Nouriel Roubini's Global EconoMonitor

The Impact of the Chrysler Bankruptcy

On April 30, Chrysler filed for Chapter 11 Bankruptcy protection from its current creditors.  As such, Chrysler will be able to operate as a going concern, while the company renegotiates its debt structure and other obligations.  The U.S. government has described Chrysler’s action as a ‘prepackaged surgical bankruptcy’, in which it hopes that the company will be able to exit the bankruptcy process within 30-60 days.  If Chrysler achieves this, then it will emerge with a new global partnership with the Italian based Fiat. Instead of cash, Fiat will provide the equivalent of billions of dollars in R&D related investments for a 35% stake in the new Chrysler.  However, many experts think that a quick trip into bankruptcy might be unrealistic.

In the administration’s view, cost cuts, implemented by Cerberus and the new management brought in by Bob Nardelli, who cut into Chrysler’s R&D budget and new product development, left Chrysler, the smallest of the Detroit automakers, with a very thin line up of new vehicles.  The Obama administration set partnering with Fiat as a precondition for any further government assistance.  Nevertheless, Chrysler was unable to avoid the bankruptcy process, because some creditors balked at the terms being offered in the proposed debt to equity swap by the government.

Fiat is vying to get a 35% stake in Chrysler, without paying anything for it.  What it brings to the table is billions of dollars in R&D that have positioned it well to produce new cars in the future.  Fiat exited the U.S. market decades ago.   The marriage between Fiat and Chrysler is based on harsh realities, as evidenced by continuing layoffs in Chrysler’s bloated U.S. and Canadian operations, but it seems to be a symbiotic relationship, aimed to help both car makers survive the new realities of an even more competitive landscape.  Moreover it is a reflection of the considerable overcapacities in the global auto sector which may require further consolidation both in several national and international markets.

The short term outcome of Chrysler’s bankruptcy filing may come to determine the path for General Motors, if not the entire U.S. auto industry. If bankruptcy proceedings for Chrysler go as the company and the U.S. government have planned, then Chrysler’s filing may very well turn out to be just a test case before the bankruptcy filing of GM itself.  GM has until the end of May to convince the government that it has a viable business plan to restructure outside of an official bankruptcy filing for Chapter 11 reorganization.  If it fails to renegotiate its debt and convince its current creditors to undergo a debt for equity swap, as Chrysler failed to do, then GM will have no option but to file for Chapter 11 protection.  GM’s new CEO, Fritz Henderson has vowed to do whatever is reasonably necessary to prevent the automaker from going under including seeking loan packages from U.S., Canadian and European governments (especially Germany). However, GM can no longer afford its extensive European operations and is in the process of looking for bidders.

The significant role the auto sector plays in employment, exports and industrial production have heightened the political importance of responding to their vulnerabilities, which have been exacerbated by the credit crunch, prompting rescue packages including bridge loans, incentives to purchase domestic vehicles and increases in tariffs on imported cars and auto parts.  In the face of rising unemployment in other sectors, governments hope to avoid any disorderly bankruptcy proceedings.

Furthermore, the Chrysler-Fiat merger could set off a chain of consolidations within the auto sector which continues to have significant production overcapacities. Even emerging economies are likely to contribute slower auto demand growth in coming years. In Russia, automakers including Toyota have repeatedly shuttered production and domestic automakers are now increasing car loans in order to encourage purchases. Other countries like China also face the near-term challenge of consolidating its many automakers into several companies large enough to take advantage of economies of scale, increasing their share of the domestic market and possibly expand abroad.

Fiat is also trying to position itself to obtain an ownership stake in GM’s European affiliate Opel. The plan, which includes the other GM subsidiaries in Europe – Vauxhall in Britain and Saab in Sweden, would create a new global auto company with annual sales of up to 7 million cars and €80 billion ($106 billion) in revenues, which would secure Fiat a winning position in the post-crisis market.  The move however is likely to face political hurdles, as neither the German nor Italian governments would like to deal with the job losses (an estimated 8,000-9,000 jobs) likely from such a merger, particularly not in an election year (Germans vote this fall).

According to press reports, Berlin issued a list of conditions for Fiat, which includes stating where the headquarters would be located, where the taxes would be paid, the number of expected job losses and the future of Opel plants in Germany. GM though has the final say in assessing Fiat’s offer. Yet, the German economic minister suggested that Fiat needs German state credits in lieu of adequate financing, which might increase the German government leverage. However, supporting the formation of a global car maker with the German government’s credit guarantees may enrage other German carmakers such as the VW Group, BMW and Mercedes-Benz.

