True Cost of the GM Bankruptcy
As can be expected, the media really did a poor job of covering the GM IPO, consistently underestimating the total public cost of the bailout (e.g. no one is mentioning the $45 billion in tax-loss carryforwards GM was allowed to keep, against all precedent).
But the real cost of the handling of the GM bankruptcy is in 1) the terrible precedents it set in hammering secured creditors to the benefit of favored political allies of the Administration and 2) the loss of the opportunity to get billions of dollars in production assets out of the hands of the people who have be sub-optimizing them.
It was this latter issue I have focused the most on, particularly in this post where I argued for letting GM die. I said in part:
All these management factors, from the managers themselves to process to history to culture could better be called the corporate DNA. ...
Corporate DNA acts as a value multiplier. The best corporate DNA has a multiplier greater than one, meaning that it increases the value of the people and physical assets in the corporation. When I was at a company called Emerson Electric (an industrial conglomerate, not the consumer electronics guys) they were famous in the business world for having a corporate DNA that added value to certain types of industrial companies through cost reduction and intelligent investment. Emerson's management, though, was always aware of the limits of their DNA, and paid careful attention to where their DNA would have a multiplier effect and where it would not. Every company that has ever grown rapidly has had a DNA that provided a multiplier greater than one"¦ for a while.
But things change. Sometimes that change is slow, like a creeping climate change, or sometimes it is rapid, like the dinosaur-killing comet. DNA that was robust no longer matches what the market needs, or some other entity with better DNA comes along and out-competes you. When this happens, when a corporation becomes senescent, when its DNA is out of date, then its multiplier slips below one. The corporation is killing the value of its assets. Smart people are made stupid by a bad organization and systems and culture. In the case of GM, hordes of brilliant engineers teamed with highly-skilled production workers and modern robotic manufacturing plants are turning out cars no one wants, at prices no one wants to pay.
Changing your DNA is tough. It is sometimes possible, with the right managers and a crisis mentality, to evolve DNA over a period of 20-30 years. One could argue that GE did this, avoiding becoming an old-industry dinosaur. GM has had a 30 year window (dating from the mid-seventies oil price rise and influx of imported cars) to make a change, and it has not been enough. GM's DNA was programmed to make big, ugly (IMO) cars, and that is what it has continued to do. If its leaders were not able or willing to change its DNA over the last 30 years, no one, no matter how brilliant, is going to do it in the next 2-3.
So what if GM dies? Letting the GM's of the world die is one of the best possible things we can do for our economy and the wealth of our nation. Assuming GM's DNA has a less than one multiplier, then releasing GM's assets from GM's control actually increases value. Talented engineers, after some admittedly painful personal dislocation, find jobs designing things people want and value. Their output has more value, which in the long run helps everyone, including themselves.
The alternative to not letting GM die is, well, Europe (and Japan). A LOT of Europe's productive assets are locked up in a few very large corporations with close ties to the state which are not allowed to fail, which are subsidized, protected from competition, etc. In conjunction with European laws that limit labor mobility, protecting corporate dinosaurs has locked all of Europe's most productive human and physical assets into organizations with DNA multipliers less than one.
alanstorm:
IIRC, "Parkinson's Law" covered this concept quite well.
November 19, 2010, 10:58 amMesa Econoguy:
The true crime as mentioned by Coyote above was the re-ordering of secured creditors vs. equity holders in the bankruptcy process, against 200+ years of bankruptcy law.
It would be very interesting if some rabid Repub were to open an investigation into how the entire reorg process was handled, including the bankruptcy piece.
In a way, this last election was somewhat about getting assets of varying value out of the hands of those destroying and sub-optimizing them.
Let's see if this trend has legs.
November 19, 2010, 5:19 pmIgotBupkis, President, United Anarchist Society:
I strongly recommend the light comedy movie Other Peoples' Money
It is the anti-Wall-Street, and possibly the single best pic about high-finance that exists.
