Felix Salmon Says: Not Bailout or Bankruptcy But Bailout and Bankruptcy for GM

He writes:

GM: The Bailout vs Bankruptcy Meme: At heart, this argument is simple. There's no available DIP financing for an orderly Chapter 11 bankruptcy, and Chapter 7 liquidation would be disastrous, therefore we need a bailout which avoids any kind of bankruptcy at all. But I don't see why a government bailout must, ipso facto, avoid any kind of bankruptcy. GM alone has $35 billion in long-term debt, most of which is trading at about 20 cents on the dollar. That might only be a drop in the bucket compared to its total liabilities of $193 billion, but it's a good place to start: if bondholders took an 80% writedown while the government pitched in $12 billion of preferred equity in the post-restructuring entity, that's a $40 billion improvement to GM's balance sheet right there. And of course bankruptcy would give GM the opportunity to renegotiate onerous contracts with its dealers, as well as other real and contingent liabilities.

This is what I've been referring to as a "bail-in", and it makes quite a lot of sense on its face. Let the government provide the necessary financing, but ensure that bondholders share some of the pain as well, especially since doing so would simply ratify the mark-to-market losses they've already taken.

Such a plan would involve working out the details of a bankruptcy in advance: there are large dangers involved when a company the size of GM enters bankruptcy without any clear conception of how it might exit. So there would need to be serious negotiations between all of GM's stakeholders and the government -- negotiations which, I'll concede, would be all but impossible during this uncomfortable interregnum between the election and the inauguration. Even if GM can somehow muddle through until January, it can hardly expect such negotiations to be concluded in a matter of weeks. So there's a timing problem here, given that the present administration has demonstrated zero inclination to help out Detroit. But I still think that it would be useful to stop thinking of a bailout as an alternative to bankruptcy, and start thinking more imaginatively about the different mechanisms, including both government funds and bankruptcy, which could help put Detroit on a more sustainable footing.

The government could, for one thing, provide DIP financing...

Comments

[Denis Drew]

Exactly the wrong moment to quit on the Big Three:
Abandoning gas drive and multi-speed transmissions for almost overly simple electric motors and one speed gasoline generators -- with no transmission -- is a great leap in technological simplification -- even inviting boutique startups at a rate impossible with chemical technology. Point being, this is not the time to give up on the Big Three (who have re-invented themselves before -- remember the first high price gas crisis in the late 70s?), not when the "perfect" 100 mpg technology is just over the next hill and is almost foolproof to boot!
***
Doubly free upgrade to plug-in hybrid?

Reported by Tom Krishner, AP Auto Writer Monday, July 21, 2008: ..."lithium-ion battery packs needed to power even a small car now cost in excess of $10,000..."

A couple of years ago, I came up with the fun dollar-savings equation that: if America needed only half as much imported oil (meaning 5 million bbl/day then) and if we needed to pay only half the price ($30/bbl then) due to lowered demand, then, we could save $165 billion a year (by spending only 5,000,000 bbl/day X 365 days X $30 instead of 10,000,000 bbl/day X 365 days X $60 = a saving of $164,250,000,000/year)...
...or, exactly enough to subsidize buidling the 16.5 million cars and trucks we manufacture every year as lithium plug-in hybrids -- at $10,000 per vehicle! Said one-time subsidy could be collected back from buyers over the years of ownership -- paid for by gas savings: free, free upgrade?
***
The news only gets better:
For 30 years it has been known that building lithium ion batteries with silicon wires (instead of carbon wires) could yield ten times the power holding ability but, because silicon wires expanded and contracted too much as they cycled, they quickly destroyed themselves. The development of silicon nano wires -- about a thousandth of the width of a sheet of paper -- has solved that drawback -- while potentially making lithium ion batteries more stable (safer) at the same time!

Near term, only the anode side of the batteries will be manufactured with nano wires, yielding the quadruple jump (up powering GM’s Volt to go 160 miles on one charge instead of 40?). Long term, manufacturing the cathode side with silicon nano wires is expected to reach the ten multiple target (introducing hybrid, long distant trucks?).
http://news-service.stanford.edu/news/2008/january9/nanowire-010908.html

[mkl]

I know the 'lets shoot the bondholders' sentiment is nice but I don't think this is thought through. E.G., the bondholders' claims in bankruptcy are up with the trade creditors - so can we take out the bondholders without killing off all the suppliers? Further, what will the knock-on effects of the debt default on the insurers, pension funds et al holding the debt?

