Opinion: General Motors becomes Government Motors

What seemed inevitable five months ago is finally about to occur. General Motors, once the largest corporation in America, the largest employer, and the first one to make $1 billion (1955), is about to enter bankruptcy. I always felt that bankruptcy was inevitable due to the conflicting interests of various parties (such as current employees, retired workers, shareholders, bondholders, auto dealers, and governments.)

Like most liberal governments, the Obama administration tried its best to avoid bankruptcy but was unable to do so. My Canadian government also pumped money into these failing enterprises with questionable results. I think what the US government attempted was fine, but I would have liked to see less heavy-handedness directed towards the bondholders (the GM bondholder situation doesn't seem so bad since all of them are supposedly unsecured creditors, but the Chrysler situation where the US government was playing hardball with secured bondholders hurts everyone in the long run.) Overall, contrary to what some critics on the right have suggested, even though the government was favouring retirees at the expense of bondholders, I don't think the government trampled property rights. The GM case, as well as Chrysler, will be ultimately decided by the courts so anyone (with resources) can challenge the government if they wanted to. Since I generally have faith in the independence of America's courts, I think the courts will rule against the government if it was genuinely violating property rights.

GM Has Support of Bondholders

The GM bankruptcy will essentially be a pre-packaged bankruptcy so it is likely to re-emerge within an year. The New York Times is reporting that GM has secured support from more than 50% of the bondholders:

Over the weekend, G.M. cleared a couple of obstacles to a court reorganization. Late Saturday, a majority of G.M. bondholders agreed to exchange their debt in exchange for an ownership stake as high as 25 percent in G.M.

Holders of about 54 percent of G.M.’s $27.2 billion in bond debt, agreed to support the plan by the Saturday afternoon deadline, according to Elliot Sloane, a spokesman for a committee representing some of G.M.’s largest bondholders, which negotiated the deal with the government. All told, 975 investors expressed support for the plan.

Mr. Sloane said that 20 percent of the support came from the ad hoc bondholders committee, another 15 percent came from bondholders who had backed earlier G.M. offers and 19 percent from investors who got on board between Thursday and Saturday.

But groups representing some of G.M.’s retail bondholders — individual investors who purchased the company’s bonds for as little as $25 a piece — said they still planned to contest the reorganization plan...It is not known how many of these individual investors there are, but some estimates place their holdings of G.M.’s $27.2 billion in bonds at more than 25 percent.

Retail investors—people like you and me—are not supporting the deal but I am not sure they have much of a case. You have to keep in mind that some people will complain just because they lost money—some would have purchased GM bonds 5 or 10 years ago assuming that there is no way GM would go bankrupt. We, as capitalists, should dismiss this argument. If someone loses money on their investments by misreading the future of a company, that's their problem. Ignoring that, there are two issues that are worth talking about.

First of all, some seem disgruntled that a big chunk is going to employees (specially health care trust for retirees). I'm not a lawyer and I could be completely wrong but my understanding is that retiree obligations (such as pensions or promised healthcare) have high precedence. A company cannot just ignore pension obligations (this case is really about healthcare obligations but I suspect it is similar to pension obligations.) GM has massive retiree obligations (not sure how much is unfunded) and I think a court of law would likely give a big chunk of the ownership of GM to cover these obligations. So, even though bondholders are unhappy, the payout to the retirees would likely have occurred anyway.

The second issue, and the one that is probably a legitimate concern, is the fact the bondholders are ending up with far less than anyone would have thought even 2 years ago. The reason, it seems, is because the government is taking a huge stake in the company. Instead of GM being divided up largely between the pensioners and the bondholders, a majority stake is going to the government. This has occurred because the government provided emergency funding that has high seniority compared to the unsecured bonds. If GM had gone straight into bankruptcy, the portion given away to the government (or anyone) providing emergency funding would likely have been smaller. If the government wasn't involved, it is also possible that the company would have been tougher with employees and possibly extracted more concessions. However, one of the key reasons the government involved in the first place is due to the concern that GM would end up liquidating itself rather than re-structuring due to lack of bankruptcy funding. The credit markets did lock up late last year, and it wouldn't have been easy to fund up to $50 billion, so maybe it was proper for the government to be the sole capital provider.

I, as an investor, would have made a mistake in the second point above. Like other retail investors, I never would have imagined that whoever that was providing bankruptcy funding would have to inject so much capital. Just goes to show how much of a newbie I am when it comes to bankruptcy (admittedly, part of the problem is the lock up in the credit markets and the collapse of auto sales and not many could have forecast the scope of such events.)

