naked capitalism

By Edward Harrison of Credit Writedowns

Yves is going to be in a light posting mode, so I will be posting some links and a few posts for your reading pleasure. The first one is an update to some thoughts that Yves had on GMAC on the 27th.

By the way, where is Jesse? I want to see him posting here too. (hint, hint)

And you thought the bailouts were over and market discipline might be restored.  Not a chance – the bailouts will continue, come hell or high water. The latest demonstration of this is GMAC, where the government will now be majority owner. GMAC has officially been nationalized. Now the government is running auto financing in addition to running the companies making the cars.

Below is a quote from the Financial Times. Notice the parts I have bolded.

GMAC, the car financing company, is set to receive up to $5.6bn in a new capital injection from the Treasury, filling a hole identified in the “stress tests” earlier this year and paving the way for the government to become the majority shareholder.

The company, formerly the financing arm of General Motors, was one of 19 institutions to submit to a capital adequacy programme led by the Federal Reserve and completed in May. That determined that GMAC had a shortfall, which will now be provided by the government in the form of preferred equity, according to two people familiar with the situation.

As widely expected, GMAC has been unable to raise the necessary capital in the market and the company – which will take on fresh lending responsibilities when it merges with Chrysler Financial – was seen as vital to the government-led restructuring of the US automotive industry and deserving of more funds from the $700bn troubled asset relief programme.

“When we laid out the stress tests, we expressly said that some additional Tarp capital may be needed given the severity of the downturn – this capital need is not new information,” said an administration official.

“But the transparency brought about by the stress tests allowed all other institutions to raise the capital required by the stress tests to ensure these firms could withstand a more severe economic scenario than anticipated,” the official said.

What you should be reading from this statement is the following:

• All the firms identified as lacking capital under the stress tests were given time to raise funds in the capital market to meet the shortfall.
• Some firms did meet the shortfall and they are now free to do as they please.
• Others have not and we the government are now going to take a more muscular approach in dealing with them.
• GMAC is the first public example of our flexing our muscles.
• But there surely are/will be other examples; some may already be happening in secret.

If the US government is going to throw its weight around to deal with financial firms short of capital, I would personally prefer they try a process which allows these firms to fail whereby equity and debt holders suffer consequences that are consistent with taking market risk.  Bailing out GMAC is a moral hazard plain and simple.

But, what’s done is done. The GMAC case does, however, give a lot more credence to my view that Citigroup’s actions are being dictated by government. As I indicated when the stress tests were done in April, firms were going to get some time to raise capital and if they didn’t, the government was going to move on to Plan B (debt-for-equity swaps, nationalization, and FDIC seizure). Expect to see more indications that other financial companies with capital shortfalls are falling under the government umbrella.

The numbers aren’t as impressive as AIG’s but the general premise is the same. The automaker’s financial service arm it asking for a third taxpayer-provided cash transfusion. Might help if someone stanched the bleeding first.

But no, bleeding is part of the game plan. The reason for more dough to GMAC is so GM and Chrysler can continue to finance auto purchases, not as a result of greater than expected losses on its existing portfolio. So this is cash for clunkers under another brand name.

From the Wall Street Journal:

GMAC Financial Services Inc. and the Treasury Department are in advanced talks to prop up the lender with its third helping of taxpayer money…

The U.S. government is likely to inject $2.8 billion to $5.6 billion of capital into the Detroit company, on top of the $12.5 billion that GMAC has received since December 2008, these people said. The latest infusion would come in the form of preferred stock. The government’s 34% stake in the company could increase if existing shares eventually are converted into common equity.

The willingness by Treasury officials to deepen taxpayer exposure to GMAC reflects the troubled company’s importance to the revival of the auto industry….

Federal officials also are moving to shore up GMAC’s ability to fund its daily operations, with the Federal Deposit Insurance Corp. telling the company Tuesday the agency will guarantee an additional $2.9 billion in debt, according to people familiar with the discussions. The FDIC guarantee will make it easier for the company to sell debt to investors. The FDIC backed $4.5 billion in GMAC-issued debt earlier this year.

