The dangers of GM's deal
GM is close to following Chrysler into bankruptcy.
While the shareholders of these two firms will walk away with nothing, still at stake are the interest of bondholders and other creditors to the firms.
US Bankruptcy laws have been around for more than a century. However, through these new bankruptcies, the government is attempting to upend a "market driven" system for handling a bankrupt firm. And the consequences will likely be catastrophic.
A quick primer - Under Bankruptcy law, when a firm takes bankruptcy, the creditors are paid back in the following order:
1. Secured Creditors (bondholders, collateralized lenders)
2. Unsecured Creditors (suppliers, vendors, etc.)
3. Shareholders.
Currently, GM has the following major debts.
1. Secured Creditors
Bondholders $27 Billion
US Govt. $15 Billion
2. Unsecured Creditors
UAW Pension $20 Billion
There are, of course, hundreds of other unsecured creditors, but there will be little pie left on the plate, when GM's market cap is only $775 million.
In a traditional bankruptcy, the secured creditors step into the shoes of the shareholders and take over the ownership and direction of the firm. ie. The bondholders have a priority in the return of their funds. It is this fundamental principal of security that encourages large banks and small investors to purchase corporate bonds. They know they will get paid back before the shareholders or unsecured creditors will.
That's all about to change. Here's what the government is demanding the breakout of GM ownership will look:
Amount Owed New Ownership %
1. Secured Creditors
Bondholders $27 Billion 10%
US Govt. $15 Billion 50%
2. Unsecured Creditors
UAW Pension $20 Billion 40% + $10 Billion Note
Look closely at the above. Even though bondholders held the majority of SECURED debt on this company, they are receiving a paltry 10% of the ownership interest. And the UAW, who were unsecured creditors, are receiving 4 times as much ownership, plus a note for half their money.
It's readily apparent that Obama is rewarding the UAW for their support of him. And he's doing it at the expense of bondholders.
Here is the long term consequence. Thousands of corporations have issued bonds to fund their capital needs. If the GM bankruptcy goes through, in its current form, this will cast a deep chill of uncertainty over every other corporate bond in the market. As a result, the market will begin to place a discount on the value of those bonds, when their security is now determined, not by law, but by the whims of an administration. Corporations will suddenly have a much tougher time raising the necessary capital in the future.
Even scarier is the position for most state and local governments. Because, you see, they too have to issue all types of municipal bonds to cover the new sewer plant or water works. And some simply reissue bonds to pay off old debts.
Just as declining tax revenue dollars are depleting the communties financial coffers, they'll also find out the ability to raise money from selling bonds will get that much tougher.
Some cities have already taken bankruptcy due to high pension and health insurance obligations. That fact, along with the new face of bankruptcy (as dictated by the Obama administration) could only add to the woes we face as a nation.
This short sighted approach to the GM bankruptcy will be in the hands of the bankruptcy judge. That judge - one man - will likely shape the future of coporate and municipal bonds in America, the engine that has driven our economy for decades.
While the shareholders of these two firms will walk away with nothing, still at stake are the interest of bondholders and other creditors to the firms.
US Bankruptcy laws have been around for more than a century. However, through these new bankruptcies, the government is attempting to upend a "market driven" system for handling a bankrupt firm. And the consequences will likely be catastrophic.
A quick primer - Under Bankruptcy law, when a firm takes bankruptcy, the creditors are paid back in the following order:
1. Secured Creditors (bondholders, collateralized lenders)
2. Unsecured Creditors (suppliers, vendors, etc.)
3. Shareholders.
Currently, GM has the following major debts.
1. Secured Creditors
Bondholders $27 Billion
US Govt. $15 Billion
2. Unsecured Creditors
UAW Pension $20 Billion
There are, of course, hundreds of other unsecured creditors, but there will be little pie left on the plate, when GM's market cap is only $775 million.
In a traditional bankruptcy, the secured creditors step into the shoes of the shareholders and take over the ownership and direction of the firm. ie. The bondholders have a priority in the return of their funds. It is this fundamental principal of security that encourages large banks and small investors to purchase corporate bonds. They know they will get paid back before the shareholders or unsecured creditors will.
That's all about to change. Here's what the government is demanding the breakout of GM ownership will look:
Amount Owed New Ownership %
1. Secured Creditors
Bondholders $27 Billion 10%
US Govt. $15 Billion 50%
2. Unsecured Creditors
UAW Pension $20 Billion 40% + $10 Billion Note
Look closely at the above. Even though bondholders held the majority of SECURED debt on this company, they are receiving a paltry 10% of the ownership interest. And the UAW, who were unsecured creditors, are receiving 4 times as much ownership, plus a note for half their money.
