There are a lot of threads to tie together in today’s reporting of news in the auto sector.

General Motors has reported a third-quarter loss of $1.15 billion. But all indications are that car sales continue to outpace expectations in the United States.  Meanwhile, there are conflicting stories that GM both plans to pay back its bailout money, and to use it to help its ailing European operations. I will try to tie all these stories into a common thread.

First are the earnings. This is the first report by General Motors since leaving bankruptcy.  The results are decidedly mixed showing increasing sales, but a large loss and declining liquidity.

The video above points to losses and negative cash flow. But Bloomberg has reported that GM had significantly positive cash flow in Q3: $3.3 billion worth. Irrespective, sales are up.

The New York Times’ Deal Book says:

Excluding taxes and one-time items like the costs related to restructuring its dealership network, G.M. said its operations lost $261 million from July 10 and September 30. The loss in North America was $651 million.

For the entire third quarter, including the final 10 days of G.M.’s bankruptcy, the company said its revenue was $28 billion, up 21 percent from the second quarter.

In addition, retail sales have revealed that car sales in the U.S. are still relatively brisk for October despite the expiration of cash for clunkers. So, GM is benefitting from more sales, but is still not making money and still seeing cash go out the door. Obviously, they are going to need to cut costs even more, unless they count on sales returning to pre-crisis levels.  However, all indications are that they do, as CEO Fritz Henderson says revenue growth is their number one priority.

“We have significantly more work to do, but today’s results provide evidence of the solid foundation we’re building for the new G.M.,” the chief executive, Fritz Henderson, said in a statement. “With a healthier balance sheet and a competitive cost structure, our focus is on driving top line performance.”

See the Bloomberg video below for my comments by Henderson.

Meanwhile, in what should be seen as a PR move, General Motors has also announced it will begin repaying government money. The first $1 billion to be repaid in December. The company will make $1 billion payments to the U.S. government and $200 million payments to the Canadian government every quarter. It has said it could repay all the aid money by 2011, four years ahead of schedule. Presumably, this does not include the equity government stakes which can be sold on in the open market in an I.P.O.

Given the fact that General Motors is still losing money, it would make sense for them to delay repayment. However, I reckon they are going to repay early in order to tamp down criticism about their government-funded bailout.

The same is true in Germany as well as GM has also announced it will repay ALL German state aid before month’s close.  That is big. It significantly reduces the German government’s leverage over GM plans for restructuring in Germany.

This makes the recent statements about using bailout funds to bolster European operations seem inexplicable. If GM is losing money and needs to use bailout funds to plug up holes in Europe because it has decided to renege on an agreement to sell operations, why is it paying back bailout funds?  Is it not obvious the company needs the money?

My interpretation of GM’s actions is this: they are still a loss-making company and their cost basis is unprofitable at present sales levels. In order to return to profitability, they will need to further reduce costs or increase sales. At present, management have opted to grow the top line – and this makes retaining the European operations vital as the auto technology at Opel is considered first class.

So, GM has reneged on the Opel sale, risking the political backlash, because it is flush with bailout cash.  However, it knows that its desire to use these funds to stabilize the European business is likely to invite populist outcries in North America. This is why they have announced the repayment schedule today; it is purely a public relations maneuver to quell any anti-bailout sentiment. They are repaying German state aid for similar reasons, but also because it gives them greater flexibility in making operating decisions about job cuts and plant closures.

As GM is not publicly traded, we do not have stock prices as a gauge of how receptive investors are to these latest moves. But, according to Bloomberg, GM 8 3/8 bonds maturing 2033 jumped significantly, adding $2.63 to move to $20.3 on $100 par value.

You can expect to see GM as a topic in both the business and political press for some time to come.

Related posts:

• GM looks to use US and Canadian tax money to bailout Opel
• GM and Chrysler to get more bailout money
• GM headed for bankruptcy
• GM considers keeping Opel, raising capital
• Chrysler: bulls make money, bears make money, pigs get slaughtered

An article in the National Post suggests General Motors may look to divert some of its bailout money to Europe in the wake of a chill in German government support for subsidies. Talk of using taxpayer money to benefit workers in other countries is sure to raise ire, especially in the United States where the unemployment rate has hit double-digit levels.

When General Motors was forced into receivership this past Spring, it received tens of billions in bailout money from the U.S. and Canadian governments in order to protect jobs in the auto sector.

For his part, Stephen Harper, Canada’s Prime Minister said the aid was regrettable but necessary.

The Vancouver Sun reported at the time:

Canada had no choice but to support the restructuring of auto giant General Motors Corp. with about $10 billion in taxpayer aid or face devastating economic consequences, Canadian government and union leaders said Monday.

Hundreds of thousands of jobs would have been lost and communities across southern Ontario would otherwise have been devastated, Prime Minister Stephen Harper and Ontario Premier Dalton McGuinty said at a news conference Monday, hours after the 100-year-old company sought protection from bankruptcy in the U.S.

"We could either participate in reshaping these companies for the future or stand idly by as they restructured out of Canada," Harper said in Toronto.

"The decision announced today is regrettable but necessary."

The federal and Ontario governments’ contribution to the restructuring is set at $9.5 billion US, according to a joint statement Monday from the prime minister and U.S. President Barack Obama.

For that, Canadian taxpayers will hold a 12-per-cent equity stake and will also appoint one independent director to the company’s board.

The U.S. government sunk even more into General Motors – $50 billion. All of this money and the ‘cash for clunkers’ program have allowed General Motors to return to life. However, many issues remain, the most consequential of which is GM Europe. 

Since late May, it has appeared that a consortium headed by Magna International was set to take over GM Europe on the condition of 4.5 billion in state aid from Germany. As early as August, stories surfaced in which GM was considering raising capital in order to keep Opel. GM never wanted to sell Opel and Vauxhall, but it was forced to do so by circumstance.

However, when GM abruptly backed out of the Magna deal early in November it enraged the German government, who are now not likely to offer any aid. At the time I said:

Will Obama now come up with the funds?  If this minister gets his way, there don’t seem to be a whole lot of solutions here.

Well, here is one solution via the National Post (note the part I have highlighted in bold):

General Motors Co. may use some of the money it won from Canadian and U.S. taxpayers in the spring to fix its Opel unit in Europe in the months ahead as it works out a new financing plan for the money-losing business.

Detroit-based GM plans to fund Opel’s turnaround using a mix of sources after deciding to keep the business itself instead of selling a majority stake to Magna International Inc. and Russia’s Sberbank. That could include tapping funds pledged by the federal and Ontario governments, said Chris Preuss, GM’s vice-president of global communications.

"We’re going to be needing to participate directly in the financing" of Opel, Mr. Preuss said in an interview yesterday. "The taxpayers of both Canada and the U.S. have a stake in this. But what was agreed upon was that we have to be able to run a global business."

Translation: GM has every right to use its bailout money as it sees fit.

GM continues to misjudge the political situation. They handled the decision to back out of the deal with Magna very poorly. We are now likely to see increasing signs of economic nationalism at play.

But, just as the backing out created huge waves in Germany, this latest salvo from GM is likely to enrage Canadians and Americans as they see their tax dollars at work to protect the jobs of Europeans. GM may think using Canadian and American bailout funds for GM Europe is a good ‘technical’ solution. But, it is a very poor choice politically and they will pay the price.

Related posts:

• Germany gives GM a stiff arm on state aid
• Germans reject Chinese offer for Opel
• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• GM board decides to keep European Opel unit

You could see this one coming given the humiliating circumstances under which the German Chancellor learned that GM was pulling out of the Magna deal.

The BBC is now reporting that Germany will give General Motors no aid to restructure it’s business. That’s 4.5 Billion Euros they now need to come up with.

Economy Minister Rainer Bruederle told GM executives that they had to be responsible for restructuring the unit.

Germany had previously offered 4.5bn euros ($6.7bn; £4.1bn) to support Opel and protect German jobs if the company was sold to car parts maker Magna.

On cancelling the sale last week, GM said it would still seek state aid.

The German minister’s comments now raise question marks over whether GM will get it.

"I expressed my expectation that General Motors should basically carry out the financing itself," Mr Bruederle said.

Will Obama now come up with the funds?  If this minister gets his way, there don’t seem to be a whole lot of solutions here.

Related posts:

• Germans reject Chinese offer for Opel
• GM looks to use US and Canadian tax money to bailout Opel
• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Economic nationalism and GM’s decision to keep Opel and Vauxhall

I have been reading press accounts of the GM decision to back out of the Opel/Vauxhall sale to the Magna/Sberbank consortium from various countries. There are a lot of different perspectives on this event in the U.S., Belgium, Spain, Germany, Russia, the U.K and elsewhere, because a lot of players are involved.

The conclusion I come to is that economic nationalism is the driving motivator behind much of what you read. To the degree, we continue to experience a soft global economy, this should be seen as a warning of how individual actors will respond in future.