The FDIC approval came just four days before the expiration of the regulator’s program that guarantees debt issued by certain banks. It ended months of tense negotiations between GMAC and regulators. Without a deal, the company would have been forced to further reduce its lending volume. New-car loans by the company tumbled 55% to $5.6 billion in the second quarter from a year earlier.

The US tonight imposed steep tariffs on tires, a move directed against Chinese imports. From the Wall Street Journal:

The Obama administration will put steep import duties on Chinese passenger and light truck tires, responding to what the U.S. International Trade Commission determined to be a surge of Chinese tire exports that has rocked the domestic U.S. tire industry and displaced thousands of jobs, U.S. Trade Representative Ron Kirk announced Friday night.

The announcement of 35% import tariffs, which would decline to 30% in the second year and 25% in the third, comes at a sensitive time. The heads of state of the 20 largest economies arrive in Pittsburgh in less than two weeks for a summit of the Group of 20, amid rising trade tensions and looming economic disputes. The United States needs China to help float a U.S. deficit expected to reach $1.56 trillion this year. President Barack Obama is also likely to seek new sanctions against Iran to combat its nuclear program, and China’s vote on the United Nations Security Council is pivotal….

Between 2004 and 2008, China’s tire production capacity surged by 152% and is projected to jump an additional 16% by 2010. At 235.2 million tires, China’s production capacity in 2008 was more than three times greater than its shipments to its home market. U.S. imports of tires from 2004 to 2008 jumped from 14.6 million to 46 million. China’s share of the U.S. tire market surged 255% in that time, to 16.7% from 4.7%.

Meanwhile, four U.S. tire plants closed in 2006 and 2007. Three more are planned for closure this year. There were 5,168 fewer workers in the U.S. tire industry in 2008 than there were in 2004.

The New York Times stresses that this is the first time the US has invoked a specific safeguard included as a condition of China’s entry to the WTO:

Under that safeguard provision, American companies or workers harmed by imports from China can ask the government for protection simply by demonstrating that American producers have suffered a “market disruption” or a “surge” in imports from China.

Readers are welcome to correct me, but it looks as if Team Obama has chosen to take a stand on a pretty narrow matter. Given this Administration’s history of brave talk combined with cautious to no real action, this is more likely to be meant to be a concession to labor than a shot across China’s bow.

But it is easy to see that the Chinese may view this differently, particularly since given the precedent set by relying on a heretofore unused mechanism.

And it is hard to know what the Chinese will do. On the one hand, China is clearly wedded to mercantilist trade policies and it is hard to see them making serious changes when their economy is flagging. So they could see this as a frontal challenge at a time not of their choosing. The rhetoric from the Chinese, at least as reported in China Daily, says the Chinese regard this move as an affront, but the Chinese so frequently go into high dudgeon mode, it is hard to tell when they are merely posturing and when they are quite serious:

Experts have called the proposal “unreasonable and unfair” and said that Chinese tire manufactures “largely do not compete against their American counterparts in the US.

Chinese tires have been “targeting the budget and no-brand replacement tire market for US consumers with severe budget constraints,” a sector that the US tire makers
gave up long ago and are unwilling to enter again, said China Chamber of Commerce of Metals, Minerals & Chemicals Importers & Exporters in a letter to President Obama….

But the Chinese government will not turn away from issues that will harm the interests of Chinese industries. Officials from the Bureau of Fair Trade for Imports & Exports with the Ministry of Commerce said China has prepared an assortment of plans for countering different possible results from the Obama administration.

“We will surely protect local tire manufacturers from being hurt when needed,” they said.

China will likely take retaliatory measures against the US industries. The Tire Industry Association has petitioned China to launch restrictive measures.

Moreover, experts suggested the Chinese government clamp down on US auto imports. During the first half, China imported more than $1 billion worth of automobiles from the US, up by 9.1 percent year-on-year.

“It’s unfair for Chinese laborers, after we made the American automakers happy, if the US launches sanctions against Chinese tire imports,” said He Weiwen, a council member of the China Society for American Economy Studies.

