The path of self destruction

General Motors finally filed for bankruptcy today. Those reading this blog [me and possibly my mother] will relate to my interest in General Motors. This has been since I wrote the first paper on the topic. It was something everyone was talking about. The inevitable finally happened. Mr. Ingrassia in the article below [published in the Wall St. Journal] talks about the path to self-destruction.
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Decades of dumb decisions helped send General Motors to a bankruptcy court yesterday, but one stands out.

The year was 1998, and the United Auto Workers was striking at two factories in Flint, Mich., that made components critical to every GM assembly plant in the country. The union was defending production quotas that workers could fill in five or six hours, after which they would get overtime pay or just, you know, go home.

Most strikes are forbidden during the life of a labor contract, so to provide legal cover the union started filing grievances. GM lawyers contended the walkouts violated the contract anyway and drafted a lawsuit -- the first by the company against the UAW in more than 60 years. But GM's labor-relations department freaked out because the lawsuit would antagonize the union.
[How GM Lost Its Way] Chad Crowe

Just think about that. The union had shut down virtually all of GM, costing the company and its shareholders billions of dollars, and yet the company's labor negotiators were afraid of giving offense. After heated internal arguments, the suit was filed and GM seemed on the verge of winning. But the company settled just before the judge ruled.

UAW members marched victoriously through downtown Flint. GM executives who advocated a tougher stand got pushed out of the company.

The picture of a heedless union and a feckless management says a lot about what went wrong at GM. There were many more mistakes, of course -- look-alike cars, lapses in quality, misguided acquisitions, and betting on big SUVs just before gas prices soared. They were all born of a uniquely insular corporate culture.

The GM bailout probably will cost close to $100 billion, counting money from the governments of the U.S., Canada and Germany. On paper, the new company should emerge from Chapter 11 fully able to compete in the brutally competitive auto industry. Whether it will actually prosper is far less certain, but some things are beyond dispute. Bankruptcy didn't have to happen and the fact that it did happen is incredibly sad given GM's many contributions to American society and culture.

General Motors invented the modern corporation by developing the concept of giving operating executives power and responsibility to run far-flung operations subject to central financial control. While Henry Ford invented mass manufacturing, GM's long-time president and chairman of the board, Alfred P. Sloan Jr., developed mass marketing: a "car for every purse and purpose," as he put it in the company's 1924 annual report. This meant a hierarchy of brands ranging from practical Chevrolets to prestigious Cadillacs. GM's industrial might helped win a world war and made America rich in its aftermath.

For half a century, between the 1920s and the 1970s, GM seemed to have an instinctive feel for what Americans wanted before consumers themselves even knew it. Chrome, tail fins, muscle cars and even the first catalytic converters that let cars run on lead-free gasoline were developed at GM.

But the company signed generous labor deals during the 1970s, including the right to retire after 30 years with full pension and benefits, partly because it believed the contracts would cripple its smaller competitors, Ford and Chrysler. Then along came Honda, Nissan and Toyota, which didn't have to deal with labor contracts at all. That was the beginning of the agonizing decline.

This fate could have been avoided with better foresight and less hubris, but by 18 months ago bankruptcy was inevitable. GM's U.S. market share had declined to 22% from 52% in the early 1960s. There were too many brands, too much debt, a cumbersome union contract as big as a phone book, and an enormous dealer network built for the glory years of yesterday instead of the market share of today.

The question for Presidents George W. Bush and Barack Obama was whether to stand by and watch, or instead to use the public purse to shape the bankruptcies of both Chrysler and GM to mitigate the damage to a shaky U.S. economy. They intervened, which was the unpleasant but correct decision.

By and large, Mr. Obama's automotive task force has done its job pretty well, forcing the companies and the UAW to make difficult decisions that they should have made themselves long ago. GM will shed four of its eight U.S. brands -- Saab, Saturn, Pontiac and Hummer -- thousands of dealers, 11 factories, and much of its debt. It is no small irony that a Democratic administration brought in a bunch of private-equity types to impose rational management on big business.

That said, a couple of aspects of the GM and Chrysler bailouts could come back to haunt U.S. taxpayers and the Obama administration.