The pressure on domestic jobs has increased the political importance of responding to the automakers woes in many countries. In February, France raised protectionist fears after introducing state aid for the domestic car makers in return for an unwritten pledge to keep jobs and production at home. It posed a test for the EU’s single market rules and triggered an angry response from the Eastern European countries that would be hurt the most by the measure. Other countries like Argentina and Russia have increased restrictions on auto or parts imports in an attempt to support domestic industries. These might actually have the opposite effect; those in Russia hurt the business of used car sellers.

However, some government attempts to stoke auto demand may well erode future demand. So-called ‘cash for clunkers’ deals in which governments provide incentives for consumers to trade in their old cars for new (and often more fuel efficient) ones, have had the desired effect, boosting auto sales in countries like Germany and China for the types of cars targeted. These measures are helping to erode the inventory of manufacturers in a relatively orderly manner, but may be deferring the adjustment process that the automakers face. Moreover, rising unemployment is likely to weigh on consumption especially of large credit-dependent purchases like cars.

The bankruptcy also has significant repercussions on the corporate bond market. Chrysler’s bankruptcy filing was preceded by tough negotiations among creditors and the government to conclude an out of court restructuring in which lenders would receive 29 cents on the dollar in cash in exchange for wiping out about $6.9 billion of Chrysler’s debt. A group of about 20 secured creditors refused to sign off on the deal, arguing that their stake was worth more and demanding that their seniority rights be observed. However, recent empirical evidence shows that as default rates increase, recovery rates are falling fast in this cycle. Moody’s reported that in the past seven months, completed CDS auctions resulted in a recovery rate of 30 cents on the dollar for loans and about 15 cents on the dollar for bonds compared to 85 and 70 cents on the dollar, respectively, for all of 2008. The latest research by Edward Altman yields similar results stressing that distressed exchanges to avoid bankruptcy have surged since 2008 and that they usually yield significantly higher recovery rates to participating bondholders. In fact, S&P warns that due to loose covenants and missing early warning triggers, the losses even for secured creditors in this cycle might turn out to be substantial if a company cannot reorganize and liquidate.

Henry Hu from Texas University points to the ‘empty creditor’ phenomenon to explain why some lenders prefer to hold out and force a bankruptcy seemingly against the company’s and thus their own best interest. In short, creditors with enough credit default swaps may simultaneously have control rights and incentives to cause the debtor firm’s value to fall. And if bankruptcy occurs, the empty creditor may undermine proper reorganization, especially if his interests (or non-interests) are not fully disclosed to the bankruptcy court. See: Distressed Debt Investors Dictate The Terms: How Big An Issue Are ‘Empty Creditors’ With CDS Hedges? Another example is the case of the Kazakh bank BTA. Gillian Tett reports that Morgan Stanley in mid-April called for repayment of a loan thus forcing the already troubled lender into partial default. The fact that just after calling the loan, Morgan Stanley demanded ISDA to initiate a CDS settlement of contracts written on BTA, exposing Morgan Stanley to the ‘empty creditor’ criticism even if many details are missing. Dynamics of this kind make defaults more likely and need to be taken into account when forecasting the severity of the current corporate default cycle.

But are credit markets finally thawing? Indeed, corporate bond issuance has picked up substantially since December especially in the high-yield segment amid tighter spreads since the immediate Lehman aftermath. On a more cautious note, the IMF notes that given shortening credit lines and still tight bank lending standards (confirmed in the April Bank Loan Officer Survey), corporations are taking advantage of this window of opportunity to refinance themselves in the bond market despite substantially higher costs. An additional factor fueling this frontloaded corporate bond activity is the likely future crowding-out by sovereign and government guaranteed debt. While the high-yield segment has returned 17.4% YTD in 2009, the fate of Chrysler and GM shows that the default rate may not yet have reached its peak.

Also in the Monitor:

‘Detroit Of Europe’ Hit By Slowing Auto Production

South African Auto Industry Driving Off Course: 43% Vehicle Sales Plunge

As The Japanese Auto Industry Goes, So Goes Japan’s Economy?

