Bondholders probably have the most leverage in the talks. The president gave away his stick

TO BE NOTED: From the NY Times:

"G.M.’s Bondholders Speak in the Voice of the Aggrieved

By ANDREW ROSS SORKIN

President Obama had scarcely outlined his plan to save General Motors and already, the big money was pushing back.

Not three hours after the president spoke on Monday I received an e-mail message from a group representing G.M. bondholders — people who are likely to have an enormous influence over the future of the Detroit carmakers.

The e-mail message, from advisers for an “ad hoc committee” whose members collectively hold G.M.’s $28 billion of debt, started by suggesting that they wanted to be part of the solution.

But by the end of the e-mail message, they were complaining that they were “very disappointed that the government and company have had virtually no real dialogue with bondholders while designing the proposed restructuring plan.”

The e-mail message came from the same group that two weeks ago grumbled that “G.M. bondholders have been asked to make deeper cuts than other stakeholders,” and threatened to send G.M. into bankruptcy. “Unless the framework we suggested is utilized,” the group said, “the restructuring currently contemplated will not achieve the required level of acceptance to succeed on an out-of-court basis.”

During the next 60 days, G.M. and its stakeholder have the last opportunity to save the company — or risk letting a bankruptcy judge do it for them. To do so, G.M. will almost certainly need concessions from two groups: workers and bondholders.

The workers, represented by the United Automobile Workers, have made concessions already. And the president said they need to make even more, as painful as it will be. The workers — despite often appearing recalcitrant — have the most to lose. If G.M. falls into bankruptcy protection, they could lose not only their jobs but also much of their retiree health care plan.

Then there are the bondholders. Their motivation is very different. For them, this is not about keeping their jobs or, frankly, about patriotism. It is about dollars and cents. And, according to some analysts, there is a chance they would actually do better in bankruptcy court than they would negotiating against G.M. or the government, which is seeking to reduce G.M.’s debt by two-thirds.

“If I’m a bondholder, the best forum for me is in front of a judge,” said Daniel Alpert, a founding managing director of Westwood Capital, an investment bank. “Let’s face it: the biggest problem at G.M. is still its cost basis, and that’s chiefly labor,” he added, suggesting a judge would look at the situation dispassionately.

So far, bondholders have been offered 8 cents on the dollar in cash, 16 cents on the dollar in new, unsecured debt, and a 90 percent stake in G.M. G.M.’s bonds closed Monday at 16 cents on the dollar. Hoping to apply some public pressure to the bondholders, Senator Carl Levin, Democrat of Michigan, said Monday that if G.M.’s bondholders “refuse to work out a deal, they will likely end up empty-handed.” (That is not exactly true.)

Hoping to attract a bit of public sympathy themselves, the ad hoc committee has said, “G.M. bondholders are not a collection of Wall Street banks. Many of these bonds are owned by average citizens, who purchased them to support their own retirement and college expenses and other critical needs.”

That’s a bit of misdirection, however. While it is true that there are some “retail” investors that own G.M., about 80 percent of the bonds are held by large investors and hedge funds, many of which play in distressed debt markets. Some of them would less politely be called “vultures.” Indeed, G.M. bonds have been changing hands rapidly, suggesting that some hedge funds have been plowing into them, gambling that these investments soon will be worth even more.

It seemed unlikely to me that students or grandmothers had formed this ad hoc committee and would hire Paul, Weiss, Rifkind, Wharton & Garrison, the law firm, and Houlihan Lokey Howard & Zukin, the restructuring advisory firm, to advise them. That takes millions of dollars. Whoever these investors are, they must have billions at stake.

So I called Gabe Roth, the spokesman listed at the bottom of the message, and asked if I could speak with some of the bondholders the committee represents. The answer: “No. We’re not making them available.”

I followed up by asking which investors were members of this ad hoc committee. “We’re not making that public,” Mr. Roth said.

I reminded Mr. Roth that government money was at stake, and that we taxpayers might end up bailing out the bondholders. Doesn’t the public have a right to know whom they are negotiating with — or against? He demurred, suggesting that he needed to protect the bondholders’ identities.

But the identities of big G.M. bondholders are not a secret. They are disclosed in regulatory filings. Here are some of them: Capital Research & Management; Loomis, Sayles; and the Pacific Investment Management Company. Those are not exactly the mom-and-pop investors.

To be fair, many bondholders have lost a small fortune on G.M.’s bonds. And they have been frustrated that they have not been part of the dialogue in Washington and are worried the negotiations will be hijacked by the U.A.W., which has said it wants bondholders to make concessions before it does. (Bondholders say they have only had one official meeting with the administration.)

What is less clear, however, is how many new bondholders stand to make a small fortune if G.M. gets bailed out. (The government has a track record, which deserves scrutiny, of regularly bailing out bondholders and other Wall Street heavies.)

To its credit, the ad hoc committee was right about one thing: G.M.’s own restructuring plan clearly did not go far enough. In its e-mail message two weeks ago, the group said that “we are concerned that the company is putting too much faith in a near-term turnaround in the economy that would enable annual car and truck sales to reach previous levels. We do not know if the plan would, in fact, keep the company out of bankruptcy.”

President Obama concurred, pressing G.M. to come up with a better, more aggressive plan in the next 60 days.

Bondholders probably have the most leverage in the talks. The president gave away his stick — of threatening liquidation — when he said, “we will not let our auto industry simply vanish.”

The outcome for G.M. may still be bankruptcy, a plan that many have advocated. But if there is any chance of keeping the company out of Chapter 11, odds are bondholders — and not just workers — will have to come to the table with an open mind."

"Each used its bureaucratic clout to insulate itself from the pressures of capitalism. ..."

I keep getting no credit. This is my view:

"How Cronyism and Rent-Seeking Replaced 'Creative Destruction'"

Eliot Spitzer:

America's Fear of Competition, by Eliot Spitzer, Commentary, Slate: Although everybody claims to love the market, nobody really likes the rough-and-tumble of competition that produces the essential "creative destruction" of capitalism( TRUE ). At bottom, this abhorrence of competition and change are the common theme that binds together the near death of the American car industry, the collapse of the credit market, the implosion of the housing market, the SEC's disastrous negligence, the Madoff Ponzi scheme, and the other economic catastrophes of recent months.

