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Too Bad Banks Missed Out On the GM Treatment

Posted By Barry Ritholtz On November 18, 2010 @ 8:00 am In Bailouts,Corporate Management,Credit,Foreclosures,Real Estate,Really, really bad calls,Regulation | Comments Disabled

GM history in the second half of the 20th century is a story of executive arrogance, missed opportunities, poor decision-making and reckless finance.

After WW2, everyone was making money hand-over-fist, and GM became known as “Generous Motors.” Starting in the mid-1950s, rather than risk a strike that could slow production and sales, GM chose to kick the can down the road. When it came to wages, and benefits, the execs made the union contracts, guaranteed pension benefits, health care costs someone in the future’s problem.

Then the future arrived.

The industrial giant went from owning their market, to being an insolvent, hollowed out rust bucket of a company. The website The Truth About Cars [1] started a GM Deathwatch [2] several years before the company finally succumbed to its own failures.

Contrary to popular belief, it wasn’t the credit crisis and recession that killed GM — the crisis merely revealed the structural deficiencies that were there all along. The company had diversified into auto finance, then home finance, all the while designing boring, poorly manufactured machines that got poor gas mileage and were vastly inferior to their European and Japanese counterparts. Insolvency was inevitable.

The weakened mid-western firm lacked the lobbying muscle to force an ill advised bailout. Rather than give GM the Hank Paulson bank treatment — throw trillions at them and hope for the best — Uncle Sam actually took an intelligent approach to the issue.

But even a weakened giant, a shadow of its former self, GM was still a substantial employer. That had political ramifications in an election year. Instead of letting them do the Lehman Brothers face plant into the pavement, the choice was made for a prepackaged bankruptcy.

This was the single best decision of the bailout era.

It seemed to be the only decision that was not made in a panic. It adhered to the rules of capitalism — when your company is insolvent, it goes into reorganization or dissolution. The brutal, Darwinian rules of the market and of bankruptcy applied — not the influence of lobbyists, or special favors from Senators. The Treasury Secretary’s former gig was not running an auto company, he ran a Wall Street bank — so there could be no special favors expected to come from that quarter either.

Instead, Uncle Sam’s involvement was to provide Debtor-in-Possession [3] financing. The bankruptcy plan was obvious: Wipe out shareholders, give bond holders a haircut, fire management, pare the company down to a sustainable size without sentiment.

This was what was done. A turnaround plan was created and executed. If the company met its milestones, the firm would be taken public, which would allow the government to significantly reduce its stake and exposure to GM. The Fed also helped, keeping financing rates at ultra low levels.

The long term stock sale plan would lead to the taxpayers being made nearly whole. All told, it was a wild success. Malcolm Gladwell [4] argued that Rick Waggoner [5] should get more credit and Steve Rattner [6] less, for GM’s effective turnaround; many of the new models that are now doing so well were first created and planned for under Waggoner’s tenure 5 years ago.

So what is arguably the most successful bailout of the 2007-2010 era was in fact a non-bailout: It was a bankruptcy reorganization that eliminated the most toxic aspects of a century old rust bucket of a company. The new firm has clean books, is well capitalized, is without crushing debt, has a less onerous labor contract, pension and health care obligations. Its hard not to see how this was anything but a ginormous winner for all involved.

Which brings me to the Banks.

Currently, the United States has a weakened financial sector. Many of the largest Banks are technically insolvent, but thanks to an accounting rule change, are not required to admit this simple mathematical fact. They are carrying an enormous amount of bad loans on their books. They are sitting on several million REOs — bank owned foreclosures for which there is essentially no market. This shadow inventory of houses amounts to years worth of sales, not mentioning the depressing effect the excess supply will have on prices.

The reckless lending of the 2000s was merely the tip of the iceberg. From start to finish, the engaged in all manners of irresponsible behavior. When a company’s actions are so reckless it compromises the firm’s ability to survive, why would we expect it to have performed any of its other duties competently? They didn’t, which is why we have learned about how poorly the banks not only made these loans, but also administered, securitized, serviced, and foreclosed on them. The entire process was reckless, it was done on the cheap, riddled with errors, fraud and felonious behavior.

It has become a national embarrassment.

