Markets in Asia are staging a peppy rebound rally on the assumption that US rescue of the Big Three is in the cards.
No one seems to be taking seriously the possibility that bankruptcy is inevitable for GM and perhaps Chrysler. And were that to take place, opinion is sorely divided as to what that might mean for the industry and economy.
The US papers, even though they indicate that a rescue is moving forward, are also making clear that this process has multiple constraints. The first is the the Administration seems reluctant to run roughshod over the Senate Republicans, and seems disposed to impose tough conditions on the automakers. But can they? As a Wall Street Journal story notes in passing:
The Bush administration must also figure out whether, and how, to try to wring concessions from affected parties, including factory workers, dealers and holders of the companies’ debt. Without such concessions, the companies are likely to need cash infusions long into the future, congressional critics say.
The Bush administration can try to demand concessions upfront as a condition for making initial rescue loans. But it is unlikely Treasury can extract concessions from all the affected parties as part of a loan deal.
The Financial Times also described the Senate Republican’s desire to extract a pound of flesh:
President George W. Bush was on Sunday facing growing pressure from his own party to impose wage cuts and debt write-downs on the US’s troubled auto industry as conditions of the $14bn-$15bn emergency loan Detroit says it needs.
Republicans have stepped up their calls for Mr Bush to go far beyond legislation that failed in Congress last week and set tough demands on General Motors and Chrysler for lower labour costs and a debt/equity exchange….
In contrast with recent financial interventions, which have sometimes been pulled together over a weekend, the Treasury is proceeding deliberately over the conditions of the loan.
Another issue that has been raised is that the funds remaining under the first TARP installment are only $15 billionish, and it is possible that the Administration may decide to offer a bigger loan (sizes under consideration supposedly range from $10 to $40 billion). That strikes me as a red herring. The Wall Street Journal reported last week that $89 billion of the $250 billion TARP funds had not been allocated, and even though some applications were still in process, they were almost certain not to use all of the remaining funds before Obama takes charge. It’s a pretty safe guess at least $20 billion could be raided from that kitty, providing more than enough to get through January, perhaps even through the end of March.
But how will a deal get done? Although senators and the media like to beat up on the UAW, the bondholders are at least as big a problem. Felix Salmon noted that many GMAC bondholders were refusing to take a modest haircut in a swap that would have enabled GMAC to become a bank holding company and added this in a later post:
….there’s a large contingent of GM bondholders who don’t mark to market and therefore won’t jump at any opportunity to get, say, 50 cents on the dollar for their paper. They want what they’re owed, and the easiest legal way of preventing them from getting it is bankruptcy.
Yes, there can be a tender offer with things called “exit consents” which make it harder for holdouts to sue for the money they’re owed. But the results of the GMAC tender offer would seem to imply that getting a critical mass of bondholders to agree to those exit consents would be tough. And in any case such an offer wouldn’t extinguish the holdouts’ debt, and those holdouts would certainly be a noisy thorn in GM’s side for many years to come.
GM doesn’t have a group of bank lenders it can get round a table and negotiate with: it has a bunch of very angry bondholders who do not, under any circumstances, want to take any haircut at all.
So Paulson is left with unattractive choices, He cannot force either the bondholders or the unions to make concessions ex a bankruptcy. The bondholders and UAW know that they pretty much will be funded (do Bush and Paulson want to be associated with the wealth destruction of a disorderly bankruptcy?) and if they get a deal that tides them over until the regime change in January, the deal they get then is likely to be less punitive.
That would seem to suggest that the implicit consensus, that the automakers will soldier on, with some requirement to streamline operations and UAM concessions, will in fact take place. But what if the bondholders or UAW refuse to accept the cuts demanded by the Democrats? The Deal argues an even more aggressive, but entirely plausible, version of this viewpoint (hat tip reader Hubert). And before you reject it out of hand, note that the Journal and other financial papers are now mentioning bankruptcy as the only way to cut the Gordian knot of irreconcilable demands:
Here’s the reality: Bailout or not, GM will file for bankruptcy. There’s no escaping it. To drastically reinvent the 101-year-old company to keep it alive and return it to prosperity will require tools only available in a bankruptcy process. All the talk about no one buying cars from a bankrupt company will evaporate as everyone realizes consumers aren’t buying GM vehicles, anyway. There will be a car czar, but it won’t matter. Congress will fulminate, but it won’t matter. GM will have to file, Wagoner will be fired, a new CEO hired….
….we offer a speculative look at how the GM bankruptcy scenario will unfold.
