Page 1 of 2 Better than war By Julian Delasantellis
In Funny Girl, William Wyler's 1968 film version of the Broadway stage
musical, Fanny Brice (Barbara Streisand) , laments her role in life as the girl
who gets the finer things only when others are through with them:
in our apartment came from father's store
Even things I'm wearing someone wore before
It's no wonder that I feel abused
I never get a thing that ain't been used
I'm wearing second hand hats
Second hand clothes
That's why they call me
Second hand Rose.
Even Jake, the plumber, he's a man I adore
Had the nerve to tell me he's been married before!
One wonders if, when China picks the United States up off
bargain basement floor, whether they will be similarly self pitying, or will
they know a good deal when they see it better than poor Fanny?
You can feel it; it's that moment just before the credits are set to roll on
that long, sad saga that is the US auto industry. Chrysler fell into bankruptcy
on April 30, GM on Monday. When next we see Chrysler it will be only as a
digestive of the Italian automaker FIAT. GM, Alfred Sloan's once proud
amalgamation designed to provide price and lifestyle points all along the value
spectrum for the entirety of the huge American market, will be mutilated and
shorn down to a company consisting of basically just two operating entities -
Chevrolet and Cadillac.
Press reports are speculating that the new company may be brought back to the
stock market in 18 months or so, but with US auto sales currently running at
about a 9.3 million unit annual sales rate, down 45% from their highs in 2000,
sales will have to recover quite a bit, perhaps all the way back to the teens,
before Wall Street will be willing to take another look at an industry whose
failures have just wiped out every single penny the Street had put in it for,
in the case of GM's up to yesterday tenure of a member of the Dow Jones
Industrial Average, the last 83 years.
The key operating concept of bankruptcy, of course, is that an individual,
company, or even a nation, lacks the funds to pay back the debts it has
incurred. Putting the whole matter in the hands of the bankruptcy court judge
does not generate one extra penny for the debtholders; it just provides a
framework and structure by which what few assets the company has can be
somewhat equitably distributed among the large pool of creditors that the
company owes money to.
If the ultimate intention is not to liquidate the enterprise but to keep it
functioning in some manner after emerging from bankruptcy court, the asset
sales must necessarily be more constrained, since the cuts can't be so deep as
to strip the company of operating assets and equipment needed to produce its
product. For GM, with over US$173 billion of debt, owed to everybody from
holders of its bonds to those who delivered stationary and pencils to its
accountants, against just over $82 billion in assets, the challenge involved in
keeping GM around will be substantial.
It now appears that the bankruptcy court framework to be utilized with GM will
be similar to that used with other large corporate bankruptcies (GM will be the
fourth-largest bankruptcy in US corporate history, behind last September's
Lehman Brothers filing, WorldCom in 2002, and Enron in 2001) - a so called
In this, the bondholders are going to be forced to exchange the debt owed by
the company for equity shares in the new company - shares that, for a while at
least, will have almost no value. According to press reports, the deal has the
biggest bondholders exchanging $27.2 billion in GM debt for between a 10% and
25% equity share of the company.
At Friday's GM total market capitalization of $457 million, the bondholders are
exchanging their billions of dollars of debt for no more than $120 million.
Reports of the final deal have the United Autoworkers Union (UAW) and US
government taking the remaining equity shares, the UAW taking an ownership
stake in return for giving up its previously negotiated health and retiree
benefits, the government taking a 60% majority ownership in return for the $60
billion in TARP and other aid provided to the company since last December.
If you followed my writings on developments in the mortgage markets, you may
recognize what's going on here. This whole debt/equity swap process is not much
more than a very sophisticated mortgage "cramdown", where debtholders find that
they are being given an ultimatum to accept less than they are rightfully due
and desire in the hopes that this will preclude the possibility of getting
In relation to mortgages, cramdown referred to ultimately rejected proposals
that would have given judges in bankruptcy court the right to alter mortgage
repayment terms so that the guy maybe a few thousand dollars down on his
mortgage might get a chance to get his head above water rather than
automatically and inevitably face foreclosure. (See
A break from the bankrupt norm, Asia Times Online, May 7, 2009.)
The banking and finance industry screamed like banshee divas getting bounced
from a cheesy reality TV show over the prospect of mortgage cramdown, defeating
the proposal in the US Senate, but GM's ability to sail through bankruptcy,
cramming a deal down the bondholders' throats that they hate (of course, they'd
rather have the money owed them - wouldn't you? ), retiring debt by giving
shares of, to put it mildly, uncertain value, only once again proves an
important, eternal truth of finance. If you owe a creditor $5,000, the creditor
owns your soul, if you owe the creditor $5 billion, you own his.
