Horacio Marquez
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With America’s “Big Three” automakers all due to submit turnaround plans to Congress Tuesday – a requirement if General Motor Corp. (GM), Ford Motor Co. (F), and Chrysler Corp., are to receive $25 billion in government loans – I couldn’t help but recall the moment eight years ago when I realized the U.S. auto industry was skidding toward a financial collapse.
I’ve been thinking about that market call of mine a lot of late, particularly after recently reading that JP Morgan Chase & Co. credit analysts had rated GM’s distressed debt as a “Buy,” noting that the company was likely going to survive.
It was October 2000, and I’d just joined a multi-billion-dollar asset management organization as its head of credit. While most of my experience before this was with very risky and fast-moving emerging markets, this new position was focused on the top tier of the investment market, since the group I was joining had a marked risk aversion and was managed with capital preservation as its main mantra.
“Piece of cake,” I thought to myself. After decades of deciphering volatile emerging economies, I had “graduated” to analyzing strong companies in the top economies in the world. These credits were all rated “A” or better. And the proportion of our holdings that were not rated “AAA” was a rounding error.
WorldCom Inc., Enron Corp., and the U.S. “Big Three” carmakers were among the companies I had to analyze, as well as some 208 structured investment vehicles (SIVs). The curious asymmetry was that while companies like Enron and WorldCom were rated “A,” and had tremendous – yet officially unrecognized – risks to the downside, their commercial paper was rated “A1” and “P1,” the highest possible rating offered by leading rating agencies.
The SIVs, Enron, and WorldCom did not resist even minimal analysis. I axed the two companies, as well as the SIVs that did not offer a full guarantee from the sponsor.
So I ended up starting with the corporate bonds, by first addressing the largest exposures we had.
A Debt-Focused Tour of America’s “Big Three”
Since the three U.S. carmakers – all carrying “A” ratings on their bonds, and “A1” to “P1” on their commercial paper – accounted for about one-third of all investment-grade paper outstanding, I analyzed them first. I had a large advantage over my peers in the investment grade industry: Since emerging-market credits – both sovereign and corporate – were overwhelmingly in junk bond territory, I had seen over years how late the rating agencies were in adjusting their ratings to the credit reality of the issuers in general.
The foregone conclusion in “junk land” was that the rating agencies provided lagging indicators of credit risk. In addition, having analyzed credits in Argentina with 1% inflation a day, as well as massive, surprising devaluations, I knew how distorted financial statements can become and was highly skeptical.
When I downloaded the balance sheet for General Motors back in the third quarter of 2000, I was stunned. Something just wasn’t right. These numbers I saw just couldn’t be correct.
“Surely I had made a mistake and downloaded the wrong one,” I thought to myself. “I must have downloaded a subsidiary’s or maybe the parent company’s unconsolidated balance sheet.”
I checked and re-checked. I had the right one. The company’s equity-to-assets ratio was only about 2% – and that was before counting its under-funded pension liabilities. With that deficit factored in, GM had negative equity.
In other words, the leading U.S. carmaker was technically bankrupt.
Now, I wouldn’t even lend money to a bank with such high leverage. And a bank diversifies the risks in its lending portfolio, is highly regulated, and secures a huge amount of its lending with hard assets.
But an industrial company sitting on hoards of car inventories and loans backed by used cars … that nobody particularly liked? Not a chance.
With such low levels of equity, the ability of a company to withstand an economic shock is almost nonexistent. So, I searched around for any possible redeeming qualities that I could be missing. But after a very thorough review, I concluded that we had to drop all three of the U.S. carmakers – GM, Ford and Chrysler.
When I brought my decision to the firm’s chief investment officer, a portfolio manager with years of experience in the investment-grade debt market, and a person I’d known back during my days at Merrill Lynch & Co. Inc., he was unnerved. He trusted my judgment, but he, like the rest of the market, was confident that each of the Big Three was “too big to fail.”
Nevertheless, with our firm’s overarching commitment to capital preservation, we negotiated a fast wind-down of exposures: We would sell all the long-term exposure immediately, freeze any new exposure and we would not roll over the commercial paper – most of which was due to mature within a couple of weeks. In this way, all of our Big Three exposure would be gone within weeks, and we were confident each of the three had the cash and near-term liquidity to pay us back.