By its own admission, GM is suffering from “the worst economic downturn, and worst credit market conditions since the Great Depression.” The company has negative net worth of nearly $60 billion and massive losses since 2005 — $21.3 billion in net losses in just the first nine months of 2008. Even worse, GM is a relic, making as many as 14 million vehicles a year, hemmed in by collective bargaining agreements, lifetime employment contracts, too many dealerships and brands.
Despite the unions’ political clout and fears that GM’s image will be fatally wounded, the federal government finally makes bankruptcy a condition for further help. Only bankruptcy can impose the discipline necessary to remake GM. “It’s the rule of law instead of the rule of politics,” says John Jerome of law firm Saul Ewing LLP. “The judge … operates in a nice confined box with a set bunch of rules and laws.”
After the short-term bailout fails, GM files for bankruptcy, ousts Wagoner and receives a $25 billion debtor-in-possession financing provided by the federal government either directly or out of the Treasury’s Troubled Assets Relief Program, or TARP. The company make its Chapter 11 filing in the U.S. Bankruptcy Court for the Eastern District of Michigan in Detroit. It’s neither prepackaged nor, for that matter, significantly prenegotiated. Congress has been throwing the prenegotiated concept around, but in reality, because of GM’s size, only a partial prenegotiated filing is practical.
Why no prepack? GM simply lacks the time to prepare a prepack, where a company works with lenders, creditors and shareholders to craft a reorganization plan and then solicits votes, all before entering bankruptcy. A prepack would require a “bajillion” creditors to buy in, says veteran auto industry attorney Jean Robertson of Calfee, Halter & Griswold LLP, an inordinately lengthy process when GM is burning through roughly $1 billion in cash a month.
The article is very much worth reading and works through its scenario in instructive detail.
What concerns me is the ease with which legislators, economists, and deal mavens cheerily brush aside how customers might react. They forget the first rule of business: you have a business ONLY if you have customers.
Now with auto sales plunging regardless, it is hard to parse out the impact of BK worries (they are overshadowed by economic contraction and scarcity of financing, plus bankruptcy talk became acute only recently). And I strongly suspect that very few of the people volunteering an opinion on how consumers will react actually own a US car.
Surveys suggest as many as 80% of customers would NOT buy a car from a company that had filed for bankruptcy (the handful GM car owners I have asked have said to a person they would not buy a car from a company that had filed for bankruptcy). And frankly, why should they? The world is lousy with cars, and there is nothing unique about the Big Three offerings. It is common sense that consumers would be likely to steer clear. Even if the company makes it, your dealership might not (The Deal envisions that at least a quarter were due to be cut; this could be accelerated and/or go further), and then where do you go for servicing?
So let’s play out my variant of how a bankruptcy goes. The three ring circus described in The Deal moves forward. The story anticipates the bankruptcy process lasts till late 2010. I tell you what happens in the meantime: there are just about zero car sales. No normal prospective car buyer is going to have any confidence with a process this protracted and uncertain and will take his business elsewhere. GM runs through its DIP money faster because neither it nor any of its dependents are getting any dough, The assumptions going in, made with unduly optimistic assumptions about sales (no allowance for customer revulsion) are way way off base.
But now that GM is in Chapter 11, there is no turning back. Its cash hemorrhaging has grown far beyond what was ever envisaged even in supposed worst case forecasts. The only options now are nationalization (to what end? The brand has been destroyed) or liquidation. And liquidation takes down the parts suppliers, which in turn makes most of the foreign transplants unworkable.
So for the hatred of UAW and the stubbornness of some GM creditors we destroy the entire US auto sector.
Having said that, I am not sure there is any happy ending here. Obama does not have the appetite that FDR did for pushing the envelope legally. You need a cramdown of bondholders, dealers, and (to a lesser degree than widely thought, labor is an issue but not to the extent depicted) the UAW, and no one seems to have a solution other than bankruptcy (maybe this is Dick Fuld’s real chance for rehabilitation. Lock the bondholders up with him and have him tell them he’ll eat their hearts unless they concede).
As I said earlier, insufficient attention is being paid to consumer reaction to a protracted bankruptcy process, which per the Deal this, is certain to be. If you lose consumers, you lose the automakers, pure and simple
I think it is a no brainer that a year plus bankruptcy process will kill sales. But this is the core issue, and should not be left to speculation. It isn’t hard to gin up focus groups and surveys (better yet, conjoint analyses, they tease out how customers trade off product attributes better than simple questions). This question, which is not hard to pin down, is instead being left to guesswork and personal prejudice. So in the end, we will have only ourselves to blame if this turns out as badly as I fear.
Perhaps the best assessment comes, from all places, the movie Elizabeth, on the early years of the reign of Elizabeth I. When her advisers are egging her to take on Spain, she mutters darkly, “I do not like wars. They have uncertain outcomes.” As we learned from Lehman, the same can be said for bankruptcy.