Friday, November 21, 2008

The Ill-Considered Problem of a GM Bankruptcy

(Naked Capitalism) Let us start with the basics. Like it or not, for GM to go under risks a disaster of colossal proportions. Although Lehman, the biggest bankruptcy in US history, appeared to have an orderly settlement of its credit defaults swaps, the disruption occurred before-hand, as protection writers had to post additional collateral PRIOR to settlement. That in turn was a major factor in the horrific downdrafts in October.GM is bigger, ergo bigger collateral damage, and this would take place when the financial system is even weaker than when Lehman hit the wall.

However, a second, and potentially far more damaging issue, may have been largely overlooked. The proponents of letting GM go argue that it can go into Chapter 11 just like other big companies that get themselves in trouble. That may not come to pass, and a Chapter 7 (liquidation) would be a seismic event.

We have noted more than once on this blog that debtor-in-possession financing, along with other forms of credit, has become virtually non-existent and costly. DIP is essential for most Chapter 11 bankruptcies. Why? It actually takes time to get the plan of reorganization approved by creditors and the courts. Most companies, and GM is in that category, head to bankruptcy court when they are at the end of their rope liquidity-wise.

So how do they keep the business going and also pay that army of attorneys they need to get through court? That is where DIP financing comes in. DIP is specifically for companies in, or on the verge of bankruptcy, and the debt is generally senior to other outstanding creditor claims. So it is actually very low risk (the amount spent to shepherd a company through the bankruptcy process is usually not large, relatively speaking), but many types of lending are being severely curtailed right now.

GM would be a massive bankruptcy. It is doubtful whether it could obtain enough DIP financing, which means it might be forced into a partial, perhaps a full liquidation. The ramifications are nightmarish. Aside from the loss of jobs at GM itself (100,000), GM's business is critical to keep many US auto suppliers in business. No GM, pretty soon you see most, possibly even all. of the auto suppliers go under. And those parts suppliers are important to OTHER auto makers. Many foreign car factories would be shuttered due to loss of suppliers. Some analysts put 2009 job losses from one automaker failure as high as 2.5 million due to the knock-on effects.

Now the government could provide the DIP directly. While that idea is does not appear to be on the table, that would solve this conundrum. A government guarantee worked with Chrysler, but given how skittish investors have been over the less than full faith and credit status of Fannie and Freddie debt, it isn't clear that guarantees to possible DIP providers would be as effective as one would hope (look, the government is already yelling at banks to lend, and they aren't).

Normally, you'd expect the government to blink in this game of chicken. What has me worried is the demand for GM to produce a plan in twelve days. Mind you, I think the plan is a great idea. GM should say what it plans to do with the dough and how it plans to straighten itself out. But twelve days to conceive a grand strategy and price it out?

Now normally would just be part of a ritual: Congress goes through the motions of due diligence and appears to reluctantly hand out the dough, presumably after making management sweat a little and the unions sweat more.

No, what has me worried is that GM asked for $25 billion. I suspect that if they sharpen their pencils they will determine they need more (I am not saying they deserve more, but GM is a huge mess. and the guys at the helm don't have a clue how to fix it, and with the economy tanking, even if they do all the right stuff, it will take years before you see it in the bottom line).

If they ask for more, or cannot truthfully say they will not be back asking for more (the only acceptable answer to this question) the negotiations could go off the rails. The private jet ride to DC was a warning sign that this crowd is capable of blowing a deal that would otherwise be made.

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