GM versus GMAC

The markets have clearly stabilized and are hopefully ready to move appreciably higher - at least for a time. Barron's reports that money is once more flowing back into equities. Enormous piles of cash sit on the sidelines. Some stocks are probably as cheap as they're ever going to get, though it pays to be selective. Junk bonds have never been more attractive, and (just as important) the high yield bond prices have begun to move up, as have preferred stock investments.

December opened to a national debate about whether or not taxpayers should bail out the Big 3 auto companies. I clearly see two sides to that discussion. The auto industry is a basket case where we pay unionized labor about twice the going rate to stay at home and not make cars, much as we have paid farmers in the past not to grow crops (and we're paying Citigroup bankers, apparently, not to make loans). The car companies have been dysfunctional for as long as I've been alive. They are managed for the benefit of unions and management, with shareholders often getting left out in the cold. Of all the bailouts we've made, this bailout is, to me, the one where we have the lowest likelihood of ever seeing our tax dollars again. All we've done, most likely, is push their bankruptcy date back a few months to early 2009. We've thrown good money after bad, and it's nothing but a corporate subsidy for organized labor and the state of Michigan.

On the other hand, GM, Ford, and Chrysler likely wouldn't be on the verge of bankruptcy if Wall Street hadn't essentially destroyed our banking system for a few months. The one-two punch of no car sales and an inability to find financing to roll upcoming bond maturities is what pushed them to the wall. Had normal financing been available, it is possible that neither of those situations would have occurred.

General Motors Acceptance Corp. (GMAC) is a separate financing company. GMAC did have some subprime loan problems, but they are a fairly small part of the overall company. However, GMAC is a huge borrower. When the bond markets closed down, GMAC had no way to roll over maturing debt. GMAC's assets (car loans) weren't in horrible shape. In fact, consumer loans are typically pretty easily sold assets, in a more normal market. GMAC wasn't upside down, with huge liabilities and deteriorating assets. GMAC just couldn't roll over its paper, and that threatened to bring the entire company down. GMAC isn't dysfunctional. It just got caught in the squeeze like just about every other big financial borrower.

Saving GMAC will help re-start car sales, but local banks have been providing car loans to other dealers, even during the worst of the crisis in mid-October. Saving GMAC, however, prevents a lot of bond funds and banks and pension funds from having to realize a loss on GMAC bonds had it gone bankrupt. Bankruptcy has its place - and is probably something the Big 3 need to use to restructure their costs. However, bankruptcy also destroys a lot of value. Some have estimated that Shearson Lehman saw about $74 billion in assets evaporate in its quickie bankruptcy filing. That's a lot of bling that creditors would like to have, but its lost forever. Had GMAC been forced to declare bankruptcy, the bond markets might still be closed. As it stands now, we've seen the high quality bond market show a dramatic recovery during December. Junk bonds are starting to recover as well. Hopefully that trend will accelerate in 2009.

There is a reasonably good chance that the market is poised for more gains. We're already almost 20% off the absolute lows hit on November 24. We may have another 20% to go. Our theme has been to "invest with imagination." The economy has begun to stabilize, albeit at a very low level. Still, we've stopped sliding toward the abyss, which is something.

Clients are fully invested, finally. We've been buying more junk bonds and fewer stocks than would be the case at a typical bottom. More to the point, I'm not sure we've actually seen the bottom, but I believe in the short-run this little Thanksgiving rally has some room to run.

Happy New Year. So long, 2008. Remember that a fast start doesn't guarantee a smooth ride.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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