The company that controls Chrysler, Italy's Fiat, is getting a special government incentive -- a potential increase in its Chrysler ownership stake -- to build a small car in America that will get 40 miles per gallon. General Motors made a similar decision to build a high-mileage small car in the U.S. of its own accord, but certainly with an eye toward current political "realities."

Both moves fit the green agenda of Mr. Obama and congressional Democrats. They're also egregious examples of mission creep. GM and Chrysler should get just one marching order from the government: Earn enough money so taxpayers will recover as much as their investment as possible. If the new small cars flop because gas prices drop, the result will be more losses and, potentially, Bailout II.

The other questionable call is the government's big ownership stake in both companies -- 60% of General Motors and a much smaller share of Chrysler. The rationale is reasonable. The government is providing the $50 billion of financing needed to restructure GM so taxpayers might as well get something for their money. But this relegates unsecured lenders to the back of the line behind the government and the union. More worrisome, it invokes the question famously asked before the U.S. invasion of Iraq: You can go in, but can you get out?

The answer will depend on the success of GM, which in turn will hinge on whether the new company can cast off the culture of the old one. One encouraging sign is that, thanks to the labor contract amendments imposed by the Treasury's task force, UAW members will be required to work 40 hours a week before getting overtime pay. Less encouraging is that workers still will be allowed six unexcused absences before being fired. It doesn't take that many at a Honda plant.

As for management, not long ago a group of executives was reviewing a prototype new Buick model, about the size of a BMW 3 Series, at GM's design studios. The sporty styling had been developed in China for sale both there and in the U.S. But the company's cautious product planners suggested conducting customer clinics to gauge reaction to the design and possibly changing both the front and back end. It would have delayed the project and cost tens of millions of dollars.

CEO Fritz Henderson wisely said no. But the very next day the product planners were charging ahead with their clinic plans anyway, just in case the boss wanted to see the results of their research. Maybe the new Buick should be named the CYA. Neither billions in losses nor the brink of bankruptcy, it seems, have been enough to change many traditional ways of doing things at GM.

Heaven only knows what will be enough. But a company with a cautious, slow-moving management and a union committed to defending ridiculous work rules won't have a chance of succeeding. Perhaps everyone remaining at the new GM will realize that. The rest of us can only hope for the best.

Mr. Ingrassia won a Pulitzer Prize in 1993 for covering the last crisis at GM. His book on Detroit's current crisis, "Crash Course," will be published by Random House in January.

An Orderly Chapter

Taking my point [well, based on what I have learnt from professors, the press and my research] further on how I believe GM should handle its bankruptcy, this new article by Andrew Ross Sorkin of the DealBook column in the NYTimes online website talks about why he believes General Motors needs an orderly Chapter 11 bankruptcy.

Picture Source: Consumerist.com

Published in verbatim below from the article in DealBook in the NY Times.

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Taxpayers shouldn’t fork over a cent to General Motors, Andrew Ross Sorkin argues is his latest DealBook column, noting that G.M is using money so quickly that a $10 billion infusion made today would disappear by February.

Instead of giving the ailing automaker a loan to get them over this “rough patch,” Mr. Sorkin says, the government should shepherd G.M. into an orderly bankruptcy, so that the company can begin a much-needed reorganization.

The goal — one aided by government involvement in a debtor-in-possession loan and a warranty guarantee fund — is to guide the carmaker into a Chapter 11 restructuring, not a Chapter 7 liquidation.

A Bridge Loan? U.S. Should Guide a Helpful Chapter 11
By ANDREW ROSS SORKIN

Tony Cervone, a spokesman for General Motors, has a warm and friendly way to summarize his ailing company’s ongoing dance with disaster.

“The fact is we’re looking at a short-term liquidity crisis that needs a bridge loan,” Mr. Cervone said this weekend to The Detroit Free Press.

To him, G.M. is merely in a temporary bind. If the government — that is, taxpayers — were just willing to spot G.M. some cash to get it over this little rough patch, everything would be just fine.

Mr. Cervone’s comment reflects what’s wrong with the mind-set in Detroit.

G.M is using money so quickly that a $10 billion infusion made today would disappear by February. That is why taxpayers shouldn’t fork over a cent, at least until shareholders are wiped out, management is tossed out and the industry is completely reorganized.