Stay tuned. This could get interesting in a bad way.

It looks like I am being proven wrong on this one. I was of the view that the GM bankruptcy could get bogged down in court, since it had many more parties who could protest the use of section 363 to expedite asset sales than Chrysler did, some of whom also appeared to have better arguments.

Now it was a given that the company would jurisdiction-shop and pick a favorable venue. so the progress so far isn’t completely unanticipated. But I had also assumed that the unhappy creditors would also look for friendly judges, and at least some of them would be successful enough to throw some sand in the gears. That does not appear to be happening.

From Reuters:

A U.S. judge on Sunday approved General Motors Corp’s bankruptcy sale, in a move that will allow the company’s most profitable assets to exit bankruptcy protection under government ownership….

Under the deal, New GM will operate the best parts of the old company, including its Chevrolet and Cadillac brands, with a less-expensive workforce, smaller dealer network, and much less debt.

The “old GM,” which includes unpopular brands and unneeded factories and liabilities, will remain behind in bankruptcy court to be liquidated.

The U.S. Treasury has agreed to provide $60 billion in financing to the new company, including a proposed $50 billion that would give the U.S. Treasury a 60 percent stake in the company.

The UAW would gain a 17.5 percent stake, the Canadian government would own about 12 percent, and GM bondholders would be expected to obtain about 10 percent of the new company.

At a three-day sale hearing that concluded July 2, some small bondholders had objected to the deal, but no other bidders presented an alternative, and the 100-year-old automaker warned of “catastrophic” consequences to the auto industry if the sale was blocked.

A successful sale of GM’s main assets is the second big victory for the Obama administration’s auto task force. It helped broker the sale of Chrysler LLC to a group led by Italy’s Fiat SpA last month.

Readers may recall that we’ve been of the view that the expedited bankruptcy planned for GM would run into more snags than its advocates assume. We have not felt as strongly on that point as far as Chrysler is concerned, since that deal has vastly fewer moving parts.

Nevertheless, a hold-up on Chrysler illustrates the sort of impediments that need to be cleared up. The number three automaker has not yet secured the right to use all the tools it needs to manufacture cars. That is not to say Chrysler won’t get this matter resolved, but the sticking point illustrates how messy big bankruptcies are.

From Bloomberg (hat tip reader Scott):

Chrysler Group LLC, created out of the best assets from its bankrupt predecessor, can’t make new cars until it gets needed tools tied up in legal disputes,….

The streamlined carmaker, created two weeks ago, may need mediation to resolve disputes over access to tools, Frank Oswald, a Chrysler lawyer from Togut, Segal & Segal LLP, told U.S. Bankruptcy Judge Arthur Gonzalez in Manhattan today. Oswald was updating Gonzalez at a hearing on disputes over “cure costs,” or amounts owed to suppliers to resolve contracts signed before Chrysler’s bankruptcy.

“We don’t want to have a situation where, after rushing to get the sale closed in 42 days, Newco is unable to start up production because we don’t have necessary parts,” Oswald said, referring to the new Chrysler entity.

Of 500 objections to Chrysler’s proposed cure amounts, only 70 remain unresolved, Oswald said in an interview after the hearing. He said he doesn’t know of specific tools Chrysler Group is missing. Oswald said lawsuits may need to be filed “to the extent that there are recalcitrant suppliers.”

Submitted by Edward Harrison of the site Credit Writedowns.

We have just learned that Fiat has successfully completed its deal with Chrysler.  This means that the bankrupt ‘Old Chrysler’ will now have far fewer cash and assets available for creditors and that it will be liquidated with large or total losses likely for creditors.  Dissident creditors tried to get their case heard by the Supreme Court.  But this was rejected, paving the way for the Fiat deal. 

Key to why things turned out as they did is the use of section 363 of the bankruptcy code, which allows a company to sell assets without creditor approval and before a re-organization plan can be submitted.  The sale produces cash available to creditors in the eventual liquidation of the company. The sold assets can continue to operate as before, but in a re-organized fashion.  This is exactly what the Obama Administration wanted for Chrysler. So, in the case of the government versus bondholders count round one to the government.

