UPDATE: It looks like the deal is off (for now at least). Even the article to which I linked below has been pulled in favor of another. The latest is that Chrysler’s creditors rejected the government’s offer (see Chrysler Talks Seen on the Rocks). The question now becomes: Is this truly a temporary bankruptcy in which the deal with Fiat is done but minor structural details need to be ironed out; or, will everyone (Fiat, Chrysler creditors, the federal government, and the UAW) come to their senses and realize that this is a lost cause and that Chrysler should be liquidated?

I leave the original post, as it expresses many of my concerns regarding a Fiat/Chrysler alliance.

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And there you have it.

According to the Associated Press, Fiat will sign a pact with Chrysler to officially extend its existence as a going concern (see Fiat to Sign Partnership Deal).

Italian automaker Fiat Group SpA will sign paperwork to become a partner with Chrysler LLC by Thursday, according to three people briefed on the deal…

“It’ll be signed by tomorrow, I know that,” one of the people [familiar with the deal] told The Associated Press.

As I’ve mentioned before, I am not convinced that this alliance is the best outcome for Chrysler, Fiat, the auto industry, or the U.S. taxpayer (see Fiasco for Fiat? or Chrysler Miracle for background). The following issues concern me:

1. Are the auto union concessions enough to make Chrysler viable for the long run, …especially since the various agreements with the auto union did not involve wage cuts that would make Chrysler more competitive on an operating basis moving forward.
2. Is the taxpayer getting a fair shake in exchanging $10 Billion ($4 Billion in outstanding loans plus an additional $6 Billion cash) for a 10% stake in Chrysler? I am assuming that the additional $6 Billion that the federal government intends to pump into Chrysler has already been factored into its 10% stake in Chrysler. If so, by that calculus, Chrysler would be worth an imputed $100 Billion (if not, at the very least they are valuing Chrysler at $40 Billion). That’s more-or-less the current valuation of GM. Is Chrysler really worth that much?? Under such generous exchange terms, it is possible that the taxpayer would have been better off calling the preexisting loans and simply liquidating Chrysler.
3. Is Fiat up to the task? It has entered and exited the U.S. market once already. Are we looking at a possible repeat performance? Let’s not forget that Fiat is a firm that, as little as two years ago, was on the verge of bankruptcy itself.
4. Fiat is not prepared for what it is about to get into by acquiring a stake in Chrysler. Global expansion and integration is difficult enough in the best of circumstances, but Fiat is now acquiring a feeble company with little in the way of design and product capabilities. It is not clear that Fiat will be able to manage the cross-cultural complexities associated with this deal. Moreover, it is possible that Chrysler’s products (even with technology infusions from Fiat) will not improve quickly enough for it to become a profitable enterprise.
5. The global auto industry continues to be plagued by massive overcapacity. Keeping a weak competitor like Chrysler around will certainly not resolve systemic overcapacity in any meaningful way.

So while it looks like there is currently a future for Chrysler, it might prove to be a temporary future. It is entirely possible that despite the effort, Chrysler might end up right back in the same place in a few short years – on the verge of bankruptcy.

In previous posts (see Chrysler Still Needs a Miracle or Chrysler/Fiat Update) I suggested that the Fiat/Chrysler deal looked increasingly like a longshot. Fiat was asking for deep concessions from both the auto union and Chrysler’s creditors, and it seemed unlikely that Fiat was going to receive those concessions.

But over the past few days, the Obama Administration, the auto union, and Chrysler’s creditors seemed to have come to some sort of understanding (see Treasury Close to Deal with Chrysler Creditors, Chrysler Reaches Agreement with UAW, and UAW Gets 55%).

Hallelujah??

Maybe, but not so fast. Several issues remain:

1. Creditors must agree to the debt cancellation.

According to the NY Times:

Chrysler has about $6.9 billion in secured debt owned by big banks like Citigroup and JPMorgan Chase and a group of hedge funds. Under the proposal, all of the debt would be canceled in exchange for $2 billion in cash…

The Treasury drew up the latest proposal in consultation with Chrysler’s biggest secured creditors, which hold about 70 percent of the company’s secured debt. It requires approval by almost all of the secured lenders. That could be difficult as some lenders, including several hedge funds, may hold their ground and reject it.

2. The issue of pay for union workers must still be resolved. Although Chrysler, the federal government, and the union have come to terms with respect to pension and benefits, my understanding is that they have not yet reached a meaningful agreement to reduce wages. Just how important are wage reductions to Fiat? That remains to be seen. According to the Michigan Messenger:

The new agreement does not cut wages, but it does apparently reduce Chrysler’s commitment to pay into the UAW-run retiree health care fund.