14 Responses to “The Impact of the Chrysler Bankruptcy”

MM CAMay 8th, 2009 at 1:32 pm

repost: NO JOBS! As I have stated previoulsy they keep adjusting previous months upwards. Both March and FEB were adjusted up by approx 30,000 jobs. they are now counting Census workers as new jobs and thegreat pay rate of 10.00 an hour- roughly 72000 jobs. I suspect they “purposley” lowered april to 540K job loss to ride the WAVE of GOOD NEWS about the banks only needing 75 Billion. this way they show job loss going from 699k to 540k! Thats great news for stocks – LOL- but what about the 540K who lost thier jobs. And now with Chyrslar shut down and GM headed that way Job Loss will continue. We are on pace to lose 7 million Jobs this year and that is the offical number. And how many ahve been created?NO JOBS equals more foreclosures and more people not payign thier mortgages. And it means less consumption.If one looks at the stress tests on the banks the risk is closer to 500 Billion as more and people cannot pay thier mortgages and CRE tanks. Bottom line as Roubini has stated over and over the Banks are Insolvent.Bad news has been all over the past 2 months, its just harder to quantify it because the Devel is in thedetails, meaning the banks balanace sheets and their fancy accounting methods and all with the Govt OK to do so.Yet the market keeps going up… What goes up must come down and it would be nice if the everyone would just give eup on watching the market to tell us how we are doing.We are not doing well, NO JOBS, 60 million without health care, 35 million on Food stamps, Auto industry 1/2 of what it was, Banks ripping people off with high interest, fees, cutting credit lines, People stnading in line and gettingangry because they cant get thier FREE OPRAH Chicken for KFC….. Stores closing all over, Housing still dropping, 20 Million unocupied Housing units, 2 TRILLION 2009 FED Deficit, State and local Gov’ts on verge of bankrupticies, Schools and Edcuation all over getting cut…AGAIN NO JOBS and NO JOBS in sight from what i see…Hide reply Reply to this comment By MM CA on 2009-05-08 08:15:04check out ZH’s postThe Real Memo Out Of The Bureau Of Lies And Statistics to this comment By Hayes on 2009-05-08 09:26:01

JLarkinMay 8th, 2009 at 1:35 pm

Re: no jobsAnd as I’ve stated here before, most do not realize the width and depth of the automotive supply chain. Auto plant closings will drive hundreds of suppliers into the red, not to mention local small businesses that used to supply these plants with everything from cleaning chemicals to metal shelving, etc.

GuestMay 12th, 2009 at 9:09 pm

Yep. It is hurting use in a very big way and we aren’t Tier One; more like Tier three for most an A.M. for more. The plant I am in has 5 major production lines composed of various minor cells. In 2K4-2K5 we couldn’t run enough hours in the week PERIOD. We now run 3-4 lines one shift, 2 cells 2 shifts. One whole line (the plants largest both in physical size and volume is basically shut down in Jan won’t start again until late July-Aug at best…. if ever again? Months ago I had vendor reps cold calling me basically begging me to buy capital equipment. No more calls and most of them are out of business. We have cut everything from big expenditures to the lights we use to the shop rags and rugs we used to have cleaned and replaced. I can no longer purchase anything over $50 without approval. Put this in perspective; almost exactly a year ago I speced out and purchased a $120K machine without so much as anyone saying anything short of ‘Did you get that ordered yet?’! Times have changed and they are not at all pleasant. But as mentioned above sh*t rolls on down hill and GM is a freakin mountain. The snowball effect (read sh*tball) will be incredibly bad.