Now, it’s time to turn to General Motors. This is a very important case because GM is such a big player in so many arenas. Think of Chrysler as a  test run of GM, the real US auto emergency.  A bankrupt GM that does not receive the same quick section 363 treatment that Chrysler received would be a very nasty  shock to the U.S. and global economy. 

The problem is that General Motors is a whole different case altogether.  And I am not so sure the government is going to be successful here. Here’s why. While the Chrysler deal involved a sale of the principal assets, the GM bankruptcy looks more like a stealth re-organization which violates the spirit of section 363. Back in 2004, Daniel Glosband, a bankruptcy expert at the law firm Goodwin Proctor reflected on this issue at the site FindLaw. (emphasis added below)

Advantages of a Section 363 sale include speed, transfer of assets free and clear of encumbrances and interests, transfer of restricted contracts and avoidance of exposure to claims under fraudulent transfer laws. For a seller, the Section 363 process eliminates director and officer exposure for the sale and limits exposure for breach of representations and warranties. Cosmic balance, however, requires a few clouds to accompany the silver linings.

Traditionally, the sale of a business in chapter 11 was accomplished through a plan of reorganization that identified and dealt with each class of creditors and equity holders. The sale plan was described to the affected creditors and equity holders in a prospectus-like disclosure statement and put to a vote. Bankruptcy law required acceptance of the plan by specified majorities of affected parties, a cumbersome process that lasted for several months and sometimes several years. Initially, courts were skeptical of Section 363 sales that circumvented the protective reorganization plan process. Early cases required the debtor to prove that a sale outside of a reorganization plan was necessary, for example by showing that the debtor’s business had insufficient cash flow to survive the full plan process. Lately, however, the Section 363 sale, which can be completed in as little as two to three months, has become the preferred method for sales of distressed businesses.

Clearly, if the courts decide that the government is trying to circumvent the normal Chapter 11 process by invoking section 363, you are going to have a problem.  The Obama people are going to argue that GM is dependent on government monies to exist and that it cannot ‘survive the full plan process.’  But, creditors are going to contest this case and they may have more success than they did at Chrysler.

Stay tuned.

As for Fiat, the last paragraph of the FindLaw article describes quite well why their stock has popped on the news of a successful Chrysler deal.

The goal of the purchaser at a Section 363 sale is to take advantage of the financial distress of the seller and the power of the Bankruptcy Code to make a safe, profitable investment. While a Section 363 sale is a complex exercise with risks for the unwary, it can be an efficient avenue for a well-prepared buyer to acquire a financially troubled business.

This is now getting interesting. Conventional wisdom among most bankruptcy commentors was that the objections to the Chrysler deal were not strong from a legal standpoint. Thus the fact that the Supreme Court has decided to stay the deal comes as a surprise, particularly to Team Obama, which has put its prestige and considerable muscle behind getting the deal done. And any complications or delay with Chrysler puts the much larger and more complex GM bankruptcy at risk.

The deal with Fiat requires that the transaction close by June 15.

From Bloomberg:

Justice Ruth Bader Ginsburg ordered a delay in Chrysler LLC’s planned asset sale to a group led by Italy’s Fiat SpA while the U.S. Supreme Court considers a request for a longer postponement that might scuttle the deal…. Indiana pension funds and consumer groups asked for an order blocking the sale while the Supreme Court decides whether to take up the funds’ appeal.

Ginsburg’s one-sentence order, which came only in the pension fund case, said the bankruptcy court orders allowing the sale “are stayed pending further order” of the Supreme Court.

Chrysler said in court papers that the sale is necessary to stanch losses of $100 million a day.

Yves here. I would assume Chrysler made a more compelling from a legal standpoint than “we really need the deal done.” But maybe not (apologies for not independently checking the filings, but Internet access continues to be dreadful). From the Wall Street Journal:

Ahead of the decision, Chrysler and the federal government warned such an intervention might lead to the liquidation of the auto maker….

