The Market Ticker - Business

GM and Chrysler: Goodnight

nospam@example.com (Karl Denninger) — Thu, 23 Apr 2009 08:06:00 -0400

By now it is clear that both GM and Chrysler are likely done.

Treasury "asked" Chrysler's bondholders to take a huge haircut:

April 23 (Bloomberg) -- The U.S. Treasury asked Chrysler LLC’s secured lenders to reduce their debt to $1.5 billion from $6.9 billion in exchange for a 5 percent equity stake in the automaker, a person familiar with the negotiations said.

The offer followed by a day a proposal by the lenders to reduce the debt to about $4.5 billion and take 40 percent equity. The person describing the Treasury offer asked not to be identified discussing the private talks.

That's not only too far apart, if I was a bondholder I think I'd take my chances in a bankruptcy court.

We are talking about a 75% whack here, which implies recovery of 25 on secured debt.

I wouldn't do it if I were them. I'd go see the judge; in a crack-up of Chrysler I bet there's more than a quarter in recovery value, and at that point you may as well have a roll of the bones.

But who's negotiating here? Gee, who 'ya think?

The lender group is composed of New York-based JPMorgan Chase & Co., Goldman Sachs Group Inc., Citigroup Inc., Morgan Stanley and the investment funds.

Big surprise. Not.

But in this case I have to defend the banks' position. I don't know exactly where Chrysler is in terms of "how bankrupt are you" but it is unlikely that they've destroyed 75% or more of the bondholder value.

This interchange, however, tells us quite a bit. It is, in fact, a model for the banking system - its called a cramdown (no matter what you might want to call it) and it is what happens in bankruptcy.

GM, for its part, is saying it will idle virtually all of its assembly plants in the US for at least a week (and probably more like a month or two) between May and July, and in addition yesterday said it will not make a scheduled June 1st debt payment.

Anyone care to bet on whether GM files before the end of May? That's where my money would be - but I refuse to short a $1.69 stock!

In any event if GM and Chrysler are put through a prepackaged bankruptcy this will prove an instructive example for the banking system - and what must happen to clear excess debt from the system across the board.

While nobody wants to see GM and Chrysler go through a bankruptcy, the fact remains that the debt levels these firms are carrying cannot be sustained. That's clear from their operating results and inability to meet debt service and operating cash requirements from sales - ergo, it's time to get on with it.

GM: Bankrupt, UNLESS....

nospam@example.com (Karl Denninger) — Wed, 01 Apr 2009 15:06:00 -0400

GM is likely finished.

April 1 (Bloomberg) -- General Motors Corp.’s 60-day deadline to restructure is unlikely to be extended because the U.S. won’t repay $1 billion in convertible notes maturing June 1, according to a person with knowledge of the discussions.

This is basically the government telling GM that either they get the bondholders to agree to whatever is necessary, or they're dead.

They're dead, and here's why.

Back on Monday I wrote about the Automakers and said this in closing:

And then there's the nearly $1 trillion in CDS that will trigger. There is no accurate way to know what the net exposure is on those, but I'd take the "over" on $100 billion, focused in you-know-where.

Here's the problem - I'm willing to bet that a huge percentage of those were written by AIG.

The government has provided a history now that says that if you are a holder of CDS written by AIG, you will get 100 cents on the dollar, even if the notes don't default. In addition that 100 cents is above what you would normally get even if there IS a default, because normally you have to tender the defaulted bond or the payout is limited by the recovery, and recovery on a defaulted bond is almost never zero.

So in this case the winning play, if you're a big bondholder, is to tell GM to suck eggs; you'll get paid 100 cents on your CDS even though AIG has no money, because the taxpayer will make you whole on those CDS, even if the bonds have a recovery in bankruptcy.

In other words you could conceivably get more than 100 cents if you hold those bonds - so long as you also hold a CDS as a hedge.

It must be nice to be able to screw the taxpayer for more than a 100% payout, right?