Why stop with GM's $173 billion of debt? If debt/equity swaps are the magic
trick that squares circles and makes everybody happy, might one work with the
world's currently biggest debt problem - America's $11.3 trillion of government
debt, now growing at close to $5 billion each and every day?
I frequently receive questions seeking my opinion as to how I think the entire
economic and financial crisis will end. Assuming that you have not yet drunk
from the "green shoots" Kool-Aid cup and so now believe that things are getting
great even as the economy dies around you (the horrible Case/Shiller home price
and loan origination numbers should disabuse most of those who seem to be
smoking and toking the green shoots), you may be one of those who think that
the US government and Federal Reserve are going to be printing money so fast so
as to debase the economy and inflate the currency out of the real value of its
With the Federal Reserve first pegging short-term US interest rates at zero,
and then initiating a massive "quantitative easing" expansion of its balance
sheet, the salvation-through-inflation crowd's argument is somewhat convincing.
Still, with the "inflation vigilantes" on watch in the government debt market,
the same force that has put over 100 points on the 10-year note yield in just
two months, the market may he just a bit too clever to allow itself to be
shafted so blatantly and obviously.
But it's not the hyperinflation/it'll take a billion dollars just to buy a loaf
of artisan sourdough bulgur wheat bread scenario that I'm looking for. I'm
looking for the greatest debt/equity swap of all time.
When the talk turns from how much debt to who owns the debt, everybody knows
who we're talking about. China has earned a national treasure since assuming
its role as America's factory floor, and the specific national treasure I'm
talking about is what once was America's. Out of almost $2 trillion in total
foreign exchange reserves, China, according to the most recent US Treasury
data, holds over $760 billion in official US government securities; add in
government agency bonds and corporates, and well over half of China's reserves
are held in US dollar-denominated debt securities.
There is every indication that, what with the incredible fiscal profligacy
forced on the Barack Obama administration by the financial crisis, the Chinese
government enjoys this financial dependence on the US not one little bit. It's
now a regular occurrence to have Chinese officials wag their fingers at America
and scold it for its budgetary licentiousness, and the US Treasury's monthly
Treasury International Capital report, the ledger as to who is taking money out
of America and who is putting it back in, is showing China lightening up on
both the maturity and duration of its US Treasury holdings, shifting to the
shorter, safer, more liquid leg of the yield curve.
In response, the Obama administration has shifted its policy focus as well.
Gone are the days early in the administration when China would be warned to
stop keeping its currency, the yuan, too low. Now, the policy is much simpler.
It consists of having US officials, such as US Treasury Secretary Timothy
Geithner last weekend, make the trip to Beijing to prostrate themselves before
the country's ruling communist plutocrats and beg them not to pull their money
out of US assets, and, by extension, the US economy.
Obviously, with the twin risks of both currency and capital asset depreciation,
China is starting to examine seriously the wisdom of holding so much of its
hard-earned treasure in debt securities of a questionable currency paying
coupon interest, in the case of the US 10-year note, of just under
three-and-a-third percent per annum. Still, America desperately needs China's
money. It is frightening just to think of the extent of financial deleveraging
that would befall the US economy should a trillion dollars of Chinese assets be
suddenly withdrawn from the current weakened American financial system.
Some might think that a limiting factor making a US debt/equity swap impossible
is the basic fact that, of course, you can't buy and sell shares of the US
government (US politicians - that's another story). If there's no shares,
there's nothing you can swap your debt into - right?
What has the last year taught us more than the fact that in contemporaneous
mixed economies, private and public sectors are very flexible and diaphanous
concepts? Since the current crisis began, and whenever it needed to, the public
sector of America, as well as in many other previously assumed to be market
governed economies, has intervened deeply and repeatedly in corporate affairs
previously assumed to be wholly within the purview of the private markets.
Northern Rock, Bear Stearns, AIG - the roster will surely not end with GM. The
flip side of this is how we have learned that, for many government officials,
their time in government service is somewhat comparable to a sideways transfer
to the company's branch office in the public sector - still very much within
the corporate megalith. Assuming they have direct deposits of their paychecks
and so don't actually see them, it's a wonder that anybody at Goldman Sachs
ever knows whether they're working in house for the company or for the
government from one week until another.