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So, how exactly does an auto bailout help?

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November 07, 2008 – Comments (11)

I wrote a long reply to MichaelinWA's blog on bailing out the auto industry and thought it was worth it's own entry.

I see several flaws with an auto industry bailout.

Proponents argue bailing out automakers will save jobs.  I disagree.  Even if the gov't steps in, these companies need to downsize and cut jobs.  If one of these companies go bankrupt, the jobs don't just disappear.  Operations don't cease. 

Since these are ongoing operations, a bankruptcy would likely be Ch.11 - restructuring, not Ch. 7 - liquidation.  A restructuring is just that.  A bankruptcy court hears arguments and restructures contracts and obligations.  Typically, shareholders get wiped out and creditors end up with some reduced settlement.

Those who argue that a gov't bailout will save jobs need to explain how gov't intervention results in fewer job losses than a bankruptcy proceeding.  I don't see any way anyone could predict which approach would result in the smallest number of lost jobs.

The group a bailout helps the most is bondholders and other creditors.  Outside of bankruptcy, the companies have few options for restructuring the debt.

Union members who keep their jobs are probably the next group who benefits most since it's highly unlikely pay and benefits packages get restructured outside of bankruptcy.  However, because a bankruptcy restructuring might lower labor costs, it's possible fewer jobs would be lost in a bankruptcy.

Shareholders also benefit from gov't intervention compared to bankruptcy.  If history repeats, the gov't will demand warrants severely diluting common stock holders.  Not good for them, but better than going to zero in bankruptcy.

Management is probably better off with a gov't bailout.  The gov't could demand a clean slate of upper management as a condition for a bailout, but no way to predict how they might do that.  If it went to bankruptcy, the creditors take charge and current management has little say in running the show.

We're being sold a bill of goods again.  There are proven procedures in place for businesses that can't pay their bills.  Bankruptcy would not mean the end of GM or F and a reset might be just what they need to become competitive again.

This needs to stop.  If the gov't intervenes to save auto companies, you can bet homebuilders and others will be quickly lining up with their lobbyists arguing why they deserve a bailout too.

If we're going to break the Treasury's bank, let's at least break it for something we need anyway like repairing infrastructure.  Guaranteed jobs there and if we're going to drive little shoebox cars, the potholes better get filled. Corporate bailouts are nearly certain to cost taxpayers money - not nearly so certain there's any benefit for the dollars spent.

Allright Fools, help me out.  What did I get wrong? Can anyone explain definitively why a gov't bailout works better than Chapter 11 for automakers?

11 Comments – Post Your Own

#1) On November 07, 2008 at 9:54 PM, Option1307 (29.77) wrote:

Ya its simple...Politicians get to say "we saved these companies" and then they keep their jobs...Sadly that is the truth why this bailout will happen. It's just a matter of time, don't be fooled.

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#2) On November 07, 2008 at 10:20 PM, NEWSMONKEY (80.59) wrote:

Looting The American Dream: Prevent the bail out of Chrysler and GMAC

If you are opposed to the Government's bailout of Cerberus Capital Management, the owner of GMAC and Chrysler please join our petition.

Cerberus Capital Management the multi-billion dollar vulture hedge fund has made billions of dollars for it's owner Steve Feinberg and the hedge fund's wealthy investors by taking advantage of other companies going bankrupt.  Now that Cerberus is faced with massive losses they want help from the US Taxpayer.

It is ironic that Cerberus Capital Management's founder Steve Feinberg, well known for his ruthless and cutthroat style of vulture investing is now looking for the US Taxpayer to bail him out.  Cerberus Capital Management has made billions of dollars by wiping out share holders, pensions, laying off employees and liquidating companies without a second thought.  Steve Feinberg is known throughout Wall Street and the investment community as one of the meanest, vindictive and ruthless investors in the world.  He has benefited personally over the years by taking advantage of others who had fallen on hard times.

He is known to have always extracted maximum pain when following his "Loan to Own" investment thesis.  For more information on Cerberus Capital Management follow this link: http://en.wikipedia.org/wiki/Cerberus_Capital_Management .