The bondholders "committee" is all made up of big players who presumably are hedged, ergo, this has to be assumed to be part of their "thought process" - if not the controlling factor.

Small bondholders on the other hand (who have no hedge, unless they were smart enough to buy lots of PUTs a few months ago) are just going to get plain old-fashioned screwed.

Since the only way GM survives is for it to get the bondholder committee to agree to restructuring it therefore follows that the only way this can happen is if the administration (and Fed!) makes very clear that all funding to AIG has been cut off and therefore no further "pass through" payments will (or can) occur.

That is, The Obama Administration has to bankrupt AIG to save GM, or we will instead see the banks again rip off the American Taxpayer through yet another "passthrough" CDS payout stream AND GM will go bankrupt.

Get ready America - you're about to get it in BOTH holes this time.

This is analysis and deduction based on the available and public facts - I have no proof - but I'll bet this is exactly how this deal will go down, and why.

PS: Every firm in America that has a significant amount of CDS outstanding is potentially subject to this same attack. It's all very nice that our government is permitting banks to rob the citizens like this, isn't it?

Automakers: Monday Update

nospam@example.com (Karl Denninger) — Mon, 30 Mar 2009 13:08:00 -0400

I let this settle for a bit before Tickering it, as this morning the news was coming fast and furious, and I wanted to write one instead of three......

First, the "easier" - apparently Chrysler and Fiat have reached terms. This may take Chrysler off the table in terms of a bankruptcy. Maybe. No details as of yet.

GM on the other hand is in trouble. There are those who back Wagoner, who was forced out. I'm not one of them.

Wagoner came into the firm's top spot well aware that GM needed to make some very difficult choices and screw a lot of people, or it was done. The firm has been functionally bankrupt for twenty years, and avoided the fate back then only by levering up using cheap money in their financing side, managing to roll people into upside-down car loans to pull forward demand and then spreading out into home equity and mortgage lending to gear it up even higher.

None of this was sustainable and it still isn't, and the legacy costs are murderous. Those costs came about through several decades of knuckling under to the UAW and managing to finagle people into buying their debt. The KoolAid was definitely being drunk at all levels; it is simply impossible to build a sustainable auto company when your only seriously profitable lines are big trucks and SUVs, all of which have a sales curve that depends on "forever" cheap fuel.

The collision between reality and this corporate posture was inevitable and well-known more than a decade ago - more than enough time to tell the stakeholders to cut the crap and resolve the problems, or face being wiped out.

But Wagoner didn't do that, with this changes being incremental rather than the necessary revolutionary upset.

Now President Obama has grown a tiny little set of mouseballs and threatened to do what should have been done last year:

“We cannot, we must not, and we will not let our auto industry simply vanish,” the president said at the White House, announcing new and final deadlines for the No. 1 and No. 3 U.S. automakers to remake themselves. “But we cannot continue to excuse poor decisions. And we cannot make the survival of our auto industry dependent on an unending flow of taxpayer dollars.”

If plans for automakers fail, the administration is prepared to let them slide into a structured bankruptcy that he said would make it easier GM and Chrysler to clear away old debts and emerge as smaller, leaner operations.

A fair question is why the administration has continued to allow the poor decisions in the banking system, both regulated and shadow, to stand and be profited from on the backs of the taxpayers.

While this is clearly a good move in terms of what needs to happen, it is only a small start.

From a macro economic perspective removing the bad debt on GM's balance sheet through bankruptcy (or renegotiation) is a good thing, but it is only a first baby step along the road to returning our economy to balance.

Should Obama's mouse-balls grow into elephant nuts then there will be something to celebrate. Wake me up when President Obama forces identical haircuts on the bondholders of the banks and other financial institutions, thereby reducing the outstanding debt in the system to a meaningful degree, and cuts the Federal Budget so that he does not spend more than the government can take in. (Holding your breath in anticipation of such an act is suicidal; I do not recommend it.)