Consider the examples of the SEC and GM, which would appear to have nothing to do with each other. The traditional critiques of the SEC have been that it was underfunded and didn't have up-to-date laws needed to regulate sophisticated financial transactions in evolving markets. That's not accurate. The SEC is a gargantuan bureaucracy of 3,500 employees and a budget of $900 million... And the ... powers of the SEC are so broad that it needs no additional statutory power to delve into virtually any market activity that it suspects is improper, fraudulent, or deceptive. ... The SEC has all the money and people and laws it needs. For ideological reasons, it just didn't want to do its job, and on the rare occasions when it did, it didn't know how.( YES )

GM's excuses—that its UAW contract and health care costs make it too top heavy to compete—are partially true but ignore a simple reality: These are the self-inflicted wounds of a company that chose a path of least resistance rather than confront the need for dynamism and innovation. ... The auto industry preferred protection to competition( YES ). And when it had to compete, it wasn't up to the task.

Both the SEC and GM refused to adapt from the world of the last century to the more dynamic new millennium. Each reacted the same way to competition: Instead of improving its product, it played defense. ... No one at the SEC seemed to ask the most important question: Given how the market is changing, what should we change to insure the integrity of the capital markets?

Instead, the SEC spent its energy preventing others from doing the work it should have done. Using the rather arcane doctrine of pre-emption, the SEC fought in the courts and on Capitol Hill to keep other enforcers at bay: Apparently, worse than having fraud in the marketplace was the possibility that an entity other than the SEC would appear to be more effective than the SEC at finding it.( TRUE )

For both the SEC and the auto industry, Congress was a place to find protection from meaningful competition. Each used its bureaucratic clout to insulate itself from the pressures of capitalism. ...( THAT'S MY VIEW! )

The result has been unfortunate: Over and over, we supplied the protection from needed change that these entities desired. Then, when the going got tough, neither the SEC nor GM was up to the task. By preventing the stern taskmaster of competition from forcing adaptation, we became complicit in their becoming dinosaurs. ... Both GM and the SEC need to see a change in market conditions as an opportunity—not a challenge to market share.

We must rebuild these two institutions. If we don't infuse them with a culture of change and love of competition, they will fail once again. ... This is a unique opportunity for President Obama and the Congress to take two seemingly different entities and force them to play by the real rules of capitalism...

Congress and the executive branch have, to a considerable extent, been devoted to business interests in recent years( YES ). In essence the argument is that what's good for business is good not just for America, but for the whole world. The ideological basis for this approach is that the interests of business and of greater society always coincide so that maximizing business interests maximizes social benefits at the same time, and that a hands off( WRONG. HANDS ON. ) approach from government is the best way to allow those coincident interests to express themselves.

Unfortunately, however, this ideological foundation incorporated a flawed understanding of the interaction between market structure and social benefits, particularly the ability of markets to self-correct when the market structures deviate from the socially optimal structure( WHAT'S THIS? ). The result of this, particularly as it came to be applied in the political arena, contributed to the existence of cronyism, rent-seeking, institutions that became too big, interconnected, and too powerful to fail, and other problems. Political power combined with rigid ideology built upon a false premise - the doctrine of immediate self-correction by markets - gave us a result that was far from the competitive ideal presented in textbooks, a world that was far from the ideal competitive model that produces such large benefits for society.( THIS IS NOT CORRECT. THEY DON'T WANT A FREE MARKET. )

I think there is some understanding that the approach of the past did not work, with the current state of the economy it's hard to argue that it did, and that we need to go in a new direction. And I'm sure we will try. But I wonder, when all is said and done, will anything really change?( NOT MUCH. IT'S HARD. THIS IS OUR SYSTEM )"

Spitzer gets it right, but Thoma doesn't. We don't have a free market system. Our businesses are not prepared to compete in one. The Investor Class believes in and counts on government intervention when things are going poorly for them. They will use free market arguments when it suits their interests, and national security or government intervention arguments when it suits their interests as well. It's called Rationale or Argument Shopping. There is no way to understand these bailouts without understanding this basic fact.

"Firms That Got Bailout Money Keep Lobbying "

Just as I've been saying, from the NY Times:

"Firms That Got Bailout Money Keep Lobbying

By DAVID D. KIRKPATRICK and CHARLIE SAVAGE

WASHINGTON — The financial giant Bank of America says it is no longer lobbying the federal government about its unfolding bank bailout. After receiving $45 billion in bailout money, lobbying was just too unseemly.

“We are very sensitive to the fact that we have taxpayer money,” said Shirley Norton, a spokeswoman for the company.

Citigroup, recipient of another $45 billion, made the opposite call. While trying to keep a low profile, the company is still fielding an army of Washington lobbyists working on a host of issues, including the bailout. In the fourth quarter, it spent $1.77 million on lobbying fees, according to its lobbyists’ filings. ( YES )

The different approaches from the two banks that have received the most money underscores the growing quandary facing private companies, which increasingly deal with the federal government not only as rule-maker but also as shareholder, lender and trading partner.

Pressing federal policy makers risks the appearance of recycling public money to advance a private agenda, while staying on the sidelines could put a company at a comparative disadvantage.( A HYBRID DILEMMA )

Citigroup and Bank of America are hardly the only two financial firms to confront the issue. During the last three months of 2008, at least seven other firms receiving bailout funds — American Express, Capital One, Goldman Sachs, KeyCorp, Morgan Stanley, PNC and Bank of New York Mellon — all lobbied the government about the bailout, according to a review of their most recent disclosure reports. ( GEE )

The automakers that received billions under the same program lobbied as well( WOW. WHO KNEW? ): including General Motors; its financing arm, GMAC; and Cerberus Capital Management, the private equity firm that controls Chrysler. Other recipients of federal financing also lobbied Congress, the Treasury or both about other matters.( WHAT A SURPRISE )

The American International Group, taken over by the government during an injection of more than $40 billion last fall to prevent the company’s collapse, has discontinued all its federal lobbying; it is now in effect government-owned. But its former executives continue to lobby.( YEP )

Its former chief executive, Maurice R. Greenberg, ousted a few years ago amid allegations of securities fraud, is leading a group of shareholders lobbying for a chance to renegotiate the terms of the government takeover or buy back a bigger stake in the company.

According to a recent filing, A.I.G. shareholders paid $90,000 in the fourth quarter to a lobbying team at Ogilvy Government Relations that includes the Republican lobbying powerhouse Wayne L. Berman, a former assistant secretary of commerce under the first President George Bush and a major fund-raiser for the second.

