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GMAC's Expensive Debt


The price of GMAC's debt became very expensive due to deteriorating fundamentals...

I mentioned in November that this tender offer by GMAC to buy back its bonds was at below fair value and that the market would probably not cooperate. So far that is coming true.

The re-organization is an attempt to gather assets at below market prices to sell them back off at higher ones. Such an arbitrage occurs only in the most unusual of circumstances (we are nearly there). At the time a Minyan told me I can't have it both ways: on one hand I cannot complain about too much debt and then complain when someone tries to retire it.

But I can. His claim misses a very fine point about finance: it is all about price. Economic transactions create value at a certain price; they can create havoc at another. It is really all about stability. The price of debt for the last twenty years, but especially the last seven, has been too cheap. As a result, there is now way too much of it. There is too much to be supported by income generation to service it, so it becomes very unstable. The predominant part of that debt which no one sees is imbedded in the derivative market (only about 20% of the total debt is what the market sees and talks about), which priced that debt using too low a volatility assumption. Now the price of debt has gone up hugely as a result and all those who sold it too cheap are trying desperately to buy it back.

The GMAC situation is one where investors originally sold debt very cheap. The price of the debt became very expensive due to deteriorating fundamentals (lower income). But the price became even more expensive, more than warranted, due to emotion. GMAC recognized that the debt was too expensive relative to its assets (due to a small component of investors that wanted out at any price) and tendered for it. Some panicked investors have responded, but most investors understand the price is not correct for these particular assets (they could be liquidated to pay of the debt at a better price than the tender) and have not tendered.

Always understand what the right price is.
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