A couple of weeks later, at a charity function, I happened to bump into the former head of one of the premier asset management organizations in the world. In a short conversation, I mentioned my private concerns. The gentleman draped an arm across my shoulders and essentially told me that “the Big Three are not going to go bankrupt.” That was it. Another too-big-to-fail advocate.
The Too-Big-to-Fail Myth
Evidently, there were reasons beyond mere creditworthiness that led this very smart man – and others – to keep ignoring the fact that the automotive emperor had no clothes. The pre-eminent one is the “too-big-to-fail argument,” and those who make that argument are trafficking in the moral hazard trade. Yet, even today, GM on its website ardently contends that it is indispensable to the U.S. economy, hoping to persuade U.S. taxpayers to throw good money after bad.
(We’ll find out how Congress feels about that argument after GM, Ford and Chrysler submit their plans. It certainly won’t help that Tuesday we’ll also likely find that November sales from the major automakers show only a limited bounce from 25-year lows.)
The other argument is that the auto industry is “strategic” to national interests. That is to say: How can a country defend itself if it produces no vehicles? And what about advanced transportation and classified technologies research?
But that argument does not hold up under scrutiny, either.
As eminent economist Martin Feldstein has reminded us, giving the Big Three $25 billion will last less than a year. The reason: They are burning through about $7 billion each a quarter.
Clearly, forcing the three carmakers to restructure will be in everybody’s interest.
Through bankruptcy – with some minimal government intervention – we should force the inevitable restructuring to take place. As a result of that restructuring, worker compensation levels will be brought into line, employee and retiree health benefits will be reduced to lower-but-still-competitive levels, any dividends will be eliminated, and executive payouts and perks will be capped. How far must this go?
That’s easy – keep cutting until the companies are restored to health and, most important of all, to a state of long-term viability.
This does not mean that the Big Three will disappear. What will disappear is corporate waste. The companies will restructure/continue profitable activities and liberate resources from unprofitable ones to expand future development. This has been done successfully – and en masse – in many “strategic” industries, such as the steel business in the United States, and telephony, utilities, energy, aerospace, and many others that were restructured in the 1990s in Argentina, Brazil and South Korea.
There is no reason why each of the Big Three – each currently the laughingstock of the global auto industry – should not regain their leadership positions, as measured by profitability and technological prowess. In this way, GM, Ford or Chrysler – or even all three – can create good, secure jobs and contribute to the U.S. economy, rather than detracting from it.
To be fair to GM and the others, they all have attempted to restructure. They’ve secured agreements with the United Auto Workers union that were designed to control costs. And they’ve tried to launch newer, better vehicles. But those agreements are too little/too late, and the sands have run out of the hourglass.
Union leaders from GM, Ford and Chrysler have now scheduled an emergency session for Wednesday in Detroit as the companies plan to seek concessions from the United Auto Workers to help land those $25 billion in government loans, Bloomberg News reported Monday. Participants will be asked to reopen a 2007 labor agreement to consider concessions. GM, which has said it may run out of cash to meet its obligations, wants to stop paying union workers when plants are closed and there isn’t any other work for them to do. Now Ford and Chrysler are expected to ask the UAW for similar concessions as part of their bid for the government aid package, Bloomberg said.
All three of the American carmakers were technically bankrupt since at least the time of my first analysis near the end of 2000, and the union agreements still did not bring compensation down to levels comparable to that of their competitors. Now the U.S. automakers are on life support. There is no time left for gradualism. They missed that window long ago and the costs imposed on all U.S. taxpayers figure to be huge.
The current predicament in which GM, Ford and Chrysler now find themselves is not only their own fault, as we’ve now already been subsidizing the unions for far too long.
Are Unions to Blame?
One of the biggest reasons Detroit’s Big Three have run out of capital is the extraordinary compensation that has been paid out to unionized workers in the United States.
Even in the last reported quarter, when the economies of Europe and Asia had slowed dramatically, GM was almost breakeven in those two regions and actually had 10% profit growth in Latin America, Africa and the Middle East, where GM also has unionized work forces. But the company is losing money in the United States.
That’s because GM pays about $75 per hour – $156,000 a year – to its assembly line employees.
And because of that, the Big Three are lagging far behind in technology investment. That has not only damaged the auto-related technology industry, but has decreased productivity and innovation, delaying the shift to more fuel-efficient technologies. And because they have jointly held the market leadership, they set prices high, allowing foreign competitors to undercut them.