The bank bailout plan was ill conceived and poorly executed. Trillions were thrown at them before Uncle Sam had any idea as to how much debt was actually on the books. What were once considered decent holdings were eventually revealed to be highly toxic assets.

Recapitalizing the banks is a huge priority. But after the first round of trillions were given away to the banks, the public was disgusted. The politicians lost their appetite for overt bailouts. But the banks were still under-capitalized, their balance sheets were still laden with junk. A direct transfer of taxpayer monies was out of the question.

An easy backdoor was found: Arbitrage the Fed and Treasury. Zero interest rates and QE allowed giant Wall Street banks to borrow at no cost from the Fed, and then turn around and lend this same zero cost money back to the Treasury at 3% or so. Do this for another 10 years or so, and the banks would be recapitalized. By then, maybe there might even be a market for all those REOs. Sure, that would mire the nation in a decade long Japanese-like slump. Hey, at least the bonuses would be paid on time.

The motto of the bank bailouts: To hell with the banking system, save the banks!

The results should not be surprising. The banks remain in a weakened condition, perilously at risk for additional problems in RE. Despite the massive liquidity, Credit still remains tight. If financing is the fuel that drives the economy, the US is running on fumes.

Wall Street has returned to business as usual. The Street is nothing if not savvy. Just as a shark detects blood in the water, the Street can smell weakness and exploit it like no other industry. Once they figured how to play chicken — mutual assured destruction –  with the entire global economy, there would be no restraining them.

~~~

Compare the differences between the banks and GM/Chrysler, and will see the full folly of how we rescued the financial sector.

Instead of letting insolvent banks fail, we turned over the keys to the castle. We could have fired the incompetent management that caused the problems — but most of these execs are still in the same highly placed positions in their firms. In terms of senior personnel, the industry is literally unchanged [7].

Bad debt? Still on the books.

Sufficient capital? Many years away.

Business model? The same highly leveraged reckless strategy that got them into trouble in the first place

Regulatory Oversight? A modest improvement which the newly elected, bought and paid for Congress, seems hellbent on overturning.

If you want to understand why we should never have bailed out the banks, just look at the differences between the Auto and Banking industries. One is healthy, with a likely cost of near zero. The other remains a debacle, whose costs are incalculable are likely to be an economic drag for years if not decades.

Too bad the minds behind the bank bailouts did not have the foresight to appreciate the full advantages of prepackaged bankruptcy for the sector . . .

>

Previously:

Looking at the 1980 Chrysler Bailout [8] (November 20th, 2008)

Why Are Banks So Different From Autos? [9] (December 9th, 2008)

Why Bankruptcy For Autos But Not Banks? [10] (February 23rd, 2009)

Banking Sector Remains (literally) Unchanged [7] (January 4th, 2010)


Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2010/11/banks-prepackaged-bankruptcy/

URLs in this post:

[1] The Truth About Cars: http://www.thetruthaboutcars.com/

[2] GM Deathwatch: http://www.thetruthaboutcars.com/search-results/?cx=partner-pub-7865546952023728%3Aceccux-eg79&cof=FORID%3A11&ie=ISO-8859-1&q=GM+Death+Watch&sa=Search&siteurl=www.thetruthaboutcars.com%252F#1317

[3] Debtor-in-Possession: http://www.financialstability.gov/docs/AIFP/GM_Corporation_DIP_Loan_090909_new.pdf

[4] Malcolm Gladwell: http://www.newyorker.com/arts/critics/books/2010/11/01/101101crbo_books_gladwell

[5] Rick Waggoner: http://en.wikipedia.org/wiki/Rick_Wagoner

[6] Steve Rattner: http://www.amazon.com/exec/obidos/ASIN/0547443218/thebigpictu09-20

[7] industry is literally unchanged: http://www.ritholtz.com/blog/2010/01/banking-sector-remains-literally-unchanged/

[8] Looking at the 1980 Chrysler Bailout: http://www.ritholtz.com/blog/2008/11/looking-at-the-1980-chrysler-bailout/

[9] Why Are Banks So Different From Autos?: http://www.ritholtz.com/blog../2008/12/why-are-banks-so-different-from-autos/

[10] Why Bankruptcy For Autos But Not Banks?: http://www.ritholtz.com/blog../2009/02/why-bankruptcy-for-autos-not-banks/

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