“There is no other bidder for Chrysler’s assets,” an attorney for Chrysler said in a legal brief. “The only other viable alternative for Chrysler is to proceed with a liquidation that will return no more than $800 million for all constituents.”

The appeals were filed over the weekend after the Second U.S. Circuit Court of Appeals in New York approved the acquisition of most of Chrysler’s assets by a group led by Fiat. The appeals court stayed the sale until Monday so the funds could make their case to the Supreme Court. A U.S. bankruptcy judge early last week approved the transaction…

A lengthy delay for a Chrysler-Fiat transaction would jeopardize jobs and tarnish President Barack Obama’s efforts to save Chrysler and General Motors…

According to a Chrysler filing, the Indiana pensions challenging the deal are set to lose $5 million dollars under the terms of the Fiat purchase. The pension funds, in their own filing, put their losses in the “millions of dollars.”

The pension funds argued the sale, orchestrated by the U.S. and Canadian governments under bankruptcy laws, was illegal and that the federal government exceeded its bailout authority with its involvement. “The negative economic consequences of permitting an unlawful sale to proceed may well over time dramatically outweigh Chrysler’s short-term harm,” the funds said.

Update 3:00 AM: The commentary in the media suggests that the prevalent view is that the deal will still go ahead, and with not much delay. From the New York Times:

The delay could be resolved by Tuesday, freeing Chrysler to join forces with Fiat. But if the court decides to hear an appeal that lasts weeks or months, it could put Chrysler at risk of going out of business. Fiat, the only company to show an interest in acquiring most of the assets of Chrysler, can walk away from the deal if it is not concluded by June 15.

In a broader context, such a decision would also give the justices an early opportunity to consider the scope of the wide-ranging but not unlimited authority that Congress granted the president to address the economic crisis…..

Several legal experts noted that the action should not be interpreted as a signal of the full Supreme Court’s intentions. And it is not unusual for the court to issue a stay while it considers whether to hear a case, but it rarely grants the kind of expedited hearing on the merits that the Indiana funds are seeking.

“I’m astonished she even stayed the sale, but I find it quite encouraging, because I find it important that they take a close look at the issues,” said David A. Skeel Jr., a law professor at the University of Pennsylvania. “I think it’s a good move. My guess is in the end they will approve the sale.”

The Financial Times noted the upbeat reading from Team Obama versus the possibility of the deal gong pear shaped:

…people close to the Obama administration’s car industry task force and Chrysler suggested that the stay was not a catastrophe and that the sale was likely to proceed as planned. “We understand this to be an administrative extension designed to allow sufficient time for the Court to make a determination on the merits of the request for a stay,” said an administration official….

Elena Kagan, US solicitor-general, said in a brief opposing the Indiana funds’ request that unless the Supreme Court was able to complete a full review of the Fiat deal by the deadline, a stay order “could itself have the effect of preventing the sale from going forward”.

The last person one might expect to criticize the Obama Administration bailout of GM is a unapologetic liberal like Robert Reich, labor secretary under Clinton. Yet he does precisely that in today’s Financial Times.

And his logic is similar to the arguments made here and elsewhere against the bank rescue operations. Unlike some other commentators, who would be happy to Big Auto fail and devil take the hindmost, Reich believes the social cost would be so great (if nothing else, the whackage to GDP), that means to address the fallout are warranted, But he strongly disagrees with the bailout program, seeing it as wasteful and intellectually dishonest.

Bizarrely, the rescue, by throwing dollars at the problem, somehow looks more surgical and hands-off. Indeed, in the various announcements of the imminent GM bankruptcy filing, the powers that be have gone to some lengths to say they will be a hands off 60% owner. Yet the sort of active measures that Reich calls for, such as retraining programs, extended unemployment (and I would add relocation aid) weirdly raises the specter of “big government” in the public mind more than just writing very large checks. So we’ll go for costly and indirect rather than focused, cheaper, but more moving parts.