For more information on Steve Feinberg follow this link: http://en.wikipedia.org/wiki/Steve_Feinberg .

Join us in out fight against bailing out one of the richest men in America, Steve Feinberg, his losing investment in Chrysler and GMAC and the multi-millionaire investors in Cerberus Capital Management.

If this makes you as angry click here and sign the petition to fight this.

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#3) On November 07, 2008 at 11:04 PM, ikkyu2 (99.17) wrote:

There are real foreign competitors to F and GM.  Many of them enjoy a great deal of support from their home nations.

If you believe the automobile industry is through - in the same pot as typewriter ribbons and buggy whips - then, yes, let them go under and restructure.

If you believe that people - worldwide, not just in the US - will continue to purchase automobiles, there is a sound mercantilist argument to be made that it is good for the US to have those people purchase US-made automobiles.  It might be so good as to warrant some G investment in these industries, especially bearing in mind that they are cyclicals and always bounce back.

Don't forget, by the way, that until just recently GM was leading the market share wars in China and Latin America, among other places that it does good profitable business.  In 2006 the best selling car in China was the Buick Lucerne, believe it or not.

Global demand for automobiles will be filled, by F and GM or by other companies.  Restructuring and chopping up F and GM is within the power of the US gov't; so is bailing them out so that 3-5 years from now when the global economy recovers they are still going concerns.  One of these options ruins their ability to compete with Toyota and the other global giants; the other one could enhance it if done right.

I'm not sure I'd throw the weight of my own opinion behind that argument, now; but I think it is the argument in favor of the bailout.

Full disclosure as I think you're already aware, rd80:  I'm (still) long GM.

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#4) On November 08, 2008 at 12:50 AM, Option1307 (29.77) wrote:

ur long GM? Honestly? I hope your time frame is like 100 years, good luck with that one ikkyu...

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#5) On November 08, 2008 at 1:23 PM, rd80 (98.21) wrote:

Thanks for the comments.

I do believe it's in the the best interest of the US to have an auto industry that can compete worldwide.  I travel on business quite a bit and based on my experience with rental fleets, the US automakers are producing cars that match up very well against the Japanese brands.

Operationally, the companies have good potential.  But the heavy debt load, pension obligations, etc. present cost structures that don't work in the current economy.  If operating cash flows continue to deteriorate to the point where they can't service the debt and other obligations, the two options are gov't support or bankruptcy.  I don't see any reason why one of those approaches offers a better chance for a viable company to come out the other side.

What I don't know about the corporate bankrupcy process could fill textbooks.  But it seems to me the main difference between the gov't doing a TARP, AIG type bailout or outright subsidy and a Ch. 11 filing is who foots the bill for the restructuring; taxpayers or bond holders and other creditors.

One thing I didn't mention above is taxpayers are on the hook for some expenses regardless.  If one of the automakers went into Ch. 11, it's safe to assume the pension assets and liabilities would shift to the PBGC.  I don't know what that balance sheet looks like, but doubt PBGC could absorb that without some additional gov't funding.

ikkyu2 - I hope the GM long (dice roll?) works out for you.  Based strictly on business fundamentals, I would have a CAPS red thumb on GM.  But the gov't wildcard makes it too tough to predict and I make enough bad calls on easy picks. 

 

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#6) On November 08, 2008 at 7:30 PM, columbia1 wrote:

They need to go bankrupt, and renegotiate terms of their debt and labor contracts, the unions make it impossible to quickly change business plans, and until they have a new business plan and the flexibility to change, they will bleed themselves dry. Its is best for the workers, and also all the subcontractors (that employee more) that G.M. gets a fresh start as soon as possible. Loaning them money is just wasting our taxpayer dollars. Why don't the unions stand up and give some concessions? United airlines emerged from bankruptcy much stronger, without tarnishing their image over the long run! United emerged from chapter 11 on February 1, 2006, and as of July 31, 2006, was the world's second largest airline by revenue-passenger-miles.