But there is a fix. Call it a government-sponsored bankruptcy, a G.S.B., if you will. It might sound a bit like an oxymoron, but it is an idea that has been quietly making the rounds in Washington. It makes a lot of sense.

Here’s how it could work:

First, let’s recognize that G.M. doesn’t need life support. What it needs is Chapter 11. The bankruptcy process is not a bad thing — indeed, it should be embraced. Bankruptcy allows companies to do tough things they could never do in the normal course of business. It has helped many companies turn themselves around and come out even stronger.

Bankruptcy would give G.M. enormous leverage with its debt holders — and, perhaps more important, with the U.A.W., whose gold-plated benefits are one reason G.M. is no longer competitive. A bankruptcy filing would also give G.M. the cover to close plants, rid itself of unprofitable brands and shed dealerships. In fact, unless G.M. files for bankruptcy, state laws would make it prohibitively expensive to shut dealerships.

So, first, the government would force G.M into a prepackaged bankruptcy now — even before policy makers may think it needs to be. As an inducement, the government would allow the merger with Chrysler to go forward. (There’s a lot of resistance to saving Chrysler too, but we need to look at the industry as a whole. And don’t worry: Cerberus, the private equity firm that owns Chrysler, would have its equity wiped out too.)

The merger should reduce costs by as much as $7 billion. But that’s not the tough stuff. The harder decisions are these: Both companies would have to jettison brands — lots of them. In the case of G.M., frankly, the only ones worth saving are Cadillac, Chevy and Buick. (Buick? Yes. Despite its lackluster sales and fuddy-duddy image in the United States, it’s a huge seller in China.)

That means Saturn, Pontiac, GMC and Saab would all disappear. Deutsche Bank estimates that reducing G.M.’s brands from eight to three would bring down the company’s cost base by $5 billion annually. If you’re able to shut the dealerships too, lop off another $4 billion. Chrysler is an even sadder situation: the only brand with any value is Jeep. Its Dodge Ram truck lineup could be merged with Chevy, which would also pick up pieces of the GMC business. And Chrysler’s minivan business could be combined into the Chevy brand as well.

In all, the 35 plants of G.M. and Chrysler would probably be cut by half.

Then the auto workers, whose benefits are off the charts.

G.M. currently employs about 8,000 people who actually don’t come to work. Those who do go to work are paid about $10 to $20 an hour more than people who do the same job building cars in the United States for foreign makers like Toyota. At G.M., as of 2007, the average worker was paid about $70 an hour, including health care and pension costs.

Those costs are already coming down slightly because of a renegotiated deal with U.A.W. last year, but not nearly enough.

Part of the problem is summed up by comments like this one in The Detroit Free Press, made by Kandy O’Neill, 39, an assembler at G.M.’s plant in Lake Orion, Mich., where she builds the Chevy Malibu and Pontiac G6. “I think we’ve given enough,” she said about the cuts to her salary and pension plan.

“Everybody wants to come down hard on the workers,” she said. “Nobody knows what we do inside there but the people who work there. It’s hard. It is not an easy job.”

When you read a line like that you might sympathize with her, but then you realize that nothing can be accomplished without bankruptcy. Ms. O’Neill: your company is asking the taxpayers — many of whom don’t have health care coverage — to pay your salary and health insurance.

And then we need these companies to agree to serious, strict enforcement of gas mileage standards. They should be producing the cleanest cars on the street. We may lose hundreds of thousands of jobs in this industry in the near term, but with the right kind of innovation, we should have millions of new jobs in the next 10 years.

Finally, we need to kick out management. That Rick Wagoner, chief executive of G.M., can say with a straight face that he still deserves to run this company is laughable. It would be impossible for him to put in place the serious changes that need to be made because he carries too much baggage. He’d have to undo years of his own neglect.

After all that is agreed, and only then, the government should come in with what’s known as debtor-in-possession financing to help the company through the bankruptcy process. Ideally, the government would be a “seed investor” and others would join it.

The goal should not be to keep these companies from filing Chapter 11, but from filing for Chapter 7 — which would mean liquidation.

With the debt market virtually closed, this is the time the government can come in and try to help. But to jump in front of the train now, without the requisite changes made to the industry first — which we all know can’t be done without Chapter 11 — would be foolish.