From the Financial Times:

As president of General Motors when Eisenhower tapped him to become secretary of defence in 1953, “Engine Charlie” Wilson….asked whether he could make a decision in the interest of the US that was adverse to the interest of GM, he said he could.

Then he reassured them that such a conflict would never arise. “I cannot conceive of one because for years I thought what was good for our country was good for General Motors, and vice versa. Our company is too big. It goes with the welfare of the country.”….

In 1953, GM was the world’s biggest manufacturer…It generated 3 per cent of US gross national product….It was also America’s largest employer, paying its workers solidly middle-class wages with generous benefits.

Today, Wal-Mart is America’s largest employer, Toyota is the world’s largest carmaker and General Motors is expected to file for bankruptcy. And Wilson’s reassuring words in 1953 now have an ironic twist. There will be little difference between what is good for America and for GM because it is soon to be owned by US taxpayers who have forked out more than $60bn (€42bn, £37bn) to buy it.

But why would US taxpayers want to own today’s GM? Surely not because the shares promise a high return when the economy turns up. GM has been on a downward slide for years. In the 1960s, consumer advocate Ralph Nader revealed its cars were unsafe. In the 1970s, Middle East oil producers showed its cars were uneconomic. In the 1980s, Japanese carmakers exposed them as unreliable and costly. Many younger Americans have never bought a GM car and would not think of doing so. Given this record, it seems doubtful that taxpayers will even be repaid our $60bn. But getting repaid cannot be the main goal of the bail-out. Presumably, the reason is to serve some larger public purpose. But the goal is not obvious.

It cannot be to preserve GM jobs, because the US Treasury has signalled GM must slim to get the cash. It plans to shut half-a-dozen factories and sack at least 20,000 more workers. It has already culled its dealership network.

The purpose cannot be to create a new, lean, debt-free company that might one day turn a profit. That is what the private sector is supposed to achieve on its own and what a reorganisation under bankruptcy would do.

Nor is the purpose of the bail-out to create a new generation of fuel-efficient cars. Congress has already given carmakers money to do this. Besides, the Treasury has said it has no interest in being an active investor or telling the industry what cars to make.

The only practical purpose I can imagine for the bail-out is to slow the decline of GM to create enough time for its workers, suppliers, dealers and communities to adjust to its eventual demise. Yet if this is the goal, surely there are better ways to allocate $60bn than to buy GM? The funds would be better spent helping the Midwest diversify away from cars. Cash could be used to retrain car workers, giving them extended unemployment insurance as they retrain.

But US politicians dare not talk openly about industrial adjustment because the public does not want to hear about it. A strong constituency wants to preserve jobs and communities as they are, regardless of the public cost. Another equally powerful group wants to let markets work their will, regardless of the short-term social costs. Polls show most Americans are against bailing out GM, but if their own jobs were at stake I am sure they would have a different view.

So the Obama administration is, in effect, paying $60bn to buy off both constituencies….But it is not telling anyone the complete truth: GM will disappear, eventually. The bail-out is designed to give the economy time to reduce the social costs of the blow.

Behind all of this is a growing public fear, of which GM’s demise is a small but telling part. Half a century ago, the prosperity of America’s middle class was one of democratic capitalism’s greatest triumphs. By the time Wilson left GM, almost half of all US families fell within the middle range of income. Most were headed not by professionals or executives but by skilled and semi-skilled factory workers. Jobs were steady and health benefits secure. Americans were becoming more equal economically.

But starting three decades ago, these trends have been turned upside down. Middle-class jobs that do not need a college degree are disappearing. Job security is all but gone. And the nation is more unequal. GM in its heyday was the model of economic security and widening prosperity. Its decline has mirrored the disappearance of both.

Middle-class taxpayers worry they cannot afford to bail out companies like GM. Yet they worry they cannot afford to lose their jobs. Wilson’s edict, too, has been turned upside down: in many ways, what has been bad for GM has been bad for much of America.

The New York Times discusses whether Americans will return to buying cars at the pre-bust level when conditions return to some level of normalcy. Of course, the subtext is that the US economy will get back on track later this year, when many those who anticipate growth starting 3Q/4Q, when pressed, say the recovery will be so lackluster as to be a borderline recession.

