might me a better description after this morning’s first quarter earnings release. Our erstwhile largest auto maker announced that it managed to lose $6 billion in the first quarter. As Oscar Wilde would say: that’s downright careless. At the same time it burned through over $10 billion in cash. There is no way it can keep this up. So buckle up. GM will certainly be bankrupt by the end of the month.

As seems to be the case with all our various crises the epicenter of the storm is a group of creditors who hold about $27 billion of unsecured bonds. GM has proposed swapping those bonds for equity, which would give the bondholders approximately a 10% ownership stake. So far they have resisted. Presumably because they feel they could get more through a bankruptcy or even a liquidation process. I don’t see how that could be, but there again I’m not sure I would have bought GM debt: it’s been a dying company for years.

Meanwhile the company’s management is aggressively pursuing its re-organization plan. It has put Saab, Saturn, and Hummer up for sale and will close Pontiac by year end. It speaks volumes about the state of GM when those brand names elicit not much but a yawn. The company had collected some dogs along the way, and ridding itself of them will be an uphill battle. Approximately $800 million of the first quarter loss comes from Saab’s effort to enter bankruptcy in Sweden.

It is also trying to eliminate over a third of its dealerships. This latter exercise will be difficult. The nature of American politics is the cause of that difficulty. Dealerships are very often significant local businesses. Most towns have one. The owner of a dealership is often a big player in local commerce and thus in local politics. So much so that most states now have laws preventing the arbitrary closing of dealerships by the car makers. So GM finds itself entangled in a morass of local and state level negotiations, which absorb management effort and take time. And, as the first quarter earnings report shows very clearly: time is something GM does not have much of.

So to sum up our auto industry report:

We have one company speeding through bankruptcy, so far at least. With another speeding towards bankruptcy. We have absolutely nothing to say about Ford at the moment. That’s a good thing.

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Fiat on the Rise?

News has emerged over the weekend about the plans that Fiat has after its deal with Chrysler is consummated. The story is an ideal example of the way in which recessions produce opportunities as well as the more often described disasters. Somewhere the great economist Joseph Schumpeter is smiling: the ‘creative destruction’ he saw in the inevitable cycles of capitalism reveal the next path toward new wealth, just as it lays bare the folly of the old path.

Of course he also said that a ‘depression is just a cold douche for capitalism’, so perhaps he had less empathy for the unemployed than we might want from one of our leading thinkers.

Still he had a point.

Fiat is attempting to use its new and strengthened competitive position by cobbling together a vast auto empire from the ashes of Chrysler and GM.

Its plan is complex, with many moving parts, but its timing is impeccable. Essentially Fiat wants to spin off its car making operations, based in Italy with eleven factories, into a new auto group, and then add in the European operations of Chrysler and GM. The latter include brands such as Opel, Vauxhall, and Saab. The various European parts of the defunct American auto makers consist of ten more factories, mainly in Northern Europe – in particular Britain , Germany, and Sweden. None of these countries have much appetite right now for further plant closings, so they may well be supportive with cash grants as well as other subsidies and pressure on local unions to ease the plan’s implementation.

Were Fiat to pull all this off the new car maker thus created would rank second worldwide to Toyota ahead of Ford and Nissan/Renault and roughly on a par with Volkswagen. GM would be reduced to a third rank, but would have part ownership in the new company.

This is heady stuff and demonstrates the advantage that the non-US auto industry has at the moment. Not only are they ahead technologically and operationally, but they are better capitalized and thus in a much stronger position to dictate the outcome of what appears to be the inevitable shake-up in the industry now that GM and Chrysler have foundered. With worldwide demand at a low ebb the industry has vast overcapacity that needs to be eliminated. Not only this, but the assets within the industry need to be allocated to those shareholders and managements most able to create value.

This was Schumpeter’s point: basic economic forces will always force assets into the hands of the most able. Thus new opportunities are always emerging even in the depths of recession. While Schumpeter’s theories represent something of a backwater his imagery certainly is vivid. And his larger point seems to have validity.

Just ask Fiat: there’s money to be made in this recession. Too bad for Chrysler and GM. But that’s capitalism for you.

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