I have written, many times, that banks are not using capital raised earlier this year to lend to consumers, but to repair their balance sheets. I have also commented on how companies which are unable raise money in the capital markets have been taping bank lines of credit. CIT Group was one notable institution to do this earlier this year. Genworth Financial did the same last Friday. Although these backstop provisions are beneficial to the borrowers, they are putting already battered banks under even more stress. Although I failed to make the connection between reduced consumer lending and corporate lines of credit, an article in today Wall Street Journal has not.
The article details how corporate backstop facilities are putting banks under pressure because banks cannot securitize these loans. The capital markets are dysfunctional at this time. The author makes the case that the government's attention should focus on repairing the capital markets. This is easier said than done at this point in time.
Why is it so difficult? First, the media and certain government officials have made the crisis a battle between Wall Street and Main Street. What many of our leaders do not understand (or won't admit) is that Wall Street and Main Street intersect. Shut down Wall Street and business shuts down on Main Street. The country needs functioning markets.
Secondly, government actions (halting GSE preferred dividend payments, the ever changing TARP plan and inconsistent dealings with troubled institutions, etc.) have only helped to shut down the capital markets to companies needing funding, especially financial institutions.
I agree with the Journal that corporate backstop financing is helping to prevent banks from lending, but this is a result of the credit crisis not a cause. If banks did not have many billions of writedowns from bad assets, the credit markets would not have seized and these corporate loans and lines of credit never would have been tapped. Until the capital markets are unfrozen the crisis will continue.
How to we unfreeze the markets? Here is a crazy idea. Why not insist that banks receiving TARP funds use the funds to pay preferred dividends, bond interest payments and loan to companies needing capital, but which cannot access TARP themselves. After all, not every company can become a bank holding company, although they will try.
Da Do Ron-Ron
UAW chief Ron Gettelfinger announced over the weekend that the UAW will make no further concessions, its workers earn about the same as those working for foreign companies in the U.S. and GM's problems are not the result if the UAW OR management. Rather, it is the result of higher fuel prices (until recently) and the Wall Street credit crunch.
That's right Ron, GM, which has lost money for the last several years and which has been on the decline for over 30 years is in trouble because it cannot issue more debt and afford more 0% financing. Toyota, Honda, Nissan, Subaru, Hyundai, Mercedes and BMW, all which build vehicles and components in the U.S., do not appear to have such problems. The problem, Ron is that UAW workers have benefit packages which far exceed those of workers at foreign-owned factories, GM is saddled with legacy costs (pensions, retiree benefits, etc.) and stupid ideas such as the Jobs bank, which pays workers not to work.
Agreeing to the aforementioned compensation packages is the fault of GM (and Ford and Chrysler) management. GM culture is that the company is THE U.S. automaker and that it will regain market share. I don't think executives get out of Michigan much. Although Detroit vehicles may rule the road in and around Detroit, the are not as dominant in other areas of the country. Many people get by just fine without a mammoth SUV.
Detroit's bloated corporate structures, generous labor agreements and ostrich-like behavior with regards to its competition is dooming Detroit to fail. When one needs to sell small or mid-size car for at least $24,000 (GM's figure as of 2005), one cannot make money in today's environment. The Detroit Three have not made money on passenger cars for many years. The only reasons Detroit continued to build cars along with trucks is because the needed fuel-efficient, albeit obsolete, cars to bring their Corporate Average Fuel Economy (CAFE) numbers down to government-mandated levels. That is right boys and girls, the Detroit Three are forced to build vehicles which are unprofitable to meet government mandates. That and the fact that it would have to pay assembly line workers not to work if car plants were idled force Detroit to build unprofitable cars. If one is not going to profit any way, why bring them up to Toyota or Honda standards. In a perverse way of thinking, it is more cost-effective not to invest in passenger car technology.
Many people have asked me what to do with their GM bonds. As they are trading at prices in the $20 area, I do not think investors are harmed by waiting to see how the situation plays out. However, I do not see any disadvantage to selling now. Sound confusing? Let me explain.
The street is essentially telling us what to expect from bankruptcy recovery. However, in a bankruptcy, bondholders may not receive cash. In a bankruptcy, creditors may receive cash, new stock, new bonds or a combination thereof. Investors wanting cash may want to sell now.
What about a government bailout? Even a government bailout does not guarantee that investors receive par or receive cash. In a bailout, investors will still probably receive cents on the dollar for their bonds and probably will not receive much, if any, cash. Investors may receive more GM bonds and stock in a bailout than they would receive in a traditional bankruptcy, but they may not. What about the government just giving GM (and Ford and Chrysler) cash? Since that doesn't fix the problem, I would recommend that any investors still holding GM bonds to sell into any rallies.
What about GMAC? GMAC has no cross-default responsibilities with GM. There was never any, even before the 51% spin-off to Cerberus (the same is true of Ford and Ford Motor Credit). I am cautiously more optimistic about GMAC. Why am I more optimistic? If there is any hope of rebuilding GM, there needs to be a viable and functioning finance company to fund the purchase of vehicles. GMAC COULD become a bank holding company, but that probably would not happen until (unless) GM is saved in some form. After all, why make GMAC a bank holding company just to have the FDIC (or the OTS if it becomes a thrift) if GM collapsed leaving GMAC without vehicles to finance.
My opinion for GMAC bonds is similar to that for GM bonds with one caveat. I think that GMAC will be in business. As long as GM is producing vehicles (whatever its corporate condition), GMAC should receive TARP money and will make good on its obligations.
What if I am wrong? Those investors who cannot risk a GMAC failure should cash out now, especially into any rallies. The one exception may be GMAC Smartnotes. GMAC Smartnotes (which are senior notes) are trading 10 or more points below other GMAC senior notes. This is due to the lack of liquidity which is a result of small deal sizes. Since Smartnote holders would receive the same recovery as larger senior notes in a bankruptcy and the market is pricing (possible bankruptcy recovery estimates) large senior note issues 10 or more points higher than Smartnotes, investors may wish to ride this out. As always, investor suitability should reign supreme.
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