Unfortunately what I believe is going on here is yet another diversion - this time away from the ever-growing evidence that the big banks have effectively "captured" the government much like occurs in any good Banana Republic, and we're headed down the same hole as those nations in terms of our economic outlook - that is, destruction, and the government, instead of addressing the problem will continue to look for things they can misdirect with.

This misdirection is very likely to blow up in their face as I suspect the UAW's Gettlefinger is going to give the finger to Obama and GM, forcing a trip through the bankruptcy process, while at the same time the government's backing of warranties will turn into a monstrous inducement for fraud among the dealerships who are rapidly seeing their credit access and cashflow disappear.

And then there's the nearly $1 trillion in CDS that will trigger. There is no accurate way to know what the net exposure is on those, but I'd take the "over" on $100 billion, focused in you-know-where.

Battle Of Lawyers!

nospam@example.com (Karl Denninger) — Fri, 20 Mar 2009 08:32:00 -0400

This promises to get amusing; two headlines:

"Countrywide sues AIG unit over its failure to cover loan losses"

and

"AIG Sues Countrywide for Misrepresenting Mortgages"

You can't make stuff like this up; here's a few choice quotes from both stories (you match 'em!)

Eggert added, "Here Countrywide displays a huge amount of chutzpah because it's suing because its loans went bad, and it claims United Guaranty should have done better underwriting, when it's the failing of underwriting by loan originators that got us into this stuff."

United Guaranty said in the complaint that it had reviewed loan files that showed that most mortgages covered by 11 policies for asset-backed securities were either underwritten in violation of Countrywide’s own guidelines or contained defects, such as missing documents, misrepresented credit scores or false social security numbers.

You just have to chuckle at the "ready fire AIM!" chutzpa here.

Never mind the obvious appearance of bribery found in this nugget:

Countrywide was also a focus of attention Thursday in Washington, where Rep. Darrell Issa (R-Vista) released a 63-page report detailing the company's practice of giving discounted mortgages to influential people, particularly key lawmakers, staffers and other government officials.

No really? I wrote about this when it first came to light. You don't think that Countrywide was perhaps "buying" a little willful blindness, do you?

There's nothing particularly wrong with issuing no-documentation "I don't care about credit quality" loans, provided you don't lie about what you're doing - to anyone! That is, if investors are willing to buy unrated paper (you can't rate a loan without knowledge of what you underwrote, and if the answer is "I didn't" then it is NOT POSSIBLE to rate the deal) with full knowledge that someone working at WalMart may have claimed a $300,000 income, that's fine. The free market will dole out reward (or harm) as it should.

But when you have people claiming that these loans were "underwritten" when in fact no such thing happened - there were either blanks on the forms or worse, blatant falsehoods, that's a major problem and people will get defrauded - that is, ripped off - and they did.

Quite some time ago I said that I wished there was a way to go long lawyers, because this entire mess would be the lawyer's full employment act for the next decade.

It appears that we're just getting started in this regard.

I Think I See A Smart CFO!

nospam@example.com (Karl Denninger) — Tue, 17 Mar 2009 13:17:32 -0400

Who'd a thunk?

Coca-Cola, health-insurer WellPoint Inc. and more than 30 other companies are issuing bonds and using the proceeds to repay their short-term IOUs, according to data compiled by Bloomberg. The amount of commercial paper outstanding shrank 16 percent since Jan. 7 to $1.48 trillion last week and daily issuance dropped to a four-year low, according to the Federal Reserve.

No really?

Hint from the Peanut Gallery - using short-term debt to pay longer-term obligations is criminally stupid.

Commercial paper should not be used for funding requirements that remain open longer than its maturity. Why not? Well, gee, what did we learn last fall?

If I want to, for example, build a new plant, I should issue bonds with a sufficient duration to guarantee that I can (1) get the plant built, (2) get it online, and (3) have it contribute enough to the firm's cash-flow that rolling over that debt will not be an issue, as I will have proved that the installation is salutary to the firm's health.

Even better would be to amortize that structure over its service life on the original issue (or at least to where I anticipate needing to perform a significant refit on the facility)

This is called sound business practice; you know you have the money for the length of time necessary to deploy that capital and put it to productive use.

