GM Banruptcy Appears Certain

We have for some time been concerned about the odds of a GM bankruptcy. While bankruptcy in theory offers some compelling advantages, GM is so large that only certain operations could be hived off. The thought, as with a traditional Chapter 11, is to skinny up the company and a have a new sleeker version emerge from the bankruptcy process.

The problem is that no automaker has ever done that. And that is why the Obama Administration is applying exceptional pressure to have things go its way with GM and Chrysler. I’m not entirely sympathetic, given my belief in due process and the complete inattention to what it will take for GM to be viable (how can you devote your energies to deal and political machinations without understanding what it will take for the company to be operate successfully? And before you pooh-pooh that idea. the idea that GM makes crappy cars is not exactly accurate. Buick scored at the top of JD Power surveys last year. And the wee fact that Japanese cars, even ones assembled here, have a fair amount of Japanese content at what was until recently depressed currency prices is another wee subsidy typically ignored. GM has way too much capacity, granted, but that does not mean the whole operation is a goner. But you still need to have a picture of the end game and work back from that). Chrysler as a situation with many fewer moving parts is more amenable to pushing and prodding than GM is.

The current state of play is that the bondholders appear certain to have rejected an out-of-court restructuring, so a filing is unavoidable. The risk is that the government’s plan to arrange a 363 sale will be blocked, and GM will have to go through a normal Chapter 11 process. Given the enormous complexity of the task, it would take close to two years, according to an extensive analysis in The Deal. So let us be clear, the problem is not a bankruptcy filing per se, it is that if the fast track fails, it becomes a very protracted bankruptcy. And that two years could prove to be optimistic if the 363 gambit fails.

A process that long has other implications. First, the longer things play out, the greater the odds that customers get cold feet and sales fall below projected levels. That will require Uncle Sam to provide more in the way of financing, and will also damage GM suppliers, who are already on the ropes. If sales fall far enough, GM may no longer look viable and may go into Chapter 7, a liquidation. That would produce huge job losses.

The analogy here is Million Dollar Murray. As told by Malcolm Gladwell, Murray was a homeless alcoholic:

Murray Barr was a bear of a man, an ex-marine, six feet tall and heavyset, and when he fell down—which he did nearly every day—it could take two or three grown men to pick him up….He was missing most of his teeth. He had a wonderful smile. People loved Murray….

“If he was on a runner, we could pick him up several times a day,” Patrick O’Bryan, who is a bicycle cop in downtown Reno, said. “And he’s gone on some amazing runners. He would get picked up, get detoxed, then get back out a couple of hours later and start up again. …Murray was such a character and had such a great sense of humor that we somehow got past that….

“I’ve been a police officer for fifteen years,” O’Bryan’s partner, Steve Johns, said. “I picked up Murray my whole career. Literally.”…

Johns and O’Bryan realized that if you totted up all his hospital bills for the ten years that he had been on the streets—as well as substance-abuse-treatment costs, doctors’ fees, and other expenses—Murray Barr probably ran up a medical bill as large as anyone in the state of Nevada.

“It cost us one million dollars not to do something about Murray,” O’Bryan said.

The article discusses the problem of Murray and other “power law” situations. It concludes it would be cheaper to give Murray an apartment and 24/7 nursing than have him continue on the streets as he did.

But that isn’t fair. There are poor people who are far more deserving of help. Why Murray?

And that is the problem. You can have efficiency, or you can have fairness. You cannot have both.

Now I there are reasonable odds that I am wrong about GM. Maybe the 363 will work. Maybe sales won’t fall off as severely in a normal bankruptcy process as I fear. But as I have said here repeatedly, these risks do not appear to have been diagnosed (I may be unfair, but given the actions of the Treasury/Fed finance team from the onset of this crisis, they don’t appear to consider worst case scenarios). Similarly, the fact that they have no auto industry experts at the table is stunning. If GM does liquidate, we will be in a Million Dollar Murray situation. Doing almost anything else would have been all in cheaper. But I confess to not having a good handle on the odds. The only thing I can say with confidence is that they are higher than Team Obama has assumed they are.

And the GM situation, appearances to the contrary, differs from the “too big to fail” bank situation. The binding constraint, there, weirdly, seems to be, a la Freddie and Fannie, that the government does not want to assume full ownership for accounting reasons. (Well, I am being simplistic, there is that wee “we don’t do nationalizations” problem too). But the big problem with taking over a bank and maybe partially or considerably cramming down bondholders is that the really troublesome ones (Citi and BofA) are big trading firms and need continued access to credit. If they were temporarily controlled by the government, that is less problematic from an incentives and governance standpoint than this bizarre situation now, of a public/private partnership called the taxpayers eat the big mistakes and the perps get to keep the gains when they manage not to screw up.

And they appear to be hugely screwing up now. The primary dealer community is very long Treasury bonds when the market is taking a dive, a lot more supply is in the pipeline, and Fedwatchers are saying the Fed intends to stand pat on quantitative easing for at least June and July (meaning Ben will not jump in to buy more long bonds than planned and rescue the dealers).