The group also includes three Democrats who had been top aides to the House speaker, Nancy Pelosi; Senator Edward M. Kennedy; and the former House majority leader, Richard A. Gephardt. (Mickey Kantor, secretary of commerce under President Bill Clinton, has advised the group as a lawyer as well.)

Lawmakers, troubled by the prospect of taxpayer-subsidized influence-peddling, are threatening to crack down. Senator Dianne Feinstein, a California Democrat, and Senator Olympia J. Snowe, a Maine Republican, are pushing legislation that would explicitly bar companies from using bailout funds for lobbying or campaign contributions. ( YOU THINK? )

Although hard to enforce, the measure would put banks on notice that aggressive lobbying could set off a negative reaction from Congress.( NOT LIKELY )

“That taxpayer dollars intended to stabilize the economy could find their way into the bank accounts of lobbying firms” is “completely unacceptable,” Ms. Feinstein said in a speech supporting the measure.

On Friday, President Obama issued his own call for more oversight and transparency, citing “companies that have received taxpayer assistance then going out and renovating bathrooms or offices, or in other ways not managing those dollars appropriately.” This was an apparent allusion to reports of office renovations by the former chief executive at Merrill Lynch, a recent acquisition by Bank of America whose heavy losses led to an expanded bailout for the bank.

Bankers, though, defend their right to a voice in public policy debates about the industry’s future. “Nobody mentioned that you are giving up your Constitutional right to petition the government” when accepting federal money, said Edward L. Yingling, president of the American Bankers Association.( HE'S GOT A POINT )

He acknowledged, however, that Citigroup and Bank of America were in a more ambiguous position than the rest of the roughly 200 banks that accepted money from the Treasury and agreed to pay it interest as part of the bailout program. While most banks are required to demonstrate financial health to qualify for the deal, the two giants received $90 billion in emergency measures to prop them up and agreed to give the government a larger say in management.

The two banking behemoths had entered a “middle ground( THEY'RE ALL HYBRIDS. THIS IS BS ),” Mr. Yingling said, between the other private banks accepting federal investments and the three financial firms under full federal control: A.I.G. and the failed mortgage giants Fannie Mae and Freddie Mac. “I would expect that institutions in that middle ground would be well aware that they need to be careful about the tone and manner in which they lobby,” he said.

Citigroup and Bank of America say internal policies prohibit the use of any bailout money for lobbying. Neither, however, has stopped pressing its interests in Washington, albeit more quietly. ( YES )

Though Bank of America says it has stopped lobbying about the bailout legislation — the Troubled Asset Relief Program, or TARP — it continues to lobby on other matters. The bank spent about $1 million on federal lobbying in last year’s fourth quarter, including $820,000 for its own lobbyists, according to filings.

Ms. Norton, the spokeswoman, declined to comment on whether Bank of America was lobbying on other financial crisis proposals, such as creation of a government-controlled “bad bank”( I SAID THAT THIS WOULD HAPPEN ) to take over toxic securities.( WHY NOT? )

Nicholas Calio, Citigroup’s top lobbyist, handled Congressional relations for both the first and second President George Bush. Its team of outside lobbyists has also included a former Congressional liaison for President Clinton, a former chairman of the Federal Deposit Insurance Corporation, a former deputy assistant Treasury secretary and the veteran Democratic strategist Steve Elmendorf.

The two banks’ problem is an increasing one for the industry, said Scott Talbott, top lobbyist for the Financial Services Roundtable. “There is a TARP blowback problem,” he said. "

This was all predictable. I predicted it in the beginning of October. This is our system. This is what happens with a Hybrid Plan, and why Nationalization, while not perfect, is preferable to Hybrid Plans like TARP or a Bad Bank.

"And I don't like the way that Pimco's Bill Gross is trying to paint this as some kind of win for the little people"

Here's Felix Salmon:

"Fragmented Bondholders

During the Great Moderation, institutional fixed-income investors had boring, if lucrative, lives. They'd buy paper, clip coupons, and make money. Now, however, faced with a stream of high-profile defaults, they're going to have to start justifying their former paychecks by getting down in the trenches with the distressed companies they lent money to, and negotiating hard to maximize their eventual payout.

Or not. The biggest bond investor of all, Pimco, has resigned from the investor committee negotiating with General Motors, despite being one of GM's largest bondholders. And I don't like the way that Pimco's Bill Gross is trying to paint this as some kind of win for the little people:

"We're just not good committee members," Bill Gross, Pimco's co-chief investment officer, said in an interview yesterday from his Newport Beach, California-based office. "We have the interests of our clients more at heart than the interests of particular corporations or even the government, I guess, so it's best that we simply look at the situation from afar as opposed to from inside."

Of course bondholders will represent their clients' interests in negotiations. No one's expecting anything else. But that doesn't mean they shouldn't talk at all. Creditor committees exist for a reason: they allow companies and their creditors to gauge which solutions are likely to be mutually acceptable, and move on past a debt restructuring to a period of profitability and growth. After all, neither company nor creditor likes it when bonds are in default, and they both have an interest in ending that state of affairs as soon as possible.

Interestingly, the news of Pimco's resignation from the GM committee arrives just as Ecuador announces that it has managed to find a bank to advise it on its own debt restructuring: Lazard. The last time that Ecuador defaulted, back in 2000, the country evinced very little interest in meeting or negotiating with its creditors, and Ecuador bondholders were furious. They set up the Emerging Market Creditors Association, or EMCA: a forum where the biggest holders of emerging-market bonds could get together and try to force countries to come in good faith to the negotiating table.

And who was the co-founder of, and single largest bondholder within, EMCA? None other than Pimco's very own Mohamed El-Erian. Back then, El-Erian fought hard for the right of bondholders to sit down and negotiate with distressed debtors; now, he seems happy for Pimco to unilaterally resign from such negotiations, citing vague reasons about just not being good on committees.

EMCA no longer exists, which is a shame, since it's needed now more than ever, in the wake of Ecuador's default and as emerging-market bond spreads price in a massive wave of further defaults in the future. But maybe that's symptomatic of a broader problem: bondholders compete against each other, to see who can get the highest returns, and are never very comfortable when they try to cooperate. Which means that they fragment -- as the GM bondholders just did with Pimco's departure from the negotiating table -- and leave debtors in a more powerful position.