Post-bankruptcy Ownership Structure

The New York Times has the following on the ownership structure of the new GM that will emerge from bankruptcy:

In a regulatory filing last week, G.M. said the government, which is to provide bankruptcy financing of about $50 billion, initially would hold 72.5 percent of G.M., with the United Automobile Workers union receiving 17.5 percent, and bondholders 10 percent.

But the percentages held by the bondholders and the union could conceivably be larger because each are being offered warrants in the new G.M., which would be created in bankruptcy.

Under the terms of the plan, bondholders would initially receive 10 percent. They could then exercise their warrants for an additional 7.5 percent when the new G.M. rises to about $15 billion in value. The second set of warrants for the final 7.5 percent would be exercisable when new G.M. rises to $30 billion in value.

The union would initially receive a 17.5 percent stake to finance a health care trust for its retirees. It has also received warrants to raise that holding to 20 percent — but those warrants are exercisable only if new G.M.’s value hits $75 billion.

Once the union and bondholders achieve their full stakes, the government’s share would drop to 55 percent.

Well, it's Government Motors then ;) It looks like the government will own 72.5%, while the employee union owns 17.5% and the bondholders get 10%. However, the bondholders will own another maximum of 15% if the value of the company rises to $30 billion. The retiree trust run by the union will get warrants worth an additional 2.5% if the value of the company rises to $75 billion.

Cursory look seems to imply that current shareholders will get nothing. It is also not clear if the new company will be publicly listed (and if it is, I'm not sure who is going to sell their stake to the public.) It also remains to be seen if any of the warrants will be publicly traded (although it wouldn't surprise me if it shows up on the OTC Pink Sheets market.)

Government Ownership is Undesirable

The government owning General Motors is not a good thing for America (or even Canada.) Governments are inefficient by design—due to democracy—and they likely won't do a good job running a massive automaker like this.

Perhaps the worst impact of government ownership is the impact on competitors. Non-government automakers may have difficulties competing. On top of direct manipulation of laws that impact automakers, governments can severely hurt competitors by undertaking uneconomic decisions. For example, if GM introduces a car and it is not selling well, the government can simply get various branches of the government to buy them. The economies of scale provided by such large purchases by government divisions may turn the car into a profitable one. But how is Ford or Toyota supposed to compete against that? I'm not saying that is what is going to happen but just pointing out why it is preferable to have less government ownership, especially for consumer discretionary items.

Now, one can argue that manufacturing is rarely a true free market. Just like how the Chinese government manipulates the free market to favour its manufacturers, the same thing sort of happens in the auto industry. Toyota, for instance, doesn't pay healthcare costs whereas GM in America does (in Canada it doesn't pay either.) Obviously this is because healthcare is socialized in Japan, Canada, and most European countries (probably including big auto manufacturing countries like Germany.) It's not a coincidence that a big part of the problem for American auto manufacturers is healthcare costs. So, auto manufacturing is not exactly a true free market—nothing is a true free market. Nevertheless, America provides a beacon for capitalism and government ownership tarnishes the image.

A Looming Problem

There is another serious problem with government involvement in auto manufacturing. One will notice that almost every government out there is trying to protect every auto manufacturer out there. Those that are gravely affected—this indirectly includes people like me in Ontario since we depend on auto manufacturing for a big chunk of our economy—would prefer to keep the companies from disappearing. But the reality is that, crises are the symptoms of economic re-structuring.

I hope I'm wrong but I have a feeling that there is an overcapacity in auto manufacturing in North America (yes this is just a guess on my part.) Not only that, but we may also be looking at the start of a decline in auto consumption over the next few decades. As the baby boomers, who not only saw the emergence of the auto culture but also are wealthier than my generation or any of the younger ones, retire, I suspect car ownership will decline. It is possible that we may enter a slow, secular, decline in auto ownership. (However, note that there are many other factors that can influence this, including fuel costs, cost of a car, urbanization rate, and so on.)

Government actions are simply promoting the overcapacity problem. By keeping alive too many auto manufacturers, it is possible that the auto industry may end up like the airline industry—too many airlines with many ending up unprofitable and with poor service. (However, while overcapacity is bad for the owners and the industry in general, it's good for consumers since it will drive down prices.)

General Motors has become Government Motors... I hope it reverts back to General Motors sooner rather than later.


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