The automobile industry has argued that bankruptcy will be a disaster for the industry; that people won’t buy vehicles while they’re in bankruptcy for fear that the warranty won’t mean anything. There’s a fix for that too. The government should establish a warranty insurance fund that would insure the warranties of all G.M. and Chrysler vehicles bought while the combined company is still operating under bankruptcy protection. The cost to taxpayers should be next to nothing, assuming the company survives and can takeover the warranty obligations.

The government also should consider using some of the money for the financial industry rescue not to save the companies, but to retrain employees in the Detroit area and help promote development of new industry. A lot of people complain about the role of government in business and free markets. But it is hard to complain about efforts to make the nation’s workforce more employable.

Barack Obama, on “60 Minutes” Sunday night, said that government assistance must be “conditioned on labor, management, suppliers, lenders, all the stakeholders coming together with a plan.” He said, “So that we are creating a bridge loan to somewhere as opposed to a bridge loan to nowhere.”

Take note, Mr. Cervone: that bridge is called Chapter 11.

Cutting the LEH pie

He cuts the LEH pie. Well, he is doing his job and is getting paid for it. We are talking about Bryan Marsal, Lehman Brothers' Restructuring Officer. Nevertheless, his demands are not exactly reasonable. This sounds like a classic case of make hay while the sun shines.

An article on how the Lehman Restructuring Officer wants very high incentive fees. This is what I call highway robbery. Creditors and management should not allow it. I guess the verdict for this question really lies in the hands of the honorable bankruptcy judge in the court of South District of New York.

Produced in verbatim from Bloomberg.com below

Lehman Restructuring Officer Marsal Wants 25% Incentive Fees
By Linda Sandler and Christopher Scinta

Nov. 18 (Bloomberg) -- Lehman Brothers Holdings Inc.'s restructuring officer, Bryan Marsal, asked a court to pay his firm incentive fees as high as 25 percent on top of the hourly rates he's charging to liquidate the bank.

Marsal's company, Alvarez & Marsal, has 125 employees helping Lehman sell assets and unwind trades. Marsal previously asked for $2.5 million upfront and hourly fees of as high as $850 for himself and other top executives. Under a proposal filed yesterday, A&M would start earning its bonus after recovering $15 billion for unsecured creditors of Lehman, which listed $613 billion in debt.

"Especially in a case like this, where the firm is also getting hourly rates, you would not want to have triggers for the incentive payments that are too easy to meet," said Stephen Lubben, who teaches at Seton Hall University School of Law in Newark, New Jersey. "The triggers do seem to be low, and at the very least A&M should offer some explanation for why this should be so."

The restructuring firm's request is part of an estimated $1.4 billion in fees for lawyers, accountants and other professionals that will make Lehman's bankruptcy the most expensive ever, surpassing the record set by Enron Corp. in 2004 according to calculations by Lynn LoPucki, who teaches bankruptcy law at Harvard University and the University of California at Los Angeles.

Fee Enhancements
Restructuring experts often demand bonus payments. Perella Weinberg Partners LP in 2007 had to forgo a success fee it wanted for advising shareholders in the bankruptcy of energy company Calpine Corp., which objected to paying the bonus. A judge ruled the same year that law firm Cadwalader Wickersham & Taft, which represented Northwest Airlines Corp., wasn't entitled to $3.5 million in ``fee enhancements'' on top of its $502 average hourly rate.

Also in 2007, Alix Partners gave up a $5 million success fee it had sought on top of $25.6 million in professional charges while winding down futures-trader Refco Inc.

"Bonuses are normally only granted after the fact to crisis managers who produce exceptional, outstanding, and unexpected results," said Martin Bienenstock, a Dewey & LeBoeuf lawyer who represents Lehman creditors including Walt Disney Co.

"Crisis manager employees do not need to be guaranteed bonuses in advance because they expect short-term work and have no reason to threaten to leave (just the opposite, in fact)," Bienenstock said in an e-mail.

Lehman's lead law firm, Weil Gotshal & Manges, may earn $209 million in fees from the Lehman case, LoPucki estimated. Lehman would pay Weil, led by bankruptcy partner Harvey Miller, $650 to $950 an hour for partners and counsel, and $155 to $295 for paraprofessionals.