Pitting the eeeeevil corporate raider (played by Danny Devito) against the forthright, honest (but failing) businessman (played perfectly by Gregory Peck), it culminates in a beautiful speech by Peck, that resonates with the heart and seems simply unbeatable...
If Devito is to win, he'll have to cheat, or pull some trick.
We know this, after that magnificent speech.
Then Devito gets up and gives a speech that just flat-out blows Peck out of the water!!!
We are talking Peck getting carpet bombed, folks.
GREAT movie.
November 20, 2010, 9:41 amdavid foster:
Agree that OPM is a great movie. Interesting, though, that the hero (well, heroine) is a *lawyer* who does the job that the CEO *should* have been doing by locating another market for the company's product. Anyone ever hear of that happening in real life? Hollywood just can't resist making its heroes either lawyers or journalists.
November 20, 2010, 1:30 pmRolfe Glover:
The GM bail-out was the direct result of the 1979 Chrysler bail out. Then, due to the arrival of Japanese auto manufacturers, there was too much US capacity. Rather than let the market rationalize via the Chapter 11 re-organization process, the feds bailed out Chrysler with a $1.5 billion loan package, (the amount sounds quaint).
This left us with too much capacity and signaled to the UAW that uneconomic contracts would not be voided by a bankruptcy judge. The result, this time we got to bail out two auto manufacturers. Will it be 3 next time? How much will that cost?
Ironically at the time GM’s Chairman Thomas A. Murphy critized the Chrysler bail out as "a basic challenge to the philosophy of America."
November 20, 2010, 4:52 pmBob Smith:
The true crime as mentioned by Coyote above was the re-ordering of secured creditors vs. equity holders in the bankruptcy process, against 200+ years of bankruptcy law.
What I don't understand is why the creditors didn't fight. Obama had no legal authority to make the demands he did, and if the bankruptcy judge ruled otherwise it could have been appealed all the way to the Supreme Court. If GM owes you a billion dollars spending a few million on appealing an outrageously unlawful ruling is nothing. Watching Obama get slapped down would have been a sweet moment. Instead the creditors caved and agreed to what Obama demanded, and the BK judge approved it because he's basically required to approve agreements that have the approval of all the parties. There must have been some backroom dealing going on, perhaps regulatory threats, to make the creditors back down.
November 21, 2010, 1:07 amIgnoramus:
"the true crime was the re-ordering of secured creditors vs. equity holders"
False.
The GM deal was an aggressive use of Bankruptcy Code 363 -- which allows for a sale of assets out of bankruptcy to a designated buyer on the condition that other stakeholders -- or anyone for that matter -- can come in and make a higher bid. "363" sales are often used for sales of stand-alone divisions of bankrupt companies. What was aggressive in the GM situation was the size of what got sold, both as a percentage of the GM bankruptcy estate and the aggregate dollar amount -- but there's precedent for this and it was legal.
The debtholders could have used the face value of their debt as part of a consortium bid, in which case they could have topped anyone, if they wanted to. But they didn't. That's because -- on the numbers -- GM wasn't worth saving. On the numbers, GM should have been liquidated. In which case debtholders would have gotten less, or more likely -- nothing.
So GM's secured creditors didn't get screwed with GM, and actually got more than they should have, had the USA not intervened.
So who got screwed? ... the US taxpayer ... and Ford, Toyota, etc
The USA lost money the day it invested in GM. The right benchmark was to use Ford as a comparable. We invested in GM on the basis of an implied $70 billion pro forma valuation at a time when Ford's market cap was only $40 billion. GM wasn't worth 7/4x Ford then, and it isn't worth 7/4x Ford today.
So who won? ... the UAW.
We can argue whether "investing at a loss" for a bigger public policy goal was justified with the GM, but the entire deal was structured to put the UAW -- and particularly its retirees -- at the front of the line with no haircut. In effect, Obama handed the UAW pensioners $10 billion. The left says "we're all in this together", but it always works out that some pigs are more equal than others.
It's all about the optics.
