Scary Thought for the Day

General Motors’ debt, most of which is rated as “junk,” is worth 4,000 Dow points.

Before 1997, it was accepted wisdom that nuclear powers simply “don’t go bankrupt.” Well, Russia changed all that. If you recall, when the ruble went under, it also took down the infamous hedge fund, Long-Term Capital Management. The world financial markets got a bit freaked for a few days.

History may be repeating itself, but this time the culprit is much more important that some has-been empire. General Motors could actually declare bankruptcy. One of the great American corporations could join the ranks of Willie Nelson, Hammer and Sherman Hemsley. Once again, the markets seem pretty nervous. Some hedge funds reportedly took big losses when GM’s debt was downgraded.

Consider the facts: GM has $284 billion in debt and roughly 560 million outstanding shares. That comes to about $500 a share in debt. Since GM is a Dow component, and each dollar in share price is equal to about 8 Dow points, GM’s debt represents around 4,000 points on the Dow.

So if you buy one share of GM for $35, you’re picking up more than 14 times that in debt. If you buy it on margin, you’re borrowing money to borrow money. All you need is a pinky ring and 1978 Cadillac to complete the outfit. Nearly 90% of GM’s debt is for GMAC, which is its financing arm.

Fortunately, GMAC is one of the few parts of GM that’s actually making money. The problem is that the overall company’s lousy credit rating is holding back GMAC’s profitability. Lower-rated debt means higher borrowing costs. On top of that, interest rates are rising.

One solution is to spin off GMAC. In fact, GMAC recently announced a deal to sell $55 billion in car loans to Bank of America over the next five years. But that doesn’t solve anything. It simply let’s some of the crew jump ship. There is the option of Chapter 11. It’s not unthinkable, but time is running out.

The new bankruptcy law goes into effect on October 17. If GM wants to move, it had better do so before then so it can take advantage of the older, more lenient law. I’m sure some airline will be taking the plunge, but airlines are always declaring bankruptcy.

The bad news gets even worse. A few years ago, GM spun off Delphi Automotive. Delphi’s bankruptcy seems to be an almost certainty. But here’s the problem: GM makes up half of Delphi’s business. So if Delphi goes, GM is also screwed. Unless, GM tries to save Delphi. But who will save GM?

I’m not sure, but if you pay taxes, I think you already may know the answer.

Posted by on August 7th, 2005 at 9:47 pm


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