Don Miller (Money Morning):
The U.S. Federal Reserve may take an unorthodox approach to raising interest rates by paying interest on bank reserves rather than relying on traditional open market remedies, as it exits from its long-term fiscal stimulus programs, Reuters reported today (Tuesday).

Paying interest on reserves is mostly untested and would represent an unexpected twist in the Fed’s response to the financial meltdown.

“In the old days … the Fed controlled the federal funds rate with open market operations,” Antulio Bomfim, a former Fed economist now with Macroeconomic Advisors LLC in Washington told Reuters. “Now, at least in this period when reserves are over-abundant, the way the Fed hopes to raise the federal funds rate will be primarily by raising the interest rate it pays on reserves.”

Usually, when the central bank wants to set a target for the federal funds rate it buys or sells Treasury securities on the open market, influencing interest rates by deploying or withdrawing capital.

By paying interest on reserves, the Fed makes it attractive for banks to keep their money at the central bank as long as interest rates in private markets are lower.

By doing that, the Fed can put a floor under the lending rate that banks charge each other for overnight loans, which is the central bank’s traditional choice for influencing the economy. Open market operations to raise interest rates would be relegated to a supporting role in the initial stages of tightening.

In order to spark an economy mired in deep recession . . . Click here to read the rest of Mr. Miller’s article.

But while many analysts are focusing on threat of inflation – which could be a byproduct of the U.S. Federal Reserve’s reluctance to withdraw monetary stimulus – investors should really be watching China.

“In the post-financial crisis global economy, China is quickly becoming the proverbial ‘800-pound gorilla’ – the player that has to be courted, but that can’t be tamed,” said Money Morning Contributing Editor Peter Krauth.

In a recent article for Money Morning, Krauth said that he believes the stage has been set for gold to make a lasting run above $1,000 an ounce, in no small part because of China.

For the past six years China has quietly been stocking up on gold, boosting its holdings of the yellow metal to 1,054 metric tons from 400 metric tons in 2003.

What’s more is that earlier this year, the government finally made it legal for Chinese citizens to make their own purchases of the yellow metal.

As recently as 2002, the private ownership of gold was prohibited in China, with jail as the penalty for possession.  But now the government executed a stunning about face and removed all such restrictions. In fact, Beijing is actually encouraging its citizens to purchase the precious metal through state-run media.

China’s Central Television, the nation’s main state-owned television company, is now running news programs, which strongly resemble infomercials, explaining just how easy it is to purchase gold and silver as an investment.

“Simply put, the Chinese government is trying to trigger a national gold craze…and it’s working. The Chinese public now has gold trading platforms on steroids,” Paul Atherly, managing director at Leyshon Resources Ltd. (OTC ADR: LYRSY), said in an investor presentation in London.

Physical gold demand from private Chinese households rose 9% in the first half of this year, due to an “unprecedented” sales push across rural China, according to Gerry Chen, the World Gold Council’s local business development manager.

Most banks in China already offer customers gold and silver bullion bars in four different sizes ranging from one to five kilograms.

A Golden Opportunity?

Of course, it’s not just the Chinese public that is interested in stepping up its gold purchases. Even though China has nearly tripled the size its gold reserves in the past six years, the declining value of the dollar has given the Red Dragon even more incentive to stock up.

China has about $2 trillion in foreign currency reserves. The vast majority those holdings are in dollar-denominated securities, and therefore are susceptible to the declines in the value of the greenback.

The dollar was been in a precipitous freefall for years before the financial crisis hit in full, sending droves of investors flocking to shelter of the U.S. currency. But now that the global downturn is being to abate, many investors have regained their appetite for risk, and the dollar has resumed its decline.

The dollar has lost 2.5% to a basket of six currencies this month and nearly 5% since early July.

China’s Cheng Siwei, former vice chairman of the Standing Committee of the Chinese Communist Party, recently told Great Britain’s Telegraph newspaper that “If [the Fed] keep[s] printing money to buy bonds, it will lead to inflation, and after a year or two, the dollar will fall hard. Most of our [Chinese] foreign reserves are in U.S. bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen and other currencies.”

Gold provides China with an excellent opportunity to diversify away from the dollar. Many of the nation’s top policymakers agree, but there’s a question of timing.

“When we buy, the price goes up,” Siwei noted. “We have to do it carefully so as not to stimulate the markets.”