Easy decision to keep Opel

GM’s decision to keep GM Europe is fairly straightforward in my view. The cars and technology in GM Europe is something General Motors never wanted to part with. They only did so because of the need to raise cash in a weak economic environment. Now, things at GM (and Ford) are looking much better and GM has exited bankruptcy. There is no desperate need to sell.

Moreover, the EU was asking GM a lot of questions about the subsidy deal they struck with the German government in order to effect the sale of Opel. Other European nations, Spain and the U.K. in particular, were livid because they suspected an unfair subsidy of German jobs over Spanish or British jobs. But, it goes far beyond those two nations as GM Europe employs 55,000 people in places like Sweden, Poland and Belgium.

We saw what happened to ING, RBS and Lloyds due to the EU’s rules on competition. One could reasonably expect a similar crack down in the auto sector. Details will emerge at some juncture, but one could conclude that GM did a cost-benefit analysis in which the wrangling with the EU weighed heavily on their decision to back out of the Magna deal.

And, in the end, should we expect the restructuring GM performs to be qualitatively any different than what Magna’s consortium would have done? They too have announced 10,000 job cuts, a figure in line with what was expected under Magna’s control. So, on the surface, this looks like a net benefit for GM, a net loss for the Magna-led group, and a wash for workers and politicians.

Enter economic nationalism

But, unfortunately, that’s not how it is likely to be seen. Let’s look at it from a German perspective.  Germany’s Chancellor Angela Merkel went to bat for the Magna deal, winning what was widely seen as a measure of security for German workers at a critical time during economic weakness. This bolstered her election chances. As a result, the center-left SPD has now been replaced by the Libertarian-minded FDP in a coalition reminiscent of the Helmut Kohl days. Consider this a move to the right in Germany.

Nevertheless, Merkel has stuck with her allegiance to Barack Obama. In fact, as a result of this relationship, she was the first German Chancellor in 50-odd years to deliver an address before Congress just two hours before she learned of GM’s backing out. What’s more is the U.S. Government is the majority owner of General Motors. One would think the Obama Administration had some insight into the decision-making at GM. Either the Administration didn’t know and is being recklessly hands-off in an enterprise where it has sunk tens of billions or it did know and did Angela Merkel a disservice by not informing her of what was to come well before her speech to Congress.

So, you have an American company owned by the American government backing out of a signed agreement and potentially thousands of jobs at risk. Talk of plant closures at Eisenach, Bochum (and Antwerp in Belgium) and the loss of jobs is rampant in the German press. GM Europe’s head John Smith says, "if they like the Magna plan, they will also like the GM plan." That is not an argument likely to gain sway in a period of economic uncertainty.

The Germans are livid.  German workers have gone on strike. Meanwhile, you have the UK Business Secretary Lord Mandelson warning that the division of job cuts must be ‘fair.’ And the Spanish Opel workers had just OK’ed the Magna plans two weeks ago. This is a bit of a zoo, isn’t it?

It is every nation for itself – precisely what one would expect with a shrinking economic pie and a deep downturn.

Going forward

GM has mishandled this affair quite badly I believe. At least with the Magna deal, the Germans were in the driver’s seat. Now, all of the individual European nations are angling for their say in this matter. Yes, GM had little choice given the likely scrutiny it was under via Neelie Kroes, but it certainly could have handled the political aspects of this much better.

However, now that this situation is out, it gives us a bird’s eye view into how nations respond when a division of the spoils becomes an issue.  And what we have seen does not give confidence that a coordinated approach will prevail. I take this affair as a clear indication that economic nationalism is alive and well and very much a threat to our collective well-being.

Related posts:

• Germany gives GM a stiff arm on state aid
• GM board decides to keep European Opel unit
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Germans reject Chinese offer for Opel
• GM considers keeping Opel, raising capital

The sale to Canadian auto parts maker Magna International and its partner, Russian lender Sberbank is off. With bankruptcy now behind it, General Motors now feels confident it can proceed with Opel under the GM umbrella.

From the GM press release:

Given an improving business environment for GM over the past few months, and the importance of Opel//Vauxhall to GM’s global strategy, the GM Board of Directors has decided to retain Opel and will initiate a restructuring of its European operations in earnest.

“GM will soon present its restructuring plan to Germany and other governments and hopes for its favorable consideration,” said Fritz Henderson, president and CEO. “We understand the complexity and length of this issue has been draining for all involved. However, from the outset, our goal has been to secure the best long term solution for our customers, employee, suppliers, and dealers, which is reflected in the decision reached today. This was deemed to be the most stable and least costly approach for securing Opel/Vauxhall’s long-term future.”

On a preliminary basis, the GM plan entails total restructuring expenses of about € 3 billion, significantly lower than all bids submitted as part of the investor solicitation. GM will work with all European labor unions to develop a plan for meaningful contributions to Opel’s restructuring. While Opel continues to outperform against its viability plan assumptions and immediate liquidity is stable, time is of the essence.

“While strained, the business environment in Europe has improved.” Henderson said. “At the same time, GM’s overall financial health and stability have improved significantly over the past few months, giving us confidence that the European business can be successfully restructured. We are grateful for the hard work of the German and other EU governments in navigating this difficult economic period. We’re also appreciative of the effort put forward by Magna and its partners in Russia in trying to reach an equitable agreement.”

I will be speaking about this issue in an hour’s time on the BBC. But, look at this as a result of economic reflation. GM has exited bankruptcy and feels confident enough of the future path of the economy to keep Opel instead of having to sell in a fire sale. 

The Germans are livid, according to the Wall Street Journal.

The governor of the German state of Hesse, where General Motors Co.’s Opel unit is headquartered, said Wednesday he is "concerned and at the same time annoyed that the months-long efforts to find a good solution for Opel have failed because of GM."

In a statement, Roland Koch, a confidant of German chancellor Angela Merkel, said that considering the "negative experience in recent years with GM’s corporate policy, I’m worried a lot about the future of (Opel) and its staff."

In a surprise move, GM’s board late Tuesday decided it wants to retain its core European operations after talks over a possible sale have been dragging on for months.

Koch said he expects GM to repay by Nov. 30 the bridge financing provided by the German state "so that the German tax payer doesn’t get harmed."

Remember that other EU countries came out of the woodwork saying, in effect, that the Germans had bought off GM and were being advantaged by unfair subsidies while in places like Belgium and Spain workers were suffering.

Very interesting. More after the BBC show!

Related posts:

• GM considers keeping Opel, raising capital
• GM looks to use US and Canadian tax money to bailout Opel
• Economic nationalism and GM’s decision to keep Opel and Vauxhall
• Germans reject Chinese offer for Opel
• Germany gives GM a stiff arm on state aid

China has sent yet another public signal that it is unhappy with the U.S. and its trade policy by prepping an investigation into alleged illegal auto subsidies by the U.S. government.  The timing of this announcement puts a spotlight on the bailout of GMAC, the auto financial company which effectively has been nationalized the firm. This may be by intention.

The Financial times reports:

China is preparing to launch a trade investigation into whether US carmakers are being unfairly subsidised by the US government, according to people familiar with the matter.

The move comes at a time of heightened trade tensions between the two countries after the US imposed duties on Chinese tyres last month. Many warned this would prompt Beijing to retaliate.

Few vehicles are actually exported from the US to China, but the move would have symbolic power by turning the tables on Washington.

US labour groups have long accused Beijing of unfairly subsidising its exporters. However, through a “countervailing duties” investigation, China would assess whether the US was open to the same charge. The investigation could lead to import duties.

General Motors and Chrysler have received about $60bn in government bail-out funds, though Ford has received nothing.

Yes, General Motors has a large presence in China and its bailout by the government has an impact on its ability to operate competitively in China. But, because the U.S. does not export many cars to China, one might see this as a strange action on China’s part.  In my view, China is telling us with this action that “what is good for the goose is good for the gander.”

I find this story a bit curious because China already said in September that it would investigate autos and chicken in retaliation for U.S. tariffs on tires. But, we should look at this in a wider context. The US is also angling to get Chinese to revalue renminbi. The Chinese are resistant to this and their actions here can also be seen as a warning to the U.S. that any and all protectionist threats will be met with retaliation.

Elliot Feldman, head of international trade at Baker & Hostetler, the law firm, said his firm warned the USTR last January that the approach the US was taking towards China and other countries over subsidies was dangerous in the light of the US’s own support for carmakers, banks and financial institutions.

“We warned that other countries could apply to the United States the same principles the United States was applying to them,” he said. “Apparently we have arrived.”

The problem with protectionism is not that it can protect sectors, but that it leads to retaliation and escalation. This is now what is beginning to occur.