These phenomena have increased the costs of transportation for all Americans for decades. Americans have overwhelmingly voted with their dollars by buying foreign brands, which has contributed to our growing trade deficit.
Ultimately, inefficiencies in the auto industry have imposed huge costs on the rest of the economy, putting the Big Three at a competitive disadvantage that has hurt profits, cost the economy jobs, and opened the door to foreign companies to export U.S. dollars back to Germany and Japan (and now South Korea and China).
GM lost $21.3 billion in the third quarter and burned through about $7 billion in cash. It has only about $16 billion in cash left, and already its liabilities are $60 billion larger than its assets, which means that GM has negative equity.
And the current quarter will be worse.
The bottom line is that GM is essentially bankrupt – and has been for years.
At this point, GM should – like so many companies before – have to restructure its costs to a point that allows it to be competitive before receiving a single taxpayer dollar. Otherwise, we are just throwing good money after bad and it won’t be long before GM comes crawling back for more.
I just hope that the politicians and government officials in Washington are wise and determined enough to control the situation, and force the bitter medicine down the company’s throat.
To Buy, or Not to Buy
In this environment of high uncertainty, I would not go near any GM securities.
However, highly sophisticated players may consider making a very small bet, in one of several ways. With GM’s bonds and credit default swaps trading at near-bankruptcy levels (15 cents on the dollar), it may be attractive (albeit highly speculative) to buy GM’s bonds, in the hope of converting these debt securities into the debt-and-equity of a newly restructured General Motors. Over the course of a couple of years, this could turn out to be extremely profitable, but only if GM’s work-force wage-and-benefits costs are brought in line with the company’s global rivals – and if the U.S. economy recovers. Among the many financial scenarios under review, GM’s board of directors is reportedly considering an option that would grant current bondholders equity in a restructured company in return for maneuvering room, according to media reports.
Reuters reported that GM’s bonds fell nearly 12% early Monday as investors waited for the automaker to submit a new turnaround plan that might actually have a chance of winning lawmaker support. GM’s 7.125% notes due in 2013 fell to 23 cents on the dollar, down from 26 cents on Friday, according to MarketAxess. As we noted earlier, GM is due to submit that plan by Tuesday.
When JP Morgan’s credit analysts made their market call last month, GM’s benchmark 8.375% bond due 2033 has dropped to 25.75 cents on the dollar, which was down from 36.5 cents at the end of October, MarketAxess said. The bonds had traded at more than 80 cents on the dollar at the beginning of the year and currently yield 32.5%.
In the case of selling credit default swaps, an investor would get paid some 80% to 85% of the value they are “insuring” up front. If GM gets bailed out, which is an increasingly likely scenario, that investor would keep the full premium and walk away. And in the case of default, that investor would have to pay the buyer 100%, therefore losing some 15% to 20% after the default, but getting the bonds he is insuring in exchange for that loss. We would then take the bonds into the restructuring as noted above.
I would not buy the actual GM shares, even though I have friends in high places in finance that still believe in the too-big-to-fail theory. My concern with GM’s stock is that there would be a very strong chance the company’s equity gets totally wiped out in a bankruptcy, or at least heavily diluted as a result of any government infusion the company receives.
GM’s shares closed Monday at $4.59 each, down 65 cents each, or 12.4%. They have traded as high as $29.95 in the past 12 months. The company right now has a market value of only $2.8 billion.
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This article has 21 comments:
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John D
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38 Comments
Dec 02 09:15 AM-
Brad Ferris
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29 Comments
My Website
Dec 02 09:20 AMThe bottom line is that the 3 NA autmomakers have a cost base well above their competition, have not been on the leading edge of innovation and have far too much supply.
If all three of those components are not addressed in any federal funding agreement then we'll find ourselves right back here shortly once again.
The prudent financial decision would to be to allow these companies to file for chapter 11 and protect jobs by providing interim funding for continued operations but making it very clear that a sustainable business model is the only option. The government should take an invested interest if they're putting taxpayer money into these failing businesses and the management of all should be dismissed. There are a number of past executives from 3M, GE and other industrial giants who don't need to know how to build cars to build a functional business globally.