From 2003 to 2009, China spread out its gold purchases over a long period of time and relied heavily on Chinese producers.

But this time around there may be a shortcut, because the International Monetary Fund (IMF) has formally endorsed a plan on Friday to sell 403.3 tons of gold – equal to about one eighth of its holdings – to central banks or in the gold market. Gold demand was 3,880 tons last year, according to the World Gold Council.

That presents China with a tremendous opportunity, because if it decided to buy the gold, China would be able to seek a discount from spot prices, since a market sale would put downward pressure on bullion prices.

“China only has about 1,000 [metric tons] of gold reserves and the investments in other assets are performing not very well,” one official, who declined to be named, told Reuters. “I think we should build up more gold with foreign reserves, but when to buy is the key. It’s a good idea if China can buy the gold from IMF at prices well below market level.”

The Chinese are currently being converted from being the lowest per capita gold consumers in the world to a nation of small precious metals investors. By next year, Chinese gold consumption will likely overtake India, which has been for years the world’s biggest gold market.

With global gold production at best flat and probably in decline, even a small increase in Chinese buying could have a substantial impact on gold prices.

“The lesson here is clear: China’s growing appetite for gold is a powerful trend that will benefit gold investors for years – even decades – to come,” said Money Morning’s Krauth.

According to Krauth, “the biggest bang-for-buck still lies with the junior gold sector. The best proxy for this is the S&P/TSX Venture Composite Index (CDNX),” otherwise known as the Toronto Venture Exchange. It consists of about 75% resource stocks.

The CDNX has been steadily carving new highs almost uninterrupted since March, now posting a whopping 80% gain since its December 2008 low. That’s an impressive performance.

The players in this sector promising the best returns are the junior gold-and-silver companies either already producing, or with near-term production.

“With gold breaking and sustaining the $1,000 barrier, junior gold and silver miners are the place to be for explosive returns,” said Krauth. “Just hold onto your hat.”

Source: How China became the ‘800-Pound’ Gorilla in the Gold Market

Wall Street cheered the announcement as Boeing’s stock soared more than 6% in New York trading after the company said it still expects the 787 to be profitable.

The rally came despite news that costs for the first three test planes would be charged-off as having no commercial value, resulting in an estimated pretax charge of $2.5 billion, or $2.21 a share, in the third quarter. Boeing said the charge wouldn’t affect its cash flows.

“This new schedule provides us the time needed to complete the remaining work necessary to put the 787’s game-changing capability in the hands of our customers,” said Boeing Chief Executive Officer Jim McNerney.

The 787, already two years behind its original schedule, was scheduled for its first test flight in the second quarter of 2009, but the flight was delayed so Boeing could address newly discovered structural problems. The latest development marks the seventh delay in the production cycle for the highly anticipated plane.

“The real challenge for Boeing is to actually stick to this revised 787 timetable — something it has been unable to do in the past.” Rob Stallard, a New York-based analyst with Macquarie Capital Inc., wrote in a note to clients obtained by Bloomberg News.

All Nippon Airways Co. Ltd. (OTC: ALNPY), which is scheduled to take delivery of the first 787, was quick to register displeasure with the latest delay.
“We understand the need to make the best and safest aircraft possible and appreciate that delays due to engineering issues of the current nature must be solved in order to move forward and achieve this,” ANA said in an emailed statement obtained by Reuters. “However, as launch customer and future operator of the 787, the length of this further delay is a source of great dismay, not to say frustration.”

The repeated delays have cost Boeing millions of dollars in penalties and concessions to customers.

Major airlines have used the delays as bargaining chips to squeeze concessions from the plane maker on delivery dates, incremental payment schedules and even the final purchase price.

Some airlines have gone so far as to threaten to cancel orders for the 787, as well as larger 777s, because of delays caused by disruptions at Boeing.
“Boeing doesn’t realize how much they’re hurting their customers’ plans,” Akbar Al Baker, chief executive officer of Qatar Airways WLL told The Wall Street Journal at the Paris Air Show in June. It’s now uncertain when that airline might receive the first of 30 787s it had ordered to be delivered starting in 2011.

The fastest selling plane in history, the Dreamliner has racked up over 900 orders since it was announced in 2005, largely based on fuel efficiency.  With recent cancellations that number is now closer to 850.