MM CAMay 8th, 2009 at 1:44 pm

i reposted and aologize for the way the belwo sounded…NO JOBS- so offcially they are saying 14 million out of work now.The U6 Rate is at 16% and now includes over 25 million AMERICANS with NO JOBS.At this rate we will have 30 Million people out of work by end of 09.Folks they are Bull shitting us and they are stealthing whatever we have leftand are intent on screwing us and out kids for decades to come.Oh – dont forget the unfunded liabilties of Medicare and SS to the tune of 60 Trillion,We can kiss that goodbye within 10 years…. at least ill be gone in about 25 years… buti worry for my kids and all the youth of this country, including the spoiled 20 and 30 somethingswho have no clue in general…How the F..k do they put 25 million people to work…We are so F..ked payroll employment continued to decline in April (-539,000), andthe unemployment rate rose from 8.5 to 8.9 percent, the Bureau of Labor Sta-tistics of the U.S. Department of Labor reported today. Since the recessionbegan in December 2007, 5.7 million jobs have been lost. In April, job los-ses were large and widespread across nearly all major private-sector indus-tries. Overall, private-sector employment fell by 611,000.UnemploymentThe number of unemployed persons increased by 563,000 to 13.7 million inApril, and the unemployment rate rose to 8.9 percent. Over the past 12 months,the number of unemployed persons has risen by 6.0 million, and the unemploymentrate has grown by 3.9 percentage points. (See table A-1.)Unemployment rates rose in April for adult men (9.4 percent) and blacks(15.0 percent). The jobless rates for adult women (7.1 percent), teenagers(21.5 percent), whites (8.0 percent), and Hispanics (11.3 percent) were littlechanged over the month. The unemployment rate for Asians was 6.6 percent inApril, not seasonally adjusted, up from 3.2 percent a year earlier. (Seetables A-1, A-2, and A-3.)Hide replies Reply to this comment By MM CA on 2009-05-08 08:35:50Whatever happened to all the ‘service industries’? Can’t they accomodate the 25 million?Hide reply Reply to this comment By Anonymous on 2009-05-08 09:07:39The service industry requires that people first earn money doing productive, real work, non-service type jobs; i.e manufacturing, farming etc. Then those honest hard workers may have some money to pay service workers.Reply to this comment By Hubbs on 2009-05-08 09:28:17 I don’t want to start a fight, but I take exception to your comment about my generation (the 20-30 year olds). Most of us are just doing our best, trying to get along, and live in a world that YOUR generation created.As President Obama loves to say, we inherited your mess – so instead of complaining about how spoiled we are, recognize that we make up a large part of the 8.9% of people who are out of work, and help us figure out how to get our country back on track, so that we can leave a better world for our children (since your generation won’t be able to do so for us).Hide reply Reply to this comment By 30inAugust on 2009-05-08 10:15:14@30inAugustIt is not starting a fight when a respectable person calls someone down for making an irresponsible and sweeping remark.It is important to realize that there are bad eggs in every generation. I am sure that you know at least a few in yours.@MM CATo your remark “as a concerned parent”, it could be well argued that many (maybe most)in this country are spoiled and clueless, especially in the “parent” demographic. Look at this mess, who created it, who is benefiting from it, and who is continuing to do further damage. I would venture to say that many in 50+ crowd falls in the same category as you describe the 20-30 year olds.Reply to this comment By SimpleIsBest on 2009-05-08 10:46:30 Don’t forget the millions of May college graduates that will be out of work. But conveniently this number won’t be in U3 unemployment.Reply to this comment By Guest on 2009-05-08 10:44:29 Next time, leave out the 30 somethings when you criticize the younger generation.The 30 somethings are in a different generation from the 20 somethings.The entitled or as you call “spoiled” generation you refer to arethe millennials – born after early 1980’s. Most 30 somethingshad to work hard to go to college w/o Mommy and Daddy and are notthe later childern of the boomers that received the spoils from the boomers.Hide reply Reply to this comment By Guest on 2009-05-08 11:11:04How about criticizing the generations that CREATED the problem. That would be the boomers…Reply to this comment By Guest on 2009-05-08 11:27:50 let me restate… I feel sorry for the younger generations, there is a lot of truth in that the parents of thelast 20 years did indeed not do enough to inform the younger generation. 2 parent working families, the needfor greed by the “boomers” a totally and ineffective Educational system that has just deteriorated over the last 20years… to those offended, it was not intentional and kudos to those that do and are paying attention andtrying to better themselves. My daughter graduates from college in 2 weeks, she Double majored and completed 4 yearsand will only be 21 at the time of her graduation, but their are NO JOBS at this point other than 20k-30k jobs forher and that is not why she went to school. I am very connected with those in 20-30’s and i do sense their affinityfor Ipods, Gaming, not valuing saving, not fully understanding hard work, they expect to have what thier parents have orhad, but not fully understanding all that is going on now and wanting to help help effect change. the boomers and 40,50,60 somethings that created this absolute disaster and theft of our culturaland finanical morals should be held accountable, but again it was not all of us either. in fact most of feel as if we have been swimming upstream the past 10 years or so… in order to fix any problem you have to understand it first. and I’ll end with thier are NO JOBS and NO GOOD JOBS on the horizon so how do we FIX that?Reply to this comment By MM CA on 2009-05-08 13:39:31