3. According to the latest accord, the auto union will get a 55% equity share in Chrysler. The US government will get a 10% share. Fiat would get a 20% share. Where does the other 15% go? Is this 15% set aside for Fiat depending upon whether it meets performance goals? Will this 15%, or a portion of it, get doled out to Chrysler’s creditors? This was not entirely clear to me.

4. Ultimately, Fiat needs to agree to be party to the alliance. Until that happens, there is no deal. Time will tell if these concessions are enough to convince Fiat that the deal is worthwhile.

Nevertheless, given the concessions that all parties have made to help Chrysler avert bankruptcy, a Fiat alliance seems far more likely today than it did as little as one week ago. Chrysler is no longer looking for a miracle. Perhaps now just a random act of kindness.

But assuming a Fiat/Chrysler deal goes through, the question then becomes: Is this the best outcome for Fiat, Chrysler, and the auto industry? It is not entirely clear. The global auto industry continues to be plagued by massive overcapacity. Keeping a weak competitor around will certainly not resolve systemic overcapacity.

For Fiat, it might be a bit premature to re-enter the U.S. market (the most competitive auto market in the world) and sign on for a complicated global expansion/integration (see Fiasco for Fiat?). Let’s also not forget that Fiat is a firm that, as little as two years ago, was on the verge of bankruptcy itself.

Finally, for Chrysler, it is not clear that its products (even with technology infusions from Fiat) can improve quickly enough for it to once again become a profitable enterprise. For this reason, and as I’ve mentioned before, Chrysler likely needs more than Fiat and an additional $6 Billion infusion from the federal government to survive.

So even if the deal goes through this week, it is entirely possible that Chrysler might end up right back in the same place – on the verge of bankruptcy.

And we wait…

The Geithner Treasury team finally unveiled the details of its Stress Test methodology today (see Supervisory Capital Assessment Program). We will have to wait a few more weeks for the results. Based on early returns, the results are all but a foregone conclusion – most banks will likely pass with flying colors.

So in the absence of meaningful outcomes from the Stress Test, we might be better served by deconstructing the process itself. In this way we can better determine what it might mean for a bank to pass or fail, better assess the results to sensitivity in the data, and ultimately, determine whether the test itself even made any sense.

So what can be made of the process?

It has recently been argued that the “more adverse” scenario should actually have been the baseline (see Stress Test Scenarios or Stress Testing the Stress Test). I agree wholeheartedly. It has been clear for awhile now that the Treasury’s scenarios did not adequately reflect economic reality. There is even some evidence that the economy has already deteriorated to a point where it is currently worse off than the “more adverse” scenario.

That notwithstanding, there were two other details about the methodology (among others) that raise some concern.

First, from p. 4 of the official Stress Test document:

The BHCs [bank holding companies] were asked to estimate their potential losses on loans, securities, and trading positions, as well as pre‐provision net revenue (PPNR) and the resources available from the allowance for loan and lease losses (ALLL) under two alternative macroeconomic scenarios.

My comment: So if I understand this correctly, the Treasury is relying on banks to provide them with an assessment of their current troubles. This is like asking an alcoholic if he thinks he has a problem.

Second, on p. 3 of the document, the Treasury points out:

The economic value of loans in the accrual book is reduced through the loan loss reserving process when repayment becomes doubtful, but is not reduced for fluctuations in market prices, which may be driven by market liquidity considerations…As a result…the results of this exercise are not comparable with those that would evaluate such assets on a mark‐to‐market basis.

My comment: So here we are again in a mark-to-fantasy kind of world, where banks (which possess asymmetric information about the true quality of their underlying asset portfolio vis-a-vis the Treasury) might be able to favorably adjust the value of their assets. In my opinion, the best assessment of the underlying value of the assets on the books is what the market is willing to pay for those assets. The Treasury’s approach, in my opinion, leaves too much room for banks to claim, “It’s a liquidity problem.”

All this begs the question: While most banks will pass, does the Stress Test fail?

Last week, in the post Chrysler/Fiat Update, I suggested that Chrylser’s debtholders would likely be better off with Chrysler in bankruptcy. I wrote:

Some creditors (e.g., secured bondholders debtholders) would likely be better off with Chrysler in bankruptcy than make the kinds of concessions that would allow the Fiat deal to go through.

For this reason, among a host of others, I concluded:

Chrysler now needs a miracle to survive.

Sure enough, as reported yesterday in the Wall Street Journal (see Banks Reject U.S. Terms for Cutting Chrysler Debt), Chrysler’s debtholders seem unwilling to make the necessary concessions.

A group of big banks and other lenders rebuffed a Treasury Department request that they slash 85% of Chrysler LLC’s secured debt, proposing instead to eliminate about 35% in exchange for a minority stake in the restructured car maker and a seat on its board.

