By the end of last year, the reported cost of swaps protection ballooned to $8 million up front and $500,000 a year

TO BE NOTED:

"Don’t Blame G.M.’s Creditors

Recalcitrant creditors were made scapegoats for the collapse of Chrysler, Breakingviews says. And, it says, they may play the same unhappy role if General Motors runs off the road.

G.M. bondholders who have hedged their exposures are said to want the carmaker to file for bankruptcy. But that doesn’t make them opportunistic speculators, Breakingviews argues.

If G.M. files, these investors could indeed collect on their credit-default swap contracts. But in many cases, Breakingviews says, they’ve already suffered big losses on their bonds. Making up for those is what hedging is all about.

Meanwhile, G.M.’s government-inspired overhaul plan looks like a raw deal, the publication argues. Lenders would get only 10 percent of G.M.’s new equity, rather than the lion’s share, which, as the largest block of creditors, is arguably their due, it says.

It’s also unlikely that most of the bondholders concerned are short-term speculators, according to Breakingviews. The economics of hedging G.M.’s bonds haven’t looked great in a while, it notes.

The last time it was attractive was probably in early 2007, when G.M.’s bonds fetched around 97 cents on the dollar, the publication suggests. An investor seeking to hedge $10 million of those bonds for five years would have paid about $390,000 a year in the credit-default swap market, a cost covered by the interest received on the bonds, Breakingviews calculates. By last summer, that bondholder had lost $1 million on the bonds, but that was roughly offset by the increased value of the swaps contract, it says.

But then the carmaker’s wheels had started coming off. By the end of last year, the reported cost of swaps protection ballooned to $8 million up front and $500,000 a year, and the bonds plunged in value to about 25 cents on the dollar, Breakingviews says. Buying the bonds then and insuring their $10 million face value would have cost $11 million in the first year, a losing proposition even if G.M. filed for bankruptcy, it says.

So the hedged bondholders have probably been in the game for a while, Breakingviews argues. They have the advantage of some bankruptcy insurance. But there’s little reason to excoriate them for risking a G.M. failure when the alternative deal on offer is so meager, the publication says."

The problem he faces is that the government’s credibility in a situation like this is weak

TO BE NOTED: From The Baseline Scenario:

"The New Masters of the Universe

with 12 comments

Back in the early days of the Clinton administration, James Carville was credited with saying something like this:

I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 basball hitter. But now I would like to come back as the bond market. You can intimidate everybody.

The story back then was that bond investors, by buying or selling Treasury bonds, could lower or raise the government’s cost of borrowing and interest rates across the economy, depending on how they felt about government policy.

Today bond investors have discovered a much more direct lever over government policy. I’ve already written about the importance of bondholders in dealing with the financial sector. This week we are seeing their power over the auto industry.

GM faces roughly the same problem as the banks we have been talking about so much. Its assets, broadly speaking - not only factories, designs, and patents, but its general ability to make money by selling cars - don’t cover its liabilities. Those liabilities are largely bonds ($28 billion - I believe that excludes the recent bridge loans from the government) and union contracts ($20 billion owed to a health care fund, along with ongoing payroll). In order for GM to avoid bankruptcy, the creditors (bondholders and the union) need to voluntarily give up some of their claims. This is what is known as restructuring.

Now why would a bondholder do this? Right now you are holding a piece of paper that says GM will pay you $100 million plus interest. Why would you give that up for $8 million in cash, a new piece of paper saying GM will pay you $16 million plus interest, plus about0.3% of the equity (stock) in GM, which is apparently the deal on the table?

You would only do this if you think the alternative is worse. The alternative, in such a situation, is bankruptcy, where a judge will decide how much you get. And clearly at least some bondholders are afraid of this alternative, since bonds were trading around 16 cents on the dollar on Monday. But this is a special case, since we know that for both political and economic reasons the Obama administration does not want the American auto industry to disappear, and many commentators (Yves Smith, for one) think that a bankruptcy would have that outcome.

The result is a high-stakes game of chicken. Bondholders are betting that President Obama will not take the risk of forcing GM into bankruptcy. If that is true, the government’s only option will be to sweeten their offer to bondholders, or to give up on restructuring and bail out GM the old-fashioned way (large low-interest loan, equity injection, etc.). Either way the value of GM’s bonds would go up.

Obama, by contrast, has to show that he is serious about the bankruptcy option, if he is to have any hope of scaring the bondholders into agreeing to a restructuring. I think this is the most likely explanation of his statement that bankruptcy might be the best medicine for GM and Chrysler - which drove one series of bonds down from 19 cents to 10 cents in trading today.

The problem he faces is that the government’s credibility in a situation like this is weak, both because of the political and economic risk of a GM bankruptcy, and because of its flinching in a similar situation involving GMAC in December.

And who is on the other side of the table? Why, it’s PIMCO, the fund manager that has patriotically volunteered to be one of the participants in the Treasury Department’s public-private investment funds to buy toxic securities.

Written by James Kwak

April 1, 2009 at 12:38 pm"

Me:

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=axxcb9lRvYP8

“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.”

That’s William Gross about GMAC. It worked. But, here’s the deal: That’s his job. His job is to make money for his clients. If he doesn’t try and do that, he can be sued.

One of the main causes of this crisis, from my point of view, is that many investment managers did not do this. They enriched themselves at the expense of their clients. Call it negligence and fiduciary mismanagement.

This point also applies to Citi. We are shareholders. It is the job of Pandit et al to make us money. This is why TARP is so weird. On the one hand, Citi was given money to lend, while, on the other hand, as investors, we simply expect them to do the best with the money they have. This conflict is inherent in any government/public hybrid plan.

The main argument for a Swedish type solution, if that were possible now, is that it could clearly have the taxpayer’s interests come first, and avoid most of the conflicts of interest, mismatched incentives, and mixed signals inherent in a hybrid plan.

Frankly, if you wanted a cleaner version of TARP, you should be for the plan proposed by William Gross in September, in which the government would have hired investors to buy the toxic assets for us. It too would have problems, but one could argue that it would be a cleaner plan than PPIP.

If you want businesses to voluntarily lose money for the country, then you will need to make sure that their clients agree with that

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."