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Tuesday, June 2, 2009

GM Filed for Bankruptcy

Yesterday, General Motors filed for bankruptcy.

GM was removed from the Dow index and replaced with Cisco. At the same time, Citigroup will be replaced by Travelers. This change doesn't take effect for a week. In the meantime, a bankrupt business will be included in the Dow index. A bankruptcy by GM has been inevitable for awhile. GM should have been removed from the Dow index a long time ago, although that probably wasn't politically acceptable until they filed for bankruptcy.

The Federal government is contributing additional bailout money as part of the bankruptcy arrangement. If you listen to pro-State trolls on the Communism Channel, they'll say "Good for the State! GM is 'too big to fail'." If GM is going to be such a great business after bankruptcy, the shouldn't GM's management be able to raise capital from sources other than the government? By definition, the Federal government is paying above-market rates for the "investment" in GM. Also remember that the Federal government may make a 5% return over two years on its "investment" and claim a profit, even though that return underperforms true inflation.

Before filing for bankruptcy, GM's creditors already agreed to get paid a certain percentage of the face amount of their bonds. That isn't the way bankruptcy is supposed to work. The corporation's assets are supposed to be sold to the highest bidder, and the creditors get whatever they can. Some of the Federal government bailout money is being used to repay creditors.

There also is supposed to be a clearly determined order of which creditors get highest priority. The pre-bankruptcy negotiations meant that creditors were paid in a different order than they should have been paid. Of course, lobbyists from the bondholders made sure they got a good deal. There probably won't be adequate public disclosure of which creditors got how much bailout money. You might be able to find out who gets paid what, but it's practically impossible to determine what creditors whould have received if there were no bailout.

If you were foolish enough to lend GM money in the past 5-10 years, or bought their bonds, then you deserve to lose most of your investment. Even if the Federal government contributed zero bailout money, GM's assets still would be sold in bankruptcy court (if they're worth anything). If the State spends another $10B or whatever bailout out GM, that's $10B that couldn't have otherwise be spent on something useful.

Notice that GM's creditors made out on both the initial bailout and in bankruptcy. The bailout in 2008 meant that GM was able to make another 3-6 months of payments on their bonds before filing for bankruptcy. This is substantial, because GM's bonds were "junk" paying yields of 15% or more. If you bought GM debt just before the first bailout was announced, you made a huge return. For the second bailout, anyone who knew that there would be no additional bailout could have made money short selling GM stock. Alteratively, insiders who knew what the bailout/bankruptcy deal would be made a killing. They could have bought or short sold GM debt, based on how good the bailout/bankruptcy deal would be.

GM's dealers also got a bad deal. GM has selected some dealerships to close, as part of the downsizing. A GM dealer is a separate business, who has a franchise agreement with GM. I believe the same is true with Ford and Chrysler. When the franchise agreement is terminated, the franchisee loses their investment in the business. Plus, closing franchises allows insiders to profit. Suppose that X and Y both own a dealership franchise in the same area. If GM orders X to close but not Y, then this is a windfall for Y. For this reason, operating a franchise seems like a stupid business idea, as an auto dealer or restaurant or other franchises. If the controlling corporation makes bad decisions, then the franchisee is SOL.

You might wonder "If GM, Ford, and Chrysler are so inefficient, then why doesn't someone start a competing car manufacturing business." The answer is State restriction of the market. The auto manufacturing industry is heavily regulated. There are lots of regulatory hoops for getting a new car approved as "street legal". You can't start out making 10-20 cars per year and then bootstrap to a larger business. The cost of regulation compliance makes a small car manufacturing business illegal/impractical. All the "consumer saftey" regulations are really "corporate safety" regulations, because they increase the cost of new competitors entering the market.

GM's CEO appears to get to keep his job, even during bankruptcy. He can claim "GM had structural problems that couldn't be solved in the short time I've been working here. The recession/depression is to blame, and not anything I did. An executive who's familiar with the business will do better than hiring someone else." He'll probably be paid with options/equity in post-bankruptcy GM. During the next inflationary boom, he'll be able to cash out his options for a huge windfall.

Most of the discussions of GM's bankruptcy are evil fnords designed to distract from the true issues. The issues of GM's bankruptcy are:

  1. Why is GM "too big to fail"? Why aren't smaller competitors entering this market, when the established corporations are so obviously inefficient?
  2. Is a heavily regulated auto industry a good idea?
  3. Why can't GM raise capital from sources other than the government?
  4. Why should creditors get a bailout? They should have known about GM's problems when they lent them money. GM has been struggling for years now.
  5. Why should unionized employees get a bailout? It's irrelevant if a monopoly/oligopoly pays above-market labor costs, because the cost is passed on as higher taxes. Some of the bailout money will be used to pay GM's employees.
The economic and political system is one big scam. It's annoying to watch pro-State trolls discussing the merits of various economic policies.

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