The lenders’ counteroffer marks a significant act of brinksmanship as the banks and the Obama administration’s auto task force duel over concessions to avoid liquidating the country’s third-largest car company.

In their five-page counteroffer, which was sent to the Treasury late Monday, the lenders said they are prepared to cut Chrysler’s first-lien debt by $2.4 billion, or down to about $4.5 billion, in exchange for a 40% equity stake and a Chrysler board seat, according to a copy of the proposal provided by individuals outside the lenders’ group.

In making their case for a significantly smaller sacrifice than what the government wants, the lenders have argued that their fiduciary duty to their own shareholders and investors requires them to recoup as much as possible from the car maker. The lenders have told Treasury officials they believe they could recover at least 65% of their loans if Chrysler is liquidated in bankruptcy.

Tick, tick, tick. We are now one week from the government imposed deadline. And we aren’t any closer to a deal. Fiat wants the auto union and Chrylser’s creditors to grant more concessions. Chrylser’s creditors and the auto union do not seem particularly motivated to make such concessions. What’s more, they both want Fiat to put more skin in the game.

Looks like time for that miracle is running out fast. Now let’s see if the Obama administration has the fortitude to make good on its bankruptcy threat…

From the vault of “Oh Gee, What a Shock” comes the latest pronouncement from Fiat: Concessions or No Chrysler Deal. According to the Associated Press:

Automaker Fiat Group SpA will walk away from a deal to take a 20-percent stake in Chrysler LLC if the U.S. automaker’s unions don’t agree to major cost cuts, Fiat CEO Sergio Marchionne said in an interview published Wednesday.

…Chrysler…needs concessions from creditors and unions to ink the Fiat deal.

My comment: As I suggested in a prior post (see Finally a Sensible Approach), Chrysler needs much more to survive than Fiat and the $6 Billion that the US Government has promised. Moreover, since Chrysler has no other options and the federal government has given Chrysler an ultimatum with respect to the Fiat deal, Fiat can play a very strong hand in any negotiation. And they will.

“Absolutely we are prepared to walk. There is no doubt in my mind,” Marchionne told the Toronto Globe and Mail. “We cannot commit to this organization unless we see light at the end of the tunnel.”

Marchionne said there is a 50 percent chance the deal will fail because of lack of progress in labor negotiations in both the United States and Canada.

“The dialogue is out of sync,” Marchionne said. “I think they need to see what state the industry is in. Canada and the U.S. are coming in as the lender of last resort. … No one else would put a dollar in. This is the worst condemnation of the viability of this business.”

My comment: I think Marchionne’s estimate, that there is 50% chance that the deal goes through, is wildly optimistic. As with GM, it will be very difficult for Fiat/Chrysler to extract meaningful concessions from the auto unions and Chrysler’s various creditors. Some creditors (e.g., secured bondholders debtholders) would likely be better off with Chrysler in bankruptcy than make the kinds of concessions that would allow the Fiat deal to go through. Therefore, and as I alluded to in my previous post, Chrysler now needs a miracle to survive.

And we wait…

I had been asked to write an Op Ed for the IB Times, an on-line only newspaper with a fairly impressive circulation of about 4 million readers. Honestly, I had never heard of the publication until they reached out to me. But I have to say, I was impressed with what I saw. It even made me hopeful for the future of the on-line only newspaper format.

But that is neither here nor there. The matter at hand is the Op Ed piece.

The piece that I penned for them dealt with executive pay, and was loosely based on a blog post (see Revisiting Executive Pay) from several years ago. In the Op Ed (see Executive Pay: The Problem is Systemic) I argued that simple band-aid type solutions such as increasing the proportion of independent directors and allowing shareholders to vote on pay do not address the root cause of the problem. I wrote:

The issue of executive pay has resurfaced again in the wake of questionable AIG bonuses, and exorbitant compensation packages for banking executives. Pundits see the problem largely as a consequence of a lack of independence among boards of directors. They criticize compensation committees for being too cozy with top management – showering them with lavish pay, outsize option packages, and a host of other perquisites. The solution, they argue, is to increase the percentage of independent directors serving on the board, and to provide shareholders the right to vote on executive compensation.

I agree that boards ought to share some of the blame for a system that has seen executive compensation rise from about 30 times the average employee’s salary in the 1970’s to over 100 times the average employee’s salary today…But boards are not wholly to blame.

The reasons for the spectacular rise in executive compensation are complex. The problems are endemic to a market and institutional system which has radically changed over the last half century. Therefore, to arrive at an appropriate solution, we must start by asking ourselves some fundamental questions…

I’ll leave you with that teaser. To read the Op Ed in its entirety, please visit Executive Pay: The Problem is Systemic.