Related posts:

• China: we “will take steps to protect the interests of our domestic industries”
• Should we expect a protectionist China?
• Beijing starts a ‘Buy China’ policy
• Tariffs: Other industries may line up for sanctions against China
• China detains Rio executive on suspicion of espionage

And you thought the bailouts were over and market discipline might be restored.  Not a chance – the bailouts will continue, come hell or high water. The latest demonstration of this is GMAC, where the government will now be majority owner. GMAC has officially been nationalized. Now the government is running auto financing in addition to running the companies making the cars.

Below is a quote from the Financial Times. Notice the parts I have bolded.

GMAC, the car financing company, is set to receive up to $5.6bn in a new capital injection from the Treasury, filling a hole identified in the “stress tests” earlier this year and paving the way for the government to become the majority shareholder.

The company, formerly the financing arm of General Motors, was one of 19 institutions to submit to a capital adequacy programme led by the Federal Reserve and completed in May. That determined that GMAC had a shortfall, which will now be provided by the government in the form of preferred equity, according to two people familiar with the situation.

As widely expected, GMAC has been unable to raise the necessary capital in the market and the company – which will take on fresh lending responsibilities when it merges with Chrysler Financial – was seen as vital to the government-led restructuring of the US automotive industry and deserving of more funds from the $700bn troubled asset relief programme.

“When we laid out the stress tests, we expressly said that some additional Tarp capital may be needed given the severity of the downturn – this capital need is not new information,” said an administration official.

“But the transparency brought about by the stress tests allowed all other institutions to raise the capital required by the stress tests to ensure these firms could withstand a more severe economic scenario than anticipated,” the official said.

What you should be reading from this statement is the following:

• All the firms identified as lacking capital under the stress tests were given time to raise funds in the capital market to meet the shortfall.
• Some firms did meet the shortfall and they are now free to do as they please.
• Others have not and we the government are now going to take a more muscular approach in dealing with them.
• GMAC is the first public example of our flexing our muscles.
• But there surely are/will be other examples; some may already be happening in secret.

If the US government is going to throw its weight around to deal with financial firms short of capital, I would personally prefer they try a process which allows these firms to fail whereby equity and debt holders suffer consequences that are consistent with taking market risk.  Bailing out GMAC is a moral hazard plain and simple.

But, what’s done is done. The GMAC case does, however, give a lot more credence to my view that Citigroup’s actions are being dictated by government. As I indicated when the stress tests were done in April, firms were going to get some time to raise capital and if they didn’t, the government was going to move on to Plan B (debt-for-equity swaps, nationalization, and FDIC seizure). Expect to see more indications that other financial companies with capital shortfalls are falling under the government umbrella.

Related posts:

• Bank by bank breakdown of stress test results
• BofA, Citi, Wells and GMAC biggest losers in stress test leaks
• GMAC: Loosening credit standards in the teeth of recession
• GMAC gets a helping hand
• GMAC chairman resigns effective immediately

Toyota, now the world’s largest automaker, has said it would halt production at a plant in Aichi prefecture in Japan, reducing total output by a massive 220,000 cars.  This should be seen as a recognition of the over-capacity tat exists in the auto sector despite other recent upbeat news.

Toyota raised its parent-only production target for 2009 by 150,000 units to 5.95 million on Aug. 20 in response to various government stimulus programs and a reduction in inventory. The last press release from Aug. 21 on Toyota’s US website touts Toyota’s addition of capacity at its site in Huntsville to produce an additional 216,000 vehicles, with production scheduled for 2011.  From these two announcements, one would assume that production is slated to ramp up.

Yet, we now understand that the company is looking to actually reduce overall capacity in order to return to profitability.  In fact, some experts believe Toyota’s capacity cuts could eventually reduce capacity by 700,000 cars or 7% of annual production.  Reuters is talking about a cut of 1 million units of capacity or 10% of annual production.

The problem is that Toyota, which produced 8.2 million vehicles in 2008, has a capacity of about 10 million units worldwide.  And when your 2009 target is for 5.95 million vehicles that necessarily means you have a huge amount of excess capacity.

To my mind, these announcements speak to the vast difference between the meaningful uptick in demand today, the much larger demand of just a few years ago, and the capacity built for even more demand that was expected. 

Yes, the economy is picking up globally, but while 5.95 million units is more than 5.8 million, it is nowhere close to 10 million.

Related posts:

• Third quarter auto production to be significant boost to U.S. GDP
• Industrial production implodes
• Auto sales plunge in September
• Sweden: competitive auto bailouts begin with Saab and Volvo
• Chart of the day: Industrial Production

You may have heard the reports that US auto dealers were swamped on Monday night as the car scrappage scheme dubbed “Cash for Clunkers” expired. American taxpayers were eligible for a tax rebate of up to $4500 for trading in an older gas guzzler for a new vehicle.  And all evidence shows that they took the government up on the offer – in droves.  According to the U.S. Department of Transportation, there were in excess of 625,000 transactions for $2.58 billion in rebates.

While I tend to think this scheme is pulling forward demand for vehicles, it is going to mean a huge boost to Q3 GDP.  Unless we get a relapse in Q4 or Q1 2010 when I had expected the recession to end, the recession is technically over right now in all likelihood.

Related posts:

• Heavy early voting in US Presidential election
• GDP: imports, inflation and local government are the story
• ISM shows manufacturing sector close to recovery
• U.S. ISM manufacturing survey hits 28-year low
• What is the recent increase in U.S. jobless claims telling us?

Now that it has emerged from bankruptcy and received free money from the Federal Government, General Motors is seriously thinking about keeping Opel by raising capital.  The German government has been urging GM to make a decision about the bids it received for GM Europe from Magna, the Germans’ preferred bidder. But, the company has dragged its feet. We now know why.

According to the FT, one plan has GM stiff-arming the German government and raising 3 billion euros of capital.

The US carmaker and its advisers are studying a scenario that would see GM abandon the German plan and instead raise roughly €3bn ($4.3bn) of rescue funds for Opel and its British Vauxhall brand from the US and other European governments, including the UK and Spain.

I can’t imagine this sits well with the Germans as they should feel like GM has not exactly considered them at all in its plans.  This is certainly going to have repercussions for German elections coming forward. The FT says:

Were GM to abandon the German-backed sale process, it would be an embarrassment for Angela Merkel’s government.

As for GM, it does seem to be a good move.  Having secured huge concessions from unions and bondholders, the company is in better shape.  What’s more, it has received direct aide from the U.S. and Canadian governments and is further benefitting from government largesse due to the just-ended Cash for Clunkers scheme. 

With equity markets soaring, I bet they could even try raising money in the capital markets.

Related posts:

• GM headed for bankruptcy
• GM board decides to keep European Opel unit
• GM looks to use US and Canadian tax money to bailout Opel
• Germans reject Chinese offer for Opel
• German Press: Fiat to sign a deal with Opel, not Chrysler

Dick Berner, Chief North American Economist at Morgan Stanley, thinks we are in for a sizable uptick in GDP for Q3.  I must be honest; I am sceptical about this, but Berner is a well-regarded economist  whose views can’t be dismissed out of hand.  He says:

Incoming data… confirm that the deepest and longest post-war recession is now ending.  And it’s ending with a roar: A temporary surge in vehicle production is likely to pace a much stronger rebound from recession than we thought only a month ago, so GDP may rise 3-4% annualized in 3Q.  The recession and recovery are starting to look more ‘V’-shaped: Revised data now show that the economy declined by 3.7% since the recession began in 4Q07, making it the deepest post-war downturn.  But significant economic headwinds mean that the 3Q surge is unlikely to spill over into a stronger overall recovery.  And with inflation declining, a tighter monetary policy is unlikely soon.  We continue to think that the Fed will remain on hold until mid-2010.

Ingredients for a rebound.  There’s no mistaking the ingredients for a sharp summer rebound, including a classic inventory snapback and modest improvements in some components of final demand.  Aggressive vehicle production cuts (a 46%, seven-quarter plunge in motor vehicle output, with the first half down at a 36.3% annual rate) have brought motor vehicle inventories in line with sales.  Indeed, the cuts in output overshot, pushing annualized US production 2-3 million units below the pace of domestic sales in the past three months.  Just to catch up, vehicle production surged about 60% in July over June, and seems likely to rise further through the summer.  As a result, motor vehicle output likely will add about 4 percentage points, or roughly double our estimate last month, to overall GDP.

A reduced pace of inventory liquidation elsewhere in the economy will probably also contribute to growth.  Apart from motor vehicles, companies liquidated about US$100 billion in real inventories in 2Q, bringing the level of inventories in relation to sales down somewhat from its 4Q08 peak.  And even if companies are still liquidating stocks, a slower pace of liquidation (which means that the change in the change in inventories is positive) will likely add more to growth in output than we expected last month.  Indications of stronger orders and production in July’s ISM report suggest that manufacturing outside of motor vehicles is beginning to bottom.

