It sure is funny how things change. Just three years ago, General Motors lost a whopping $30.9 billion dollars in a single year. High operating leverage stemming from the exorbitant fixed cost of manufacturing automobiles coupled with slowing car sales decimated the company.
In 2011, the company reports that it made $7.6 billion, helped in part by lower operational costs, improving car sales, and restructuring that allows the company to make more money with less.
Step back into 2009, one-year after a record loss of nearly $31 billion, General Motors recorded a profit of $104 billion. Was General Motors actually profitable in 2009? Did it really make $100 billion selling cars?
Of course not.
General Motors recorded its massive profit from a write-down of its own debt. The company restructured, allowing it to shed debt held by bondholders and other creditors. Cash flows derived from the issuance of debt is certainly not income, however, getting a free pass on repayment is technically income.
This is also true for individuals, who have to report forgiven student loan and mortgage debt (any debt, really) as income for tax purposes.
Bankrolled by Bondholders
Plenty changed during the years of the bailouts. General Motors was allowed to skip through bankruptcy laws, which would have required liquidation of the firm to repay bondholders first. That is to say that all the assets owned by General Motors should have been sold, with the proceeds going exclusively to bondholders before repaying any other investor or creditor.
That’s not exactly how the deal worked out. Instead, bondholders, who financed as much as $27 billion of General Motors’ operations, eventually received only 10% of the shares in the new, post-bankruptcy firm. The US government in tandem with the United Auto Workers would receive the remainder. (You can read more about the plan proposed in 2009 here.)
The US government earned its portion in exchange for financing. The United Auto Workers union would receive its portion for concessions in worker contracts.
Assuming bondholders held onto their shares to see GM post a record profit in 2011, their 10% share is worth only $4.2 billion at current valuation. The company had as much as $90 billion in assets that would have been distributed first to bondholders in 2008. There’s quite a difference between $90 billion in assets and $4.2 billion of equity market value in 2012.
Now exorbitantly profitably, General Motors will distribute $7,000 cash bonuses to more than 40,000 workers due to profit-sharing agreements in place with the UAW. That is the maximum amount workers could receive as part of new contracts.
Elsewhere in evil Wall Street, CNN reports that bond bankers and investment managers will see their 2011 bonuses decline 35-45% from 2010.
It really is funny how things change. Bondholders, who literally had General Motors stolen out from underneath their otherwise perfect contracts, face the worst 2011 bonuses of any group on Wall Street. General Motors employees will receive a bonus for their hard work, nevermind that General Motors would still be unprofitable if it were to pay on issued bonds as it had before a bailout agreement.
Investing in a New Financial World
This is not just about main street vs. wall street. In fact, Wall Street institutions actually owned a share of GM debt large enough to settle an agreement between bondholders, the US Government, and the UAW. Institutional investors who owned secured debt – debt secured by property and other assets specifically tied to debt issues – had little to lose.
Individual investors who were invested in GM had plenty to lose. Their $7 billion unsecured proportion of the $27 billion in direct bond debt couldn’t hold up to Wall Street’s $20 billion. Ordinary retirees like Debra June received GM stock worth less than $200 in exchange for the $70,000 of GM debt she held as a retirement investment.
Wall Street’s bond bankers will still get a bonus, though smaller than previous years’. United Auto Workers employees will receive the largest bonus possible. Debra June and other investors are left with practically nothing.
Bonds Aren’t what they Appear to Be
I wrote previously about how bond investors could avoid one major risk: the risk of rising interest rates. Today, I’m writing about another risk to bondholders – the potential for a firm to be declared too big to fail.
Bonds are only safer than stocks during bankruptcy in the sense that you aren’t the little guy, the small investor without highly-paid legal teams or the ability to enforce typical bankruptcy law. In truth, Debra June and individual investors with $7 billion in GM debt should have been in the stock. I’m sure if you were to ask her, the $200 in equity she received wasn’t worth the headache or trouble. Going to zero would have been a wound, but $200 of stock in exchange for $70,000 in debt obligations is just unneeded salt laid right on top.
If today were the 1980s, we would talk about how people like Debra June are on a crash course with dog food retirement. I’m sure employees represented by the UAW are looking forward to their filet mignon tonight!
Written by JT, who blogs at MoneyMamba.