Clearly, Lazard wasn't scared enough of its buy-side clients to refuse the Ecuador mandate. What that says to me is that bondholders don't have teeth these days. You'd think that Pimco would be worried about that state of affairs, but evidently not."

Here's Bloomberg:

"By Caroline Salas and Kathleen Hays

Jan. 21 (Bloomberg) -- Pacific Investment Management Co., manager of the world’s biggest bond fund, resigned from an investor committee negotiating with General Motors Corp. to exchange debt for shares.

The decision by Pimco comes about a month after it reneged on a Dec. 15 agreement to join bondholders in GMAC LLC’s $38 billion debt swap. The 10-member GM bondholder committee overlaps with the GMAC group, including San Mateo, California- based Franklin Resources Inc. and Fidelity Investments of Boston, said a person with knowledge of the situation who declined to be identified because the members haven’t been publicly announced.

“We’re just not good committee members,” Bill Gross, Pimco’s co-chief investment officer, said in an interview yesterday from his Newport Beach, California-based office. “We have the interests of our clients more at heart than the interests of particular corporations or even the government, I guess, so it’s best that we simply look at the situation from afar as opposed to from inside.( GET IT. HE HAS NO INSIDE INFO. )”

The withdrawal means Pimco may gain less information from other investors or have a smaller influence in talks with Detroit-based GM, which needs to cut two-thirds of its $27.5 billion in unsecured public debt. GM is negotiating with the committee of creditors as part of a government bailout of the biggest U.S. carmaker.

Reducing Debt

GM is attempting to reduce debt to avoid bankruptcy as the economy sinks deeper into a recession. Pimco’s resignation from the committee may not hamper GM’s restructuring given that GM Chief Executive Officer Rick Wagoner said last week it was too early to say how GM would work with creditors to win their assent in slashing debt.

GM’s 77-year reign as the world’s largest automaker ended after it said today that 2008 sales fell more than 11 percent to 8.35 million vehicles. Toyota Motor Corp. recorded a 4 percent drop to 8.92 million. GM’s U.S. sales fell 23 percent last year, outpacing the 18 percent industrywide decline. The company has posted about $73 billion in losses since the end of 2004, the last time it recorded an annual profit.

Pimco pulled out of its agreement with a committee of GMAC bondholders to swap their debt for as little as 60 cents on the dollar. The exchange allowed Detroit-based GMAC, the main lender to GM dealers, to convert to a bank and obtain federal aid. GM sold a 51 percent stake in GMAC to a group led by New York-based private equity firm Cerberus Capital Management LP in 2006 for $7.4 billion.

Government Blessing

The decision by Gross, 64, initially raised concern the swap would fail to meet government requirements that 75 percent of the bonds be tendered. Without Pimco’s participation, 59 percent of the bonds were exchanged. Pimco is a unit of Munich- based Allianz SE, Europe’s largest insurer.

Pimco bet correctly that GMAC would get bailed out anyway because the government wouldn’t allow the lender or GM to collapse. The value of the firm’s holdings soared as much as 83 percent, to 80.5 cents on the dollar.

Members of the GMAC committee “probably felt shortchanged and rightly so,” Sean Egan, president of ratings company Egan- Jones Ratings Co., said in an interview from his Haverford, Pennsylvania, office. “There’s a variety of reasons why the other creditors would have cause for being upset with Pimco.”

Gross said he “can understand” how other committee members would be upset( YES ).

“All members of the GMAC deal basically agreed with each other that each member was able to, you know, go their own route in terms of decision making, so the fact that Pimco did I think would not have been an abrogation of the agreement,” he said.

Bullying Creditors

Gross told the New York Times last month he wouldn’t tender because Cerberus was trying to bully creditors to reduce their claims by as much as half. Gross told the Times he wanted Cerberus to put more money into GMAC. Pimco owned more than $340 million of GMAC debt as of Sept. 30, according to regulatory filings and data compiled by Bloomberg.

Such committees often negotiate with troubled borrowers to obtain the best terms in a restructuring for bondholders, who get repaid after banks and ahead of shareholders in a bankruptcy.

“The advantage of being on a committee is you can help guide the firm and have an active voice in the firm’s future,” Egan said. The disadvantage is holders on the committee may have trading restrictions imposed if they gain access to insider information( YES ), he said.

Pimco’s Holdings

Pimco is among the biggest holders of GM bonds, behind Franklin, Capital Research & Management Co. and Fidelity, Bloomberg data show. Pimco owns more than $138 million of the debt, according to Bloomberg data based on regulatory filings in September. Its largest holding is 39 million euros ($50 million) of GM’s 1.5 billion euros of 8.375 percent bonds due in 2033, according to Bloomberg data.

Those bonds, part of a $13.5 billion sale of dollar-, pound- and euro-denominated debt in 2003, closed today at 16 cents on the dollar to yield 51 percent, down from 73 cents on the dollar a year ago, according to Bloomberg data.

GM’s bonds have gained 1 percent on average this month, compared with a return of 4.7 percent for high-yield, high-risk securities, according to Merrill Lynch & Co. index data. On Jan. 12, analysts at JPMorgan Securities Inc. cut their recommendation on GM’s bonds to “hold” from “buy.”

Bonds rated below BBB- at Standard & Poor’s and less than Baa3 at Moody’s Investors Service are considered high-yield, or junk. GM’s senior unsecured debt is rated C by Moody’s, the lowest grade, and CC by S&P. As recently as 2005, the company had investment-grade ratings.

GM shares rose 3 cents to $3.53 in New York Stock Exchange composite trading today.

Beating Peers

Gross’s Total Return Fund, which outperformed 99 percent of its peers over five years, rose 4.8 percent in 2008, Bloomberg data show. Its peers, government and corporate funds, declined an average of 8 percent last year, according to Bloomberg.

The government provided $6 billion in aid to GMAC. Cerberus and GM must divest most of their ownership under the accord. GM received $4 billion in government loans last month through the Troubled Asset Relief Program after saying it would run short of operating cash by the end of 2008. It’s due to get an additional $5.4 billion this month.

With the release of the second $350 billion in TARP funds, approved by the Senate on Jan. 15, GM is scheduled to get $4 billion more in February. The automaker has to restructure its business and present a progress report to the Treasury Department by Feb. 17. The TARP program was originally designed to purchase bad mortgage assets, then later expanded to inject capital directly into troubled companies.