(Disclosure: I was not remunerated for having written the Op Ed, …or for that matter, to drive traffic to the IB Times or speak highly of the publication. I have no relationship with them other than their request for an Op Ed, and my agreement to write it.)

Advertising Age recently asked me to write a short Op-Ed summarizing my reaction to the Obama administration’s stance toward GM and Chrysler. You can find the full piece on the Advertising Age website, or by clicking on the accompanying link (The Obama Administration Got it Right).

For those of you who have followed this blog, my opinion should not come as a surprise. I have expressed sentiment consistent with the Auto Task Force’s decision for the last half-year or more (see GM and Chrysler: Finally a Sensible Approach, Pre-Packaged Bankruptcy, Preventing Moral Hazard, and Aid for Chrysler? Just say No! for background).

Given that the decisions made by the Obama administration were largely consistent what I had been advocating, I am sanguine.

From the vault of the sublime, a friend recently e-mailed me a story (hat tip Joel) about how the Topps Company plans to release a set of trading cards depicting the “world’s biggest hoaxes, hoodwinks and bamboozles” (see Topps to Issue Cards with Swindlers). According to Fortune:

This year’s product will…nod to Madoff’s financial chicanery as part of a group of cards featuring the “world’s biggest hoaxes, hoodwinks and bamboozles.” Among the other do-badders in the subset are Charles Ponzi, The Runaway Bride, and Enron.

“These cards feature 20 perpetrators of some of the most notorious pranks, dubious claims, and outright frauds of the last 2 centuries,” boasts a Topps sell-sheet for the collection.

Apparently the “gimmicky” cards depicting the deplorable will be inserted into packs of baseball cards.

Upon hearing the news, I confess I chuckled at first. I’m always game for a good laugh. But then reality set in: The cards would be much funnier, and certainly less crass, had the victims of these “hoaxes, hoodwinks and bamboozles” not lost so much money.

In January I predicted (see Notable Bankruptcies of 2008) that “major” bankruptcies in 2009 would challenge the 383 mark set in 2001 (the high-water mark after the dotcom bubble). I even suggested that it was possible that we could exceed 400 “major” bankruptcies in 2009.

According to Bankruptcydata.com, there have been 90 “major” filings thus far in 2009. Assuming that bankruptcies are equally distributed throughout the year, this puts us on pace for 360 bankruptcies. I fully expect the filing pace to quicken as the year goes on, and as the economy continues to deteriorate.

Below you can find an updated list of what I see as the “noteworthy” bankruptcies of 2009, as reported by Bankrupctydata.com (please note that this is not an exhaustive list):

• Bearingpoint, Inc. (Consulting)
• BI-LO, LLC (Supermarkets)
• Charter Communications, Inc. (Telecom)
• Chemtura Corporation (Chemicals)
• Fleetwood Enterprises, Inc. (Recreational Vehicles)
• Fortunoff Holdings, LLC (Retail)
• Goody’s LLC (Retail)
• Herbst Gaming, Inc. (Gambling)
• Idearc (Publishing)
• Journal Register Companies (Newspapers)
• Lyondell Chemical Company (Chemicals)
• Magna Entertainment (Gambling)
• Masonite Corporation (Real Estate Manufacturing)
• Midway Games, Inc. (Entertainment Software)
• Monaco Coach Corporation (Recreational Vehicles)
• Nortel Networks, Inc. (Telecom)
• Pacific Energy (Oil & Gas)
• Philadelphia Newspapers, LLC (Newspapers)
• Ritz Camera Centers, Inc. (Retail)
• Shane Company (Jewelry)
• Silicon Graphics, Inc. (IT/Computing)
• Silver State Bancorp (Banking)
• Smurfit-Stone Container Corporation (Paper Manufacturing)
• Spectrum Brands (Consumer Products)
• Star Tribune Companies (Newspapers)
• Sun-Times Media Group, Inc. (Newspapers)
• Tarragon Corporation (Real Estate)
• Trump Entertainment (Gambling)
• WL Homes, LLC (Real Estate)
• Young Broadcasting, Inc. (Television)

In addition to “major” bankruptcies (e.g., those firms with assets greater than $50M) tracked by Bankruptcydata, the U.S. government tracks all bankruptcy filings by type (e.g., Chapter 7, Chapter 11, Chapter 13). You can find detailed bankruptcy statistics at the U.S. Courts website. Business bankruptcies for 2008 came in at 43,546, slightly shy of my 45,000 prediction; however, that still represents a 54% increase over 2007, and the greatest number of business bankruptcies since 1997.

The chart above presents annual (calendar year) business bankruptcy filings from 1990-2008 (click on the picture for a larger image). Interestingly, the number of filings had been trending steadily downward from 1990 through 2006. In 2007 the numbers started to reverse course. I expect that trend to continue in 2009, with total business bankruptcies reaching 55,000.