Barack Obama and the carmakers

Barack Obama and the carmakers

An offer you can't refuse

In its rush to save Detroit, the American government is trashing creditors’ rights

NO ONE who lent money to General Motors (GM) or Chrysler can have been unaware of their dire finances. Nor can workers have failed to notice their employers’ precarious futures. These were firms that barely stayed afloat in the boom and both creditors and employees were taking a punt on their promise to pay debts and generous health-care benefits.

The bet has failed. The recession has tipped both firms into the abyss—together they lost $48 billion last year. Chrysler has entered bankruptcy, from which it may emerge under Fiat’s control (see article). GM could soon follow if efforts to hammer out a voluntary restructuring fail. America’s government, keen to protect workers, is providing taxpayers’ cash to keep the lights on at both firms. But in its haste it has vilified creditors and ridden roughshod over their legitimate claims over the carmakers’ assets. At a time when many businesses must raise new borrowing to survive, that is a big mistake.

Bankruptcies involve dividing a shrunken pie. But not all claims are equal: some lenders provide cheaper funds to firms in return for a more secure claim over the assets should things go wrong. They rank above other stakeholders, including shareholders and employees. This principle is now being trashed. On April 30th, after the failure of negotiations, Chrysler entered Chapter 11. Under the proposed scheme, secured creditors owed some $7 billion will recover 28 cents per dollar. Yet an employee health-care trust, operated at arm’s length by the United Auto Workers union, which ranks lower down the capital structure, will receive 43 cents on its $11 billion-odd of claims, as well as a majority stake in the restructured firm.

The many creditors who have acquiesced include banks that themselves rely on the government’s purse. The objectors have been denounced as “speculators” by Barack Obama. The judge overseeing the case has consented to a quick, “prepackaged” bankruptcy, which seems to give little scope for creditors to argue their case or pursue the alternative of liquidating the company’s assets. In effect Chrysler and the government have overridden the legal pecking order to put workers’ health-care benefits above more senior creditors’ claims, and then successfully argued in court that the alternative would be so much worse for creditors that it cannot be seriously considered.

The Treasury has also put a gun to the heads of GM’s lenders. Unsecured creditors owed about $27 billion are being asked to accept a recovery rate of 5 cents, says Barclays Capital, whereas the health-care trust, which ranks equal to them, gets 50 cents as well as a big stake in the restructured firm. If creditors refuse to co-operate, the government will probably seek to squash them using the same fast-track legal process.

Chapter and verse

The collapse of Detroit’s giants is a tragedy, affecting tens of thousands of current and former workers. But the best way to offer them support is directly, not by gerrymandering the rules. The investors in these firms are easily portrayed as vultures, but many are entrusted with the savings of ordinary people, and in any case all have a legal claim that entitles them to due process. In a crisis it is easy to put politics first, but if lenders fear their rights will be abused, other firms will find it more expensive to borrow, especially if they have unionised workforces that are seen to be friendly with the government.

It may be too late for Chrysler’s secured creditors and if GM’s lenders cannot reach a voluntary agreement, they may face a similar fate. That would establish a terrible precedent. Bankruptcy exists to sort legal claims on assets. If it becomes a tool of social policy, who will then lend to struggling firms in which the government has a political interest?

Carmakers

Fiat’s grand plans

Fiat's ambitions in America appear to be growing

FIAT was once known for producing less-than-reliable vehicles. The Italian firm has long-since put right its car production and now seems set on remodelling the global car industry. On Thursday April 23rd rumours emerged that Fiat’s attempt to pick over America’s dying car industry for viable scraps had widened in scope. Ongoing negotiations over a tie-up with Chrysler are taking place alongside rumoured talks that could see Fiat take over Opel, the European arm of General Motors.