A&M Rates
A&M has said it will charge from $175 to $300 an hour for analysts or administrators and $550 to $850 for managing directors. It will bill Lehman for fees and expenses every month or more often if A&M prefers, according to court documents.

Lehman, once the fourth-largest investment bank, has said it foundered because of deteriorating subprime and structured investments. It filed the biggest U.S. bankruptcy Sept. 15 with mostly unsecured debts.

Rebecca Baker, a spokeswoman for A&M, didn't immediately return phone calls seeking comment today.

The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Bitter pill for GM

Article after article, class after class and discussion after discussion seems to lead to one topic these days: General Motors.
Be it Roy Smith, David Yermack, Nouriel Roubini, Ed Altman or any other finance professor in school, discussions invariably funnel down to GM and on what they believe is the right approach to solve the problem. Give or take a few, the unilateral resolution is for GM to file for Chapter 11 bankruptcy.

Let us take a look at the CDS spreads that I noticed on the Bloomberg terminal this past week for General Motors.
Source: Bloomberg terminal in school
Based on industry perception, currently, there is a 60% probability that GM will default on it 5 year and 10 year debt. That is a very high probability given that most firms have a sub 10% probability of default.

Max Holmes very interestingly taught us last week the basics of Bankruptcy law in the US of A. He talked about how it is a hotch-potch between the Queen's [British] Bankruptcy Law and the law devised in the US by the founding fathers [maybe not the founding fathers of the nation, but rather the founding fathers of the corporate and bankruptcy law]. Chapter 7 of the Bankruptcy law is straight from the Victorian era [for the uninitiated, that is the British part] which talks about liquidation and is fairly severe. Chapter 11 of the Bankruptcy law on the other hand talks about restructuring and reorganization rather than pure liquidation. It is far more accomodating and forgiving, though not always for the management.

The unilateral [footnote: the ones I have heard] opinion in the NYU Stern academic fraternity is that General Motors should file for a Chapter 11 bankruptcy. In order to facilitate in its transition and reorganization out of bankruptcy, the firm should raise DIP [Debtor-In-Possession] financing. This will most definitely wipe out the Equity holders under the new capital structure [not that they have much left on the table anyway]. It is likely to impair the various existing tranches of its debt as well [including senior secured debt] as the DIP creditors will hold the highest priority [after the lawyer and administrative costs of course].

While the credit markets have frozen, it is likely that DIP financing should be available for the firm as it will be on very favorable terms [for the creditor] and will hold the highest seniority. There will be a lot of monitoring mechanism in place as well. The biggest factor is the possibility that the government will either provide the DIP financing itself [less likely] or will secure the DIP loan.

The other benefit of bankruptcy will be that all the UAW contracts will be null and void. GM workers are currently paid higher wages than those [for the record: all of them are American workers, in the US] workers at Toyota, Honda and the like. Coupled with that are high health benefit costs, pension costs and labor restrictions as part of the UAW deal. While GM has been able to negotiate some of these liabilities with UAW, they are far from being optimal.

Another aspect of the bankruptcy will be its effect on GM's pension liabilities. When a company in the US files for bankruptcy, all of its pension obligations are transferred to a independent corporation called the Pension Benefit Guaranty Corporation or the PBGC. As the name would suggest, the job of the PBGC is to guarantee pensions. While this will place a cap on the maximum amount of pension paid out and restructure [read: impair] the pension payments, I am sure that is not the first thing that is there on management's mind. At least, it should not be. Bloody capitalist you may scream. Well, no. When the boat is sinking, the captain of the ship has to take tough decisions.

There is sufficient pressure on the government to act on this matter. The government is likely to give its current bailout of USD 25Bn to the Big Auto companies. However, this is more like pocket change, especially given that it will be split three ways. GM's problems are far more grave than most people realize. Definitely more grave than a third of USD 25Bn for sure. The other option that the government has is to double the bailout package to USD 50Bn. Even in this scenario, GM is only likely to postpone judgement day. All it will achieve will be that it will live to fight another day. What GM and Big Auto need are policies that go beyond this.

Let us take a step back and see what GM is doing as a firm to address its problems. First of all, it has been working very hard on the technology front. While it was the last kid on the block when it comes to smaller and cleaner cars, it is desperately trying to play catch up. From what we hear, it is on the right track. Business is fairly diversified. The Latin America Africa Middle-East or LAAM business actually posted a profit on increase in sales. China, India and rest of Asia have seen a bit of slowdown, mostly due to decreased consumer spending in this region. In the US, the firm has been hit in a multi-fold problem: lower consumer demand, difficult financing options, financial crisis and oil prices.

