GM Bankruptcy Appears Certain

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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.

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  1. wintermute

    The domestically-owned US car industry is following the route that Britain’s did 30 years ago.

    GM is Leyland writ large.

    “The company became an infamous monument to the industrial turmoil that plagued Britain in the 1970s. At its peak, BLMC owned nearly 40 different manufacturing plants across the country. Even before the merger BMH had included theoretically competing marques which were in fact selling substantially similar “badge engineered” cars. To this was added the competition from yet more, previously LMC marques. Rover competed with Jaguar at the expensive end of the market, and Triumph with its family cars and sports cars against Austin, Morris and MG. The result was a product range which was incoherent and full of duplication. In addition, in consequent attempts to establish British Leyland as a brand in consumers’ minds in and outside the UK, print ads and spots were produced, causing confusion rather than attraction for buyers. This, combined with serious industrial relations problems (principally, the company’s relations with trade unions; the 1973 oil crisis; the three-day week; high inflation; and ineffectual management meant that BL became an unmanageable and financially crippled behemoth whose bankruptcy in 1975 was assured.”

    We saw the effect of this 12,000 miles away in New Zealand. In the 1960’s 90% of the cars were British origin. Then came problems with supply (strikes), reliability, price and models. People started buying Japanese. Despite being called “Jap Crap” for a long while (but not anymore). Now most of that market is met by Japanese production.

    But Leyland was not the end of the British car industry. It rose pheonix-like with foreign-owmed production. It is now very efficient – suffering only recently with the credit crisis.

    US car production is going through a renewal process. But $50 billion of back-door government funding only repeats the painful lessons seen with Leyland and others before it. It also pushes marginal companies like Ford to the edge. It wastes money that could be used as tax-breaks on non-oil alternative fuelled cars.

  2. attempter

    In this whole piece the only sentence which hinted at a detail about what they’re actually going to do to enliven their fantasy of a revivified GM is this:

    “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.”

    Not much there there, while all the rest is just the same shell game with the same ever-dwindling amount of wealth which has been going on with the banks and broadly with the federal government itself.

    Bailing out zombie banks and bailing out a zombie transportation model present the same problem: the model itself is unsustainable and therefore cannot be restored to health. That’s why in both cases there’s no plan, no goal, no list of reality-based benchmarks.

    In both cases it’s the same faith-based process:

    Step 1: Throw huge amounts of money at the predicament.

    Step 2: (No one can say what actually happens here. Evidently it’ll be some kind of magic, a deus ex machina.)

    Step 3: Infinite stable growth and debt resumes. (And infinite new energy sources as well.)

    Especially in the case of the banks, the whole process is so deranged that we have to assume the real goal is simply further class war theft, since on its face it’s so obviously nothing more than a massive wealth transfer from the people to a handful of feudalists.

    As for GM, if the goal is alleged to be preserving American jobs, how can this be squared with the happy globalist assumption that “efficiency” will require further offshoring of GM jobs?

    In that case, what exactly was the point again of “saving” GM?

    I confess I don’t understand the efficiency/fairness example from above being applied in this case. It’s neither efficient nor fair to waste precious resources and time propping up a terminal zombie, while it is efficient and fair to let it die with as little pain and as much gain as possible.

    I’m not saying the inevitable demolition of large structures like GM or the holding companies won’t be painful, but there’s still a choice between the hard way or the harder way.

    But the former requires confronting our predicament and initiating the “austerity” in an active, organized manner. And as a recent post here discussed, Americans seem by now congenitally unable to even contemplate, let alone endure, so-called austerity.

  3. Yves Smith


    First, the labor cost issue is a canard. Direct labor is 7% of GM costs now, and new workers are being hired at lower rates of pay. The issue is that the world industry has way way too much capacity and GM made some bad bets with platforms and with fighting fuel efficiency. So there is good reason to think it will need to shrink more than other car makers.

    But you are completely missing the massive subsidies the transplants got. The story is made to be all about cheap labor, when the tax incentives (and in some cases additional goodies) were very large. In addition, as mentioned, the Japanese automakers had substantial Japanese content in their US manufactured cars, and the cheap yen was a de facto subsidy. Yes, the US car makers screwed up, I don’t dispute that, but the playing field was actually skewed against them. Auto analysts have said if enough (or merely the wrong) parts markers close, the transplants close as well.

    The Million Dollar Murray issue is a liquidation. If GM were liquidated, which per above is not a necessary outcome, it doesn’t just take out GM, but much of the related ecosystem, namely, parts makers that serve the transplants too. These guys are specialized. A company that makes steering wheels cannot take up the work done by a brakes maker that goes under.

    If GM liquidates, you will see us lose far more of the auto industry than is necessary. Manufacturing offers far more opportunity for productivity gains than services.

    Germany has high wage labor and is an export powerhouse, You can have well paid labor and still be competitive.

  4. Aiden

    I agree with your assessment that the Obama Auto Task Force seems much too optimistic about the success of a 363 sale and the outcome of the BK. The deals that GM has made with the UAW only prolong the pain, as they maintain the high cost structure that the company has (these include the continuation of programs that pay workers that are laid off a portion of their salary, holiday pay, break times that are outrageously long, and a continuation of high cost healthcare with virtually no employee participation on the cost side).