To contact the reporters on this story: Caroline Salas in New York at csalas1@bloomberg.net; Kathleen Hays in New York at khays4@bloomberg.net"

Here's my take on Salmon's blog:

"Let me take a stab at Pimco's decision. They are widely perceived to have taken a risky bet on the GMAC bonds and won out. Of course, this can also look like collusion, since Pimco is buying MBSs for the Fed, among other things. The GMAC business might someday be investigated because, among other things, I believe that Snow works for Cerberus. Even though I like Pimco and am a big fan of Gross, I suggested that they excuse themselves from the Fed deal as this big win on GMAC would bother some people.
Now, the reason that Gross gave for his GMAC position was that he was protecting his clients,so he held firm. He can hardly change his position now, and then win big again. It will look very bad.
Personally, I believe it makes good sense to bet on government intervention these days, and so Gross was smart with GMAC. But this entire GM and GMAC business has a real downside if it smells funny, so that I believe that Gross has to be consistent from here on in.

By DonthelibertarianDemocrat Posted: Jan 21 2009 2:15pm ET"

“We would like to sputter in shock and disbelief. "

Not a good sign.From The Big Picture:

"GMAC: 0% Financing for Subprime FICO Scores

By Barry Ritholtz - December 31st, 2008, 12:55PM

I found this quote from GM Sales & Marketing chief to be astounding:

“’Six hundred twenty is not a subprime score,’ GM’s sales and marketing chief Mark LaNeve told Automotive News. ‘That’s a very creditworthy buyer. Hopefully, we’ll have access to more of the market that is out there.’”
- Automotive News (12/30/08)

Bill Ryan of Portales Partners adds the following:

“We would like to sputter in shock and disbelief. General Motors Acceptance Corp. (GMAC) lost $5B in the 9 months ending September 2008 (on an operating basis). It has $100B in subprime and nonconforming mortgages through its ResCap subsidiary, and the government just lent them $5B at an 8% interest rate.

In addition, General Motors (GM) just announced a 0% financing option to car buyers.

So it turns out that we are now subsidizing a globally uncompetitive carmaker that does not understand what qualifies as a subprime FICO score and is offering 0% loans financed by a government (taxpayer) investment that costs 8%.

We guess they are hoping to make it up on volume.”

Astonishing.

FYI: Subprime is defined as those credit applicants with a FICO score below 660. Hence, GM plans on shoveling its excess inventory out the door — with a 8% hit on the financing — and the taxpayer bailout holding the bag.

A brand new chapter on Moral Hazard has just been written. I expect will will see significant costs for this profligacy down the road."

This deal is poor. I can't deny that.

“The GM news was a relief for many investors, who were concerned the government was starting to close the spigot on bailout money,”

I just keep piling these stories up. Here's another case of the market and investors responding positively to Government Intervention. From Bloomberg:

"U.S. Stocks Gain as GMAC Gets Government Money; GM, Ford Rise

Email | Print | A A A

By Elizabeth Stanton

Dec. 30 (Bloomberg) -- U.S. stocks climbed the most in two weeks after the government widened its efforts( GET THAT? ) to keep General Motors Corp. out of bankruptcy by shoring up its finance arm.

GM rallied 5.6 percent as the U.S. Treasury committed $6 billion to support GMAC LLC. Smaller rival Ford Motor Co. jumped 3.2 percent. Rohm & Haas Co. gained 12 percent on speculation Dow Chemical Co. will be forced to complete its acquisition of the maker of paint and coatings. All 10 industry groups in the Standard & Poor’s 500 Index advanced more than 1 percent, sending the benchmark gauge to its highest close since Dec. 17.

“The GM news was a relief for many investors, who were concerned the government was starting to close the spigot on bailout money( CAN YOU UNDERSTAND THIS? ),” said Steven Neimeth, who manages $600 million at SunAmerica Asset Management in Jersey City, New Jersey.

The S&P 500 increased 2.4 percent to 890.64 for its steepest gain since Dec. 16. The Dow Jones Industrial Average rose 184.46 points, or 2.2 percent, to 8,668.39. The Russell 2000 Index of small companies added 3.6 percent.

The S&P 500 has plunged 39 percent in 2008, poised for its worst year since 1931, as the most severe financial crisis since the Great Depression dragged the U.S., Europe and Japan into the first simultaneous recessions since World War II. At its lowest closing level of 2008 on Nov. 20, the S&P 500 was down almost 49 percent for the year and almost 52 percent from its Oct. 9, 2007, record.

VIX Retreats

The benchmark index for U.S. stock options fell to an almost three-month low as the cost of insurance against declines in the S&P 500 decreased. The VIX, as the Chicago Board Options Exchange Volatility Index is known, slid 5.2 percent to 41.63. About 7.3 billion shares changed hands on all U.S. exchanges, 28 percent fewer than the three-month daily average. Markets will be closed on Jan. 1 for the New Year’s holiday.

U.S. stocks fell yesterday, ending the first two-day rally in three weeks, after funding for Dow Chemical’s purchase of Rohm & Haas fell through.

GM shares jumped 20 cents to $3.80. The U.S. Treasury yesterday said it will purchase a $5 billion stake in GMAC and lend $1 billion to GM so the automaker can contribute to the financing arm’s reorganization as a bank holding company.

The loan is in addition to $13.4 billion the Treasury agreed earlier this month to lend to GM and Chrysler LLC.

Ford, the nation’s second-largest automaker, added 7 cents to $2.29.

‘Ready to Move’

“There are signs( DIMINUTION OF FEAR AND AVERSION TO RISK ) that equity markets might be ready to move,” Gary Anderson, manager of the $2.7 billion UMB Scout International Fund, told Bloomberg Television. The fund has outperformed 93 percent of its peers this year. “Certainly the massive amount of liquidity that central banks are creating around the world is going to find a home( TRUE ).”

Rohm & Haas, which slid 16 percent yesterday after Dow Chemical lost access to $9 billion in cash to fund the acquisition, added $6.36 to $59.70 today. Credit Suisse AG analyst John McNulty said Dow may have a “tough time” pulling out of its plan to buy Rohm & Haas after credit-ratings cuts raised the cost of the takeover. The agreement “leaves little room for Dow to walk away,” McNulty wrote in a note to clients.

Iron Mountain Inc. rose 13 percent to $22.49, its biggest gain in two months. The world’s largest seller of records- management services will replace UST Inc. in the S&P 500. Altria Group Inc. is in the process of buying UST, a Stamford, Connecticut-based snuff producer.

