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Wednesday, May 11, 2005


end of the automakers

may 5, 2005, will be remembered by future historians of the automotive industry as one of the red-letter days in american manufacturing. it was the day that the debt of general motors and ford motor company were first and finally downgraded to junk status, giving up nearly a century of investment-grade creditworthiness.

the fate of these slowly dying leviathans has been sealed for some decades now, of course, as the united states, surfeited in wealth, transitions to a high-cost service-based economy. of more immediate interest, however, is the domino effect that could be seen throughout the markets over coming months.

gm and ford are two of the largest debtors on the planet:

The numbers involved already are enormous: GM paid about $12 billion in interest on debt last year and Ford's tab totaled about $7.1 billion. GM's consolidated debt as of March 31 was $291.8 billion and Ford's totaled $161.3 billion, S&P said.
... and their debt is largely held by massive investment institutions. business week goes on to articulate the broader problem:

The move by S&P will force many institutional investors to reshuffle their portfolios, causing massive selling of GM and Ford bonds at a lesser value. That's because some institutions are banned from dealing in junk -- or high-yield -- bonds, an asset class known to trade with more volatility and greater risk of default than investment-grade securities.
these hundreds of billions in corporate debt have suddenly become illegal holdings for massive investment pools such as calpers. forced to liquidate, they are dumping onto an unreceptive market, crushing the value of gm and ford bonds.

the debt instruments of the automakers have been setting record lows for months, and this latest blow was another knock. gm 30-year 8 3/8% bonds fell 5 cents to 74 cents on the dollar, ford 4 cents to 87.

the exposure to such a rapid loss is not insufferable for most diversified institutional investors, it must be said. and the bond markets have held up fairly well for a number of possible reasons, including the anticipation of this very event. the potential spark, however, is in hedge funds which might be exposed to derivatives of gm and ford bonds or hold arbitrage positions at very high leverage -- potentially not a survivable event.

a rumor swept the market yesterday afternoon that a couple hedge funds were being pinched by exposure to automaker bonds, and stock markets quickly sold off into the red and are continuing to do so this morning.

this is a developing problem, and whether or not some people are being pushed to the wall may not be publicly known for weeks -- indeed, until the crisis is manifest or has past, as was the case with long-term capital management. but such an event in these unimaginably hazardous financial waters is not to be viewed without great trepidation.


the fate of these slowly dying leviathans has been sealed for some decades now, of course, as the united states, surfeited in wealth, transitions to a high-cost service-based economy.

Honda and Toyota have proven that world class automobiles can be successfully built in the USA.

What contributes to General Motors' financial problems:

• It spends more on health care per vehicle than steel.

• It pays the benefits of retirees, of whom there are 2.6 for every active worker.

• Health care for retired workers consumes almost 70 percent of the company's health care costs.

• Workers pay a small amount for health care services.

GM spends too little on engineering. Its products are not updated often enough to be competitive. The Chevrolet Cavalier was essentially 15 years old when it was replaced this year by the Cobalt.

It will probably end up bankrupt, but GM and the UAW have to shoulder the blame for GM's predicament. They have squandered many opportunities to negotiate better contracts for the company and workers.

From the Washington Post: "I don't think they're really in financial trouble," said Hollis, the 42-year [GM assembly] plant veteran. "General Motors will do okay." Others are less sure. "I can't say in five years my pension won't get cut off," Hellmig said. "I don't know. You can only hope it will last."

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indeed, mr twba, health and retiree costs are some of the automakers' biggest problems -- but they are intractable short of bankruptcy. generous job security packages negotiated by the unions and the automakers mean that it costs as much to fire an employee as to keep one, as the company continues to pay a wage for its former employees.

these are features still of a high-cost economy, and i expect that service providers and retailers like wal-mart are going to be faced with similar problems in the future, even if it isn't widely anticipated right now.

only bankruptcy will force a change in those contracts -- and, as we're discovering with united airlines, it won't be easy then either.

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Gaius Marius should get a Nobel Prize for prescience. Wow!!!!

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