General Motors has just announced its worst quarterly loss since it narrowly skirted financial collapse 13 years ago. The future is so uncertain that management has failed to provide Wall Street analysts with the customary forecast of earnings.
The consequences are enormously far reaching. Millions of Americans who depend on GM companies for their stock value and retirement income are risking shattering losses.
And right now, all the ghosts of GM’s past brushes with bankruptcy are returning to haunt it today …
FIRST, the Fed’s interest-rate hikes have caught GM flat-footed.
With short-term borrowing rates at record lows in recent years, GM’s sales became almost totally dependent on special offers like zero percent financing. But now, after the Federal Reserve has raised interest rates seven times, GM simply can’t afford to continue those offers anymore.
Consumers are spoiled by generous financing deals and won’t buy without them. So they’re walking into showrooms, asking for special deals, and walking right back out again as soon as they realize they can’t get the deals they want. Either GM forfeits a sale … or it takes a big loss on each car.
SECOND, surging gas prices have thrown GM for a loop. And with oil prices hovering around $56 per barrel this morning, and with a rash of refinery outages being reported in the U.S. and Venezuela, gas can only go higher.
Meanwhile, the company’s entire long-term plan was tied to the high-profit, gas-guzzling SUVs and other big vehicles — now being shunned by consumers.
In fact, GM — and Ford as well — are having such difficulty selling their cars that about a third of their sales now go to their own employees, their family and friends, or to rental companies and corporate fleets, at razor-thin margins.
THIRD, health care costs are through the roof. General Motors spent $6 billion on health care last year and will probably have to spend another $7 billion this year.
FOURTH, profits have turned to losses. Five years ago, General Motors made an average profit of $6,447 on every car or truck it sold. This year, GM will LOSE about $2,700 per vehicle.
GM Losing Nearly $2,700 Per
Vehicle Sold in 2005
FIFTH, GM has been talking about plans for closing down multiple plants around the country to eliminate tens of thousands of jobs. But the company admits that even the shutdowns and layoffs won’t help very much.
Reason: The laid-off workers will continue to get a portion of their paychecks plus generous health care benefits that are guaranteed under labor contracts.
Bottom line: General Motors is experiencing plunging profits AND plunging market share — now down to only ONE out of every FOUR cars sold in North America.
Ripple Effects
Right now, General Motors is responsible for the paychecks of 324,000 workers and the benefits of 1.1 million.
Moreover, if General Motors goes down, so do dozens of suppliers like Delphi Corporation and American Axle which rely heavily on GM.
Just in Michigan alone, GM buys about $12 billion a year in goods and services. That’s more than Toyota spends in all of North America.
So when GM cuts spending, it creates a spiraling effect. Restaurants … retail stores … even doctors, dentists, and other professionals are dragged down as well.
And this is not just about GM. The entire domestic auto industry is suffering from similar troubles. Chrysler has already been sold off. Ford is sinking fast.
Ratings Payola
You wonder what General Motors thinks about this.
So you make an appointment with two mid-level executives at General Motor’s finance division. You figure they know what’s going on. And you’re promised they’ll share their opinions with you frankly, provided it’s about publicly available information.
At the company’s headquarters in downtown Detroit, you feel the sheer power of the company’s size. You can’t imagine how this giant American corporation, once responsible for more than three out of every four automobiles made in America, could possibly be associated with the word “bankruptcy.”
But it is.
“We’ve suffered a cash drain of $3 billion in the first quarter,” confesses a VP of finance. “And that doesn’t include the $1.7 billion we spent for dismantling GM’s alliance with Fiat in Europe. If you add the two, the total cash drain is actually $4.7 billion.”
“What have the rating agencies done about this?” You wonder out loud.
“They’ve downgraded our bonds as far as possible without dumping us into the ‘junk’ category. But now it looks like a downgrade to junk is just a matter of time.”
You’re curious about the downgrade process. So you ask how it works.
“We pay Moody’s, S&P, and Fitch a tidy sum for our ratings,” replies the VP. “We’re their clients. They’re our service providers.”
“Isn’t that a form of payola?” you ask.
“Call it what you want. But we don’t have any choice in the matter.”
“Why not?”
“Because Moody’s, S&P, and Fitch are the Nationally Recognized Statistical Rating Organizations — the NRSROs. They’re the only bond rating agencies that get this official NRSRO designation from the government.”
“So?”
“So they have a government-sanctioned monopoly on the business. If we don’t buy ratings from them, we can’t issue bonds. And if we can’t issue bonds, we can’t raise the money we need to save our company. End of story.”
“What happens when you’re about to get downgraded?” you ask.