Apple Slips

Apple Inc., the maker of Macintosh computers, iPod music players and the iPhone, went from $87.90 at 12:47 p.m. New York time to $84.72 at 12:55 after Gizmodo, a Web site, published a report that said the health of Apple Chief Executive Officer Steve Jobs is “rapidly declining.” Apple declined to comment on the report about Jobs, who is a cancer survivor. The shares recovered to $86.29, a 0.4 percent drop.

Europe’s Dow Jones Stoxx 600 Index rose 1.8 percent as gains by carmakers helped trim the index’s 2008 slide to 46 percent, the worst annual decline on record for the regional benchmark. The MSCI Asia Pacific Index climbed 0.6 percent.

U.S. stocks advanced even as a gauge of consumer confidence dropped to a record low and a measure of business activity remained near a 26-year low. The Conference Board’s index of consumer confidence fell to 38 from 44.7 in November, the New York-based private research group said today. The group started keeping records in 1967.

The Institute for Supply Management-Chicago’s business index increased( GOOD ) to 34.1 this month from 33.8 in November. The gauge has been below 50, the dividing line between growth and contraction, all but four months this year.

Retail Slump

U.S. retailers’ sales declined last week the most in almost six years as steeper markdowns before and after Christmas failed to salvage what may be the worst holiday shopping season in four decades. Sales at stores open at least a year fell 1.8 percent in the seven days through Dec. 27, the International Council of Shopping Centers and Goldman Sachs Group Inc. said. Holiday comparable-store sales may decline as much as 2 percent, according to the New York-based trade group.

Home prices in 20 U.S. cities plunged at the fastest rate on record, depressed by mounting foreclosures and slumping sales. The S&P/Case-Shiller index tumbled 18 percent in the 12 months to October, more than forecast, after dropping 17.4 percent in September. The gauge has fallen every month since January 2007, and year-over-year records began in 2001.

‘Washout’

“We have had a washout in terms of asset prices around the world in the past year,” Michael Holland, who oversees more than $4 billion as chairman and founder of Holland & Co. in New York, told Bloomberg Television. “Is it possible we could get more negative surprises which knock things down even more in 2009? Sure, but that’s not a good bet( I AGREE ).”

Earnings of companies in the S&P 500 have decreased from the year-earlier period in each of the past five quarters, matching the longest streaks of declines on record, and the slump is forecast to continue. According to estimates compiled by Bloomberg, earnings from continuing operations will fall 12 percent in the fourth quarter from a year earlier, 10 percent in the first quarter, and 5.8 percent in the second quarter.

Alcoa Inc., the largest U.S. aluminum producer, is scheduled to report fourth-quarter results Jan. 12, the first Dow average company to do so."

Another obvious point about the importance to investors and the markets to government bailouts. Focus on the people will the money, and you'll understand how our system really works.

"Cerberus will be back to ask for more taxpayer dollars, and will continue to avoid responsiblity for repaying them. "

I have a different take on this than James Henley on Postive Liberty. I believe that the Automaker's Bailout is happening precisely to ward off posts like his:

"Not so widely reported in the auto bailout story is the link between Bush and principals of Chrysler owner Cerberus Financial Management. Amost immediately after stepping down as Bush’s Secretary of the Treasury, John Snow became chairman of Cerberus. Former Republican Veep Dan Quayle, who has been lobbying hard on this issue, runs one of Cerberus’s investment units. And Cerberus has just received a $4 billion loan from the government, thanks to Bush’s decisiont to tap the Troubled Asset Relief Program (TARP) funds. This decision is troubling on multiple dimensions.

First, the hint of crony capitalism just can’t be waved away by noting that Bush also made a loan, a bigger one, to GM. GM’s failure is a more serious issue than Chrysler’s by far, because it employs far more people, not just directly, but because of its larger production level, indirectly as well. And the death of Chrysler is not likely to be wholesale–the Jeep brand remains a valuable commodity that Cerberus could sell to recoup at least some of its loss, and thereby keep some of their production plants going.

Second, we once again see the president making decisions that bypass the legislative process and distort the purposes of legislation he himself has signed. The TARP money was authorized by Congress for the purpose of bailing out the financial markets. However good an idea it may be to also bail out the auto industry, the people’s representatives have chosen not to do so. But Congress’s decisions no longer matter to presidents. The evisceration of representative democracy continues apace, and we all collectively yawn as legislative power continues to shift away from the legislative branch to the executive branch.

Third, Cerberus may have gotten what they most wanted, the ability to avoid responsibility for the loan if Chrysler doesn’t survive. They originally asked for $7 billion, curiously similar to the $7.4 billion they paid Daimler to acquire Chrysler just last year. Although that was $30 billion less than Daimler paid for Chrysler nine years earlier, most observers still couldn’t figure out why Cerberus thought it was a good deal, even at the fire sale price. The amount Cerberus asked led to the suspicion that they were looking for the taxpayers to cover the upfront price of their bad business decision.

But that’s not the really bad part of it. One of the reasons Congress balked at giving Chrysler a loan was that Cerberus did not want to open their books. The suspicion remains that Cerberus’s coffers are capable of providing the funding needed, but Cerberus closely guards its figures and wasn’t willing to make them public in order to disprove that notion.

But that’s not yet the really bad part of it. Another reason Congress balked was that Cerberus wanted Chrysler alone to be responsible for repayment of the loan. That way, if Chrysler still went under, Cerberus would be wholly off the hook for the taxpayer money it begged for. A nice trick, if you can swing it, and it appears that Bush has allowed his former Sec Treas to do so. At least as reported so far, the details of the loan don’t hold Cerberus responsible for repayment. Yet again we see that Republicans, despite their long-standing claim, are not a party of fiscal responsibliity. If one group of them isn’t spending the public’s money like drunken sailors, another group of them will quickly step in to do so.

My prediction for the new year? Cerberus will be back to ask for more taxpayer dollars, and will continue to avoid responsiblity for repaying them. If only Carter had let Chrysler die 30 years ago."

The bailouts cannot be confined to simply a financial bailout. That already has plenty of charges of conflict of interest and cronyism. Many people see the Automaker's Bailout as a Jobs Bill, as opposed to a bailout of the employers. That is the reason the Fed and Treasury Department are working so hard to do something for the Automakers and Home Buyers. They need some Bailout money to effect the lives of Middle Class Citizens. Solely bailing out the Financial Sector will be perceived as Cronyism by Definition.

