Let GM go Bankrupt?
Part 1

a GM bankruptcy is huge. Job losses would go through the roof and could trigger a Global Depression

November 15, 2008

By Charles Delvalle

I’m putting myself out on the line, and I feel the risk/reward is more than worth it. If I’m right, you could make 300 percent in just a few months. If I’m wrong, you’ll lose it all.

This is one of those bets you make with your “play” money, not money that you’re counting on to pay the bills or to retire on. Some may consider this reckless. But there’s nothing reckless in taking calculated risks. That’s all investing is anyways, taking calculated risk.

Are you ready for it?

What I want you to do is play a company that I believe is too big to fail. A company that, should they go bankrupt tomorrow, would cost the US over 2.5 million jobs by this time next year.

It’s not in the best interest of Washington to let this company fail and incoming President Barack Obama has already promised to support the company.

Therein lies the problem…

Will they Make it Past the End of the Year?

The company I’m talking about is General Motors (GM). And unless you’ve been completely ignoring the market, then you know that they are running the risk of bankruptcy.

Not only that, but they aren’t even sure if they’ll have enough money to last them through the end of the year– much less get through next year. So why the hell would I be bullish on them? That’s a fair question to ask.

So let’s look at this in a variety of different lights.

1. Unions love the democrats. Without GM, unions run a very real risk of losing even more power in DC. The democrats just made a major power grab. You can be sure that they’ll try to help their union buddies. And that means keeping GM around.

2. The Big Three are interconnected. If GM goes bankrupt, it could bankrupt dealerships, advertising agencies, or parts suppliers that also do business with Ford or Chrysler. If that happens and the other two have big supply problems or see many of their dealerships go broke, they’ll also lose money. This means that if GM goes bankrupt, it’s a very real possibility that Chrysler and Ford both go bankrupt shortly afterwards.

3. Job losses would be through the roof. The US is worried about losing 1.2 million jobs so far this year. A GM bankruptcy alone would add roughly two million job losses next year. And if it hits the other domestic automakers hard, even more jobs will be lost. The entire state of Michigan would turn into a welfare state.

4. The U.S. doesn’t want the obligations. Like I said before, the pension obligations at GM are in the tens of billions (possibly even more than one hundred billion). If GM goes broke, this pension is passed on to the US under the PBGC (Pension Benefit Guarantee Corp). According to Barron’s, this would effectively bankrupt the PBGC and tax payer dollars would have to be used to cover those losses.

5. It’s cheaper to give them a bridge loan. After you add up the lowered tax revenue that would come in after two million people lose their jobs… or the increased funding the government would have to give the PBGC just to meet GM’s existing obligations… or the estimated $150 billion in reduced taxes cities, states, and the US would deal with as dealerships, advertising agencies, and suppliers go bankrupt… or the potential implications of the big three all going broke… you’d see it makes more sense to give GM $25 billion with strings attached than to let them go bankrupt.

6. The new administration has already voiced support. Obama, Pelosi, and the democratic leadership have already talked about how they want to save GM. To them, the automaker is a huge part of what’s left in the manufacturing sector here in the US. There are simply too many jobs on the line to let GM go bust. And they intend on saving them if they can.

As I write this, I have to admit that I feel conflicted.

On the one hand, I hate seeing irresponsible corporations being bailed out. Free-markets, right? I firmly believe that the competitive disadvantages (like higher union wages and wayyyy too many benefits) that GM suffers could be eliminated in a bankruptcy.

On the other hand, who the hell would buy a car from a company that just went bankrupt? Not me. Probably not you either. If GM goes bankrupt, their brand cachet goes down the drain. In fact, just for hinting at the possibility of bankruptcy, GM is having a harder time unloading their Hummer brand because potential buyers are afraid the name brand would go down the drain in a GM bankruptcy. It would be very hard for them to sell cars after bankruptcy, no matter how nice or cheap they are.

In the end, if you could save the jobs of two million people by pushing out a short-term loan, wouldn’t you want to do it? Maybe my heart is too big, but I would.

So here’s what I think will happen.

In the lame duck session of Congress next week, the Democrats could attach some type of rapid-fire stimulus for GM. I believe it will be designed to get approved and simply bridge GM up until Obama takes office.

Afterwards, I believe Barack Obama will have Congress craft a larger stimulus bill that deals with the Big Three and saves them.

I wouldn’t bet on shareholders being saved, though. What will probably happen is the same as what’s happening with the banks. The government could recapitalize GM, place restrictions regarding executive compensation and dividends, and then dilute shareholder equity to an extreme degree.

I also believe that in next year’s stimulus package, even more stipulations will be placed on the money that GM accepts (I also believe Obama will force a slew of other changes like a new board of directors, cost analysis, reworked contracts, and a focus on fuel efficient vehicle technology in an attempt to bring “patriotism” back and leapfrog the Japanese).

The government may buy common or preferred shares, diluting the value to shareholders. But bondholders will make out like bandits. Because the only thing that matters to a bondholder is if GM can continue paying their bills.

According to Bloomberg… “GM's 8.375 percent bond due in July 2033 rose 1.75 cents yesterday to 25.75 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.”

If GM is saved, these bonds will rocket in value. You could make nearly 300 percent in just a few months, PLUS you’ll receive a couple of income payments. Of course, you wouldn’t want to hold them until 2033. They are cheap today because everyone thinks GM will be bankrupt tomorrow. If the government saves them, the perception would change and the value of these bonds would move much higher.

Of course, if GM goes bankrupt, these bonds will be worthless.  Now do you see why this is a play you only make with money you can afford to lose?

Of course, if you asked me what I feel the likelihood of GM going bankrupt is, I’d say less than 10 percent. The new democratic administration seems hell bent on saving this sector. And with a clear majority in Congress, I have no doubt that they’ll do it.

But will they do it in time? That’s the question. So I see next week’s lame duck session as extremely important for GM. If a deal isn’t made then, it’s going to be tough for GM to survive into next year without some very drastic measures.

If a deal isn’t made and GM goes bankrupt, we’ll be in store for far more severe economic times than we’ve seen in a long, long time. After all, two and a half million people will lose their jobs in the next twelve months alone.

If this does in fact trigger the end to the American Automaker sector, things will get much, much worse. The recession – which is already getting nasty – could certainly extend well into 2011 – 2012.

Whether you’re a free market enthusiast or not, here’s to hoping GM receives a bridge loan. My thoughts are with the millions of families that rely on the big three for their daily bread.

Stay free,
Charles

For more on this topic see General Motors Bailout-  Part 2
General Motors Bailout-  Part 3

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Editor's Note:  In this article Charles outlines the implications of allowing General Motors to undergo bankruptcy.  I'm not sure that his premise that allowing GM to fail would take the other two (Chrysler and Ford) under with them is correct.  Typically, the failure of ones competitors allows more for the survivors.  It trims out the deadwood and makes the survivors more profitable. It is survival of the fittest in the economic arena. 

Propping them up on the other hand just prolongs the agony and prevents the elimination of unprofitable operations.  Bankruptcy would allow the "New GM" to get out from under all its union contracts  and debt obligations that makes it unprofitable in the first place. It could modernize its plants and be in a position to compete with the foreign competition. In the long run the economy would be much more healthy.

Bailing GM out would just allow them to drain money from the economy that much longer.  Of course,  in the short run the economy would probably go into an deep recession if not a depression.   Thus, a GM bankruptcy would be extremely painful for the entire country and especially for all the families directly and indirectly employed by General Motors.

So the question at this point is how do you like your pain? Short and then over like ripping off a bandage or long and drawn out like Chinese water torture?  -- Tim McMahon, Editor

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