In addition to technical problems, getting the plane to production has also been hampered by major labor disruptions.  A prolonged strike by machinists in 2008 was largely responsible for an 8% drop in aircraft sales.  Commercial aircraft generated $28.3 billion of Boeing’s $60.9 billion in sales last year, behind only defense contracts.

“Work stoppages over the past several years have cost Boeing $9 billion in revenue and $2 billion in lost profits,” Sen. Mike Hewitt, R-Wash. told the Spokesman Review.

The setbacks in bringing the plane to production have had a “significant impact” on company finances, Boeing Chief Financial Officer James Bell said in an Aug. 20 memo to employees obtained by Bloomberg.

Despite Thursday’s market rally, Boeing’s stock has lost more than half its market value since the 787’s first delay in October 2007.  At least seven Wall Street analysts have downgraded the stock since last December, including Credit Suisse (NYSE: CS) and Barclays Capital PLC (ADR NYSE: BCS).

Source: Boeing Will Test Dreamliner in 2009 but Delays Delivery, Again

After spending three days visiting the restive eastern province of Zhejiang, Premier Wen Jiabao argued for maintaining the loose economic policies implemented under the stimulus program, saying it’s too soon to be “blindly optimistic,” according to a statement by the State Council.

His remarks are likely to fuel an ongoing debate between government officials over whether it’s time to rein in bank lending.

After the government called on Chinese banks to provide increased liquidity to the economy, they lent about $1.08 trillion (7.37 trillion yuan) in the first half of the year – almost 50% over the government’s target of $732 billion (5 trillion yuan), and nearly double the total loans extended throughout all of 2008.

Most analysts credit the stimulus program for China’s economic rebound, as GDP expanded by 7.9% in the second quarter, up from 6.1% in the first quarter. But now some officials have voiced concerns that asset bubbles and non-performing loans could threaten a long-term economic recovery.

Last week, Chinese Legislator Yin Zhongqing called for limiting new loans to 10 trillion yuan for the full year, according to the Wall Street Journal.

The benchmark Shanghai Composite Index (SSE) is down 15% this month, amid fears that the government will move to tighten bank lending in the second half of the year to throw a wet blanket on the economy. The SSE, Chinas’ benchmark index, zoomed 91% from Jan. 1 to Aug. 4, hitting a high of 3,478.01.

China’s cabinet yesterday (Wednesday) said it’s watching for signs of overcapacity in industries including steel and cement and will increase “guidance” in the coal, glass and power sectors.  It will also place new restrictions on stocks and bonds sold by companies in those industries.

And continuing another trend, the People’s Bank of China last week in an internal memorandum notified its branches to curtail lending for the remainder of the year.  Other Chinese banks, including the Industrial & Commercial Bank of China (ICBC) and China Construction Bank (CBC), have also curbed lending in recent months, Reuters reported, citing anonymous sources.

The Chinese bi-monthly Caijing reported that with the new ceilings in place, ICBC has already lent 83% of its full-year new lending total, while CCB has lent 79%.

Other bankers reported that liquidity appears to be drying up and that loan approvals are taking longer than normal.

“It takes more time to process credit approval from Beijing headquarters now, and the pricing for onshore deals has been heading north in recent months, particularly for U.S. dollar deals,”a banker familiar with the process told Reuters.

And while the going rate for loans to top-tier multinational companies in the first half of the year were made at a margin of 150 basis points above the London Interbank Offered Rate (LIBOR), margins have now soared to over 200 basis points, according to the same banker.

Still, Beijing is unlikely to pull back from the massive stimulus program and the resulting liquidity that has bolstered the world’s third-biggest economy.  Even with the slowdown, analysts still expect total lending to exceed $1.5 trillion ($10 trillion yuan) this year.

And Premier Wen has called on policymakers to maintain “moderately loose” monetary policy and “active” fiscal policy.

That means the Chinese economy will remain flush with liquidity for the foreseeable future. And just to be on the safe side, the China’s State Council has issued a directive to banks to provide more loans to smaller firms.

“We will give appropriate subsidies to financial institutions to support them in extending loans to small companies,” the council said following a regular weekly meeting.

It also will extend measures to reduce the social security contributions paid by smaller firms that are facing difficulties and will increase tax support and direct government funding for them.

“This is tightening but it’s not a total shutdown,” Ken Peng, an economist with Citigroup Inc. (NYSE: C) in Beijing told Bloomberg News. “Policy hasn’t reversed but they are contemplating moves that have a lesser impact on the broader economy.”