Also, if unemployment were to drastically rise after a failure to Bailout the Automakers, and bailing out the Financial Sector had failed to keep that from happening, that would be a disaster of enormous proportions for the Bush Administration.

By definition, the Big 3 are Bush Cronies in the minds of many people. That is why my bailout plan included replacing the management, even though their incompetence was more than enough reason. But the UAW and the auxiliary jobs associated with the auto industry are viewed as a Middle Class issue, and dearly important to some people, especially the ones who find the Financial Sector Bailout dubious.

The Cerberus connection should be investigated, in order to make sure that they did not receive special treatment in this bailout, but their power and connections with the Bush Administration are not enough to kill this deal. We are battling Deflation. Some people don't see that as a big deal, but I disagree. We do not know how to deal with deflation other than causing inflation, which is what we are trying to do now. Failure to bail out the automakers could be a second Lehman, and two Lehmans could send us into a Deflationary Spiral. Beyond a certain point, in order to get inflation, the result could actually be hyperinflation. We're not there yet, and we don't want to be.

This crisis has taxed all of our knowledge and expectations as it is. We cannot afford to move the battle to territory we have no real map or experience for. That could lead to not only economic, but social problems. Problems that this Burkean takes very seriously.

"And Senate Republicans now run the risk of being portrayed as Marie Antoinettes with Southern accents."

William Kristol with a post that takes a perspective that I believe is more effective for the GOP:

"In 1953, the president of General Motors, Charles Wilson, was nominated by President Eisenhower to be secretary of defense. During his confirmation hearings, Wilson was asked if he’d be able, as defense secretary, to make decisions contrary to the interests of G.M. He answered yes, but added that he couldn’t imagine such a situation, because “for years I thought what was good for our country was good for General Motors, and vice versa.”

It wasn’t a ridiculous view. It was widely shared — by big-business-loving Republicans and big-union-embracing Democrats, by big-car-driving suburbanites and big-tank-occupying soldiers.

Today, G.M., Ford and Chrysler get no respect. Maybe they don’t deserve much. Detroit has many sins to answer for, and it’s been doing plenty of answering. But — and I say this as someone who grew up in non-car-driving family in New York and who is the furthest thing from an auto aficionado — there is a kind of undeserved disdain, even casual contempt, that seems to characterize the attitude of the political and media elites toward the American auto industry.

As Warren Brown, who writes about cars for The Washington Post, recently put it, “There is a feeling in this country — apparent in the often condescending, dismissive way Detroit’s automobile companies have been treated on Capitol Hill — that people who work with their hands and the companies that employ them are inferior to those who work with their minds and plow profit from information. How else to explain the clearly disparate treatment given to companies such as Citigroup and General Motors?”

Now there are other ways to explain the disparate treatment of G.M. and Citigroup. Finance is different from manufacturing, and banks from auto companies. It may be that the case for a huge bank bailout was strong, and that the case for a more modest auto package is not. Still, it seems to me true that the financial big shots haven’t been treated nearly as roughly in Congress or in the media as the auto executives, who have done nothing remotely as irresponsible as their Wall Street counterparts."

I think that this is a widely held view. It accords with the view that the Financial Bailout is a Crony Bailout.

"What’s more, in their disdain for the American auto companies, the left and right wings of the establishment agree. Of course, the particular foci of criticism are different — the left berates the auto companies’ management, the right the United Automobile Workers. But even on the left, while Democratic politicians still try to look out for the interests of the U.A.W., there’s not really that much sympathy for the workers. The ascendant environmentalists disdain (to say the least) the internal combustion engine and everyone associated with it. Most of today’s limousine liberals are embarrassed by their political alliance with the workers who built those limousines.

Meanwhile, on the right, free-market analysts have explained that our regulatory scheme of fuel-efficiency standards is counterproductive. But despite the fact that the government is partly responsible for the Big Three’s problems, the right hasn’t really been stirred to enthusiastically promote a deregulatory agenda to help the auto companies. What excites it is mobilizing to oppose bailouts for unionized workers.

Last week, Senate Republicans picked a fight with the U.A.W. on union pay scales — despite the fact that it’s the legacy benefits for retirees, not pay for current workers, that’s really hurting Detroit, and despite the additional fact that, in any case, labor amounts to only about 10 percent of the cost of a car. But the Republicans were fighting Big Labor! They were standing firm against bailouts! Some of the same conservatives who (correctly, in my view) made the case for $700 billion for Wall Street pitched a fit over $14 billion in loans for the automakers.

So Senate Republicans chose to threaten to filibuster the House-passed legislation embodying the George Bush-Nancy Pelosi deal. The bill would have allowed President Bush to name a car czar, who could have begun to force concessions from all sides. It also would have averted for now a collapse of the auto industry, and shifted difficult decisions to the Obama administration."

This is pure Interest Group Politics.

"Instead, Bush will now probably have to use the financial rescue funds to save G.M. — instead of being able to draw from sums previously authorized for the green transformation of the auto industry, a fight he had won in the negotiations with Pelosi. And Senate Republicans now run the risk of being portrayed as Marie Antoinettes with Southern accents.

Whichever party can liberate itself from its well-worn rut to propose policies that help both American businesses and workers has a great opportunity. That party’s leaders could begin by offering management and labor at the Big Three a little more sympathy, and heaping upon them a little less calumny. Where’s Charles Wilson when we need him? "

The French Revolution again. Along with Posner, Kristol makes two people considered to be on the right of our political spectrum who get the Political Economy of the situation. Perhaps we can't count them out yet.

As for the final point, he makes a case of it. However, I do believe that the UAW should make major concessions and the Management be replaced, quite simply because the Taxpayer's money is being invested. For me, it follows from Bagehot's notion of onerous conditions.

"What does an auto industry default cascade look like? "

Tracy Alloway on Alphaville with a post about why the Automakers would be bailed out through TARP:

"What does an auto industry default cascade look like? Like this, from Bank of America:

And that’s the reason why the US government may well be considering bailing out the country’s flailing auto industry using Tarp funds, according to the Wall Street Journal. It may even go so far as to request the second tranche of the Tarp to do so, according to the article.

