The Devil's in the Details on the Auto Bailout

04/15/2009 12:00 pm EST


Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, editor of the Forbes/Lehmann Income Securities Investor, says carrying out a restructuring of the US auto industry may be more difficult than it looks.

Somehow in all its rhetoric about saving the Detroit-based auto industry, the Obama administration forgot about all the parties it needs on board in order to make that happen.

Since the White House has decided to take the lead in restructuring General Motors (NYSE: GM), having thrown out chief executive officer Rick Wagoner and most of the board of directors, they have been busy putting out strong rhetoric about seeing a bankruptcy filing as the most likely route to restructure GM.

[But] Chapter 11 bankruptcy means government relinquishes control of the restructuring process to a judge and to a voting process which they cannot control. Sure, they say they will go into court with a prepackaged plan which they will ram through in short order, but all this talk about a bankruptcy filing is pure posturing.

The real goal is to scare enough bondholders into accepting as low a settlement payout as possible. With $28 billion in bonds, if they can scare even 60% of the bondholders into taking the rumored eight cents cash, 16 cents of new debt and 90% of the equity (worth maybe 12 cents), they will have converted $16.8 billion of debt into equity at a cash cost of $2.2 billion.

That would be the best spent money in this entire government bailout. Would they really forego this sure thing for the uncertainties of the alternative?

[Also,] President Obama personally assured the public that the government would stand behind all car warranties in order to defuse the argument that no one would buy a car from a bankrupt company.

What the president cannot assure is that after a bankruptcy there will still be a dealer you can take your car to who is within 50 miles of your home and is not scheduling warranty work into next month.

Let’s [also] not forget the United Auto Workers, the main people President Obama wants to please. They hate bankruptcy because their contracts can be cancelled and more onerous terms are then sure to follow. You can’t screw over the bondholders without doing equal damage to the $30 billion in union health care claims. This is the political element in the GM story that, in the end, will override mere common-sense arguments.

But a bankruptcy filing would trigger $37.4 billion in payments on GM credit default swap contracts currently outstanding. Many of those were bought by people who also hold bonds and would actually welcome a bankruptcy filing. They could then collect money on the default contracts that would otherwise expire worthless and still have a claim in bankruptcy court. Good luck, Mr. Obama, negotiating a voluntary settlement with those folks.

Here’s my advice to the White House: Call in the dummies who wrote those $37.4 billion in default swaps and offer them a guarantee you won’t force GM into bankruptcy in return for $10 billion. This would be a lot fairer and more constructive than asking bondholders to take a huge haircut or filing Chapter 11.

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