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eddie64
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72 Comments
Dec 02 09:35 AMIf I were the Chairman of the Congressional conference, I would arrange to ask the first question about the UAW's participation. Given the honest answer, I would immediately ADJOURN THE MEETING...........
IMHO
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Clubby
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1 Comment
Dec 02 10:35 AMWhat happens to the sick worker after 30 years on the line? Government health care? What happens to all the southern auto workers with no health care when that group ages? Government health care?
The wages are 8 to 10% of a car, and the productivity is one of the highest in the land.......what about the health care and benefits of AIG, Citi, WAMU and other banks?
These business writers could not last one shift on the line, and they hate labor and unions, even though the right to join a union in agreed on in the international declaration of human rights and is a "basic human right". He states "we have subsidized th unions for too long"...funny, they never say that about the 4000 billionaires or the 10% of the population that controls 80% of the nations wealth......
We are at the end of the Republican reign, just as we were in 1929....to many goods chasing too few dollars.... and his prescription is lets have all the workers make minimum wage....so they can buy even fewer cars.....
The UAW has agreed to take over the health care as well as move all new workers to 12.00 an hour with no pension and limited benefits. That happened last summer. Anyone (are you there Eddie64) who says they have not given is misinformed. Further, they are meeting to give even more as I write this.
What about trade barriers, transfer pricing, currency manipulation, and Asian government subsidies and government paid health care? What about Alabama giving hundreds of millions for the construction of new plants?
Is that all GM's fault too?
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User 310967
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3 Comments
Dec 02 10:44 AM-
stox2buy
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29 Comments
Dec 02 11:48 AMa piece of cake to me if i'm offered the job of the new ceo.
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dw57
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74 Comments
Dec 02 12:54 PM-
dw57
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74 Comments
Dec 02 01:01 PMOn Dec 02 10:44 AM User 310967 wrote:
> GM pays about $75 per hour – $156,000 a year ...where does this number
> come from??.....
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dw57
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74 Comments
Dec 02 01:03 PMOn Dec 02 11:48 AM stox2buy wrote:
> let them all file chapter 11 and create a new company to pick and
> choose the good asset and fire all management teams to start a new
> one that's competitive to toyota, bmw and mercedes-benz.
>
> a piece of cake to me if i'm offered the job of the new ceo.
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who
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113 Comments
Dec 02 01:05 PMLook at the financial companies, money down a hole, downsizing is their answer. You may think the Feds, Treasury, etc. would know something about the financial companies.
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Andy Singh
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48 Comments
My Website
Dec 02 01:11 PM-
Bob Lunn
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88 Comments
Dec 02 01:12 PMBased on what I am seeing, it looks like Ford is not asking for any money... They are just asking that if their competitors have access to federal loans they also have access to federal loans. It seems that if GM does go bankrupt that it will take down some of its supplier chain as well. If you say no, how do you know that? What will happen to Ford if any of their key suppliers that do business with GM go bankrupt? In other words, what would a GM bankruptcy do to Ford? If you say nothing, how do you know that?
The automotive manufacturing business is highly integrated with a lot of other businesses. I think any serious analysis of a GM bankruptcy needs to look at potential effects on the automotive manufacturing system and the United States economic system.
A second component of a complete analysis of the ramifications of a GM bankruptcy must also include the effect of a GM bankruptcy on consumer purchase intent of post bankruptcy GM vehicles. That type of analysis need to be conducted world wide. For example, Chevrolet is one of the top brands in China. If you say it will have no influence, that prospective purchasers will not be concerned, how do you know that?
If GM does go bankrupt there is a Government insurance agency that will be put on the hook for GM retirees benefits. That same Government insurance agency will also be on the hook for the retirees of the suppliers, and materials providers that go down with the GM house of cards. That aspect of a GM bankruptcy needs to be examined to see what the ramifications are to the American tax payers. Are those risks in excess of the 25 billion dollar loan? If you say no, how do you know that?
My point for those that feel a GM bankruptcy is the obvious solution for a badly mismanaged company I would argue that the consequences to the United States economy if a small company goes bankrupt are not the same as the consequences when a gigantic company goes bankrupt. That is the logical basis of the phrase "too big to fail". If you want to see the logical basis for that phrase, read the consequences provided as part of the reason why AIG was not allowed to fail.