Better-than-expected gains in housing and construction will probably add another half point to 3Q output. Despite the obvious headwinds that still face housing, imbalances are smaller, and activity is starting to improve by more than we thought previously.  The vacancy rate in one-family housing, now 2.5%, has fallen 40bp from its 4Q08 peak.  And modest improvements in sales and continued declines in inventories have brought inventories of new, one-family homes down to 8.8 months’ supply -from 12.4 months in January.  The 2.4% June surge in one-family construction outlays signals that activity began to turn at the end of 2Q.  With financial conditions gradually improving, despite lenders requiring higher downpayments, further gradual improvements in demand seem likely, and housing construction is also likely to improve further.  Moreover, thanks to the funding from the American Recovery and Reinvestment Act (ARRA), it appears that state and local infrastructure outlays are starting to pick up a bit sooner than we expected a month ago.

Limited ‘payback’.  This 3-4% 3Q surge in GDP growth is not sustainable, but neither a significant ‘payback’ nor a double dip is likely.  Vehicle sales illustrate the point.  The blowout response to the ‘cash-for-clunkers’ incentive program has been far stronger than we expected.  With the initial US$1 billion in funding used up in a few days (even if some of the deals were booked at dealers in anticipation of the July 24 initiation date), this fiscal stimulus is getting a lot of bang for the buck.  It is timely, targeted and temporary: The incentives have an immediate effect; combined with matching dealer incentives, consumers are getting a 30-40% discount off the sticker price, and consumers must use them or lose them.  The deals will run out soon even if the Senate approves the US$2 billion in additional funding voted by the House before they recessed last week.  If each billion in funding spurs an extra 250,000 vehicle sales, as seems possible, the annual selling rate in August may climb past the 12 million we expect for July.  While the sales pace will slip back in the following months, manufacturers likely won’t have to trim inventories at all in 4Q.  Beyond the spillover from the vehicle rebound, improving global growth, the growing impact of fiscal stimulus and looser financial conditions may also limit the slippage in 4Q, by sustaining exports, factory output, infrastructure and housing.

So, to recap, we have the Fed on hold at zero percent rates, a huge uptick in autos, government stimulus coming online, and a robust inventory cycle coming into place.  This does sound very bullish regarding Q3.  But, there are some major problems to contend with longer-term.

Four headwinds still indicate a moderate recovery, in our view.  First, financial conditions are still restrictive, reflecting the gradual improvement in bank balance sheets and securitization markets.  The combination of reduced access to credit and falling home prices will keep consumers cautious and promote further deleveraging and increased saving out of current income.  Second, absent a sustained pick-up in vehicle sales, the inventory-related production bounce in motor vehicles won’t last.  More broadly, inventories elsewhere in the economy aren’t yet lean in relation to sales.  Third, despite the infrastructure pick-up, stressed state and local governments are cutting current services and furloughing workers.  Fourth, ‘core’ consumer incomes (real, after-tax wages and salaries) are now falling again, following several one-time boosts to real after-tax income earlier this year (e.g., declines in energy prices, stepped-up tax refunds, a cut in withholding rates on April 1, and one-time checks to Social Security and SSI beneficiaries in May and June).  Measured by the employment cost index, private industry wages and salaries rose just 1.5% in the year ended June, a record low.  With continued pressure on wages and payrolls, and the bulk of the ARRA tax cuts likely to hit incomes only in spring 2010, real spendable income should be flat to down in 2H09.

Exactly right. Don’t forget the fact that jobs are still being cut and personal income is at 2007 levels as a result.  Not exactly the stuff of sustainable recoveries.  Berner goes on to suggest that declining inflation will keep the Fed on hold for some time to come and ends his analysis there. 

I would add the comment that this sounds bullish over the short-term but not necessarily sustainable. Auto demand is being pulled forward artificially and the inventory cycle and government stimulus are both temporary.  The only variable which is supportive of this V-shaped scenario over the longer-term is interest rates – and that is only because of the threat of deflation.  I see this as further confirmation that a W-shaped recession is a very real possibility.

Source

Roaring Out of Recession in 3Q – Richard Berner, Morgan Stanley

Related posts:

• The mother of all inventory corrections is not the same as re-stocking
• What does a double dip recession look like?
• Third quarter auto production to be significant boost to U.S. GDP
• Morgan Stanley: Recession will ‘end by mid-to-late summer’
• Economic recovery and the perverse math of GDP reporting

Roland Koch, the leader of the German state of Hesse, has dismissed the possibility of Chinese auto manufacturer BAIC acquiring German carmaker Opel.  Below is my translation of today’s Spiegel article explaining this.

Clear rejection of the Chinese: Hesse Prime Minister Koch has rejected the takeover offer for Opel by the car manufacturer BAIC. If someone seriously put in a word on behalf of the candidate from the Far East, it would be “an amazing thing.”

The Austro-Canadian auto supplier Magna can rely on the support of the ‘German princes’: In the takeover battle for Opel the chances of other candidates is dwindling. In a newspaper interview, Hesse Minister President Roland Koch (CDU) categorically rejected a takeover by the Chinese manufacturer BAIC.

The new European Opel could not be managed by a Chinese company, “that produces just 12,000 cars per year and do not even have the backing of the Chinese government,” Koch said to Hamburg’s Abendblatt newspaper. It would be “an amazing thing,” if anyone seriously believed in this solution.

An entry of Magna would be “the best solution, looking at the future of Opel, the locales concerned, and jobs in Germany, not least because of taxpayer money,” said Koch. Magna dealt “quite concretely with the American parent company, GM and has a big advantage over other bidders.” Koch acknowledged, however, that it is “still a long way” until Opel is rescued.

However, the opposition does not agrees with this strict interpretation of events. The chairman of the Bundestag’s budget committee, Otto Fricke (FDP), said to the “Rheinische Post”: “If the federal government does not even try and speak with the Chinese, it would be needlessly risking almost two billion euros in tax money.” While Magna, in the event of a takeover of Opel, requires guarantees by the German taxpayer in the amount of 4.6 billion euros, BAIC is requesting only 2.64 billion euros.

Even the Federation of Taxpayers urged the federal government to no longer unilaterally look at Magna. You must ensure that the best concept would be implemented for Opel and the taxpayer , said President Karlheinz Däke. Previously the CDU politician Mittelstandsbank Michael Fuchs and the Economic Council of the Union, which deals with the bidders competing with Magna, had requested re-examining the competing offers.

On the other hand, Prime Minister of Thuringia Dieter Althaus (CDU) said in the “Thüringer Allgemeine” that the decision for Magna as an investor is made. He expressed his expectation that outstanding issues will be resolved by next week. . Althaus was “surprised” about the objections raised.

This article makes clear that the GM Europe/Opel bailout and sale is very much a political event.  Just Wednesday in a post about the Rio Tinto situation, I mentioned that the Germans should handle the Chinese bid with care lest they be rightfully accused of protectionism.

Apropos protectionism, the German government has now confirmed an official bid for automaker Opel by a Chinese car company, Beijing Automotive Industries (BAIC). As the Chinese have become noted of late for being the high bidder, I suspect BAIC has put in a good offer. (Update 920ET: The Telegraph puts this offer at €660 million for all of GM Europe including Vauxhall) To be sure, the Austrian-Canadian auto parts maker Magna is on the verge of finalising its bid.  Nevertheless, the Germans are going to need to treat the Chinese bid with diplomatic aplomb.  We have already seen enough protectionism against Chinese companies.  Another slight of this nature would be proof positive that Chinese money is considered no good for buying top-tier western companies.

While some had conjectured that the BAIC bid is really a Chinese government bid, the Chinese automaker has no backing from the Chinese government, as Roland Koch alluded.  Koch claims this is a negative, but he is just rationalizing his decision to dismiss the bid out of hand.  In truth, the lack of involvement of the Chinese government would be seen as a good thing to most concerned parties.

The fact is the Chinese have put a superior offer to Magna’s on the table.  But, because of protectionism, this offer has zero chance of being accepted by the Germans.

Source

Koch lehnt chinesischen Einstieg bei Opel ab – Der Spiegel

Related posts:

• China detains Rio executive on suspicion of espionage
• Germany gives GM a stiff arm on state aid
• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• GM looks to use US and Canadian tax money to bailout Opel

Judge Robert Gerber has given General Motors approval to sell its assets under section 363 of the bankruptcy code.  Last month I indicated that this 363 sale was more questionable than Chrysler’s and could meet more resistance in court.  That has not happened and the GM bankruptcy looks likely to proceed according to the Obama Administration’s plans. 

I said “The Obama people are going to argue that GM is dependent on government monies to exist and that it cannot ‘survive the full plan process.’”  The judge agreed with this reasoning as evidenced by the quote from the FT article below.

Regardless of what you think about other aspects of Obama’s handling of economic issues, the general success of the Chrysler and GM bankruptcies will give Obama a lot of credibility on the economic front just when he needs it.

A US judge on Sunday approved General Motors Corp’s bankruptcy sale, in a move that will allow the company’s most profitable assets to exit bankruptcy protection under government ownership.