It's readily apparent that Obama is rewarding the UAW for their support of him. And he's doing it at the expense of bondholders.
Here is the long term consequence. Thousands of corporations have issued bonds to fund their capital needs. If the GM bankruptcy goes through, in its current form, this will cast a deep chill of uncertainty over every other corporate bond in the market. As a result, the market will begin to place a discount on the value of those bonds, when their security is now determined, not by law, but by the whims of an administration. Corporations will suddenly have a much tougher time raising the necessary capital in the future.
Even scarier is the position for most state and local governments. Because, you see, they too have to issue all types of municipal bonds to cover the new sewer plant or water works. And some simply reissue bonds to pay off old debts.
Just as declining tax revenue dollars are depleting the communties financial coffers, they'll also find out the ability to raise money from selling bonds will get that much tougher.
Some cities have already taken bankruptcy due to high pension and health insurance obligations. That fact, along with the new face of bankruptcy (as dictated by the Obama administration) could only add to the woes we face as a nation.
This short sighted approach to the GM bankruptcy will be in the hands of the bankruptcy judge. That judge - one man - will likely shape the future of coporate and municipal bonds in America, the engine that has driven our economy for decades.
Bob, remember you commented 4-5 months ago that the UAW should take over running GM. Now it may not be the best thing.
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I'm all for the UAW running GM. They can finally show management and America their talents in that regard.
Give the bondholders preferred shares (with a dividend) and let the UAW have the company.
I'm oppposed to giving the UAW an unjustified benefit at the expense of bankruptcy law and our free market system.
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totally agree with you Bob - let UAW have the company & show us their stuff.
The whole scenario is pretty scary & doesn't bode well for the free enterprise system that we used to have in this country.
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The unintended consequences just keep adding up.
Indiana workers (and many many other insurance and pension funds) are going to lose their retirement money they invested in Chrysler corporate bonds. Let's see- when the pension fund goes broke...who bails it out? PBGC? No problem! (That's the Gov't by the way..)
This is about Property Ownership in the U.S.- This is fundamental to the basis of capitalism. Would you buy a house if you didn't have clear title?
Here's a small part of the objection to the sale (which was denied 5/20/09):
http://chapter11.epiqsystems.com/viewdocument.aspx?DocumentPk=0d2e959f-6285-4208-bf8f-1c0c0dbe9165
ATTORNEYS FOR THE
INDIANA STATE TEACHERS RETIREMENT FUND,
INDIANA STATE POLICE PENSION TRUST, AND
INDIANA MAJOR MOVES CONSTRUCTION FUND
Unlike any other bankruptcy in history, Chrysler’s bankruptcy was announced by
the President of the United States. President Obama’s announcement made clear that he had made the decision to put Chrysler into bankruptcy. He blamed this decision on certain Senior Secured Lenders that had not received TARP funds and, therefore, had not bowed to the Government’s pressure to accept an unfair 29 cents recovery where unsecured creditors were receiving all recoveries. The President branded those Senior Secured Lenders with fiduciary duties to their own investors as “speculators” who were unwilling to make “sacrifices.”
(www.whitehouse.gov/the_press_office/remarks-by-the-president-on-the-Auto-Industry 4/30/2009.) He accused these lenders of refusing to compromise and instead seeking “an unjustified taxpayer-funded bailout.” Id. This was not true. First, the Senior Secured Lenders not accepting the unfair deal—including the Indiana Pensioners—are not “speculators.” They invested in first-lien secured debt, which is (or at least should be) a conservative investment. Second, certain of the Senior Secured Lenders did offer to compromise. They offered to accept a 50% reduction of their debt, even though they might receive a better recovery in chapter 7 liquidation. Their offer was in stark contrast to other Chrysler stakeholders, whose “compromise” will enable them to receive a much larger recovery then they are entitled to receive under the Bankruptcy Code. Finally, the Indiana Pensioners have never sought a Government bailout. Indeed, they are among the few Chrysler stakeholders that can make that statement. Unlike Chrysler and the TARP banks, who accepted billions of taxpayer dollars, the Indiana Pensioners have not received a dime of bailout money from the Government. To the contrary, it was the Government that was taking from them. Under the Government’s plan, billions of dollars of collateral belonging to the Senior Secured Lenders will be taken away and given to unsecured and junior lien creditors and (ironically) Fiat, a foreign automaker. Because certain of the Senior Secured Lenders asked to be paid for their interests in that collateral, they were vilified.
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