Wall Street Greek: Merry Christmas Detroit!

merry christmas detroit automakers industry

By Markos N. Kaminis - Economy & Markets:

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Merry Christmas there Detroit! There is a Santa Claus after all, but you'll never be the same after all is said and done. After first taking a moment to criticize Congress one last time (for failing to bring an auto rescue bill to his desk), President Bush offered a holiday treat to General Motors (NYSE: GM) and Chrysler on Friday. Unfortunately, since Old Saint Hank was out of TARP funds, Ford (NYSE: F) found an empty stocking. However, diverging from Santa's generous rule book, Bush sternly noted the money was just a loan loaded with heavy demands that would come due on March 31st, if the two don't reform "substantially" by then.

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On Thursday, the Administration flustered markets, and others interested in the fate of the historic and proud American auto sector, when it stated that it sought something more than a disorderly bankruptcy. It seemed clear that an orderly bankruptcy would suffice, and that was not something the consensus expected.

The President and Treasury Secretary released the remaining TARP funds to GM and Chrysler, with another $4 billion earmarked for GM in February, assuming Congress first approves the release of additional TARP capital to the Treasury. For now, the $13.4 billion dollars offers the two burdened companies a short window of opportunity to restructure for the long term... and to survive.

While the terms of the loan are not strictly binding, efforts made between now and March 31st will be weighed carefully by the new Congress as it determines whether to recall its loan. For this reason, it seems likely that if the clunkers are self-sufficient by that deadline, they'll be free to operate. However, if either firm is in need of more capital, then the highest level of scrutiny will befall it. It seems clear that if both are in trouble, they have a greater chance of finding further assistance from the Obama Administration. If Chrysler is alone in need of a hand though, I expect it will then be forced to enter into Chapter 11 bankruptcy (read orderly).

General Motors is another story. Because of its size and symbolic stature, we expect it would find more sympathy from Obama's Administration if need be. At the same time, we fully expect GM to make great strides toward the self-sufficiency necessary for this deep trough and the economic long-term.

Concessions Galore - Possibly a Pipe Dream

The relative political figureheads expect concessions from all parties, and this highlights the ideology intrinsic to a politician. The plan requires concessions from the stubborn UAW, strapped parts suppliers, and creditors who in some instances might be better off in a liquidation scenario.

The concessions from management were the easiest to obtain. Rick Wagoner and the executive teams have agreed to sacrifice bonuses, to adjust golden parachutes and otherwise alter compensation and governance to meet the standards of the United States Treasury (UST) for as long as it holds the slightest interest in the saved firms. Remember, the UST represents the American taxpayer, so for as long as we are owed money, no excesses will be enjoyed by the management teams of the otherwise failing firms. This lesson was learned the hard way, through the blatant exploitation of the America taxpayer by AIG (NYSE: AIG) and its egregious post-bailout use of capital for retreats, massages and bonus payments.

The previously pampered proprietors will have to give up their corporate jets for real. Although they have already implied action due to public scrutiny, they'll now sign their names to it. The companies won't even be able to sell anything of substance without Paulson's prior approval. This could get burdensome for the Treasury Secretary, so we expect there will soon be a Car Czar named by the Obama Administration, and he will fill the role of the "President's Designee," the label for the overseer that is splattered all over the bailout contract.

The Actual Restructuring Plan

The government has extended capital, but also has very high expectations... perhaps even impossible ones. By the 17th of February, GM and Chrysler must each submit to the President's designee their plans to "achieve and sustain long-term viability, international competitiveness and energy efficiency." These are all the goodies corporate management, the government and we the people supposedly want. I say supposedly because as gas prices decline, word is SUV sales are finding life again.

Anyway, the plan is suppose to show a path to viability and the eventual means of repayment of government loan, not to mention the repurchase of warrants or non-voting shares. Automakers will have to demonstrate they can manufacture advanced technology vehicles and meet fuel efficiency standards, as laid out in the Energy Independence and Security Act of 2007. The companies will also be asked to achieve positive net present value through the rationalization of costs, capitalization and capacity. Like the Senate, the President wants to see a Detroit that makes cars the government thinks are appropriate for today's America and at a cost structure competitive in the U.S. I think you'll agree, the plan is dangerously vague to this point.