Everywhere Treasury has tried to be cheap with bailouts or enforce moral hazard to date - killing off the Frannie preferred, Wamu bank bondholders, Lehman creditors overall - it has undermined the effectiveness of the bailout.

If we decide that failure of the auto industry right now is a bad idea, please let us not try to get too cheap or clever on the bailout.

[Neil B]

Maybe as condition for the bailout/in etc, say the government must share in half of any dividend payments for a very long time.

[DrDick]

I like this alternative as it meets all the requirements for government intervention: it saves jobs and manufacturing capacity while getting rid of the blatantly incompetent management and forcing restructuring.

[DrDick]

I like this alternative as it meets all the requirements for government intervention: it saves jobs and manufacturing capacity while getting rid of the blatantly incompetent management and forcing restructuring.

[DrDick]

I like this alternative as it meets all the requirements for government intervention: it saves jobs and manufacturing capacity while getting rid of the blatantly incompetent management and forcing restructuring.

[PQuincy]

Salmon is right, I think, in general terms: a simple "bridge-loan" solution to "prevent" bankruptcy has been made untenable, not least by GM management's blackmail-like gambling that evoking bankruptcy will get them a cash infusion so that they can keep doing what they've been doing so successfully.

By threatening a bankruptcy, GM has made one inevitable, in one form or another. The 80% discount on GM bonds suggests that this is no surprise to anyone, at this point, either: the haircut of the bondholders has already been taken.

The object of government intervention, therefore, should be to prevent major recessionary or deflationary consequences of GM's failure as a business. This might include some kind of bridge/restructuring finance, preferred stock in the new entity, but must, at this point, also involve removal of the board and senior management who have not only failed in business terms, but who have also recklessly gambled the company's (remaining) reputation to get government funds to cover up their own incompetence.

[bigTom]

I've come around to a similar POV. Some sort of bankruptcy reorganization in inevitable. The most feared effect of a bankruptcy, is the potential for a large part of the customer base to flee, based upon concerns about the availability of parts, and service etc. So the government's job has got to be to facilitate the promises of continued support/maintenence for future, and existing customers. I would think that by now, the likelihood of a near future bankruptcy has already been factored in by a large segment of potential customers.

[MattYoung]

Everyone seems to agree on one thing, GM is bankrupt. The only question is how do we manage the bankruptcy.

[Graydon]

Dissolve GM; liquidate it. GM, and all its brands, marks, and whatnot cease to exist. GM's intellectual property -- the patent portfolio, the plans for the EV2, etc. -- gets nationalized and made available on a completely standard, fixed fee, there-for-all licensing basis. Fees paid go to clearing the cost of the bailout off the US's books. All the existing labour contracts cease; the entity with which they were enacted has gone *poof*.

The funded pension obligations are spun off into a free-standing corporation and *left funded*. All that organization now exists to do is pay pensions and benefits to retirees. (It could, conceivably, start to function as that kind of corporation for a wider range of clients.)

Set up multiple -- ten or fifteen, multiple -- companies to manufacture cars using GM's employees and whatever salvageable plant is has. Provide a capital funding pool (with competitive access, based on running hardware), and guarantee design and manufacturing jobs for five years, but make the base salaries modest at best; you have to sell cars at a profit to make a good wage, since (as a worker-owned collective) most profit is shared. Set these companies up as worker-owned collectives who are buying out their rich Uncle Sam; they aren't public and can't go public. Not less than 20% of the cars manufactured have to be zero emission. Not less than 20% of the cars manufactured must be non-fossil fuel. Congress reserves the right to change those "not less" numbers. The entire existing executive -- C-titles and two layers down -- is shown the door. Entire sales and marketing org, the same. None can be rehired by any of the new car companies until at least 15 months has passed. Any intellectual property generated by any of these new companies goes into the same pool as GM's original IP, but the fees paid on new stuff go to the company of origin less 10% for the IP pool mechanism, which will need to support itself somehow.

It's not like we know for sure what kind of cars they should be making; it's not like there's any real value left in GM as an organization, which has made consistently awful decisions for twenty-odd years now. So give the people who actually know how to make cars a shot at keeping their jobs by making cars people want to buy. But don't pretend GM's organizational structure isn't most of the problem, and it's not a problem that can't be fixed through bankruptcy.

Consider the fellow who makes GM cars run, very well, on used cooking fat using almost entirely GM parts, and figures the folks at GM just aren't trying. He's almost certainly right.