Source: China Curbs Bank Lending but Vows to Keep Liquidity High

A federal judge handed the Obama administration an important victory in its push to steer the automobile industry back to health Sunday, approving the sale of General Motors Corp.’s (OTC: GMGMQ) most profitable assets to a new government-run company.

The move removes an important barrier to the company’s plan to exit bankruptcy.

Judge Robert E. Gerber of the U.S. Bankruptcy Court for the Southern District of New York issued a ruling saying the sale was GM’s only option and that it would “prevent the death of the patient on the operating table,” according to Reuters.

The 87-page ruling rejected appeals from a group of bondholders, tort claimants and unions who had objected to the plan.

“As nobody can seriously dispute, the only alternative to an immediate sale is liquidation — a disastrous result for GM’s creditors, its employees, the suppliers who depend on GM for their own existence, and the communities in which GM operates,” Gerber said in the opinion.

When the sale is completed, it would transfer GM’s “good assets” – including the Chevrolet, Cadillac, Buick and GMC brands – to a new company majority-owned by the U.S. Treasury.  It would also pave the way for the new GM to exit bankruptcy in less than two months, one month earlier than the government’s projection.

The plan would allow the company to jettison unwanted property to the old GM, including 16 automotive plants in Delaware, Ohio, New York, Indiana, Pennsylvania, Virginia and Michigan. The Treasury will also provide the estate with $1.175 billion to unwind the remaining assets, up from original projections of $950 million after creditors complained about possibly getting stuck with liquidation costs.

The U.S. government would own 60% of the new GM in return for $50 billion in loans, the Canadian government would get 11.7% for $9 billion in loans, and workers would receive a 17.5% stake for relinquishing future health-care benefits.

Bondholders would be forced to convert about $27 billion in bonds into about 10% of stock in the new company, plus warrants with a total value of $7.4 billion. New GM’s total equity is anticipated to be worth more than $38 billion, according to Bloomberg News.

During three days of hearings, the workers and bondholders objected to the plan, saying the “new GM” is just “old GM” minus a slew of liabilities. They contend the company would market nothing new, pedaling the same cars and trucks, made by the same workers managed by the same executives.

Gerber dismissed the bondholders’ assertion that GM should restructure under a Chapter 11 reorganization plan, which would let creditors vote on details of the plan, saying the argument was unrealistic.

“In the event of liquidation, creditors now trying to increase their incremental recoveries would get nothing,” he ruled.

Gerber’s ruling also torpedoed arguments from dealers whose contracts are being terminated, groups of car-accident victims who said they would now be unable to sue GM for their injuries, and others who claimed that the U.S. government had been overbearing in its negotiations to restructure the automaker.
Gerber issued a typical four-day stay of the order approving the sale, which allows for possible appeals.

Steve Jakubowki, a lawyer for product-liability claimants said he would appeal the ruling even though GM recently revised its bankruptcy plan to take on claims from future car-accident victims.

“This issue is too important, too unsettled and too many people’s lives hang in the balance for me not to pursue this appeal through to the end,” Jakubowski told The Wall Street Journal.

Gerber ruled that the sale could be “free and clear of claims,” because his hands were tied by precedents established in the second judicial circuit during the bankruptcy filed by Chrysler LLC.  The second judicial circuit encompasses Gerber’s court.

But in the end, Gerber concluded that the government’s plan was the only one that makes sense.

“GM cannot survive with its continuing losses … and without the governmental funding that will expire in a matter of days,” Gerber wrote.

The ruling marks the second big victory for the Obama administration’s auto task force, which will be charged with supervising the liquidation of the remaining assets.  The task force had previously engineered the sale of Chrysler to a consortium headed by Italy’s Fiat S.p.A. (ADR OTC:FIATY).

Source: GM Bankruptcy Judge Approves Obama Administration’s Exit Plan ]]> http://www.contrarianprofits.com/articles/gm-bankruptcy-judge-approves-obama-administration%e2%80%99s-exit-plan/18801/feed 0 http://www.contrarianprofits.com/articles/drop-in-continuing-unemployment-claims-could-signal-onset-of-recovery/18142 http://www.contrarianprofits.com/articles/drop-in-continuing-unemployment-claims-could-signal-onset-of-recovery/18142#comments Fri, 19 Jun 2009 20:00:25 +0000 Don Miller http://www.contrarianprofits.com/?p=18142 The economy continued to show signs of recovery from the worst recession in 60 years as the total number of Americans receiving unemployment benefits dropped for the first time since January, the Labor Department reported yesterday (Thursday).