It may be a bitter pill to swallow, but sometimes you are put into a situation where you have to pick the lesser of two evils. There are a lot of synergies present with respect to a GM bankruptcy and these can't be appropriately addressed with a "shoot from the hip" approach that is congruent with an individuals political orientation. Its not about how badly managed GM is, or the role of previously negotiated, ridiculously inappropriate labour contracts approved by spineless and completely myopic executive management. What ever solution is adopted needs to consider the effects of those actions on the entire United States economic system.
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Chris B
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519 Comments
Dec 02 01:21 PMLook at it this way. If the total cost (wages, taxes, benefits, perks) of an active employee is $25 per hour, and the big 3 are paying two retirees pensions and benefits at the same amount, the total compensation cost per active employee is $75 per hour.
As you can see, the big 3 are little more than a massive welfare plan in themselves, where two retirees are subsidized by every one worker. The managers who agreed to this company-fleecing plan back in the 50's-90's are long gone, taking their millions in compensation and bonuses with them in exchange for their valuable contributions to resolving strikes. The union workers who demanded this compensation are now the retirees, and have benefited for years from the fleecing of the company. They all did this to themselves.
Nonetheless, talk about deservingness is a red herring. GM, Ford, and Chrysler are a metaphor for America, with our national debt, unfunded future liabilities, and subpar industrial/educational... performance. Maybe I think I deserve a taxpayer subsidized retirement too, but I'm smart enough to know that all ponzi schemes end with some losing everything and others walking away rich.
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Itsonlymoney
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90 Comments
Dec 02 01:46 PMDoes GM have even one superior new idea to solve our transportation needs for this century? Is there one executive in all Detroit who inspires even a tenth of the confidence of say, Steve Jobs? Money flows to new ideas and inspiration. If GM has either one it is not sharing it with the rest of us. The king is dead, long live the king.
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Mike Inmich
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16 Comments
Dec 02 03:02 PMwww.cargroup.org/pdfs/...
It includes 2003 actual and 2007 projected values. See page 31 of this PDF for the original. For convenience of readers I typed the 2007 projected values below:
Wages:
Wages and Cola (28.44),
Overtime (3.90),
Vacation (6.62),
Bonus (0.60),
Other Misc.( 2.09),
Total Wages( 41.65)
Benefits:
Pensions (4.94),
group life (1.40),
healthcare (13.38),
FICA and UC (3.26),
other misc( 0.35),
total Benefits (23.34)
Grand total (64.99)
Most lilely this projection was low due to health care inflation.
This is not executive pay allocated to the workers as stated above. I don't believe it includes retired peoples benefits allocated to workers.
It is extensive vacation, and although not stated, every self respecting UAW worker takes all their 10 sick days as vacation. FYI, the salary workers do not do generally do this.
They have 30 and out pensions, and the figure above actually looks lower than I expected.
The health care looks a little high at $13.38 an hour. This would be over $20,000 per year. But they have tiny co-pays on the order of 5% so they probably waste a lot of medical resources since they have no skin in the game. And every crooked doctor in the world has migrated to UAW areas just to milk this cow. The fraud in this area is staggering according to my neighbor who is a doctor, so $20k is possible.
The shame is that the UAW works hard, while they are working. My relative makes this kind of wage and lives in a double-wide. They always viewed themselves as the vanguard of the working man, but the working man, and many otherwise socialist-liberal types have voted with their feet and supported the agressively non-union transplants.
The UAW made some real concessions recently in their retiree health plans. But they only reduced the wages and other benefits of workers who haven't been hired yet. Very magnaminous of you guys!
I suggest that the UAW take significant cuts in benefits. Start with much higher co-pays on medical like everyone else in this country has. Also fewer days off (sum of vacation and sick days), and a couple bucks off the hourly wage. And the sub pay (95% for sitting on ass) has to go immediately.
Then, maybe, just maybe, the taxpayers will support a bridge loan.
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LariAnn
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4 Comments
Dec 02 03:43 PM-
luckie911
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1 Comment
Dec 02 06:06 PM-
thedozer
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162 Comments
Dec 02 09:37 PMI drive a Ford and a Honda Accord... BOTH made in the USA!
furthermore, I don't care where it is made. I care what it costs and the utility it will provide for me.
