Option Valuation

Overheard between two MBA students [A and B] as they discuss another MBA student [C].

A: We had basically been discussing the new year eve parties
and i was telling C he should value it like an option
B: You said youu wanted help with option valuation!
A: The potential for an encounter is subject to much volatility
B: Okay, I can understand the analogy.
A: We wanted your expertise in option valuation to value the price of the party
A: Obviously the strike price is the ticket
B: Okay
A: The time frame is known. The woman's response is the volatility factor which we are having difficulty assigning value to. Bernanke has also helped by lowering interest rates to zero.
B:: Women are empirically known to be more volitile than the market. You have to take the volatility to be atleat 50%. If C can choose between the party and the chick, it has to be valued as a chooser! The best of both outcomes. Else if is buying the ticket, and can seek a refund then it is a put option.
A: One will lead to the other. Where is the chooser in it? If he doesn't got to the party, where will he meet the woman
B: I thought that he can go to a party with us or take a chick for a date
A: No, he is talking about going to a party and finding a girl there.
B: Then, it has to be valued as a compound call option. Event 2 is dependent on event 1. If he comes to the party, then there is a probability that he finds a chick. The key is in choosing the right party.
A: I guess that for him time also will be inversely proportional if he finds the girl at 6 AM, she may decide to go to breakfast rather than for some other 'activity'.
B: Yes, it seems to be a very complex option depending on whom he finds there. You can raise this question to (Aswath) Damodaran for real options. Anyway, from what i can see, we are busy valuing the option and C is busy with the chicks.
A: Yes, that is true. He seems to have disappeared.
B: I will catch up with you later.
A: Cool. Later.

Bismarck Bailout

Picture Source: Bloomberg.com
The US Government has finally saved the Bismarck from sinking by stepping in to secure a huge load of its troubled assets.
Bailout Plan
- $306 billion of troubled mortgages and toxic assets guaranteed by the U.S. government under a federal plan.
- $20 billion cash infusion from the Treasury, adding to $25 billion it received last month under the TARP.
- Citi to swallow first $29 billion of losses on the $306 billion pool
- After that, government covers 90% of losses, Citigroup covers other 10%
- CEO Vikram Pandit keeps his job

Price for Citi
- Government to get $27 billion of preferred shares with an 8% dividend
- Warrants to buy 254 million Citigroup shares @ $10.61 each

“The Achilles heel with Citi is their exposure to emerging markets and what’s going to happen when emerging markets turn down, as they’re doing now.”

Here is the entire article on Bloomberg.

PS: Seems like the government does work the weekends and late into the night.

Insurance Indeed

Picture Source: Bloomberg.com archives
Here is an interesting email that I received over the weekend that gives you an idea of the run-on-the-bank that Citibank is currently facing. While there are few rumors as to whether Citi will survive to see Monday morning, it is now almost certain that there is no news that will emerge before the start of markets. If there was any news, it would have emerged [or leaked] by this evening which would have given us a good sense of where Citi is currently headed. That has not happened and hence, I believe that we will see Citi opening to a low this coming week when markets do open on Monday.

Here is the email that I [and other Citibank customers received]

---

Dear Max,

Good news! Citibank is participating in the FDIC's Temporary Liquidity Guarantee Program. Through December 31, 2009, all of your non-interest and interest bearing checking deposit account balances are fully guaranteed by the FDIC for the entire amount in your account. *

And as a reminder, in October the FDIC increased the amount of insurance on eligible savings accounts -- such as savings, market rate, money market accounts, club and holiday accounts, and certificates of deposits -- from $100,000 to $250,000 through December 31, 2009.**
...

---

I have no doubts that my money is safe, given its meagre amounts. Nevertheless, I have withdrawn substantial amounts considering the fact that I may not be able to withdraw money immediately in case the bank does go under. Better to be safe than sorry they say.

While I do believe that Citigroup cannot be let to go down, purely because of the effect that it would have on the already bleeding financial markets, I am waiting to see what sort of a plan will be cooked up by the government and its emissaries.

Global Banking & Capital Markets

One of the most interesting classes that I take this semester is the Global Banking and Capital Markets class with Roy C Smith, an ex-chairperson of Goldman Sachs and someone who has seen a financial crisis too many [and for no fault of his own] in his long and illustrous career.

In this class, we have talked about the various crises that have been seen in the current times. We discussed a wide variety of current issues in the financial markets, while discussing the fundamentals of capital markets and financial systems
- the downward spiralling mortgage markets
- the bailout of Fannie Mae and Freddic Mac
- the unfortunate demise of Lehman Brothers
- the capital infusion in AIG
- the acquisition of Lehman Brothers' assets by Barclays PLC & Nomura
- the sale of Merrill Lynch to Bank of America
- capital raising by Morgan Stanley and Goldman Sachs
- the sale of WaMu to JPMorganChase
- the sale of Wachovia to Citi
- the subsequent renege and sale of Wachovia to Wells Fargo
- the downward spiral of Citi
- the fate of General Motors
- Troubled Asset Relief Program
- Federal Reserve and Ben Bernanke
- Treasury Secretary Hank Paulson and his efforts
- Banking Failures in the UK
- Banking Failures in the rest of Europe
- Banking in China
- the benefits of Obama vs. McCain
- What it means to have Obama

This was one of the most informative and illustrative class that I have taken at Stern. It touched upon various developments in the current financial turmoil [or what Prof. Smith refers to as the financial tsunami]. A great course. Most definitely recommended.

Here is an article that Prof. Smith wrote in Forbes where he talks about the questions that he, as a professor, and his students [that is us] would have for the new treasury of the Federal Reserve, Mr. Geithner.