But no! The financial "geniuses" that came out of our so-called "business schools" instead had been issuing short-term debt to fund long-term obligations. This makes you look smart as its cheaper to borrow for a short period of time than it is to borrow for a longer one, since the inflation and economic risk is less over a short period of time.

The "stupid", however, is that the risk did not actually decrease. Instead, what happened is that you retained it instead of transferring it to the buyer of the bond, in that the risk is now that you may not be able to roll that paper at a reasonable price - or at all!

This "something for nothing" mentality is part and parcel of why I have nothing but disgust for people who have the three letters "MBA" after their name (in most instances, not all); these are the same sort of "geniuses" who time and time again keep claiming they have found a free lunch - only to find out that they are the lunch when what they found in fact is a lion that promptly eats them.

PS: This is why you take a 30 year mortgage too. It allows you and your spouse, just married, to live in the house and raise a handful of children from conception to maturity without refinancing risk. Why is it that this fundamental fact - that matching duration of debt to expected utility of that which is purchased with it - is something that isn't instantly obvious?

More GE (IMPORTANT)

nospam@example.com (Karl Denninger) — Thu, 05 Mar 2009 13:07:00 -0500

Off the wires, no link.

"DJ reports GE Capital credit default swaps worsen even as GE released a statement emphasizing its strong cash position. The CDS are most recently quoted at 17.5 points up front, from 16.5 points up front earlier today, according to Phoenix Partners Group. That means investors must pay $1.75 mln up front, plus a $500,000 annual fee, to protect $10 mln of GECC senior bonds against default for five years."

That means the first year cost is $1.75 + $500k, or $2.25 million.

That's 22.5% first year cost to insure $10 million against default!

This means that the market is saying that the odds of GE going bankrupt within the next twelve months is greater than one in five, and that assumes zero recovery.

If the bonds would recover more than 80% in the event of a default then it is implying more than a 100% risk of default, which is obviously impossible.

This is occurring despite GE's CFO appearing this morning on CNBC making the case quite clearly that there is no risk of default under any materially possible scenario. In other words, his assertion is that the odds of default are zero.

One of two things must be true:

GE's CFO is lying and must be indicted for doing so.
This so-called "market segment" (CDS) has become so ridiculously overlevered, unsupervised and able to cause failures that it is now within days or even hours of CAUSING GE to fail - not due to GE's own internal problems, but due to positive feedback that the CDS market is capable of and is generating on the initiative and as a consequence of the action of participants in that market.

Either way a major change needs to occur right here and now, lest we find ourselves with no pensions, no Social Security, no Medicare, no annuities and no government.

THIS CAN NO LONGER BE DELAYED OR TOYED AROUND WITH; WHEN "THE BEZZLE" REACHES THE POINT THAT IT STARTS DESTROYING THE NATIONAL CORPORATE INDUSTRIAL GIANTS THAT MAKE UP OUR ESSENTIAL INFRASTRUCTURE, MILITARY AND COMMERCIAL ENTERPRISES THROUGH NO FAULT OF THEIR OWN IT IS A NATIONAL SECURITY EMERGENCY AND MUST BE DEALT WITH IMMEDIATELY.

Told You So: Pensions

nospam@example.com (Karl Denninger) — Mon, 02 Mar 2009 10:19:55 -0500

From Chicago Business:

""There are companies out there faced with paying their pension plan or staying in business," says Mark Ugoretz, president and CEO of the ERISA Industry Committee, a Washington, D.C., lobbying group. ERISA refers to the Employee Retirement Income Security Act of 1974, which sets standards to ensure pension plans are sufficiently funded."

Still think I'm blowing smoke about 20% of the S&P 500 potentially going under on a move to 500 in the index, and half if the index collapses into the 300-400 range?

The math is never wrong, and our esteemed President Obama cannot escape the mathematics, no matter how "annointed" or "destined" he wishes to believe he is.