[Denis Drew]

Now is not the time to strip GM's managment, either -- not when the company is finally being run by an engineer, Japanese style (a Boeing guy) instead of a salesman; not just when said engineer is directing GM through a giant leap forward to simple, almost foolproof, 100 mpg electric drive-hybrids.

The Big 3 re-invented themselves once before -- remember the first oil crises of the late 70s. More digital (electric) and less analog (gas) technology make the engineering more a matter of chalking equations on a blackboard then endlessly dueling with mother nature's whims.

As for all the bellyaching about high Big 3 labor costs: just when America should (hopefully) be stepping back from the homegrown race to the bottom as well as the downward pressure on wages from both (!) foreign born workers at home (at levels unique in all the OECD) as well as abroad -- via legislation that puts strong supports under the price of American labor (hopefully doubling the minimum wage to half the "true" average wage and hopefully mandating a version of sector-wide labor agreements) -- is not the time to be crushing the auto industry's gold standard of wages and (just imagine!) benefits.

Our blue collar workers right now seem to be caught between the red, white and blue conservatives who don't happen to care what happens to working Americans and supposed progressives who don't seem to care at all about the survival of the red, white and blue's flagship industries. Hopefully whoever is left will have enough sense to care about both; hopefully they make up the majority.

[Graydon]

If GM is too big to fail, it's too big. Chop it into pieces at least an order of magnitude smaller.

I'd much rather have ten guys with engineering backgrounds seeing what they can come up with than one, too.

I also think it's a perfectly reasonable tradeoff to take a wage hit -- since guaranteeing wages with public money is a bad thing -- in return for winding up owning the company. A lot of the problem with the auto makers has been a drive for immediate, rather than reliable, profits.

[Twofish]

The whole point of bankruptcy is to save the company, not kill it. If you delay bankruptcy then the hole just gets deeper and deeper, and Wagoner's way of framing the issue of "give us the money or people lose their jobs" is misses the point in that he really hasn't explained how giving the GM money is going to save jobs.

We’ll use this bridge to pay for essential operations,” Mr. Wagoner.

If you use the bridge to pay for essential operations, then what happens in a year when the money runs out? If you just have enough money to tread water, that's that going to help you in the long run.

Q: The bondholders' claims in bankruptcy are up with the trade creditors - so can we take out the bondholders without killing off all the suppliers?

Debts that suppliers undertake after the bankruptcy is filed take precedence over everything. As far as debts that are made before the bankruptcy. Immediately after a bankruptcy petition is filed, you have a round of "first day orders" in which the judge goes through and figures out what contracts are essential to maintain supplies.

Q: Further, what will the knock-on effects of the debt default on the insurers, pension funds et al holding the debt?

As it is right now GM bonds are being sold at a huge discount so that is already being felt. It's also likely that the debts for a lot of these firms are covered by credit default swaps perhaps issued by AIG. The CDS settlements worked quite well for Lehman, and it's unlikely that GM would be more disruptive.

Drew: Now is not the time to strip GM's managment, either -- not when the company is finally being run by an engineer, Japanese style (a Boeing guy) instead of a salesman

The trouble is that everything I've heard him say seems to indicate that he is quite detached from reality. I haven't heard him articulate any sort of strategic plan for GM, and that fails job one of any CEO. His strategy seems to be get money and hope for things to turn around, which strikes me as pretty unworkable.

Drew: Our blue collar workers right now seem to be caught between the red, white and blue conservatives who don't happen to care what happens to working Americans and supposed progressives who don't seem to care at all about the survival of the red, white and blue's flagship industries. Hopefully whoever is left will have enough sense to care about both; hopefully they make up the majority.

The problem here is that GM really doesn't employ that many people. Citigroup employs 350,000, GM employs 270,000 worldwide. Walmart employs 2.1 million. The number of people directly employed by the auto industry in the US is roughly the same as the number of people employed by investment banks.

Also, you have to ask whether the $50 billion would be better spent on other things.

[Twofish]

If you want a bold, original idea. I think that the Federal government should assume all of GM's health care responsibilities and offer full guaranteed coverage to all current workers, former workers, and retirees. That's $51 billion in liabilities off of GM's books. You can then put in about $50 billion in educational vouchers and loans for worker retraining. Any current worker, former worker, and retiree gets free tuition and room and board for any higher educational institution of their choice.

Once you do that then people will ask, if GM workers get such a good deal from the government, why shouldn't everyone else......

Indeed.

[stewart]

I've said before that universal health care would come when Toyota made it a condition for taking over GM. I didn't think the opportunity would be so soon.