The article does point to demographics, that the baby boomers are moving into retirement, and retirees are not big on buying cars. But it still misses or glosses over a couple of key points.

One is that every country experiencing a major financial crisis suffered a permanent decline in its standard of living. It isn’t unreasonable to think that car purchases will take dent longer term. In fact, a very good slide show by David Rosenberg, until recently, chief economist for North America for Merrill Lynch, had a chart that showed the ratio of adults to cars over a long period of time (sadly, I cannot locate said chart, but I would presume it excluded the prison population). It showed a near continuous decline to its recent level of 1.2 adults for every car.

The implication is that not even that long ago, Americans lived with fewer cars, and conceivably could again. I have also been told, but do not have any stats to prove it, that car ownership has fallen sharply among the young in Japan, in part because many are “freeters” with little job security.

The flip side is that if these conservative forecasts do not come to pass, the industry would have gotten so lean that it would be coining money if Americans start buying cars in force again.

From the New York Times:

Can American drivers live without that new-car smell?

In recent years Americans appeared to be hooked on it…Now the market has collapsed by 46 percent to below 10 million, as people are making do with the cars they have, leaving the industry to debate — and worry — about what the new normal will be once the recession ends.

Some say the downturn is temporary and that sales will spring back in a few years. Others believe Americans will rethink whether they need so many cars, particularly new ones…

The Treasury Department’s advisers, who initially expected auto sales to pick up late next year, now foresee no jump in demand this year or in 2010. And even five years out, they expect annual sales to be about 15 million, still well below the peaks of this decade…

If sales do not recover, the Treasury will have to provide more financial support for G.M. and for Chrysler, which has received about $10 billion in federal aid, before they can stand on their own and the government can divest its shares…

If sales do pick up, carmakers eventually could be more profitable than they have ever been because of all the costs they have shed, said David Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich.

“After you rebound from this artificial low in demand, wow,” Mr. Cole said of the potential for auto sales and profits.

He estimates that pent-up demand for new cars is actually about 4 million vehicles higher than the current selling rate, which in April would translate to 9.3 million a year, according to Autodata Incorporated.

Others, however, point to shifts suggesting that Americans’ desire — and need — for new cars may be cooling….

“We sold to people who purchased cars by refinancing their houses,” said Wilbur Ross, the billionaire financier who has invested in steel mills and auto parts companies….

Lifestyles have changed, too. As many people move back to cities from suburbs, they are swapping three-car garages for a single parking space. Public transit use is up….

Donald Grimes, an economist at the University of Michigan, is forecasting the lowest sales for the driving-age population this year since 1970.

From 1970 to 2001, there were 0.76 vehicles sold per driver in the United States. Now that figure has dropped to 0.4 vehicles per driver, and he does not see much of a rebound in coming years.

The swift decline has spooked the industry. “I don’t think there has ever been a period in our history like this,” Josephine Cooper, Toyota’s group vice president for government and industry affairs, said of her company, which lost $7.1 billion in the first three months of the year. “It is very, very sobering.”

Submitted by Edward Harrison of the site Credit Writedowns.

I was on the BBC yesterday talking autos and my commentary was almost entirely political. So, as we await the likely General Motors bankruptcy, I think it bears discussing how political this process has been and will continue to be.

General Motors is a monster company employing a quarter million people worldwide. It sells $150 billion in cars – or at least it used to. It is not just a producer of vehicles. It is also a supplier. It has been through several joint ventures and has owned a number of foreign manufacturers, Isuzu and Opel being but two. In short, the company is a very big player, financially, economically and politically. Yet, somehow you get the impression that many in the financial media think we could just turn the lights out and go home. Witness the video below of CNBC anchors Mark Haines, Erin Burnett and Phil Lebeau and a trio of auto analysts trying to impress upon Haines how important GM is.

The GM bankruptcy is a very big deal and will have wide-ranging implications. Let me review a few of the issues here starting with the politics.