It's important for Obama & Co to claim that the USA hasn't lost that much on GM. So they take credit for anything good that happens at GM including interest and dividends paid, and the market appreciation that automakers have enjoyed over the last year, etc.
But that still wasn't enough, so Obama & Co threw in $45 billion of net operating losses (NOLs). Ordinarily, the tax benefit of NOLs gets lost when a company runs through a bankruptcy 363 sale, but not here. Somehow Treasury found a way to give a one-off ruling that New GM could carry over Old GM's NOLs -- they have an NPV of something like a $10 to $15 billion. This is unprecedented, and I doubt it will be repeated.
This was a key selling point during the IPO and served to boost GM's valuation. To the extent that the USA is an owner of GM, we're just moving money from right pocket to left, but it made the IPO valuation higher. But to the extent that the UAW is a GM owner it's got another $3 billion or so in value as a handout from the USA.
The UAW's investment in Obama has had a remarkably high ROI, hasn't it?
November 21, 2010, 8:53 amJames H:
Bob Smith,
The creditors didn't fight because all of the big players had taken TARP money, and Obama told them that they couldn't fight it. You may recall that right after the big banks were forced to take TARP money, all kinds of rules were made.
Some of the small creditors protested, to which the president said something like he didn't stand with them, and of course they were leaned on pretty hard. Plus, they only had a 5% stake or so, and the judge didn't feel that they mattered.
November 21, 2010, 5:27 pmMesa Econoguy:
Ignoramus, I think you're being overly generous re: 363 "aggressive" jurisprudence in this case, but interesting points on UAW ROI.
November 21, 2010, 7:12 pmtxjim:
Ignoramous - wow ty for the excellent points. I agree the UAW has been racking up the chits with their great investment strategy. Unbelievably successful with this past congress and Obama. I hope I live to see the day when justice is served and those criminal bastards are burned to the ground.
November 21, 2010, 8:32 pmJeff:
We're all forgetting one additional loser in the whole GM debacle. Any company with a unionized workforce will have to pay a risk premium on future bond sales. How would you like to be the CFO of Boeing or Caterpillar trying to raise capital with the precedent that Obama just set with GM?
November 22, 2010, 7:03 amGina Becker:
Yes, the true disaster is the precedent. The constitution is supposed to protect us from arbitrary power, but it doesn't work if we allow the president to ignore law for the sake of his own popularized definition of a "greater cause."
To so many naive citizens, his actions to "save jobs" seem good, and seem to only hurt "rich bad creditors," and so they applaud the bold arbitrary action. And they remain blind to the losses we suffered by protecting inefficient jobs while hurting those providing a true service, keeping many potentially productive and creative people, on both sides, from realizing their potential.
November 22, 2010, 8:52 amIgnoramus:
"I think you’re being overly generous re: 363 “aggressive†jurisprudence in this case"
I don't understand this comment.
"Any company with a unionized workforce will have to pay a risk premium on future bond sales. "
This shouldn't be true, as GM and Chrysler were special cases. It's not every day that you have a buyer who will pay far more than bankruptcy assets are worth. It's not everyday that said buyer will gift an equity interest to a union.
1) Had the USA not intervened, GM secured creditors would have gotten little or nothing. Because the USA valued GM as worth 7/4x Ford, they got something. Also, in effect, 23.85% of Treasury's recent gift of $45 billion in NOLs went to the benefit of these creditors.
2) That the UAW -- a junior creditor -- got more than they should is incidental. It's the taxpayer who paid the cost.
This was "legal" and "constitutional" although an outrage.
In the Progressive Paradise that's the State of Michigan, the UAW -- and especially its retirees -- are at the top of the food chain, and are being kept there thanks to the detail of the GM Bailout. That's the unreported story re: GM. Collectivism always sounds good in theory, but it's always less than "fair" in practice. Not all pigs are equal. Here's but another example.
Further, when you understand the details of the GM Bailout, you can see how Machiavellian "smart" Obama & Co can be when it comes to "working" legislation and regulations. It's what they do. Be afraid
November 22, 2010, 12:34 pm