Judge Robert Gerber of the US bankruptcy court in Manhattan said the sale would ”prevent the death of the patient on the operating table.”

GM, which filed for bankruptcy protection on June 1, had argued that it would be forced to liquidate if the sale was not approved. The US government said it could walk away from funding the automaker if a deal was not approved by July 10.

”If GM liquidates, there will not only be nothing for stockholders; there will be nothing for unsecured creditors,” Judge Gerber said in a 95-page opinion.

Source

Judge approves plan to sell GM assets – FT

Related posts:

• Is the GM section 363 bankruptcy plan really a stealth re-organization plan?
• Did Tim Geithner blow it?
• The case of the dissident Chrysler bondholders
• Obama ready to put Chrysler into bankruptcy
• Obama Team considering a pre-pack Auto bankruptcy

Apparently, the U.S. auto industry is working off a significant backlog of inventory because I have been hearing that pretty much everyone in North America is planning to ramp up production for the third quarter.  This is prima facie evidence of the huge inventory-based production changes which I have said will make Q3 and Q4 look much better than Q1 and Q2.  In April, in my post “The Fake Recovery,” I said:

Obviously, this means that U.S. Q1 and perhaps even Q2 GDP will be very low due to the subtraction of inventories now being purged. However, when we get to Q3 and Q4, this effect will be gone and quarterly and yearly comparisons will look favourable. So the inventory purge may mean a huge upside surprise to GDP in the second half of the year and early 2010 – potentially enough to see positive GDP numbers.

The automakers are doing their part to make this story come true.

1. Chrysler (via Bloomberg):
   

   Chrysler Group LLC, the U.S. automaker created out of bankruptcy last week, said it will resume production at seven vehicle plants the week of June 29.

   The facilities are in Michigan, Ohio, Missouri, Ontario and Mexico, the company said today in a statement. Chrysler reopened a Detroit car factory on June 15. Other assembly plants may not open until late July after they are reconfigured to build 2010 models, spokeswoman Dianna Gutierrez said in an interview…

   Based on the current sales level and limited production, Chrysler’s inventory may be well under 200,000 at the end of July, said Haig Stoddard, an automotive analyst at IHS Global Insight’s Troy, Michigan, office.

2. Ford (via USA Today):
   

   Ford is boosting its third-quarter production schedule after seeing more demand for its cars and trucks in June, the company said Monday.

   Ford (F) plans to increase production by 16% compared with the third quarter of 2008. The automaker had said it would increase production 10%, but is adding another 25,000 vehicles because it’s seen some stabilization in June auto sales, to be reported Wednesday.

   The news comes amid several preliminary reports that June sales have been stronger than recent months. Last week, Edmunds.com and J.D. Power reported that June sales had increased significantly compared with May sales.

3. GM (via WSJ)
   

   …The deep discounts that General Motors Corp. and Chrysler Group LLC have offered to boost sales are also likely to bolster June sales.

   Those factors suggest "the worst is behind us," Mr. Pipas said. "Even if sales fail to hit the 10 million milestone, we’re still not slipping back." A GM spokesman also said an annualized 10 million sales rate is possible for June.

Expect Q3 to be significantly better than Q2.  Moreover, we should also expect Q2 to be well above the -5.5% annualized GDP change we saw for Q1 in the U.S.

Related posts:

• Strong May auto sales are bullish for retail sales
• Auto sales plunge in September
• The mother of all inventory corrections is not the same as re-stocking
• ISM: Is this the mother of all inventory corrections?
• Does positive growth in Q2 or Q3 mean the recession is over?

We have just learned that Fiat has successfully completed its deal with Chrysler.  This means that the bankrupt ‘Old Chrysler’ will now have far fewer cash and assets available for creditors and that it will be liquidated with large or total losses likely for creditors.  Dissident creditors tried to get their case heard by the Supreme Court.  But this was rejected, paving the way for the Fiat deal. 

Key to why things turned out as they did is the use of section 363 of the bankruptcy code, which allows a company to sell assets without creditor approval and before a re-organization plan can be submitted.  The sale produces cash available to creditors in the eventual liquidation of the company. The sold assets can continue to operate as before, but in a re-organized fashion.  This is exactly what the Obama Administration wanted for Chrysler. So, in the case of the government versus bondholders count round one to the government.

Now, it’s time to turn to General Motors. This is a very important case because GM is such a big player in so many arenas. Think of Chrysler as a  test run of GM, the real US auto emergency.  A bankrupt GM that does not receive the same quick section 363 treatment that Chrysler received would be a very nasty  shock to the U.S. and global economy. 

The problem is that General Motors is a whole different case altogether.  And I am not so sure the government is going to be successful here. Here’s why. While the Chrysler deal involved a sale of the principal assets, the GM bankruptcy looks more like a stealth re-organization which violates the spirit of section 363. Back in 2004, Daniel Glosband, a bankruptcy expert at the law firm Goodwin Proctor reflected on this issue at the site FindLaw. (emphasis added below)

Advantages of a Section 363 sale include speed, transfer of assets free and clear of encumbrances and interests, transfer of restricted contracts and avoidance of exposure to claims under fraudulent transfer laws. For a seller, the Section 363 process eliminates director and officer exposure for the sale and limits exposure for breach of representations and warranties. Cosmic balance, however, requires a few clouds to accompany the silver linings.

Traditionally, the sale of a business in chapter 11 was accomplished through a plan of reorganization that identified and dealt with each class of creditors and equity holders. The sale plan was described to the affected creditors and equity holders in a prospectus-like disclosure statement and put to a vote. Bankruptcy law required acceptance of the plan by specified majorities of affected parties, a cumbersome process that lasted for several months and sometimes several years. Initially, courts were skeptical of Section 363 sales that circumvented the protective reorganization plan process. Early cases required the debtor to prove that a sale outside of a reorganization plan was necessary, for example by showing that the debtor’s business had insufficient cash flow to survive the full plan process. Lately, however, the Section 363 sale, which can be completed in as little as two to three months, has become the preferred method for sales of distressed businesses.

Clearly, if the courts decide that the government is trying to circumvent the normal Chapter 11 process by invoking section 363, you are going to have a problem.  The Obama people are going to argue that GM is dependent on government monies to exist and that it cannot ‘survive the full plan process.’  But, creditors are going to contest this case and they may have more success than they did at Chrysler.

Stay tuned.

As for Fiat, the last paragraph of the FindLaw article describes quite well why their stock has popped on the news of a successful Chrysler deal.

The goal of the purchaser at a Section 363 sale is to take advantage of the financial distress of the seller and the power of the Bankruptcy Code to make a safe, profitable investment. While a Section 363 sale is a complex exercise with risks for the unwary, it can be an efficient avenue for a well-prepared buyer to acquire a financially troubled business.

Related posts:

• GM gets the green light on its section 363 bankruptcy
• The case of the dissident Chrysler bondholders
• Opel and Fiat spells bankruptcy for Chrysler and GM
• Obama ready to put Chrysler into bankruptcy
• Chrysler: bulls make money, bears make money, pigs get slaughtered

As you can probably tell from previous posts, I like he Currency Strategy Team at Brown Brothers Harriman.  I do not always agree with them – I am generally dollar bearish, whereas they are not – but I do like their analysis.  Marc Chandler and his team are out with a fairly bullish note on the auto sector and how May auto sales point to upside surprises for retail sales and the U.S. economy.  I tend to take a more sceptical view about retail sales (balance sheet recession?), but their point of caution on the employment impact of auto layoffs to seven states is duly noted.  I do not discount their views one bit.  Here is what Chandler has to say (I have added bold to the bits I find most interesting):

May auto sales were stronger than expected at a 9.9 million annual unit pace.  In the same week GM filed for bankruptcy, domestic auto sales rose to 7.4 million, the highest since December (Q1 average was 6.8 million). There are several, even if underappreciated, implications.  First, the inventory overhang in this sector appears to be easing and production looks to be below the level of sales, so this may help underpin manufacturing in the months ahead. Second, the increase in auto sales likely points to a stronger than currently anticipated retail sales report, which is expected June 11^th.  The early consensus is for a 0.2% increase on the headline and ex-auto components.  Look for economists to revise up their forecasts after tomorrow’s chain store sales.  Gasoline prices rose a little more than 20 cents in the month.

Two other factors may also support retail sales.  First, the weather generally improved, which often helps retail sales.  This is after the March-April distortions from Easter.  Second, last month the bulk of the one-off $250 payments to Social Security recipients were sent out.  This is of course on top of the more than 5% increase since January in cost-of-living, tax refunds, and a reduction in the payroll withholdings.