The good news came in spite of a small jump in initial applications for state unemployment insurance, which rose by a more-than-expected 3,000 to 608,000 in the week ended June 13. Analysts polled byReuters were expecting claims to dip to 600,000 from a previously reported 601,000.

But analysts were largely focused on a trend in continuing claims, which tracks jobless workers who stayed on government benefit rolls.

Those claims plunged by 148,000 to a smaller-than-anticipated 6.69 million in the week ended June 6, the latest week…

The Obama administration yesterday (Wednesday) continued its assault on highly paid Wall Street executives, announcing plans to appoint a “pay czar” to oversee compensation at financial firms receiving Troubled Asset Relief Program (TARP) funds.

The government also will create a new program to give shareholders at nonparticipating firms a vote on executive pay packages.

President Barack Obama has targeted executive pay practices as part of a larger effort to overhaul regulations and prevent a repeat of the worst financial crisis since the Great Depression.

Obama will unveil a “series of specific proposals” on June 17 designed to streamline and reorganize regulations, White House spokesman Robert Gibbs told Bloomberg News.

The administration originally proposed regulations in early February to put a $500,000 per year lid on the salaries of executives at firms that tapped into the government’s $700 billion TARP rescue fund. The only exceptions would be in the form of restricted stock or other long-term incentives.

But the plan was compromised when Senate Banking Committee Chairman Christopher Dodd, D-CT, spearheaded a provision that limited bonuses to no more than one-third of executive compensation. The provision was eventually tacked on to the $787 billion stimulus legislation, along with another stipulation that made it easier for banks to repay TARP funds and avoid the new regulations.

The two-pronged approach announced by the Obama administration Wednesday was designed to reconcile the administration’s initial pay policy with the Congressional bill and prevent financial companies that pay back the government funds from circumventing the guidelines.

Leading the administration’s charge has been Treasury Secretary Timothy Geithner who has repeatedly pointed to executive compensation policies based on short-term profits as a key factor in the financial crisis.

Geithner, who has said compensation practices became “divorced from reality,” met with Securities and Exchange Commission (SEC) Chairman Mary Schapiro, Federal Reserve Governor Daniel Tarullo and other compensation experts, to further discuss how to put the clamps on the practice.

“A centerpiece of sensible reforms will be to tie compensation to better measures of long-term investment and return, and to adjust them to reflect the risk” incurred by executives’ decisions, Geithner said recently during a hearing at a Senate Appropriations subcommittee.

Kenneth Feinberg, who oversaw the government’s compensation to the survivors of the September 11, 2001, terror attacks, will take over the pay czar role, Reuters reported, citing a source familiar with the administration’s plan.

The pay czar, or “special master,” will review compensation structures for the top 100 salaried employees of firms receiving exceptional assistance, such as Bank of America Corp. (NYSE: BAC), Citigroup Inc. (NYSE: C) and insurer American International Group Inc. (NYSE: AIG), the source said.

“In the case of a company receiving exceptional assistance, the special master would have the authority to disapprove of a company’s compensation plan if he determined they were paying excessive and unjustified salaries to their top executives,” the official said.

The other initiative would give the SEC authority to force financial firms to allow shareholder votes on executive pay packages. The nonbinding vote would cover everything from bonuses and salaries to severance packages, and would need Congressional authorization.

Geithner has supported the so-called “say-on-pay” rules ever since he took office. In a May 18 speech in Washington, he said that giving shareholders a vote on compensation would bring a “kind of disclosure that can help a lot.”

“It clearly is going to force companies to be more transparent with their disclosure” on compensation, Irv Becker, national practice leader for Philadelphia-based Hay Group’s executive compensation practice toldBloomberg.

Even if the measure is implemented, it likely will take several years before shareholders begin to confront management, Becker predicted.

“It’ll kind of be novel the first year, maybe the first two, and then likely be a little bit more serious in future years,” said Becker, a former head of compensation and benefits at Goldman Sachs Group Inc. (NYSE: GS).

Nevertheless, Geithner vows to press ahead with the new measures, and perhaps others still on the drawing board.