Mike n Mich: spot on... however, as I was and still am against socialistic practices, including the financial bailout... so NO for the big 3.
the Southern Auto Workers are doing well without union representation.
you ask me if I am willing to loan big 3 some of my money???'
what have they done for me? nothing... and that's the way I want it.
furthermore, the government is in violation of the constitution acting as a bank to begin with.
It is sad to see them go down... and it will drag us all down... but better to take our medicine now and get it over with than to leave this same problem for our kids to figure out in 20 more years
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thedozer
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162 Comments
Dec 02 09:40 PMentitlements or any socialism practices are flawed in principle and WILL fail.
this is going to be nasty!
Unions and its employees have a STICK IT TO THE MAN mentality...
well, ATLAS is about to SHRUG
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User 310967
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3 Comments
Dec 05 07:48 AMSouthern Auto Workers are doing well without union representation...how do you know that ..40%..temps..that have no benifits...someone the us gov will have to supprot at a later date...corp. welfare...
also with the wages they make ..they keep your taxes lower..and home prices stready.....
it's sad that it has come to this
On Dec 02 09:37 PM thedozer wrote:
> luckie:
>
> I drive a Ford and a Honda Accord... BOTH made in the USA!
>
> furthermore, I don't care where it is made. I care what it costs
> and the utility it will provide for me.
>
> Mike n Mich: spot on... however, as I was and still am against socialistic
> practices, including the financial bailout... so NO for the big 3.
>
>
> the Southern Auto Workers are doing well without union representation.
>
> you ask me if I am willing to loan big 3 some of my money???'
> what have they done for me? nothing... and that's the way I want
> it.
>
> furthermore, the government is in violation of the constitution acting
> as a bank to begin with.
>
> It is sad to see them go down... and it will drag us all down...
> but better to take our medicine now and get it over with than to
> leave this same problem for our kids to figure out in 20 more years
>
>
>
>
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User 310967
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3 Comments
Dec 05 07:49 AMOn Dec 02 03:02 PM Mike_I_N_Mich wrote:
> Here is a couple year old analysis of UAW wages.
>
> www.cargroup.org/pdfs/...
>
> It includes 2003 actual and 2007 projected values. See page 31 of
> this PDF for the original. For convenience of readers I typed the
> 2007 projected values below:
>
>
> Wages:
>
> Wages and Cola (28.44),
> Overtime (3.90),
> Vacation (6.62),
> Bonus (0.60),
> Other Misc.( 2.09),
>
> Total Wages( 41.65)
>
> Benefits:
> Pensions (4.94),
> group life (1.40),
> healthcare (13.38),
> FICA and UC (3.26),
> other misc( 0.35),
>
> total Benefits (23.34)
>
>
> Grand total (64.99)
>
>
> Most lilely this projection was low due to health care inflation.
>
>
> This is not executive pay allocated to the workers as stated above.
> I don't believe it includes retired peoples benefits allocated to
> workers.
>
> It is extensive vacation, and although not stated, every self respecting
> UAW worker takes all their 10 sick days as vacation. FYI, the salary
> workers do not do generally do this.
>
> They have 30 and out pensions, and the figure above actually looks
> lower than I expected.
>
> The health care looks a little high at $13.38 an hour. This would
> be over $20,000 per year. But they have tiny co-pays on the order
> of 5% so they probably waste a lot of medical resources since they
> have no skin in the game. And every crooked doctor in the world has
> migrated to UAW areas just to milk this cow. The fraud in this area
> is staggering according to my neighbor who is a doctor, so $20k is
> possible.
>
> The shame is that the UAW works hard, while they are working. My
> relative makes this kind of wage and lives in a double-wide. They
> always viewed themselves as the vanguard of the working man, but
> the working man, and many otherwise socialist-liberal types have
> voted with their feet and supported the agressively non-union transplants.
>
>
> The UAW made some real concessions recently in their retiree health
> plans. But they only reduced the wages and other benefits of workers
> who haven't been hired yet. Very magnaminous of you guys!
>
>
> I suggest that the UAW take significant cuts in benefits. Start with
> much higher co-pays on medical like everyone else in this country
> has. Also fewer days off (sum of vacation and sick days), and a couple
> bucks off the hourly wage. And the sub pay (95% for sitting on ass)
> has to go immediately.
>
> Then, maybe, just maybe, the taxpayers will support a bridge loan.
>
>