The bankruptcy and shrinkage of Chrysler and GM will have implications not only on their employees.  Remember there are more than three-quarters of a million workers in the auto parts industry.  A rough rule of thumb is that every auto job supports roughly 4.5 jobs, not just parts jobs, but other jobs that service auto workers and their families.  Seven states in particular will bear the burden. For them the auto manufacturing industry hired more workers than any other private sector.  These states are Michigan, Indiana, Kentucky, Missouri, Ohio, South Carolina and Tennessee.

At the same time, however, do not over exaggerate the significance.  There are some pundits who see the demise of GM (and Chrysler) as a sign the US is no longer the dominant auto manufacturer and yet another symptom of the decline of the US (and the role of the dollar).   While such sentiment appears prevalent, it seems more than a little exaggerated.

The US dominance in autos has long ceased and the bankruptcy of GM and Chrysler is not the cause of that loss of dominance, but rather its reflection.  While there will be social and economic consequences, autos have become nearly a commodity with Chinese and Indian producers able to make a car for under $5,000.   The US market is mature.  There is nearly a car for every licensed driver in the US.  Thus far this year, China has sold more cars than the US has.  This is also true in several other industries, where the market is mature and penetration rates are high.

But this should not be confused with a de-industrialization of the United States.  Before the recession, so far on par with the 1980s contraction, the US industrial output was $2.8 trillion.  This is more than the combined dollar value of Japanese and Chinese industrial output.   The value-added of automakers and suppliers is about 5.5% of GDP.  By comparison, computers and electronics value-added accounts for a little more than 7.5% of GDP.

The point is that the bankruptcy of GM and Chrysler is not an existential challenge for the US.  It does not threaten its industrial or manufacturing prowess.  The US will have to re-deploy its resources and move to more value-added sectors.  The flexibility of the US capital and labor markets will make it easier to do just that than in most other countries.

Marc Chandler, Global Head of Currency Strategy

Related posts:

• Chart of the day: Retail Sales
• Third quarter auto production to be significant boost to U.S. GDP
• Auto sales plunge in September
• U.S. auto sales plummet: everyone down over 30%
• April U.S. retail sales: upside surprise?

You probably saw in my links that Fiat had bowed out because of German government demands. The Magna story also comes via the BBC:

Canadian car parts maker Magna International is the preferred bidder for GM Europe, owner of Opel and Vauxhall, Lord Mandelson has said.

The UK business secretary said a deal between Magna and GM was very near.

He was speaking after reports that Magna had reached an agreement in principle to rescue GM Europe.

The other potential bidder, Fiat, did not attend Friday’s talks with the German government, saying Berlin’s position was "unreasonable".

GM in the US is expected to declare Chapter 11 bankruptcy on Monday.

Here is the associated video of Lord Mandelson spinning the details about how government in the UK sees things.

Related posts:

• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Opel and Fiat spells bankruptcy for Chrysler and GM
• Fiat as the engine for change in the auto industry
• Germans reject Chinese offer for Opel

I was on the BBC yesterday talking autos and my commentary was almost entirely political.  So, as we await the likely General Motors bankruptcy, I think it bears discussing how political this process has been and will continue to be.

General Motors is a monster company employing a quarter million people worldwide.  It sells $150 billion in cars – or at least it used to. It is not just a producer of vehicles.  It is also a supplier.  It has been through several joint ventures and has owned a number of foreign manufacturers, Isuzu and Opel being but two. In short, the company is a very big player, financially, economically and politically.  Yet, somehow you get the impression that many in the financial media think we could just turn the lights out and go home.  Witness the video below of CNBC anchors Mark Haines, Erin Burnett and Phil Lebeau and a trio of auto analysts trying to impress upon Haines how important GM is.

The GM bankruptcy is a very big deal and will have wide-ranging implications.  Let me review a few of the issues here starting with the politics.

2010 elections

In the U.S., we have just witnessed an historic election that some are comparing to the election of Ronald Reagan in 1980 and Franklin Roosevelt in 1932.  Indeed, there has been a sea change in the political climate here in Washington since January, with the Democrats and their agenda taking precedence over the Republicans.  But, none of that is going to last if we don’t see a recovery that lasts through the mid-term elections in 2010. And that is already very much on the minds of politicians in Washington.  Here is the calculus.

In 2008, the Democrats benefitted greatly from Barack Obama’s election as President, taking large majorities in both houses of Congress.  Their mandate was to work with the President to fix America’s economic problem.  So, Obama’s and Congressional Democrats’ first priority is to end the recession as quickly as possible.  I guarantee you there would be hell to pay if this is not done well before November 2010 when the next general election is held.

From Obama’s perspective, it is crucial that he fix the banks and fix the auto industry as these were the two economic issues front and centre in the election which he said he could tackle.  With the banking industry stabilised, the Obama legacy rides crucially on how the Auto Bailout proceeds. Under no circumstances is the Obama Administration going to allow General Motors to do to the economy in 2009 what Lehman Brothers did to it in 2008. They are going to fix GM no matter what it takes.  And if this includes heavy-handed tactics, so be it.

So, be very clear that the GM and Chrysler issue is an existential question for this administration.  Handle it well and you get the Roosevelt treatment and ensure a good outcome for your party in 2010.  Screw things up and the depression bears down on America and you’re out of office in due course.  The key policy decision is how to ensure a favourable outcome. And when I say favourable, I mean one that ensures as many jobs as possible while minimizing any wider economic fallout.  Other issues like treating bondholders well, not committing taxpayer monies to the effort, or keeping government out of the auto industry are going to be much less important.

German General Election

And if Obama is concerned about his political fortunes because of an election next year, you can bet that Germany’s Chancellor Angela Merkel is concerned given her election is later this year. In Germany, cars have a mythical status.  The Autobahn was begun in the Depression as a way to jumpstart the German economy. The first such road was completed in 1931 between Bonn and Cologne, a road I drove I have driven at least 2 or 300 times (it is a great road for fast driving, by the way, and was opened by Germany’s first Chancellor Adenauer when he was Mayor of Cologne.  I believe the Bonn Porsche dealership is literally a few hundred meters from the entrance).  Shortly thereafter, also during the Depression, the Germans began the car company Volkswagen (literally “the people’s car”) as yet another car-oriented way to jumpstart the economy.

Today there are hundreds of thousands of jobs in Germany tied to the auto sector, which has huge importance in the Rhineland, Germany’s industrial heartland and part of the most populous German state North Rhine-Westphalia, as well as in Lower Saxony, Bavaria, and Baden-Württemberg.  In short, destroying auto jobs is a sure-fire way to lose an election.  The ruling coalition is keenly aware of this and that is why they too will be very involved in the GM bankruptcy as it affects Germany through GM subsidiary Opel.

Below is the video of me discussing this yesterday on the BBC (I know I should put these videos up more often, so I promise to get a hold of the footage or audio whenever I do a media appearance).

And I haven’t even mentioned the politics in Sweden, the U.K., Austria, Canada or Italy where this expected bankruptcy is equally important.

As for the finance side of things I only want to highlight a single issue, credit default swaps.  Back on April 30th, I wrote an article called “CDS contracts and the implosion of several Eastern European economies.”  In it, I argued that the ‘insurance’ of credit default swaps changed creditor behaviour in a way that made bankruptcy more likely.  I also warned that credit default swaps were going to be an issue in the Chrysler and GM bankruptcies (for a German-language take on the same, see Blicklog’s “Warum Gläubiger von GM ein Interesse an der Insolvenz haben“).

Think about this for a second: what if CDS contracts were exchange-traded?  Then, we would know exactly who held what CDS exposure.  So the motives of creditors would be made much more transparent and I believe this would help to prevent bankruptcies. The likes of Whitney Tilson, managing partner of the hedge fund T2 Partners, have been making similar noises of late.  If any financial reforms do indeed result from this financial crisis, my hope is that this be one of them.

Related posts:

• Bank failures to surge in coming years
• Bloomberg is coming down hard on Goldman
• Obama Team considering a pre-pack Auto bankruptcy
• Fannie and Freddie: The politics of finance
• Roland Burris: more political tomfoolery in the U.S.

GM Bondholders are not happy about the GM deal because the government seems to be running the same scheme where senior bondholders get a serious haircut while other constituents like the union and the federal government get more.  Chrysler set a precedent, so bondholders are likely to hold out, GM will go bankrupt and then bondholders are going to get stuffed.

Meanwhile Deal Journal, the Wall Street Journal blog, sees this deal as a massive bailout.  They said the following yesterday:

Some extraordinary things are happening in the bailout of General Motors. Too bad everyone is too numb to notice.

Consider this extraordinary fact: The U.S. government is likely putting up to $50 billion in new money to back the company’s bankruptcy reorganization, according to people familiar with the plan.

Most of this is what is known as a “debtor-in-possession” financing made to companies in bankruptcy protection. The sum is also expected to include $6 billion to buyout GM’s secured lenders and another $7.6 billion requested by GM last week to fund ongoing operations.