MM CAMay 8th, 2009 at 2:01 pm

Dont miss Roubini’s previous post… He just went back into ATTACK MODE…. As if he was lying in wait the past 2-3 weeks with not much to say….He sees the same problems too with NO JOBS! Reasons Why the Stress Tests Are “Schmess” Tests and Why the Current Muddle-Through Approach to the Banking Crisis May Not SucceedEmail PrintShareDelicious Digg Facebook reddit Technorati Nouriel Roubini | May 8, 2009What shall we make of the recently announced results of the stress test? Are they credible? Will they restore confidence in our battered financial system? Will the current approach to resolving the financial crisis work, be effective and minimize the fiscal costs of the financial bailout?For a number of reasons these results are a significant underestimate of the capital/equity needs of these 19 large US banks. Also this underestimate of the losses and the current “muddle-through” approach to the banking and financial crisis may accelerate the creeping partial nationalization of the US financial system, exacerbate moral hazard distortions, not resolve the too-big-to-fail problem, increase the fiscal costs of this financial crisis, make the credit crunch last longer and lead some near insolvent financial institutions to become zombie banks. Let me explain in ten points why I hold such views (see also my two recent op-eds with Matt Richardson in the WSJ and the FT):

GuestMay 12th, 2009 at 8:48 pm

The fact is that the US economy (read: grassroot level peoples disposable income) is not able to support the 3 auto makers at the old levels of manufacturing.Perhaps a partnership with Fiat will provide new markets for Chrysler but are there really any markets that Fiat is in and Chrysler is not? The only thing this will provide Chrysler is more cash but the difference between that and government money is not that major. In the end the company will have to compete with others for a much smaller consumer base.

GuestMay 12th, 2009 at 8:59 pm

From Alan Abelson’s column this week in Barron’s:PERHAPS THE MOST ELOQUENT expression of how delusional Wall Street has become was its response to Friday’s report on what happened to employment — or, more importantly, unemployment — in April. Payrolls shriveled by 539,000, less than the 550,000 to 600,000 guesstimates of the seers as well as March’s initial tally of 633,000. That was enough for the choristers to start humming Happy Days Are Here Again.A slightly more careful look suggests rather emphatically that they’re not. The unemployment rate extended its doleful rise, hitting 8.9%, the highest level since 1983. The jobless ranks have swollen by 5.7 million since the recession got underway in December 2007, and there are now 13.7 million people out of work.Moreover, our favorite measure of unemployment — favorite because we think it a truer gauge — is the Bureau of Labor Statistics’ U-6, which includes the likes of workers laboring part-time because they can’t land full-time jobs, rose to a fresh peak of 15.8%. That means 24.7 million people are effectively unemployed. It’s a figure that doesn’t get too much notice — maybe it’s just too depressing — but it should.For that matter, bad as it is, 539,000 doesn’t do justice to the severity of the payroll shrinkage. For one thing, it was puffed up by the 72,000 federal census takers signed on by Uncle Sam. And for another, it includes 226,000 supposed jobs, or 60,000 properly adjusted, courtesy of what David Rosenberg calls the Alice-in-Wonderland birth/death model. Ex this pair of extraordinary items, he points out, the headline number would approach 670,000.In one of his valedictory scribblings (David’s leaving Merrill Lynch and returning to the glories of his native Canada and money management), he also notes that private-sector employment sank by 611,000 in April, and did so across a wide swath. “The data,” he contends, “just don’t square with the conventional wisdom permeating the investment landscape.”Take the notion that we’re enjoying a commodities boom; If so, it seems more than passing strange that natural resources shed 11,000 jobs last month. Or, how do you reconcile the burst of enthusiasm for leisure/hospitality stocks with 44,000 busboys, bell captains and bartenders being laid off? Or retailers’ giving pink slips to 47,000 workers — atop the 167,000 slots they let go in the first quarter — if they thought anything more than the timing of Easter underpinned their April results?Looking ahead, David scoffs at the idea that the “jobs data are about to get better because the markets have enjoyed a nice two-month rally.” Among the reasons he’s skeptical: the still record-low workweek, at 33.2 hours; the 66,000 downward revision to the back data (which, he avers, tends to feed on itself); the 63,000 slide in temp-agency employment; and the high levels of both initial and continuing jobless claims.All of which, he believes, foreshadow a further 550,000 payroll plunge when the May data roll out early next month.To David, as to us, the present buoyant mood on the Street is obviously more the result of rose-colored glasses than of green shoots.

GuestMay 13th, 2009 at 10:11 am

Roubini never seems to talk about the VIX. It’s just under 33 right now, and it seems to be trending lower and lower. Surely this is a good sign for the stock market… but does it say anything about the actual economy? What do you guys think?

GuestMay 13th, 2009 at 7:16 pm

Seems to me that it means the majority of those trading the market are sure of their trades, whether from knowledge or foolhardiness or experience–and possibly means that a lot might be sitting on the sidelines, either because they’re dealing with or avoiding losses. Doesn’t necessarily reflect anything at all about the economy.