The driving force behind Fiat’s plans for rapid expansion is Sergio Marchionne, the firm's chief executive since 2004. After his arrival at Fiat he set about a radical restructuring that transformed the company from a near basket-case to a company that has fared relatively well even as the world economy has turned. On Wednesday the carmaking division of Fiat Group announced an operating loss of €30m ($39m) in the first quarter and Mr Marchionne reckons on profits of €1 billion for the year. But for long-term survival Mr Marchionne suggest that car companies need to sell 5.5m vehicles a year. At the moment Fiat sells just 2.2m.

Hence Fiat’s interest in troubled Chrysler, which is likely to sell 1.7m vehicles this year. If a deal is done before April 30th, a deadline set by the American government which has supported Chrysler with $4 billion, Fiat will gain not only a car company but access to a dealer network in the American market. A foothold in America is another necessity for a carmaker with global ambitions, according to Mr Marchionne. It would help, too, that Chrysler could expect another $6 billion in funds from the Obama administration, if a tie-up with Fiat goes ahead. If so, Fiat would get a 20% stake in Chrysler and would in turn supply it with small-car platforms and fuel-efficient powertrain technologies. Fiat cannot increase its stake beyond 49% until the government has been paid back in full but in the meantime Mr Marchionne, who would become chief executive of Chrysler, might bring to bear ruthless restructuring of the sort that he used to rescue Fiat.

The alternative for Chrylser is bankruptcy and this could yet be its fate. Standing in the way of a deal with Fiat are Chrysler’s creditors and unions. Intense negotiation could continue right down to the wire. America’s Treasury is said to have suggested that banks, which are owed $6.8 billion, might take a “hair cut” that would see them get $1.5 billion and 5% of the new company. The banks are apparently holding out for $4.5 billion and 40%, a potentially unbridgeable gap.

The banks may reckon that selling off the Jeep brand and other of Chrysler’s few decent assets might make a better deal. Another rumour is that Chrysler could enter Chapter 11 bankruptcy to shed some liabilities before Fiat cherry-picks the better parts. But Fiat would still need to do a deal with the banks or possibly see the good bits of Chrysler sold to the highest bidder. That may cause Fiat to rethink its plans to take on Chrysler.

Leaks and rumours also suggest that Fiat is in negotiations with GM to buy its European arm, Opel (and probably Vauxhall, the British unit). This adds another level of uncertainty to the flurry of possible dealmaking. GM, with its own deadline of May 30th from America’s government to come up with a survival plan, is keen to rid itself of the troubled European car business. Were Fiat to add Opel to its stable it would acquire a carmaker that sells 1.3m vehicles a year, giving it greater scale and the chance to take out capacity. It would not have to stump up any cash and European governments led by Germany, Opel’s home, have pledged to provide €3.3 billion in loan guarantees to rescue the unit.

Fiat has declined to comment on reports that it could strike a deal next Tuesday. Opel has insisted that other options exist, such as a tie-up with Magna, a Canadian car-parts business. Some suggest that the talks with Opel are merely a feint on Mr Marchionne’s part designed to put pressure on Chrysler creditors to reach a deal. So by the end of next week Fiat could have forged a huge shiny new car company for no outlay of cash or Mr Marchionne’s impressively ambitious plans could have come to nothing.

Stocks Drop Most in 3 Weeks as U.S. Warns on Banks, Carmakers

Stocks Drop Most in 3 Weeks as U.S. Warns on Banks, Carmakers

March 30 (Bloomberg) -- U.S stocks slumped the most in three weeks as the Obama administration warned that some banks will need more government aid and that General Motors Corp. and Chrysler LLC have one last chance to restructure. Treasuries and the dollar gained.

Bank of America Corp. slid 18 percent and Citigroup Inc. sank 12 percent after U.S. Treasury Secretary Timothy Geithner said some banks will need “large amounts” of assistance. General Motors plunged 25 percent as Obama said GM and Chrysler must survive without becoming “wards of the state.” Alcoa Inc. tumbled 14 percent after Aluminum Corp. of China Ltd.’s profit decreased by more than 99 percent.