“As you’ll hear from us in the next few days, the SEC has some important responsibilities and obligations in this area, and some tools and authorities they may seek,” Geithner said.

Source: Obama Administration Wants New “Pay Czar” and Shareholder Vote to Reign in Executive Compensation ]]> http://www.contrarianprofits.com/articles/obama-administration-wants-new-%e2%80%9cpay-czar%e2%80%9d-and-shareholder-vote-to-reign-in-executive-compensation/17785/feed 0 http://www.contrarianprofits.com/articles/%e2%80%9chyper-local%e2%80%9d-stats-show-housing-market-has-bottomed/17346 http://www.contrarianprofits.com/articles/%e2%80%9chyper-local%e2%80%9d-stats-show-housing-market-has-bottomed/17346#comments Mon, 01 Jun 2009 15:37:25 +0000 Don Miller http://www.contrarianprofits.com/?p=17346 Perhaps the mishmash of numbers floating around the housing market have you confused.  For those who follow the market closely, the daily news seems to bring a never-ending stream of contradictory data. 

Here are just a few statistics in the news lately from respected market mavens like the S&P/Case-Shiller Indices and the National Association of Realtors:

• The “average” price of homes in the U.S. is down almost 35% from the record highs of 2006.

• “Median” housing prices are down 19% in 90% of the major markets in the United States.

• Building permits were up 4% in April from last year, and homebuilder confidence increased from 16 to 18.

So what do these numbers mean to you?

Probably nothing.

“It’s like a weatherman who combines conditions…

The largest of the U.S. Big Three automakers yesterday (Wednesday) announced that it failed to persuade the required 90% of its bondholders to swap $27 billion in debt for stock, pushing the venerable GM several steps closer to a bankruptcy filing.

The rejection by bondholders is the latest chapter in the ongoing saga of GM’s desperate attempts to reorganize as it faces a government-imposed Monday (June 1) deadline to restructure or file for bankruptcy.

In recent days, the company struck a deal with its United Auto Workers (UAW) union on payment terms for $20 billion of debt in a retiree healthcare trust, and it successfully convinced the union to take a reduced stake of common stock in the new company.

GM also is still in negotiations to sell its European Opel and Vauxhall units to a consortium of bidders. Those talks were scheduled to continue in Berlin last night, as German and U.S. government officials met with representatives from three prospective new owners.

Still, the odds now favor what would be one of the biggest Chapter 11 cases in history, as the global auto giant that has been an icon of American culture since the early 1900s will likely follow Chrysler LLC into bankruptcy court.

Last Hope Bond Offer Fails

In what was seen as GM’s last best hope to cut debt outside of a government-financed bankruptcy, bondholders rejected the company’s offer of 225 shares in a restructured GM for each $1,000 of principal – the equivalent of 10% of the new company for their $27 billion in debt.

The principal amount of notes tendered was “substantially less than the amount required by GM” and, as a result, “the exchange offers will not be consummated,” the company said in a statement.

The news was no surprise to many analysts.

Bankruptcy is “imminent,” Pete Hastings, a fixed-income analyst at Morgan Keegan & Co. in Memphis, Tenn., told Bloomberg News.

“It’s no surprise at all that a deal that was as unattractive as this one would be soundly rejected,” said Hastings, who had recommended that his clients refuse the exchange offer.

Some analysts blamed the offer’s failure on the unyielding stance of U.S. President Barack Obama’s auto task force, which had a hand in deciding the terms of any deal made with the debt holders.

“I think the task force made that hurdle so high, they wanted them to go into bankruptcy, they see that as the solution,” independent auto industry analyst Erich Merkle told Reuters.

Others saw GM’s long history of mismanagement and failure to respond to market conditions as the primary culprits.

“I think the exchange offer was really a transparent attempt to blame bondholders for the bankruptcy rather than to accept responsibility for years of mismanagement and failure to anticipate things that should have been understood,” Richard N. Tilton, a restructuring analyst at Covenant Review LLC, told Reuters.

The New “Good” and “Bad” GM

A GM bankruptcy is likely to involve so-called “debtor-in-possession” financing so it can continue daily operations as it is divided into a “good” and “bad” company by the bankruptcy court.

