The world as we know it is over, unless something drastic happens in the next 24 hours or so. For the entire history of our nation business has been the engine that has spurned our growth. And the engine of big business has been the ability to raise and borrow money. This has been done by selling bonds, basically chunks of debt.
This is how corporations work. A corporation is a business owned by the stockholders. Most companies sell stock to raise money to start out with, this is called an IPO. But after a while if you keep selling stock you dilute the amount that each person owns. It is basically like taking on more and more partners in your company, meaning you own less, and you control less, and these partners share in the profits. So most companies find it much cheaper to borrow money by selling bonds. These stakeholders do not share in the profits or any upside in the company, but they also are the last to be hurt by and failure in the business. As the business operates they also accumulate other debts, to vendors and to employees. If a company fails it is just like a small business that fails. The owner equity is wiped out first, the assets are sold and the bond holders get paid first and in full, and then if there is any money left over the other debts are paid. Only after all of this is paid does the owner get anything.
In the history of large American business many companies have gone bankrupt, and it has always worked this way. Almost every time the stock is wiped out. Some companies survive by getting bought out, others simply restructure and are able to get out with little pain. But here is the big change. In recent times the government has gotten involved in being the largest bond holder of many companies, but the government does not look our for the best interest of US the tax payers, they don’t mind taking a loss.
See a few weeks ago Chrysler declared bankruptcy, and their stock was wiped out. The company basically had three large creditors; The Government, the Union for future pension and health insurance payment, and the bond holders. Lucky for Chrysler they found a buyer in Fiat for 35% of their restructured company, the problem is that this buyer is only willing to pay much less than what the company actually owes. The Government is not really looking to get their money back so they are willing to take a major loss, the problem is that the Government used TARP money to invest in Chrysler and that was illegal, but that is a mute point now, they are just rolling over. But the problem is that the Government and Obama have decided that the BULK of the money should go to the Union, heck Unions are the ones that put democrats in office. So the Government decided to write the plan in such a way to pay only 29% of debt owed on the 42.5 million of debt of the bond holders, the people who should be first in line. While the unions are getting 55% ownership in the new company, and the federal government is getting 10%. A group of the bond holders spoke up and rightly said that they were not being treated right, that they should be first in line, not last. The one Justice of the Supreme Court of the US saw it this way also and decided to stop the sale to Fiat under this current plan. A huge amount of pressure came from the White House to allow the Fiat sale to go on, and the Court caved today and let it go on.
Now what this does is it creates a terrible precedent in US law that bond holders are no longer first. This means that the people who invest get in bonds get none of the upside and much more of the downside risk, all for very little return. This move will freeze the bond markets even more, in a time that we need them very much. This also sets up the precedent for when GM finally gets done with their restructure. The correct thing to do would be to wipe out the Unions. These unions are the root cause for the failure of these companies. Line workers start at more than $70 per hour in pay and benefits, many with tenure make well over $100 per hour. And then they retire with a huge pension and a huge health care bill. With such a high labor cost the average vehicle made by GM had over $7,000 in labor cost. Newer, non-union plants owned by Nissan, Toyota and such have average labor costs per vehicle under $1,500. So if GM wanted to make a vehicle for a cost of $20k (Sales price much higher), they would have much less money to work with to buy materials and make profits, in fact they have not made profits for many years, and now pay thousands per vehicle to cover their debt. So if you spend only half that as your competition on the parts going into your product then your product can not be as good for the same price. So during the 80’s and 90’s they just built a lower quality car, and recently they started building a much higher quality car, but at a much higher price. In both situations it caused a steady march of customers away from these companies, and a vast loss in market share, making it even harder to do business. The unions were like a boa constrictor, killing the company by squeezing tighter and tighter, but the Obama plan for GM is to give the unions over 90% of what they were promised, and they have taken no real concessions, not even a payout. While the Government is willing to take only 60% of what GM owes the tax payers, and what about the bond holders. Well they are going to get somewhere between 19% and 29% of what they are owed. This is crazy really. But this is payback to the unions for supporting the democrats, and a step into the much more socialist America that we find ourselves in.
If secured creditors keep loosing their rights then our capital markets will simply fall apart. I was getting hopeful about our economy recently but this will really put a crimp on things. It also does that help that the federal government needs to issue over $100 billion in bonds each month just to stay afloat with all the spending that is going on. How much longer will people keep trusting in these bonds, when you see interest rates start to go up you will know that the trust is fading, and when that happens there will be even more trouble for us.
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