Wednesday, November 19, 2008

Keeping GM Alive in Bankruptcy

The only valid argument I hear about "bailing out" GM is that a chapter 11 filing could make people afraid to buy the company's car, killing it as a business and preventing it from ever emerging intact. I researched this a little back in early 2006 as Ford and GM both descended deeper into junk.

Yes it's true the credit crunch has hurt GM, but let's not forget that their own excessive indebtedness is what now puts them in peril. Shares of Toyota, which happens to be a AAA credit, are down about 40% this year -- roughly the same as the entire stock market. GM, a CCC-rated concern, has fallen about 85% and is rapidly approaching penny-stock status. They're both facing the same terrible market. GM's problem is the debt load, which it accumulated paying for other people to buy cars and to pay employees from decades ago. Chapter 11 bankruptcy was designed to deal with a company in this position, keeping it intact for re-emergence.

Two ways to deal with GM:
1-The government will honor GM's warranty. If confidence is what they're looking for, how about the full faith and credit of the U.S. Treasury?

2-The government will provide, or arrange, the debtor-in-possession financing. This would be one of the largest DIPs ever, organized in the midst of the worst credit crisis in the post-WWII period. Leaving it to the banks, already capital constrained and risk-averse, would be like throwing a chicken to wolves.

Yes, a bankruptcy could destroy GM. But, it doesn't have to. With a rational plan and a sense of realism, we can make sure the company emerges stronger than before. They have made some real progress in cost cutting and quality. But there is simply too much debt and too much dead weight to remain alive in times like this. Going bankrupt is the normal thing for a company in their position to do. And, if the government is there to backstop the warranty, I can't see any reasonable argument against seeking Ch 11 protection.

This would be an intelligent way for the government to be active in saving GM.

(Dear me, now Andrew Ross Sorkin on Charlie Rose is saying exactly the same thing I have been about giving a government guarantee to GM.)

Companies in GM's position should go bankrupt. They put off their problems for too many years and got religion far to late in the game.

They should also talk out other deals. The government should push for things like an alliance with Google, ways to brainstorm better cars. Certain kinds of encouragement and moral/political support can pay great dividends. The real crisis we have in the US is a lack of pragmatic solutions. Our own enemy is our sense of inertia and what's not only possible, but profitable and worthwhile. Why isn't the government laying down a vision or providing direction? While many people lambast FDR as a socialist, he allowed Wall Street to fix itself in many ways. His plans were not just politically feasible -- they were socially pragmatic and truly useful. Things like the TVA and Hoover Dam had massive positive impacts on GDP for decades to come.

The key thing to remember about FDR was that he saw an economy glutted with over production and falling incomes. He knew that only by stimulating demand for stuff could all of this capacity be put back to work. He pushed things like housing and automobiles because they consumed lots of stuff. Rubber, steel, oil. The vision was laid during the Great Depression and served as the guiding principle for all US economic development until just a few months ago.

The interesting thing about FDR was his background as a jerk-turned-polite-cripple. He knew what it took to make it through a day suffering, and he knew how to survive. He knew in his heart that grit trumped principles. He knew that sometimes the economy needs some hair off the dog that bit it. If technological progress and the achievement of wealth had caused progress, which now was slowing down, why not bring it back with new demand? Why not find a way to employ all these people and their factories?

We need to think that way now about our own economy and society. In the 1930s our problem was too much production and not enough income. During WWI, the US grew as a producer of grain and industrial products. This caused general price declines throughout the 1920s and much of society was already in something of a depression when the stock market crashed. (New urban professional classes -- the emerging white collar world -- did quite well and emerged as a new consumer class.)

FDR saw a country full of potential. Society as we knew it in the late 1920s wasn't producing the kind of demand and production that was needed to employ itself. We had advanced science and engineering skills, the most factories and wealth of any country in the world.

But FDR knew that many people we still stuck in 19th century conditions. He knew that giving them things would be politically popular, and that it would only make the country stronger in coming years. After all, without power from the TVA, there would have been no nuclear weapons lab in Oak Ridge, TN.

Using electrification, roads and dams, FDR found ways to employ all this human energy and productive capacity. His financial reforms included the 30 year mortgage, which would go on to encourage a whole new kind of investment and consumption.

Today, we face very different problems. Instead of underconsuming, we have been overconsuming over the last few decades. Debt has grown just a little faster than GDP almost every year since WWII, and consumers grew increasingly dependent on credit -- similar to any older culture. (It's interesting to look at their leveraging relative to that of GM.)

We also need some new social groups to solve the generation gap problem. If we as a people continue to trust the government for solutions, we'll wind up killing each other. We essentially need a national debate forum -- two generations of stakeholders. Babyboomers on one side, and their kids plus immigrants on the other side.

The problem is that we have a leadership steeped in old ideas. We need to start thinking about what can be done, instead of indignantly declaring what must be done. "Must" only exists in the mind of man -- and algorythmns.

(We've have too many people who have studied at too many schools for too long. Too many people read too many books and wrote too many algorythmns. They drank their own koolaid and missed the bigger picture. Instead of being like eagles, deftly swiping at the markets with precision and intelligence, they were like flees on a dog. They were really good at sucking blood -- in their case by borrowing huge amounts of money to make ordinary momentum trades. But they didn't realize that 10,000 other flees are on this dog and it won't live forever.)

One other thing we need to address right away: We need a soveriegn wealth fund. It can buy structured securities now at huge discounts and use the profits to support social security long-term. This way, even if some of these loans go bad, the problem will be dealt with through the structured entity and the government will almost certainly profit. It will also prevent the collapse of the market right now from paralyzing the entire economy. We need to get issuance flowing again in the capital markets or companies and consumers will be like fish in a tank that runs out of oxygen.

I estimate something like $1-2 trillion of "extra debt" came into existence during the credit bubble. This resulted from foreigners recycling trade dollars into the US, hedge funds borrowing in yen and by structured products like CDOs and SIVs. As each of these things unwind, hundreds of billions of securities are spewed out onto the market. This has caused huge dislocations and prevented new bonds from getting issued. That means banks can't originate mortgages and credit card companies must tighten terms on customers.

This is the credit crisis. It's a huge liquidation of term debt securities. We as a country have developed a new kind of economy that is less dependent on banks. This happened because it made things better for a lot of people. We need to keep those gains now and move on to the next level of our economic life, where perhaps capital markets provide a larger role of financial intermediation.

Like it or not, these issues, like the yen carry trade WILL come up again. Bernanke's refusal to see it won't make it go away.

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