2010 elections

In the U.S., we have just witnessed an historic election that some are comparing to the election of Ronald Reagan in 1980 and Franklin Roosevelt in 1932. Indeed, there has been a sea change in the political climate here in Washington since January, with the Democrats and their agenda taking precedence over the Republicans. But, none of that is going to last if we don’t see a recovery that lasts through the mid-term elections in 2010. And that is already very much on the minds of politicians in Washington. Here is the calculus.

In 2008, the Democrats benefitted greatly from Barack Obama’s election as President, taking large majorities in both houses of Congress. Their mandate was to work with the President to fix America’s economic problem. So, Obama’s and Congressional Democrats’ first priority is to end the recession as quickly as possible. I guarantee you there would be hell to pay if this is not done well before November 2010 when the next general election is held.

From Obama’s perspective, it is crucial that he fix the banks and fix the auto industry as these were the two economic issues front and centre in the election which he said he could tackle. With the banking industry stabilised, the Obama legacy rides crucially on how the Auto Bailout proceeds. Under no circumstances is the Obama Administration going to allow General Motors to do to the economy in 2009 what Lehman Brothers did to it in 2008. They are going to fix GM no matter what it takes. And if this includes heavy-handed tactics, so be it.

So, be very clear that the GM and Chrysler issue is an existential question for this administration. Handle it well and you get the Roosevelt treatment and ensure a good outcome for your party in 2010. Screw things up and the depression bears down on America and you’re out of office in due course. The key policy decision is how to ensure a favourable outcome. And when I say favourable, I mean one that ensures as many jobs as possible while minimizing any wider economic fallout. Other issues like treating bondholders well, not committing taxpayer monies to the effort, or keeping government out of the auto industry are going to be much less important.

German General Election

And if Obama is concerned about his political fortunes because of an election next year, you can bet that Germany’s Chancellor Angela Merkel is concerned given her election is later this year. In Germany, cars have a mythical status. The Autobahn was begun in the Depression as a way to jumpstart the German economy. The first such road was completed in 1931 between Bonn and Cologne, a road I drove I have driven at least 2 or 300 times (it is a great road for fast driving, by the way, and was opened by Germany’s first Chancellor Adenauer when he was Mayor of Cologne. I believe the Bonn Porsche dealership is literally a few hundred meters from the entrance). Shortly thereafter, also during the Depression, the Germans began the car company Volkswagen (literally “the people’s car”) as yet another car-oriented way to jumpstart the economy.

Today there are hundreds of thousands of jobs in Germany tied to the auto sector, which has huge importance in the Rhineland, Germany’s industrial heartland and part of the most populous German state North Rhine-Westphalia, as well as in Lower Saxony, Bavaria, and Baden-Württemberg. In short, destroying auto jobs is a sure-fire way to lose an election. The ruling coalition is keenly aware of this and that is why they too will be very involved in the GM bankruptcy as it affects Germany through GM subsidiary Opel.

Below is the video of me discussing this yesterday on the BBC (I know I should put these videos up more often, so I promise to get a hold of the footage or audio whenever I do a media appearance).

And I haven’t even mentioned the politics in Sweden, the U.K., Austria, Canada or Italy where this expected bankruptcy is equally important.

As for the finance side of things I only want to highlight a single issue, credit default swaps. Back on April 30th, I wrote an article called “CDS contracts and the implosion of several Eastern European economies.” In it, I argued that the ‘insurance’ of credit default swaps changed creditor behaviour in a way that made bankruptcy more likely. I also warned that credit default swaps were going to be an issue in the Chrysler and GM bankruptcies (for a German-language take on the same, see Blicklog’s “Warum Gläubiger von GM ein Interesse an der Insolvenz haben“).

Think about this for a second: what if CDS contracts were exchange-traded? Then, we would know exactly who held what CDS exposure. So the motives of creditors would be made much more transparent and I believe this would help to prevent bankruptcies. The likes of Whitney Tilson, managing partner of the hedge fund T2 Partners, have been making similar noises of late. If any financial reforms do indeed result from this financial crisis, my hope is that this be one of them.