On the financial side, the firm has tried to free USD 15 Bn. in cash to support these challenging times. This includes measures such as stopping dividend payments, reducing capital expenditures, streamlining processes and earmarking labor efficiencies. They have also looked at asset sales and raising money from the debt markets, though that has been the most difficult part. At the end of their previous quarter, they increased their self-help targets from USD 15 Bn to USD 20 Bn. These measures will significantly reduce the cash burn and free up additional cash for the firm.

These are merely short-term measures. One of the four scenarios are likely to happen.
General Motors gets NO bail-out: Highly unlikely, though a probability. The firm uses its self-help measures to sustain itself. Car sales go down drastically because customers are worried about the status quo and what that means to the future of GM, their cars and spare-parts and after sales services for them. This seems like a business killer.

General Motors gets a bail-out: This is what the firm is lobbying for. In Washington and through voters, the firm is trying to drum up support for this idea. This may work only if the credit market are back in time before GM has exhausted its new resources. However, the firm is still saddled with the possibility that this could mean a reduction in customer demand for their products, owing to the uncertainty.

Credit Markets get back to good ol' days: If the credit markets get back into shape before GM has to cry 'wolf', GM could potentially tap the credit markets to raise operating capital. Credit markets are probably the single most important reason that GM is facing the crisis of today. I agree that a lot has to do with sub-standard products and strategies in the past and a late realization of their fallacies. Nevertheless, GM would not have been in such a bad shape, if the credit markets were in a better shape. The possibility of credit markets coming back soon is remote, purely based on the manner in which they have broken down. That said, they will eventually come around. The question is: will it be in time? A million dollar question that I [and most economists] don't have an answer to. The general perception though is a flat NO.

General Motors files for Chapter 11: Firm gets the money to restructure, liabilities are pushed into the future and the firm comes out of bankruptcy [whenever it does] leaner and fitter.

The final option seems to be the most plausible, reasonable and most likely to work towards a long term solution. Nevertheless, we need to consider the impact it will have on the US markets. While it will in no way match the mayhem seen in the aftermath of the Lehman Brothers bankruptcy, it will be perceived as a major failure. While most people expect it to happen, when it finally dones, it will be seen a major stamp on the malaise that the US markets are seeing right now. This is likely to adversely affect other major corporate names on Main Street.

It is interesting to note that the management is pushing very hard for a bailout package from the government. All they say is that they are doing what they can from their end. And they are looking towards Washington for help. As Rick Wagoner said, 'Bankruptcy is not an option'. All of this leads me to wonder why the firm is so shy of courting bankruptcy.

First of all, there is the point of a tarnished image. There are a lot of costs associated with the bankruptcy. This will spell difficult times. Brand value will decrease. This could result in a reduction in their sales. Suppliers and dealers will not provide credit [assuming that they do right now] and may not be ready to stock up inventory as well. Overall, this will have a negative impact on the business. The question is whether it will be more than we currently see right now.

Another factor is that the firm believes that this is a credit market phenomenon and if credit facilities are made available, they should be able to tide this time and come out stronger. This goes in line with the live to fight another day belief.

I personally believe that the biggest factor in this 'No Bankruptcy at all costs' pitch is the fact that management will most definitely lose their jobs in such an eventuality. Rick Wagoner is unlikely to be around, even if he is an inside man and may be the person best suited for the job. Simple reason is that he sat over this current crisis and did not see it coming.

With DIP financing in place, with our without government support, there will be a strong clamor for the management to be replaced. On the other hand, if the management are able to secure a bailout or are in any manner able to hold off bankruptcy, they will be hailed as messiahs. This, even though they were the people who got them into this mess in the first place.

When management starts talking about the burden on PBGC in the scenario that GM were to go bankrupt, you know that there is more to it than meets the eye. When management talks about bankruptcy not being an option, you know that there is more to it than meets the eye. Or when they talk about shareholder value or fallout on labor for that matter. Corporate Governance? I think otherwise. Each one for himself if you ask me.