Shut Down

The Beach Boys' iconic song about a drag race between a "Fuel Injected Stingray" (Chevrolet Corvette) and a "413" (Dodge Coronet) harkens back to the glory days of General Motors and Chrysler. Today, these once storied manufacturers are miss-firing badly, so badly that the government has stepped in and has grabbed hold of the wheel.

Over the weekend the government stated its requirements for further aid for GM and Chrysler. GM CEO and Chairman, Rick Wagoner has been ask to remove himself from his place of employment. That request came from the government. Chrysler, once the domestic small car leader and creator of the last profitable domestic small cars (the original Neon) has been ordered into a partnership with Italian auto giant, FIAT. FIAT left our shores in the 1980s after decades of mostly underwhelming products (X 1/9 and Spider excepted), mediocre reliability and poor dealer network. Oh how the mighty have fallen.

Initial responses from market participants were of relief that Chrysler and GM avoided bankruptcy. I would not be so quick as to dismiss bankruptcy. Part of the plan for GM is to negotiate deals with the UAW, parts suppliers and creditors (bondholders), deals which would result in these parties not receiving full payment for their obligations. The government also announced that it would guarantee Chrysler and GM warranties. This could be a dead give-away that a government sponsored, pre-packaged bankruptcy is on the way. After all, customer warranty concerns was a main argument against bankruptcy.

Since a bankruptcy, de-facto or actual, appears to be unavoidable, what does this mean for bondholders? There is no way to know how many cents on the dollar bondholders would receive in a settlement. GM senior notes were trading at prices in the high teens today. There is some speculation that creditors may receive more substantial compensation in a settlement, but little if any of that compensation is likely to come in the form of cash.

What about GMAC bonds? GMAC does not now, nor had it prior to its 51% spin-off to private equity firm, Cerberus, share cross-default provisions with GM (the same if true of Ford and Ford Motor Credit). Therefore, a GM bankruptcy filing does not include GMAC. If GMAC were to file for bankruptcy, it would have to be in a separate filing. However, if GM is to recover and survive, a functioning GMAC is necessary. GMAC not only provides dealer financing, it provides financing for dealer inventories. This is the main reason that GMAC was granted bank holding company status last December. Technically, GMAC can issue FDIC-guaranteed TLGP bonds. If GM can in fact be saved, GMAC may finally issue TLGP debt.

The government's reorganization plans will probably result in GM and Chrysler living to race another day, but I am not optimistic for their long-term profitability. Already the government is flexing its muscles with regard to product planning and business models. This reminds me of British Leyland of the 1970s. British Leyland was formed in 1968 of struggling British automobile manufacturers. In 1975, British Leyland was partly nationalized (sound familiar?). The politically-motivated British government, which knew little about the auto industry, but much about placating labor unions, ran British Leyland into the ground. The British government decided what to build and how many. This is the road the U.S. automobile industry is heading down and a bumpy road it is. I would not be a long term investor in auto-related debt. I would not go out past (she's real fine) 2009.