Why the desperation determination to bail out what seems like a dying industry? BoA’s Jeffrey Rosenberg explains:
A GM default with no [government] support could lead to payment defaults by GM to its suppliers. The most concentrated of these, Axle, provides little of its sales outside of GM so a default by GM likely cascades into a default at Axle, but becomes limited there. However, consider the exposure of Lear. Here, a default of GM could significantly restrict the ability of Lear to supply Ford. If a payment default from GM lead to a default of Lear and an inability to supply Ford, that could impair Ford’s ability to provide payments to other suppliers. Next, with Ford as its major supplier, Visteon could face payment difficulties.

…

The systemic risk argument of a set of cascading payment defaults is borne out in the close linkages between suppliers and manufacturers. However, as we have argued before, Debtor-In-Possession (DIP) financing helps to forestall such a systemic risk outcome by allowing companies to continue to operate, and in this case, to continue to make payments to their suppliers, and avoid such an event.

By BoA’s reckoning, it would take about £30bn in DIP financing to save General Motors alone (about 2 times working capital plus a £10bn cushion).

Does that seem like a lot? Yes, but when you see graphs like the above you start to understand why the government is concerned about systemic risk.

Of note however, is how potential DIP financing would work. The Fed Reserve has, under “unusual and exigent conditions,” the ability to lend to corporations on a securitised basis — though the funding requires a bankruptcy so the Fed and Treasury can obtain senior claim on all assets. Back to BoA:
Repayment of the loan would contemplate a restructured GM achieving long term viability such that loan proceeds could be paid off over time, say 5-10 years, refinanced or sold to the private market under demonstrated viability several years out.

A 10-year bet that the US auto industry will recover? A rather big gamble for the government (and taxpayers) then."

The gamble that the Treasury Dept. doesn't want to take is with employment and production falling off a cliff. The actual economic sense of the bailout, without Political Economy thrown in, is minimal, and rests on a great deal of Wishful Thinking. I've given pretty stringent requirements for the bailout, which I doubt will be met, but I understand the fear underlying this bailout.

If you believe as I do, that the government not bailing out Lehman caused a crisis of faith in the government's willingness and ability to get us all out of this mess, then you can understand why this bailout is necessary. If you don't think that this is what the underlying assumption and context really is, then I can easily understand your being against this bailout.

"Some companies are too powerful to fail": That's Our System

John Kay in the FT has interesting post this morning that echoes some of the points that I was using in talking about Yves Smith's post on the US fear of Nationalization:

"Great banks are “too big to fail”. The predictable consequence of governments accepting this argument is a queue of other companies “too big to fail” lining up at the front door of treasuries. Insurers were next. This week, the car manufacturers secured their subsidy."

It is predictable, but also, in some sense, necessary, because politically, it would be very hard for a bailout of just financial services to be accepted by the citizenry of the US.

"The failure of any business has ripple effects on suppliers, employees, distributors and customers. If the business is General Motors such effects are larger. But since GM is many times larger than most companies, the subsidy needed to keep going is correspondingly larger. There is no reason to think that the ripple effects are larger, relative to the size of GM, than the consequences of the failure of a smaller business relative to its size."

That's not the point, but he understands that.

"So the return on the taxpayers’ dollar is not likely to be larger if their largesse goes to a big company. Indeed, since the large company has readier access to a range of alternative funding options, a need for government support is more likely the result of deep-seated competitive weakness than temporary shortage of funds which can so easily cripple a smaller business."

Not exactly. The government is the implicit guarantor for these businesses at all times, and legislation has been passed favoring these businesses over time. It certainly can mean that they are competitively weak, but the system operates for the benefit of the weak and strong large businesses alike. It's a kind of insurance policy.

"That is true of the carmakers, whose problems are of much longer standing than the current downturn. In automobiles as in many industries, economies of scale are technological, the diseconomies of scale human. Human factors in business are generally more influential than technological ones in determining the long run fate of a company."

The automakers have been a major part of this system.

"The memory of a meeting in one of Britain’s largest companies – now no longer so large – is engraved in my memory. We discussed how best to persuade the regulatory authorities of the cost advantages arising from the company’s size. But the room was crowded with people who had nothing substantive to contribute. They were there to defend and advance their political position in the corporate hierarchy. The meeting itself demonstrated that the arguments we were presenting were false. Politics overrode productivity."

But Politics is important. So is Political Economy, which includes this kind of messy exchange between politics and productivity.

"As has been true in Detroit. Arrogant, complacent and only belatedly sensitive to competitive pressures and changing customer needs, the big three have been in relative decline for half a century."

True. That's why they've been lobbying congress throughout this period.

"But there really are economies of scale in political lobbying. The cost of presenting your case is independent of the size of the benefit you seek. The larger the business, the more likely that legislators will see constituency interest or political advantage in being helpful. Big companies have government affairs departments but for small groups the cost of access is prohibitive. Only large companies have access to the sharpest shooters."

That's the system.

"Too big to fail, but big enough to exert political influence. The malign consequences are evident in many areas of public policy. Large media and software companies write intellectual property rules, while the interests of users go unrepresented. Big pharmaceutical and defence companies employ thousands of lobbyists. Consumer interests come a distant second to producer interests in the formulation of trade policy. In the past two decades the financial services industry has become the most powerful and effective lobby of all. The cash contributed to political campaigns has now been repaid many times over from the public purse."

That's because lobbying is an investment.

"But few things corrode business efficiency and effective markets more insidiously than the discovery that it is more profitable to win the favour of politicians than to win the approval of customers. In Italy, and in some other European states, an inefficient large-business sector is parasitic on the vibrant small- and medium-sized enterprises, which are the mainstay of the economy."

That's true.

"The problems are worse in Russia and in many potentially emerging economies. In these countries, the nexus between the political and business elite undermines both democracy and business efficiency."

That's not good to hear.

"The populist trustbusters who framed anti-monopoly legislation more than a century ago feared that the cost and technical advantages of large companies would be more than offset by damage to economic efficiency and pluralist institutions from the political power they might acquire. These early trustbusters were right."

I agree. But the work to be done to dismantle this current system is going to be long and arduous because, again, that is and has been our system, and it seems very resilient and impervious to challenge and change at the moment. We need to plan and prepare for the the long run, and seek small victories that will allow us to get some important things done under the radar, so to speak, and before the system realizes that, this time, it really has a challenge from people who want a smaller and more effective and efficient and representative government. But anyone who says that they're surprised by the government response in this crisis needs to get out a bit more into the real world of Politics and Political Economy.