It’s clear that a large portion of this amount will be secured with the equity of the “new GM.” Why is the government likely to get equity and not, say, debt with interest and a repayment schedule? Because too much debt would apparently make the company unviable. It’s as if the government has devised an SAT exam for GM, and is blatantly funneling the company the answers.

What is clear is that Team Obama wants nothing to do with a messy bankruptcy or massive job losses. You can bet that they will do anything including bludgeoning bondholders and bailing GM out in order to make this deal work.  General Motors is too important to be liquidated or trimmed back significantly, at least domestically.

What happens in Europe is another story. In fact, what is happening in Europe is that the Chinese are now bidding for Opel in Germany.  If you recall, last year the Germans wrote a law specifically designed to keep the Chinese out of Germany (see my post “Germans to SWFs: keep your hands off our companies“).  So I see it as rather unlikely that the Chinese will get Opel before Fiat or Magna.  The German government might use the Chinese for leverage over other bidders.  However, there is zero chance that Germans would allow the Chinese to take over a prized German company like Opel.

Later today, we are to hear who the preferred bidder for Opel and Vauxhall is.  While this is an important piece of the puzzle, it is unlikely to prevent bankruptcy.

Video below on the American side of things.

Related posts:

• GM considers keeping Opel, raising capital
• Germany gives GM a stiff arm on state aid
• Opel and Fiat spells bankruptcy for Chrysler and GM
• Germans reject Chinese offer for Opel
• GM offers a debt for equity swap to bondholders

This e-mail came to my inbox from the FDIC last night:

The Federal Deposit Insurance Corporation (FDIC) announced today the approval of GMAC Financial Services to participate in the Temporary Liquidity Guarantee Program (TLGP) allowing the company to issue up to $7.4 billion in new FDIC-guaranteed debt. GMAC will pay a fee to the FDIC for this guarantee.

In connection with receiving FDIC approval, GMAC has committed to develop a funding plan. The plan will reflect GMAC’s management of the bank’s funding and deposit costs with a focus on diversifying funding sources and reducing the bank’s overall cost of deposit funding. GMAC and the bank have also committed to maintain bank capital at a level well above the regulatory minimums. These commitments, combined with the current level of TLGP-generated fees and the newly enacted holding company assessment authority, will fully protect the deposit insurance fund.

The participation of GMAC Financial Services in the TLGP is consistent with the parameters in place of the broader TLGP program. The program will expire on October 31, 2009.

Basically, GMAC has gotten $7.4 billion of new capital. CNN is calling this a bailout.  However, given the need to continue financing auto loans at both GM and now Chrysler, this move was widely expected.

Related posts:

• GMAC chairman resigns effective immediately
• GMAC has been nationalized
• GMAC: Loosening credit standards in the teeth of recession
• GE Capital is a bank, but Genworth will be too
• Paulson is handing out free money like candy to a baby

This is a video “discussing whether the Obama administration has intervened too much in business affairs, with Thomas Lauria, White & Case attorney and CNBC’s Michelle Caruso-Cabrera.”  As GM has similar circumstances, the case is still very relevant.

Note: I think Lauria forgets that the U.S. government had poured billions into the carmakers and that his clients would have gotten considerably less in a liquidation if not for that fact. With that editorial comment, here he is on CNBC arguing his case.

Related posts:

• The case of the dissident Chrysler bondholders
• Chrysler dissident lenders lose fight and disband
• UBS woes with IRS have Swiss worried
• Bernie Madoff caught on tape in 2005
• Bloomberg News is still after the Fed for more disclosure

Reuters is reporting that the dissident Chrysler lender group has disbanded. Apparently, the lenders have finally figured out that they have zero chance of getting what they want as I have been saying all along (see posts here and here).  Let’s see what is in store at General Motors now.

A group of Chrysler LLC’s dissident lenders disbanded, representatives said on Friday, removing the last legal hurdle to the embattled automaker’s quest to complete a merger with Italy’s Fiat SpA with U.S. government backing.

"After a great deal of soul-searching and quite frankly agony, Chrysler’s Non-TARP lenders concluded they just don’t have the critical mass to withstand the enormous pressure and machinery of the US government," said Tom Lauria, the White & Case attorney representing the group.

But Lauria said the group did not intend to agree to the proposal to exchange their debt for 29 cents on the dollar.

Good luck with that.

Source

Chrysler dissident lender group disbands – Reuters

Related posts:

• The case of the dissident Chrysler bondholders
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Volkswagen and Porsche have finally hammered out a merger plan after some bitter infighting. My understanding is that the new company will carry the Porsche name and trade under its ticker symbol. In addition, the company plans to raise more capital to pay off debt before the merger goes through. Why Porsche took on so much debt is beyond me.  Just this past March they had record earnings due to some hedges they took out on their purchases of shares in VW.

Reuters reported then:

Porsche SE landed a 6.8 billion euro ($8.99 billion) windfall from its share options in Volkswagen during the first half, lifting its pretax profit to more than twice its revenue.

The European automotive group said on Tuesday that earnings before tax rose to 7.3 billion euros in the six months to end-January, easily surpassing the average estimate of 3.65 billion euros from a Reuters poll of 11 analysts.

Volkswagen’s pro-rata earnings contribution to Porsche fell to 444 million euros from 484 million euros a year ago.

Late in October, news that Porsche had secured access to about 74 percent of VW ordinary shares — draining the company of almost its entire freefloat — led the stock to quintuple within 48 hours to 1,000 euros per share, briefly making the Wolfsburg carmaker the most valuable company in the world.

Porsche then sold a small package of VW cash-settled call options to relieve buying pressure, sparking outcries from investors such as Deutsche Bank’s German retail fund business DWS that the carmaker had manipulated the market and broken securities trading laws.

Although the German securities regulator Bafin began an official investigation, no findings have been published, and Porsche has repeatedly protested its innocence. Porsche, which last reported early in January that it had increased its direct stake in VW votes to over 50 percent, encountered problems last week rolling over a 10 billion euro credit line and had to increase its pool of lenders to clinch enough commitments.

The merger is definitely a consolidation play as it unites 10 brands under one roof including the main brands of Porsche, Audi, and Volkswagen.  Porsche and Volkswagen already share platforms like the Touareg/Cayenne and parts in order to reduce production costs.  However, with the two now one company you can bet their will be more cost savings.  I have yet to hear any talk of headcount reductions given that VW and Porsche operate in very different markets.  Obviously, as Lower Saxony has a blocking minority interest in VW, and given we are in an election year in Germany, major cuts are not likely.

See the BBC video below for more details.

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As developments in the global auto industry continue apace, it is becoming increasingly evident that Fiat has fashioned itself as a change agent in an industry rife with overcapacity. While eyes in the U.S. are fixed on a Fiat-Chrysler link-up, eyes in Europe are also fixed on Fiat in a Fiat-GM Europe merger.  But, these are not the only developments ongoing at present.  There has been a rush of activity involving VW, Porsche, Daimler, BMW, Saab, and GM Latin America. Let me fill in the gaps in those developments and sum up what I think it means for the industry going forward.

Fiat – Chrysler

Chrysler has now filed for Chapter 11 bankruptcy.  It has also received approval from the bankruptcy court to access a loan of $4.5 million from the Canadian and U.S. governments (Chrysler has a major presence in Windsor, Ontario, just across the U.S.-Canadian border from Detroit). 

The company is looking to sell its assets to Fiat under section 363 of the U.S. bankruptcy code.  This gives Chrysler, as a company protected under Chapter 11, the opportunity to sell assets to another party without expressed consent of its creditors, secured and unsecured.  And it can do so even before a restructuring plan has been developed.  Effectively, what this means for creditors at Chrysler is fewer fixed assets against which to make their claim.  Obviously, Chrysler will receive money for these assets, but because there is only one bidder in discussion, Fiat, the assets will not command a premium price.  It has filed a motion in court to request approval to do this quickly (the Obama Administration wants bankruptcy fast-tracked to finish in two months or less). Selling to Fiat will likely mean losses for creditors.  As a result, a number of secured creditors have sued to stop this.  You should note that Chrysler’s argument before the court is that it MUST sell quickly or its assets will quickly depreciate, leaving even less for creditors.

GM Europe – Fiat – Magna

While Chrysler has already filed for Chapter 11, General Motors is working under a deadline of June 1st imposed by the Obama Administration, after which time the company would run out of cash and be forced to file for bankruptcy protection. So General Motors is keen to sell as many assets now as possible, chief among them its European operations in Germany (Opel) and the U.K. (Vauxhall).  The major contenders for a GM Europe bid are Fiat again and an Austrian-Canadian auto parts maker called Magna.  Basically, this is a choice between vertical integration and horizontal integration as Fiat and GM Europe are direct competitors, whereas Magna is a supplier to automakers.

