Why the Government Got Involved in General Motors

Minyan Peter
  AUG 04, 2009 8:35 AM

It's all about the allocation, not prevention, of loss.


Q: What do you think of the government’s involvement with the auto industry?

A: As I shared on the 'Ville a long time ago, the balance sheets of General Motors (GMGMQ) and Chrysler flashed in red neon for a very long time that bankruptcy was inevitable.

I think Washington was so interested in being part of the auto companies’ bankruptcy process because the traditional process would have had enormous public policy implications -- specifically, union workers would have been eviscerated, and the government would have had no choice but to very publicly step up. By intervening the way it did, bond holders, salaried retirees, and others took more losses than they otherwise would have to the benefit of the rank and file.

Q: Do you think this was the right thing to do?

A: From my perspective and contrary to what I think most people believe, government intervention in failing companies -- whether they're car companies, Federal agencies, or banks -- isn't about the prevention of loss, it's about the allocation of loss: Senior debt-holders at Fannie Mae (FNM) and Freddie Mac (FRE) survived while subordinated debt holders and preferred shareholders were trashed. FDIC-insured depositors in our 67 bank failures year to date were made whole while the rest of the capital structure was obliterated. (And at the risk of taking the car too far off the road, I'd note the similar mindset of the Federal Reserve.)

As I tell my kids: Fair doesn’t mean equal. And right now, what's fair is being determined by Washington. Like military crises, economic crises require tough choices that focus on the greater good by those elected or appointed to make those decisions. And some of those decisions, I'm sure, feel unprecedented -- although I'd be quick to offer that in the 1930s, a lot of precedent was also thrown out.

I believe that right now, given the enormous losses to be taken, Washington is trying each day to determine who's in the best position to withstand another blow to the side of the ship. Their goal is to cripple, but not to kill.

But let me offer two clear consequences of this approach:

First, those with “excess” profits become the next most-likely recipients of pain. And if you don’t believe me on this one, watch how Washington retaliates against Wall Street’s “record” second-quarter earnings.

Second, the successful reallocation of losses requires enormous time. I've often analogized that what we're going through is the demolition of a house filled with booby-traps hoping that no one in the neighborhood realizes it's happening until it's all done. Each room must be “disabled” one at a time. And here I'd highlight the “serial” rather than “parallel” processing of Bear Stearns, Fannie/Freddie, AIG (AIG), GM, and so forth. If it goes too fast, too many people may notice.

Hoofy & Boo School Minyans on How Not To Save Detroit:
Positions in SH, JPM, SKF,and SPY.