Paid Cadillac Prices, Got a Chevrolet

Obama’s auto bailout punishes Wall Streeters as much his toxic-assets program helped them.

Chrysler PT Cruiser. Click image to expand.
Chrysler’s PT Cruiser

The Obama administration’s new program to encourage the purchase of troubled mortgage assets last week offered what seemed to be a nice wet kiss to the private-equity/hedge-fund complex. But on Monday, with his announcement about the future of the U.S. auto industry, President Obama delivered a slap to the same folks.

In addition to pushing out General Motors CEO Rick Wagoner, Obama also sent unwelcome tidings to other stakeholders of both GM and Chrysler. Given that Obama is being advised on these efforts by Steve Rattner, a veteran private-equity manager and investment banker, it’s not too hard to divine the unpleasant message he was delivering to Wall Street hotshots.

At GM, the action is all about the company’s debt, not its equity. GM’s market capitalization was about $2.23 billion before trading opened today and is less than $2 billion as I write. By contrast, the company has loads of debt. (Here’s a list of outstanding bonds.) The most recent quarterly results indicate long-term debt of more than $29 billion. And since the firm’s credit ratings have been pushed deep into junk territory, that means most of the holders of this debt are hedge funds, private-equity firms, and other investment vehicles. (Many mutual funds and institutional investors like pensions or insurance companies eschew junk debt.) GM’s debt is trading at what is euphemistically called “distressed levels.” As indicated here, bonds due in less than two years are trading at 20 cents on the dollar. Many of those who bought GM’s bonds did so because they hoped to 1) convert the debt into ownership in the case of bankruptcy filing or 2) see the bonds rise in value should the government step in and formally guarantee GM’s corporate debt. Obama made clear today what they suspected: No such guarantee would be forthcoming. While GM had tried to restructure, Obama noted, it hasn’t yet done enough. “I’m absolutely confident that GM can rise again, providing that it undergoes a fundamental restructuring. Have they cleaned up their balance sheets, or are they still saddled with so much debt that they can’t make future investments?” (If you answered this double question with a no and a yes, you’re right!) The upshot: Holders of GM’s debt, like other entities to whom GM has made financial commitments—dealers, the auto unions—are going to have to cut a deal, sooner rather than later, and accept less than they think they’re entitled to. None of that AIG-creditor treatment for you.

Obama’s message to Chrysler was harsher. The company’s equity—its stock—is owned not by public shareholders but by the private-equity firm Cerberus, which paid $7.4 billion to buy an 80 percent stake in the company. Cerberus sold off big chunks of its equity to other professional investors, which reduces the amount of capital it has at risk. But last year it agreed to lend $2 billion to the struggling firm. According to the viability plan Chrysler submitted to Washington, the company has about $24 billion in debt outstanding. Effectively, Obama told Chrysler that the government wouldn’t be providing much, if any, new cash and that he didn’t foresee much of a future for the company as an independent firm. He heavily recommended it pursue a deal in the works with Fiat, in which the Italian company would get a 35 percent stake in Fiat in exchange for contributing know-how. The equity that Cerberus and other investors have put in was already severely impaired. After today, it’s worth even less. Obama gave Cerberus 30 days to cut a deal with Fiat. (How do you say negotiating leverage in Italian?) Should Fiat and Chrysler cut a deal—which would dilute Cerberus’ impaired equity even further—”we will consider lending up to $6 billion to help their plan succeed,” Obama says. If not, “and in the absence of any other viable partnership, we will not be able to justify investing additional tax dollars to keep Chrysler in business.” In other words, big haircuts all around—for owners, bondholders, and creditors—even if Chrysler survives.

Obama also used the B-word, bankruptcy, which would be particularly disastrous for Cerberus. Under any circumstances, it seems, many of the Wall Streeters who celebrated Obama’s toxic-assets plan won’t profit from his auto bailout.