The “good” GM would include the company’s most successful operations, including the Chevrolet and Cadillac brands, and within months would exit bankruptcy in sound financial health. The “bad” GM would be left with such laggard brands as Pontiac, Hummer and Saturn, and other liabilities that would be divested in a lengthier court-supervised reorganization.

The U.S. government is expected to increase its ownership stake in GM from its current 50% to as much as 70% in order to slash debt and will lend the new company almost $30 billion, The Washington Post reported last week, citing sources familiar with the matter. That’s in addition to the $19.4 billion the United States has already invested. Canada is expected to lend GM an additional $9 billion for a smaller ownership stake in the company, sources familiar with the talks told The Post.

When all these financial packages are included, the GM bailout will have a sticker price of about $60 billion, making it one of the largest – and most costly – rescue and reorganizations in corporate history. When it’s finalized, the United States and Canada would own almost three-fourths of GM, the newspaper said.
Despite the vote, bondholders would be left with a 10% equity stake in the reorganized company and current shareholders would own about 1%. As much as 20% could go to the health-care trust fund for union retirees.

Chrysler Bankruptcy Paves the Way

Ironically, Chrysler’s swift journey through the bankruptcy process may be a major factor in inducing GM to steer its way into Chapter 11.

Chrysler appears to have made great strides towards a successful restructuring and may be ready to emerge from bankruptcy as early as next week, Bloomberg reported, citing an anonymous source.  That would be well in advance of the 60-day upper limit announced at the time of the filing on April 30.

Chrysler has asked a bankruptcy judge to let it sell most of its assets to Italy’s Fiat SpA (ADR OTC: FIATY) in order to avoid liquidation.  Up until now, the judge in the Chrysler case has signed off on all elements of the company’s simplified bankruptcy process that calls for Fiat to take a major equity stake. The deal is still opposed, however, by some of the automaker’s dealers, bondholders, and former employees.

But consumers apparently are buying into President Obama’s pledge to keep Chrysler alive, as the automaker’s sales in May were about even with those from April. That could mean shoppers remain optimistic about the viability of factory warranties and dealer services if GM enters the same process.

“The government has showed that it’s going to put its muscle behind this,” George Magliano, director of automotive research for IHS Global Insight Inc. (NYSE: IHS) in New York, said in a Bloomberg Television interview. “They don’t want a long bankruptcy. They want to get it in, get it out to minimize the impact of a long bankruptcy.”

Jeremy Anwyl, chief executive of automotive research firm Edmunds.com, told Reuters that “a few months ago, the idea of putting a major automaker into bankruptcy raised fears of things spiraling out of control, but the Chrysler bankruptcy seems to be going well, so right now the idea of bankruptcy seems a lot less frightening.”

GM Bankruptcy More Complex and Risky Than Chrysler’s

A GM filing would be far bigger and more complex than what Chrysler is attempting.

For one thing, GM’s bankruptcy would take longer than Chrysler’s, simply because it is a larger company. GM employees 244,500 people, compared with 54,000 at Chrysler. It also boasts a network of dealers that outnumbers Chrysler by almost two-to-one, with about twice as many brands.

And even though the automaker put 1,100 of its 6,000 dealers on notice that they will have their contracts terminated next year, they are shielded by a labyrinth of state franchise laws.

GM also has publicly traded equity and debt, complimented by international operations in Europe, Asia and Latin America.

Those factors contribute to a large web of complications that could hinder the bankruptcy process and present other, more serious risks, David Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich., told MSNBC.

“If you look at the complexity of the company infrastructure and the number of players involved here – the union, the creditors, the dealers, the suppliers and the government – it’s an unholy cast of characters,” said Cole. “Any one of them could cause a problem, and bankruptcy laws are not well designed to deal with institutions of this complexity.”

Cole also said if a “quick-rinse” GM bankruptcy predicted by the administration fails, it could present more far-reaching and serious implications for the overall U.S. economy.

If the planned bankruptcy process “blows up,” he says, it could lead to a “cascading failure,” shoving auto suppliers into insolvency and forcing other automakers into bankruptcy, according to MSNBC.

“We are talking about the potential for a rapid collapse – it could trigger a national depression,” he said. “The automotive supply structure is in pretty serious trouble now… so if we were to see a cascading failure it could quickly spread to the rest of the economy. That’s the scale of this industry.”

Source: Collapse of Bond Deal Steers GM Toward ‘Imminent’ Bankruptcy Filing and Majority Government Ownership