I hope that Mr. Geithner reads this article and implements some of the suggestions and answers the questions that the professor and his class have for him and the new administration.

Citigroup, the Bismarck?

Roy Smith, my professor and ex-chairperson and partner of Goldman Sachs talks about the run down in the share price of Citigroup.
"We used to say that Citigroup was like the Bismarck. It could take bullets forever without sinking. But ultimately, the Bismarck sank."

At $26-billion, it is now worth about the same as Toronto-Dominion Bank and $11-billion less than Royal Bank of Canada.

One thing is for sure, Citigroup CANNOT fail. I just shudder to even think of the thought of where the markets are headed if it thinks that Citi could potentially fail.

Read an interesting article here which quotes the above italicized information. Could the markets go more downward? I shake my head in disbelief.

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.

---

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.

Hedge Funds fears

An article on how the fears of a Hedge Funds bust prediction may come true.

Produced in verbatim from CNN Money below

Hedge Funds May Sell At Year End As Banks Skimp On Lending
Dow Jones
November 19, 2008: 12:36 PM EST

NEW YORK -(Dow Jones)- For equity markets, 2008 will long be remembered as a year of massive selling, and it's likely to end the same way.

Hedge funds will find it increasingly difficult to obtain lending at the end of the year, a time when banks typically tighten their lending anyway as part of the "window dressing" process. This year, two key securities firms that supplied loans to hedge funds, Bear Stearns and Lehman Brothers, have disappeared, and the remaining firms that lend to hedge funds are hanging on to cash in an effort to deleverage themselves.

"These tight financing positions over year-end are likely to result in the forced sales of securities prior to year-end," said an Alliance Bernstein research report put out Wednesday.

The prospect of tight lending and higher rates for hedge fund borrowers suggest that the markets across asset classes still face further selling by hedge funds, a process that has contributed to market selloffs this fall. Already, hedge funds have to sweat out more investor redemption deadlines - some funds force investors to give either 35 or 30 days notice if they want to withdraw money by Dec. 31 - which could lead to selling as well.

As Dec. 31 approaches, banks, in a bid to prepare their balance sheets for year-end reporting and raise Tier 1 capital, will reduce their discretionary lending. "As this large funding source disappears, the cost of funding over that short period near Dec. 31 rises rapidly," wrote Brad Hintz, analyst and author of the report.

Major lenders face pressure and sources of lending are dwindling. Commercial banks experienced huge losses in 2008, and continue to face challenges regarding capital positions.

Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS), which are in the middle of complying with their new bank holding company status, are under pressure to deleverage their balance sheet. Lehman Brothers and Bear Stearns were major sources of funding, and in 2007 provided $385 billion in funding, or about 40%, during the year-end turn, Bernstein says.

Bernstein notes that the "the year end turn is simply a seasonal spike in funding costs and liquidity pressure that occurs every December and ends Jan. 1. Though we believe this year will be worse than normal, conditions will quickly recover in the New Year."

Jobs in Asia

And the bad news seems to continue.

An article on hiring reductions in Asia.

Posted in verbatim from an article on Bloomberg.

Standard Chartered Postpones Hiring in Hong Kong

By Chia-Peck Wong

Nov. 19 (Bloomberg) -- Standard Chartered Plc, the third- biggest U.K. bank, pushed back its hiring plans in Hong Kong after the city slipped into an economic recession.

``We constantly review our hiring needs, but the market's momentum has changed so we have postponed hiring in some cases,'' Gabriel Kwan, a Hong Kong-based spokeswoman, said by phone today.

Banks and brokerages worldwide have announced more than 166,000 job cuts since the subprime-mortgage market's collapse last year. Citigroup Inc., the biggest U.S. bank by assets, said earlier this week that it will trim 52,000 jobs, while HSBC Holdings Plc said it eliminated 500 jobs in Asia, 90 percent of them in Hong Kong.

Hong Kong, the biggest contributor to Standard Chartered's pretax income in the first half with a 25 percent share, has entered its first recession since the SARS epidemic in 2003. Gross domestic product shrank a seasonally adjusted 0.5 percent in the third quarter from the previous three months, the government said last week.

Standard Chartered employs 5,500 in Hong Kong. The London- based bank has been reviewing its business and ``will try to redeploy staff to minimize the impact,'' Kwan said.

The HSBC cuts amount to about 2 percent of its total workforce in the city.

Other Banks

Hang Seng Bank Ltd., Hong Kong's second-biggest by assets, has no plans to trim its workforce of 8,210 in the city, spokeswoman Irene Chua said. The bank, a unit of HSBC, hasn't imposed a hiring freeze, redeployed workers or reduced business travel, she said, declining to elaborate further.

Bank of East Asia Ltd., the city's third-biggest by assets, said it has no plans to reduce headcount. The bank, which last cut workers in 2003, today said it will continue to monitor the situation.

The lender employs more than 4,200 workers in Hong Kong. Its shares have risen 7.3 percent since Oct. 27, when it said it would book an impairment loss of HK$3.5 billion ($452 million) this year after selling its entire portfolio of collateralized debt obligations.

BOC Hong Kong (Holdings) Ltd. is offering voluntary retirement to employees aged 50 or who have worked for 30 years to cut costs, the Standard reported today, without saying where it got the information.

``We are constantly reviewing and adjusting our human resources policy in a prudent manner according to the changes in market environment and business operation,'' BOC Hong Kong spokeswoman Angel Yip said by phone today. She declined to elaborate on specific measures or comment on the Standard report.

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.