    It appears to me that the Senior unsecured bondholders will be able to block the 363 sale and force a better deal, possibly with the PBGC taking over their monster pension liabilities, and a total wipeout (turned to equity) of the VEBA instead of the current deal which gives a more than 50 cents on the dollar recovery for what is contractually an unsecured note. This may also allow them to push for more concessions on the contract front and more much needed firings of white collar employees.

    If these real concessions do not come from the UAW, or the 363 sale is approved in it’s current form, GM will almost certainly file a “Chapter 22,” within two years of the sale, because these liabilities and work rules are too onerous for any business let alone the bureaucracy laden GM.

    Another fly in the ointment are the European Opel/Vauxhall and Korean Daewoo operations which are money losers and have the same overcapacity problems that GM North America has.

  5. Bob Goodwin

    Although the government has gotten most everything wrong, they have also gotten most everything they have wanted. I did not think it was such a stretch that the government would guarantee warrantees and offer DIP when you were first debating this subject a few months ago. I do not currently think it is such a stretch that the bankruptcy judges will be amenable to the government plan in whole.

    There are people who would never have bought a GM car 2 years ago, who will be buying from government motors in a year when it becomes the new new.

    (formerly known as bg)

  6. Daniel

    “These guys are specialized. A company that makes steering wheels cannot take up the work done by a brakes maker that goes under.”

    Uhh, Yves, since cars have pretty much the same ratio of parts per car, steering wheel makers would be shut down in the same capacity percentage as the brakes maker. Additionally, companies like Johnson Controls and Lear make more than just a few parts. If there is a need to reduce steering wheel capacity and thus shut down a “specialist”, then there is also a need to shut down an equivalent brake maker.

    The entire problem with the auto industry, the big 2.5 in particular, has been overcapacity for years (crappy small cars pales in comparison to this issue). Look at this WSJ graph:
    80% utilization in boom times? 65% utilization now? Remember, for the US anyway, Toyota has been at 100+% utilization from 2003-2007.

    Chrysler should have been liquidated to remove a large portion of this overhang. GM killing Saab, Hummer, GMC, and Pontiac would help as well. Ford sold off Jaguar, Land Rover, Aston, is selling Volvo, and has reduced Mercury to almost nothing.

    This level of massive overcapacity requires things our country is not able to do, like make hard choices and stop being wasteful. Liquidating GM would be a Panacea in the long run. IF that many cars are needed, then the assets will be bought and people will be employed to produce them. The dislocation will be massively painful but I can’t imagine it would cost anywhere near the $70B number currently being floated to fix GM.

  7. Yves Smith


    You are assuming the Big 3 and the transplants spread their purchases across suppliers proportionally. That is not correct. All went to concentrating on fewer suppliers so as to get greater integration and have greater bargaining leverage. There was a chart (I cannot recall where) showing the concentration of each of the Big 3 among each of the major US suppliers. You could see looking at the charts that some would indeed be seriously, maybe terminally damaged if GM or Chrysler cut back a lot.

  8. attempter

    Yves, I think you misunderstood my sarcasm about the offshoring. My point was to impugn the motives of the bailer-outers, not to stick up for offshoring and globalist fundamentalism, which I despise. I wasn’t clear enough there.

    I agree with you that even within the globalist rubric a country can provide good jobs and be competitive, without having to join the race to the bottom.

    My point was that if they’re not really saving GM to preserve jobs here (and who are all those domestic suppliers supposed to supply if the domestic factories close?), then we’re left with an expensive policy in search of a rationale.

  9. Daniel


    I am not making that proportionality assumption. As I said “Additionally, companies like Johnson Controls and Lear make more than just a few parts.” If the goal is to reduce suppliers, then when they have to cut purchases, the smaller partners will suffer first.
    As you said “You could see looking at the charts that some would indeed be seriously, maybe terminally damaged if GM or Chrysler cut back a lot.” Terminally damaged and killed off is much better than chronically ill and limping along at taxpayer expense. There are two ways to fix an over capacity problem, boost demand or cut supply. Since there was an overcapacity problem at a 6M higher SAAR, I’m pretty sure supply needs a drastic cut.

  10. Unsympathetic

    Yves, you are flat-out wrong when you claim that GM is anywhere NEAR Japanese quality. Yes, Buick was at the top of JD Power ratings last year – FOR THE FIRST 30 DAYS. THAT IS IT. Starting on day 31, they’re just as crap as they always have been – and always will be.

    The Big 3’s refusal to accept anything industrial engineers say is akin to Proctor and Gamble firing all its chemical engineers and then wondering why their chemical processes aren’t operating near optimal yields.

    The UAW is crap and needs to be killed. The only viable US auto industry is contained within plants owned by foreign conglomerates.

    I have a six sigma black belt and a MS in industrial engineering. This isn’t random snark – I’ve been inside to do consulting. Their internal culture is unsalvageable: their workers feel far too entitled to actually make the changes necessary to become profitable, and as a result 100% of the executives feel emasculated.

    Kill the UAW and GM has a chance. Without that, the company will NEVER be profitable.

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