Restructuring Targets

Here's where "vague" becomes vulgar to some (read the UAW). This is the part of the contract where the government lays out in black and white exactly what it wants. To my trained eye, the contract looks designed to please voters, but also near impossible to achieve in some instances. Perhaps for this reason, the government scribes included the terminology, "the company shall use its best efforts to achieve the following targets." By doing so, the authors of the contract have done what they're arguably best at, pleasing all parties and covering their own rear-ends. And there we have it, the impossible becomes policy!

The government wants these firms to cut outstanding unsecured public indebtedness by not less than two-thirds (while preserving pension and employee benefits), through conversion of public debt into equity or debt. Actually, since this is unsecured debt, it is quite possible to accomplish. I would take an equity interest in a company over unsecured debt if the deal helped to raise the chances I would get my money back. That's exactly what this does. Hmm, maybe the boys in DC aren't as stupid as they seem at times on C-SPAN after all. Thumbs up on this one!

"Never has the United States been closer to reviving civil war between north and south than now."

Here's where we approach the impossible, and definitely attempt the difficult...

The government wants the cost of labor and benefits of Chrysler and GM to match that of the average enjoyed by Honda, Toyota and Nissan in the U.S. In other words, UAW members in Michigan and Ohio are asked to swallow a pay cut to match the autoworkers of the these Asian firms operating in southern states. Never has the United States been closer to reviving civil war between north and south than now...

The UAW has fought long and hard for every upper hand it's gained against management. The union seems to still bear the scars from back in the days when it was first forced to form in order to fight for employee rights and a decent wage. God bless the union, because as anyone whose worked on Wall Street can tell you, there are some nasty SOBs in management. Some folks think a manager title gives them the right to treat you like a citizen of North Korea. I think that's plainly evident in the number of frustrated gentlemen who end up playing shoot 'em up in the office from time to time.

Now, union boys, please try to tolerate what I'm about to communicate. While the union is proud of what it has accomplished, fat firms push thinner profit margins in boom times and go bankrupt in hard times. Even when the economy is doing well, these firms can't attract the same capital more profitable ones can. They lose market share (sometimes) and post weaker returns on capital (almost always). A competitive marketplace weeds fat firms out (especially where supply is saturated), and that's partly why Detroit nearly went bankrupt, and may still yet get there.

The government wants the UAW to agree to this with GM and Chrysler by December 31st 2009. Mark that New Year's resolution down next to "lose ten pounds." Even so, without the UAW and the fact that GM's assets are so solidly fixed, the company's operations would naturally gravitate toward states where it could find equally qualified workers willing to take less pay. If Americans can accept what Nissan (Nasdaq: NSANY), Toyota (NYSE: TM) and Honda (NYSE: HMC) offer to their U.S. employees, then a near bankrupt GM needs to restructure this cost. That's plain vanilla economics; supply meets demand. Sorry guys, nothing personal. It's better to have a job these days then to push your company into bankruptcy for $3 an hour, isn't it? (Here come the angry comments!)

Some perks are expected to go. For instance, the good deal autoworkers have, where they get paid when idle or in furlough. That income, beyond regular severance, is as good as gone. The government also wants company payments to the Voluntary Employees Beneficiary Association (VEBA) to be paid at least half in stock. This one bothers me, because it ties benefits and risk to stock, and benefits are earned and shouldn't increase the employee's risk, which is already heavily tied to the company. But, I don't know enough detail about the "voluntary" nature of this benefit. Auto people, feel free to pitch in here.

By February 17th, the companies need to show all parties have agreed to these stipulations. GM and Chrysler can deviate or alter them, but are charged with the responsibility of explaining those actions to sometimes unruly Congressmen. They'll have to show how changes have not impaired the contract position of the UST. I for one, wouldn't want to face that angry firing line.

In any event, joy has been restored to WhoVille for now. It's nice to know that so many Midwestern American families can take a moment now, exhale, and enjoy the holidays. I wish you Merry Christmas Detroit. I have my own people there, and the last thing I want to see is those good friends sitting next to me blogging for Wall Street Greek! Actually I would love it, but not this way. My best...