In my opinion, much of this discussion hinges on the position of the German government, because the GM Europe deal will not proceed without government backing and credit guarantees. The government, which is preparing for a country-wide election, consists of a grand coalition of the two major parties led by the the CDU (right of centre) and joined by the SPD (left of centre).  In the elections, Chancellor Merkel of the CDU will face off against Frank-Walter Steinmeier, the Vice Chancellor from the SPD. So, this is a crucial issue for the government.

You should note that Fiat is considered the buyer of choice for the CDU. The go-between there is Roland Berger, a well-regarded businessman and founder of the large consultancy by the same name.  Magna is the SPD choice and this deal is being facilitated by none other than Gerhard Schroeder, the former German Chancellor.  SO, as you can see, this is a very political environment.

Making things even more complicated here is the fact that the German unions are opposed to a deal with Fiat. It is widely expected that there will be major job cuts if Fiat wins the GM Europe bid.  The Fiat head Marchionne pitched up in a $125,000 Maserati Quattroporte in Berlin for talks with the German government while rumors circulated that he planned to shutter the Kaiserslautern factory, one of four major Opel locations in Germany (the other three are Russelsheim, Eisenach, and Bochum).  Marchionne subsequently said he would not close the Kaiserslautern factory (perhaps just to get the deal done, in my opinion).

Other developments

But these are not the only developments in the car industry at the moment. 

Porsche – VW. The internecine fight over Porsche, pitting the Porsches against Ferdinand Piëch and his family, is reaching a fever pitch.  Somehow, Porsche got itself deep into debt as it looked to swallow Volkswagen whole.  Piëch has an alternative plan for VW to take over Porsche The whole thing is a mess that has included a massive short-squeeze last year and the suicide of a major shareholder.

Fiat – Saab.  Is Fiat looking to take over the world?  NRC Handelsblad, a major Dutch financial daily, says that Fiat is also interested in Saab, the Swedish automaker now owned by GM (See link in Dutch).   When we hear about GM Europe, it is generally used to mean Opel and Vauxhall as these two brands run on the same platforms and are easily integrated. Vauxhall had its own production pre-Oil Shock II in 1979, but around that time GM rationalised production and the Opelization of Vauxhall made the platforms identical.  Saab is another story.  It is completely separate from the other two and has significant problems in that its cars are now outdated and a major overhaul would be necessary (see my post, "GM finding no takers on Saab?”).  How and why are two good questions to ask Fiat regarding its plans for Saab.

Fiat – GM Latin America. Apparently, Fiat is talking to GM about its Latin American operations as well, or at least this is what the Sydney Morning Herald is reporting. No specifics have been given.  A blurb reads simply, “Fiat is interested in US auto giant General Motors’ operations in Latin America and discussions on a possible deal are under way, an industry source told AFP Tuesday.”  Bloomberg goes a bit further saying: “People familiar with the matter said Fiat may also seek to acquire the GM’s operations in Latin America, China and Russia to expand its reach.” From these stories, you could infer that all options are on the table for Fiat.  They want to acquire and grow in a number of different markets.

Saturn and Hummer. Dagens Nyheter, a major Swedish daily reports that, in addition to the ongoing discussions about Saab, Opel and Vauxhall, GM is currently looking at ways to unload Saturn, the once promising company within a company, and Hummer, the U.S. maker of gas-guzzling tank-lie SUV’s. While the short article (in Swedish) says there are “several” bidders for Saturn, it mentions nothing about interest in Hummer.

Daimler – BMW. As a testament to the depth of the downturn in the auto industry, even luxury car makers Daimler and BMW are looking for ways to work together.  To date, the two have cooperated in terms of buying from suppliers (like Magna).  But, they want to cooperate on deeper initiatives.  According to German daily Die Welt, they are exploring the possibility of working together on green technologies, higher safety standards and auto-assisted safety measures (see story in German).

Thoughts

I am sure there is much I am leaving out here.  But, as all of these stories have popped up just in the last day, it is testament how the Chrysler bankruptcy and the GM deadline are driving the industry toward a much-needed consolidation.  Fiat is looking to lead the charge in that realm, judging from Marchionne’s statements and the number of different fronts on which it is now holding merger and acquisition discussions.  In my view, Fiat risks over-reaching, with disastrous consequences down the line.  They have already tried and failed in a joint venture with Opel. Daimler has already tried and failed in a merger with Chrysler. And Saab is a potentially bottomless pit, which needs to hoover up cash to meet re-model its antiquated product line.  Professor Garel Rhys of Cardiff Business School compares the Fiat dealmania to the “Organized chaos” of the British Leyland merger from 40 years ago.

I would have thought swallowing Chrysler or Opel whole was enough.  Digesting them both, two companies that operate on different continents and in different languages from Fiat, is sheer madness.  Adding the talks over other GM brands into the mix makes these negotiations look that much more risky.

In the end, however, this flurry of activity is good for the auto industry.  There is significant over-capacity which makes it difficult for all players to turn a profit, especially in this downturn. One way or another, this industry will consolidate, whether through merger or bankruptcy and liquidation.

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Yesterday, I posted a video in which two auto experts argued that the dissident creditors were getting a raw deal (See “A discussion about Chrysler’s bankruptcy plan on Charlie Rose“). The crux of the problem is their belief that they were being railroaded into a deal in which they, as secured creditors, would receive less than unsecured creditors, that they would also receive less than in a liquidation, and that the government was using extortionate strong-arm tactics to make this happen. Tyler Durden has written a few posts about this (See “Guest Post: The White House Threatened To Destroy Perella Weinberg’s Reputation“).

I don’t believe that these bondholders are going to get their way and there is good precedence for this in section 363 of the bankruptcy code from the case of Adelphia Communications.

Witness this article from the Am Law Daily:

Thomas Lauria, head of the restructuring practice at White & Case, is in a tough spot: the lead lawyer for the group of holdout lenders that the Obama administration is blaming for pushing Chrysler into Chapter 11.

The group, as you know by now, refused to take 33 cents on the dollar for the approximately $1 billion in Chrysler debt they hold. The four biggest bank lenders to Chrysler–all recipients of federal bailout money–took that deal, drawing praise from Obama for their decision.

Now Lauria is vowing to fight. Specifically, he says the holdout lenders will challenge the planned sale of Chrysler’s prime assets to a new company controlled by the auto workers union and Fiat, according to Reuters. The lenders say the sale is an “end run” around established bankruptcy law that gives secured lenders priority over junior lenders (including the union) when it comes to getting repaid.

Lauria has been here before. In the contentious Adelphia Communications bankruptcy, Lauria led a group of creditors that filed late motions calling for a special trustee to investigate whether each group of note holders was getting what they deserved, according to this 2006 story from the New York Law Journal. A judge dismissed his motion, calling it a “nuclear war button” that threatened to disrupt the planned sale of Adelphia’s prime assets to Time Warner and Comcast for nearly $18 billion.

This is the exact strategy University of Chicago law professor Douglas Baird predicted the holdout lenders would use when we interviewed him yesterday. As Baird noted, creditors have the right to challenge any bankruptcy reorganization plan that ends with them receiving less than they would have had the company been liquidated. The holdout lenders believe that to be the case here, Baird told us. But section 363 of the U.S. bankruptcy code allows for Chapter 11 debtors to sell assets before creditors can challenge the general reorganization plan.

That means Lauria’s only option is to object to the sale, Baird told us.

Lauria did not respond to a message seeking comment; he’s likely tied up at a massive hearing in federal bankruptcy court in Manhattan today.

On the other end of the lender spectrum is Simpson, Thacher & Bartlett, which is advising JPMorgan Chase, the lead lender to Chrysler. Peter Pantaleo, head of Simpson’s bankruptcy practice, is representing JPMorgan. He declined to comment.

So will Lauria’s plan work, or will only serve to delay Chrysler’s emergence from bankruptcy? Steven Gross, co-chair of the restructuring practice at Debevoise & Plimpton, told our colleague Brian Baxter he’s anxious to see the group’s motion objecting to the sale. But Gross says the press release the lenders put out Thursday was “not very compelling,” and that the chips may be stacked against their objection to the Fiat sale.

“People are saying this is just the government bullying people,” Gross says. “But there is still a statute, and if there are grounds to derail [the sale], you can be sure [the non-TARP lenders] will use it, although in bankruptcy if you get some many constituents to support something, that can be very hard.”

As always, stay tuned.

In essence, section 363 gives the bankrupt entity, in this case, Chrysler, the right to sell assets to another organization, in this case Fiat, BEFORE creditors can challenge the Chapter 11 reorganization plan.  This significantly reduces the collateral against which secured creditors can make claims in bankruptcy.

The long and short is this:

• Secured creditors might have gotten more in liquidation than they were being offered before Chrysler filed for bankruptcy.
• However, because of section 363 of the bankruptcy code, Chrysler can sell substantially all of its assets to Fiat without creditor approval and before it has a definitive reorganization plan
• This leaves the secured lenders out of luck.  They could end up with less money than had they accepted the deal offered them earlier.

Related posts:

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