From Reuters:

General Motors Corp has failed to persuade enough bondholders to accept a debt-for-equity swap, setting the stage for the largest-ever U.S. industrial bankruptcy within days….

“I would say this is a sound rejection of an unsuitable offer,” said Pete Hastings, a credit analyst at Morgan Keegan who has followed GM. “I have been saying for some time that this thing was dead on arrival and we were just waiting for the doctor to pronounce it dead. Now that’s happened.”

The Wall Street Journal focused on other elements of the continuing negotiations:

General Motors Corp. and the United Auto Workers have agreed to a new restructuring plan that would give the union a significantly smaller stake in the company than previously envisioned, and leave the U.S. government owning as much as 70% of the car maker.

The government’s plan also calls for paying off in full GM’s secured lenders, banks including Citigroup Inc. and J.P. Morgan Chase & Co. that are owed about $6 billion. That would remove one potential obstacle to a speedy bankruptcy reorganization.

Under the new UAW terms, the union’s health-care trust would own 17.5% of a reorganized GM, in exchange for retiree health-care concessions…

The union — concerned about GM’s prospects — sought the lower stake in exchange for preferred shares that provide annual income, as well as a $2.5 billion note from GM, said people familiar with the situation.

The change leaves room for GM to sweeten its stock offer to bondholders to reduce the company’s $27 billion in unsecured debt. A debt-for-equity swap is another measure required by the Treasury before Monday, or else the company will be forced to file for bankruptcy, a fate most participants in the talks believe is likely.

GM’s largest union also acceded to more worker buyouts and rules changes. For its part, GM agreed to take back five car-parts plants from Delphi Corp., a former subsidiary that is in Chapter 11, and use an idled GM plant to make small and compact cars.

The UAW and people close to the Obama administration’s negotiations with GM said Tuesday that GM will need “significantly more capital” to continue operating, despite the UAW cuts. The Treasury plans to back GM with up to $50 billion in financing that will cover everything from $7.6 billion GM requested last week to $6 billion to pay off GM’s secured lenders. It will also cover debtor-in-possession financing for GM and exit financing when it is ready to emerge. In return, the Treasury could demand up to 70% of the company’s equity in exchange, said people familiar with the matter. The funds would, in effect, be a big bet by the government that GM will be successfully reorganized.

The Wall Street Journal Deal Journal weighs in with a dim view of the proceedings:

Some extraordinary things are happening in the bailout of General Motors. Too bad everyone is too numb to notice.

Consider this extraordinary fact: The U.S. government is likely putting up to $50 billion in new money to back the company’s bankruptcy reorganization, according to people familiar with the plan.

Most of this is what is known as a “debtor-in-possession” financing made to companies in bankruptcy protection. The sum is also expected to include $6 billion to buyout GM’s secured lenders and another $7.6 billion requested by GM last week to fund ongoing operations.

It’s clear that a large portion of this amount will be secured with the equity of the “new GM.” Why is the government likely to get equity and not, say, debt with interest and a repayment schedule? Because too much debt would apparently make the company unviable. It’s as if the government has devised an SAT exam for GM, and is blatantly funneling the company the answers.

Okay, fine. So what will this equity be worth?

That’s anyone’s guess. By the logic of some of the people who know the company best – its own unionized workforce – the bet is that it won’t be worth much.

Remember that the union just agreed to take a relatively small portion of its health-care trust in GM equity. The rest will be funded via annual payments on preferred stock. In other words, UAW’s view of the future is clear: Cash today over equity value tomorrow.

That comes on top of another $20 billion of existing loans that the government is likely to wipe out as part of the bankruptcy plan.

Put it all together and the government will own an extraordinary 70% of the company. And a large portion of that will have an uncertain value for an uncertain length of time.

Now this could be taken as a tacit admission that no matter what, the Obama Administration will not let GM liquidate. But the 363 sale is still a big gamble. Yes, no doubt GM has shopped for the most sympathetic jurisdiction for a filing. But so will anyone who tries to appeal. And if the 363 gambit does not work, all sorts of new elements come into play.

Bloomberg stresses that the Chrysler bankruptcy appears to be moving quickly, which in theory would argue for a fast resolution for GM. However, in practice, GM is considerably more complex, so success for Chrysler cannot be assumed to translate to GM (although Team Obama is clearly applying enormous pressure to make it so):

Chrysler LLC’s swift bankruptcy process will give consumers confidence that General Motors Corp. would also emerge quickly if it needs to seek court protection, a person familiar with the matter said.

A restructured Chrysler is almost ready to emerge from bankruptcy and will do so closer to 30 days after its April 30 filing rather than the upper limit of 60 days previously estimated, said the person.

I’m a bit surprised that Bloomberg ran a story on the say-so of a single anonymous source. Tomorrow is the big day for the Chrysler judge to decide on the objections to the deal. Steve Lubben at Credit Slips has not been impressed with most of them, but he does highlight a couple of exceptions.

Originally published at Naked Capitalism and reproduced here with the author’s permission.