Elizabeth MacDonald: Auto bailout saves Wall Street too


By Elizabeth MacDonald
Fox Business News, New York
Friday, December 19, 2008


The White House today put forth a plan to loan the automakers a total of $17.4 billion, after a bruising debate in Congress and Detroit.

One of the central arguments Detroit has used to get a taxpayer funded government bailout is this inequity, that the government has provided record bail out sums for Wall Street instead of Main Street.

But that argument misses a huge point. The White House's version of the auto bailout would help bail out Wall Street as well. Specifically, the new plan is loaded with measures to help the bond market.

Wall Street is seriously exposed to Detroit and needs the auto bailout just as much as the carmakers do. Without an auto bailout, expect Credit Crisis 2.0, analysts say.

That's because Wall Street has financed the automakers' corporate debt, has helped its lending arms such as GMAC with financing, and has issued other financial securities on behalf of the automakers.

... A Debt Torpedo Aimed at Wall Street

Michigan Democratic Sen. Carl Levin has said if you let the automakers fail, that would be like tossing another grenade into the credit markets.

That's an understatement. It'd be more like zooming a torpedo down a volcano, as one analyst told me. Levin has told Reuters that "a collapsed U.S. auto industry would lead to defaults on over $1 trillion in corporate bonds, credit default swaps and other financial instruments."

The White House plan is a rescue line for the bond market.

This first version of the auto bailout -- because there will be more iterations, trust me -- would force the automakers to cut their unsecured debt load by two-thirds via a debt for equity exchange with current bondholders. That spells massive shareholder dilution.

And it means that equity dilution would go towards retiring their debt loads, including their bonds.

And the government is calling for GM and Chrysler to use their stock to pay for half the funds needed to cover future retiree health care expenses, which will be paid by union-controlled trust funds, rather than the automakers themselves, starting in 2010. More shareholder dilution.

The plan would also force the United Auto Workers union to agree to wages and work rules competitive with non-union plants operated by Asian auto manufacturers by the end of next year. And it would force the UAW to get rid of the job bank, where laid-off workers get salary and benefits while unemployed.

... The US Taxpayer Foots the Bill Again

However, it remains to be seen whether taxpayers will get this loaned money back. US taxpayers, prudent taxpayers who pay their bills on time and treat debt like the Ebola virus, are now being saddled with US debt bills from these bailouts until kingdom come. It's an important, legitimate debate, one that has not been given the airing it deserves.

Why debate it? Because why should executives be responsible, why stop risky behavior when the lender of last resort, you, taxpayer, is now the capital cushion for the business world?

"No snowflake in an avalanche ever feels responsible," says Voltaire.

And remember this: "Christmas is a time when kids tell Santa what they want and adults pay for it. Deficits are when adults tell the government what they want and their kids pay for it," says former Colorado Gov. Dick Lamm.

... The UAW Not Having It

In a statement, the UAW says it applauds auto loans, but says workers must not be singled out for unfair conditions. "We will work with the Obama administration and the new Congress to ensure that these unfair conditions are removed," said UAW chieftain Ron Gettelfinger, "as we join in the coming months with all stakeholders to create a viable future for the US auto industry."

... A Viable Future for Wall Street Too

GM, Ford, and their related financing companies, GMAC and Ford Motor Credit, have issued a vast amount of debt to fund their operations. Right now, GM has a huge $43.3 bn in debt borrowings, both short- and long-term. GM is technically insolvent right now, as it's got a negative net worth of $59.9 billion.

GM is staggering from about $73 bn in losses since 2004 and a 22% slump in U.S. sales this year, while the drop at Auburn Hills, Michigan-based Chrysler is 28%, the steepest among the carmakers.

JPMorgan Chase says 10% of the junk bond market is tied to GM, Ford, and their financing companies. Bond markets have seen trouble coming from Detroit for years and have priced in considerable risk already, Mark Oline, managing director at credit rating group Fitch Ratings, tells Reuters.

"Some of the debt is trading at 20 or 30 cents on the dollar. Certainly there's a high probability of default factored into those prices," he says. That means that the bond markets expect that in the event of a default, it could absorb one Big Three bellyflop.

On top of this debt sits $250 billion of credit default swaps (CDS) written on Ford, GM, Ford Motor Credit, and GMAC, Reuters reports, based on data from the Depository Trust and Clearing Corp., a securities transactions clearinghouse.

CDSs are insurance contracts sold on bond and bond derivatives, ensuring repayments if these securities default.

The US credit crisis turned into a global credit crunch on September 15, when Lehman Bros. failed, says economist Ed Yardeni. The corporate and muni market went into serious disarray, and it marked the start of when the Federal Reserve began to blow out its balance sheet, with massive quantitative easing.

The Fed's balance sheet now stands at a record $2.3 trillion, up from just $924 billion on Sept. 10, prior to Lehman's collapse. Factor in its other new lending programs, and the central bank's balance sheet is fast closing in on $3 trillion.

... An Auto Bankruptcy Would Roil the Credit Markets

A bankruptcy would see the CDS market roiled once again, with Wall Street working to unwind more of these derivative contracts on top of the blizzard of CDS settlements in the wake of the collapse of Bear Stearns and Lehman Bros. (Some analysts joke that the government bailout of the financials is really a bailout of the CDS market.)

Taxpayer loans, the White House has said, would have first priority over all other debt. So that means if an automaker fails, taxpayers get their money back first, with everyone else, including Wall Street, taking a backseat. As it should be.

... Congressmen Remain Opposed

U.S. Sen. Judd Gregg, R-N.H., said in a statement the auto loans from taxpayers violates TARP.

"These funds were not authorized by Congress for non-financial companies in distress, but were to be used to restore liquidity and stability in the overall financial system of the country and to help prevent fundamental systemic risks in the global marketplace," says Sen. Gregg.

The senator adds: "Unfortunately, this decision sets a troublesome new precedent that the next administration may use to expand government control over numerous specific industries that are having troubles during these difficult times."

"I also question whether General Motors and Chrysler will truly take the painful, yet necessary restructuring measures to ensure that these so-called loans aren't simply throwing good money after bad," he says. "But now that the administration has acted on its own, it is critical that Congress redouble its oversight efforts to help protect the taxpayer who is being called to bail out companies, their investors, and labor unions from their own mistakes,” Gregg says.

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