They look at each other, then back at you. After a moment of hesitation, they explain: “OK. We can tell you this because it’s the same for all big companies like us. The rating agencies first notify us privately that they intend to downgrade our bonds.”
“Before they announce the downgrade to the public?”
“Right, before they announce it to the public.”
“Then what?”
“Then, they give us an opportunity to appeal the downgrade. So we send in our sharpest people to argue against it. That ties up the process for quite some time.”
You stop and think about this for a moment. Then you decide to ask what appears to be a dumb question: “Do you appeal upgrades?”
“Of course not. Why the heck would we ever appeal an upgrade?”
“I see. So the announcement of an upgrade is immediate. But the announcement of a downgrade can be tied up for weeks or even months. Is that what you’re telling me?”
“Yes,” comes the response.
You’re stunned. Here we are, with General Motors losing close to $5 billion in cash in just three months, and the nation’s rating agencies are holding back what could be one of their most important downgrades in history.
Moody’s and S&P know General Motors’ bonds are junk. General Motors itself knows its bonds are junk. And yet, while the downgrade to junk is tied up in a bureaucratic appeals process, the public is kept in the dark.
The public thinks bond ratings are designed to protect investors. Instead, routine delays in the process of ratings downgrades are evidence of a clear bias in favor of protecting the rated companies.
That’s why so many investors got caught in Enron. By the time the rating agencies finally downgraded Enron to junk, investors were trapped. It was too late to get out. Will we see the same pattern with General Motors and others?
Theory and Practice
“What’s going to happen when the downgrade to junk is finally announced?” You ask.
“In theory, it’s going to make it increasingly tough for us to borrow ourselves out of trouble.”
“And in practice?”
“In practice, it’s ALREADY tough for us to borrow ourselves out of trouble.”
“How much have you raised recently?”
“Nothing.”
“Nothing?”
“Right. For the past 135 days, we have not sold any of our unsecured debt. That’s the longest period of time we’ve been absent from the debt markets since I can remember. Partially that’s our decision. But largely it’s a decision that’s been forced upon us by the circumstances.”
“So what are you going to do?”
“Our CFO says he’s going to raid the company’s health care fund. We have no other choice. We have permission to grab up to $6 billion from the fund.”
“And when that money runs out?”
No answer is forthcoming.
The Fed’s Response
Also last week, the U.S. Commerce Department shocked Wall Street with news that housing starts in March plunged 17.6%, their steepest drop in 14 years.
So with both autos and housing — the two largest core industries in America — weakening, investors began to hope that maybe the Fed would go easy on interest rates after all.
No such luck! Consumer price inflation in March was roughly DOUBLE what the experts expected. And even before March’s inflation numbers came out last week, the Fed admitted that its Fed Funds rate was still well below where it needs to be.
At a speech last week at Bard College in New York, Federal Reserve Governor David L. Kohn put it this way:
“We should not hesitate to raise interest rates to contain inflation pressures just because it might set off a retrenchment in housing prices, just as we were willing to keep rates unusually low as house prices rose rapidly. Nor should we hesitate to raise rates because higher rates mean higher debt-servicing burdens for the current account, the fiscal authority, or households.”
What To Do
I have five recommendations …
Recommendation #1. Get away from the stocks and bonds of the most vulnerable companies as fast you possibly can. That includes not only General Motors, but also companies like Ford, Fannie Mae, and many other giant U.S. corporations that are vulnerable to the effects of rising interest rates.
Not every one of these companies is going to fail. Some may be able to save themselves if they take fast action to slash expenses to the bone. But at the very minimum, all are likely to suffer severe declines in the value of their stocks and bonds.
Recommendation #2. Get your money to safety. The safest, most liquid parking place for your cash right now is a money fund that invests exclusively in short-term U.S. Treasury securities. The Treasuries are guaranteed by the U.S. government. Your yield rises every time the Fed raises interest rates. And unlike a bank, all your interest is exempt from local and state income taxes.
Recommendation #3. Not all stocks are going down. There are still exceptional situations that can give you good appreciation and dividends.
Recommendation #4. With your speculative money, don’t miss the chance to reap a solid profit from the next market decline. You can do that by buying shares in specialized mutual funds that will almost invariably go UP in value when the stock market goes DOWN.
Recommendation #5. You can also buy options that give you the potential to multiply your money 3, 5, or even 10 times when the market falls — all with strictly limited risk. The more the market goes down, the more money you make.
To subscribe to my services providing specific instructions and updates for each of these recommendations, call us at 800-291-8545.
Good luck and God bless!
Martin D. Weiss, Ph.D.
Editor, Safe Money Report
President, Weiss Research, Inc.
eletter@weissinc.com
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