 

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#7) On November 10, 2008 at 12:42 AM, rocksnot (29.09) wrote:

@columbia1:  The reason the unions and creditors won't agree to concessions is because everyone is expecting a bailout.  Why would they give concessions until maybe about 5 minutes before GM really signs the bankruptcy docs?

rd80 is right on this one.  It would be best for all if the big 3 would go through chapter 11.  The companies would come out of it leaner and meaner, having found a way to shed a lot of the union responsibilities that make them so anticompetitive.  The first of the big 3 to go through chapter 11 will be in much better shape than the others.  Getting turned into a zombie by a government bailout will not be a good thing.

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#8) On November 10, 2008 at 2:48 AM, ikkyu2 (99.17) wrote:

Well, rd80, another reason not to let GM go under goes like this:

GM has about $290 billion in debt.  It depends how you count, but looking on the balance sheet, GM thinks their GAAP book value is about $56 billion.

Now go through Ch. 11 and wipe that debt.  $5B of market cap disappears.  $240B of debt obligation disappears.  And God only knows (that's literal) how much credit derivative obligation gets incurred - trillions of dollars worth?

Let's be conservative and say that a GM bankruptcy tomorrow causes $200B of assets to disappear tomorrow, and that it makes $100 billion of credit derivative obligation due and payable.  Suddenly some folks out there - let's call them "counterparties", for lack of a cleverer name - lose $200B in assets.  These aren't individual investors; they are, by and large, banks.

Meanwhile some folks out there - let's call them "counterparties," for lack of a cleverer name - suddenly are presented with "pay up" demands for $100B in credit derivative swap obligations as GM enters Ch.11.  ($100B is a really conservative estimate, as far as I can tell.)

This is not going to be exactly great news for a credit market still trying to contain the fallout from AIG, BSC, and LEH.  It will undo, in one fell swoop, nearly 50% of the TARP just by itself by sucking $300B off the asset side of banks' balance sheets.  And we're not even counting F or Chrysler here.

So there's another very practical reason that the USG may not want to see this happen, because if it doesn't bail GM out as a going concern, it's going to have to bail out all the banks that GM's bankruptcy causes to fail. 

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#9) On November 10, 2008 at 2:56 PM, rocksnot (29.09) wrote:

kkyu2, fantastic points.  So GM (or F) may be better off in bankruptcy, but the gov't (and banks, and everyone else) wouldn't be.  That's a crazy situation.

So now the only question (in my mind) is whether the gov't will bailout GM and F in a way that dilutes shareholders.  Do you, or rd80, have an opinion on that aspect?

Actually, thinking it through a little more, there are only a few billion left in GM and F in market cap, and maybe no large investors left with both something to lose and the political capital to influence politics.  I think shareholders will get burned in whatever bailout is coming.

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#10) On November 11, 2008 at 1:31 AM, ikkyu2 (99.17) wrote:

My opinion, as unfortunate as it seems, is that GM common will probably get wiped out.

The only reason I'm still long it is that I am holding it in an IRA, where I can't short it or write a put, and it's lost so much value that at this point I'd just as soon take a flyer on a non-dilutive bailout with the risk of a 100% loss, as sell it and lock in a 95% loss (yes, my basis is that bad.)  I would not buy another share at $3.36, where it closed today.

Since I have been so wrong on GM so far, it would probably be wise to take my current opinion with a grain of salt. 

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#11) On November 11, 2008 at 9:06 AM, rd80 (98.21) wrote:

rocksnot - If the gov't comes in, my guess, emphasis guess, is there will be some dilution of shareholders.  Most of the proposals talk about using part of the TARP money.  If that's the case, something structured more like what the gov't did with the banks (preferred with warrants for 15%) would be more likely than the severe dilution they did with the FNM, FRE and AIG bailouts.

ikkyu2 -  Thanks for pointing out that a lot of the debt is held by banks.  It would be interesting to know the breakdown of who holds it - banks, money market funds, bond mutual funds, hedgies, individuals etc.  Combine the gov't backing of money market funds and potential for damage to bank balance sheets and I guess we can safely say the taxpayers will take a hit regardless of how this plays out.  I hope the GM works out for you. 

Thanks for the comments.

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