The Standard & Poor’s 500 Index fell 3.5 percent to 787.53, trimming its March rally to 7.1 percent. The Dow Jones Industrial Average tumbled 254.16 points, or 3.3 percent, to 7,522.02. The MSCI World Index of 23 developed countries lost 3.9 percent.

“Whether or not there are banks at risk is still a serious concern,” said Bruce McCain, chief investment strategist at Cleveland-based Key Private Bank, which manages $22 billion. “When you’re looking for excuses to sell off, certainly those sorts of things are realistic worries. We may well go back and test the lows.”

The slide today trimmed the S&P 500’s advance from a 12- year low on March 9 to 16 percent, leaving it down 13 percent in 2009. Stocks had rebounded this month from as firms from Citigroup to JPMorgan Chase & Co. said they were profitable in January and February and Geithner detailed plans to rid banks of toxic assets.

The S&P 500, the benchmark index for U.S. stocks, advanced 21 percent in the 14 trading days ended March 27, the most over a stretch of that size since 1938, according to data compiled by New York-based S&P analyst Howard Silverblatt.

VIX Jumps

The VIX, which measures the cost of using options to hedge against further declines in the S&P 500, climbed 11 percent to 45.68 today, its steepest advance since March 2.

The U.S. government’s comments on banks, GM and Chrysler helped push the yield on the 10-year Treasury note down five basis points to 2.71 percent. The dollar and yen climbed against all other major currencies as investors sought assets perceived as relatively safe.

Morgan Stanley strategist Jason Todd said investors should sell U.S. stocks as earnings keep weakening. Goldman Sachs Group Inc. cautioned investors against moving into shares of so-called cyclical businesses, which are dependent on economic growth, from “defensive” shares because a sustained market rally may take longer to unfold.

‘Rotating Late’

“History suggests that investors are better off rotating late versus early as bottoms are hard to time and much of the cyclical outperformance occurs 4 to 12 months post-trough,” Goldman Sachs strategists led by New York-based David Kostin wrote in a report. The S&P 500 will “trade in a near-term range from 700 to 800.” Goldman Sachs’s year-end forecast for the index is 940, a 15 percent gain from its close on March 27.

Europe’s Dow Jones Stoxx 600 Index slipped 3.8 percent, erasing its March advance and leaving it with a quarterly slump of 14 percent. Goldman Sachs said the rally in European stocks since March 9 will lose steam as gains were fueled by low share prices and government stimulus rather than an improving economy.

An index of executive and consumer sentiment in the euro region declined in March to the lowest level since the gauge was first published in 1985, the European Commission said today.

‘No Magic Fix’

“There is no magic fix for the economy,” said Stephen Docherty, Edinburgh-based head of global equities at Aberdeen Asset Management, which has $158 billion. “We have had a few days without any bad news so people started to get optimistic. Trying to call the bottom for the market is impossible. We are not going to get anything sustainable until we get a solution to the financial system.”

Bank of America, the largest U.S. bank by assets, lost 18 percent to $6.03 and Citigroup dropped 12 percent to $2.31. Wells Fargo & Co., the biggest West Coast bank, slid 14 percent to $13.37. Geithner said yesterday on the ABC News program “This Week” that some banks are going to need “large amounts of assistance”

The Treasury has about $135 billion left in a financial- stability fund, Geithner said, while declining to say whether he will need to request additional money.

JPMorgan fell 9.3 percent to $24.85. The biggest U.S. bank by market value had a “tougher” month in March and Bank of America’s trading book “was not as good” as in the first two months of the year, the banks’ chief executive officers Jamie Dimon and Kenneth Lewis told CNBC last week.

Lincoln National Corp. plunged 38 percent, the most in the S&P 500, to $6.41. The insurer seeking $3 billion in U.S. capital withdrew its application for the government program to sell debt with a federal guarantee.