There hasn’t been much inspiring me to write these days. The news across the board has been pretty much the same – the economy stinks, joblessness is increasing, housing continues its downward spiral, consumption is nowhere near recovery, bankruptcies are on the rise, banks are under stress, corporations are struggling, and Jon Stewart continues his hysterical rant at the folly that is CNBC. Did I miss anything??

Seems like these days we’re in a holding pattern waiting for the results of the bank stress tests and a decision on the GM/Chrysler aid.

So while we’re all waiting, I came across an interesting issue in the debate about the merits of various approaches to the banking crisis (e.g., nationalization versus ringfencing troubled assets versus good bank/bad bank).  Paul Krugman and Simon Johnson (and the rest of the folks at The Baseline Scenario) have recently talked about what to do about bank liabilities; specifically, debt (not liabilities to depositors).

As Krugman points out (see Anti-nationalization Arguments):

some decision must be reached on bank liabilities. Sweden guaranteed all of them. If forced to say, I would go the Swedish route; but of course we can’t do that unless we’re prepared to put all troubled banks in receivership. And I’m ready to be persuaded that some debts should not be honored — this is a deeply technical question.

What’s clear, however, is that the current system, of implicit maybe-kinda guarantees on bank liabilities — call it wink-wink-nudge-nudge-say-no-more banking policy — is failing badly.

From The Baseline Scenario (see Quick Note on Liabilities):

…the government has been doing everything it can to imply that bank creditors (at least for “systemically important” banks) will be protected, without saying so explicitly, because that would suddenly increase the potential liabilities of the government by trillions of dollars.

What’s clear is that several of the largest US banks (those subject to the stress test) are insolvent – their liabilities exceed the value of their assets. For those banks that are insolvent, shareholders will get wiped out, probably through nationalization, however administered. After shareholders get wiped out, the fact remains that the value of the remaining assets (after depositors are made whole) will not make existing creditors whole.

So the question remains, should the US government (taxpayers) guarantee the liabilities?

One of the issues, as I see it, depends upon the identity of those creditors. And this is where it gets complicated. Maybe this is what Krugman means by “deeply technical” (although perhaps he had something else in mind).

To the extent that US bank creditors include large sovereign wealth funds and central banks, forcing bondholders to take a haircut may come with political consequences. In contrast to small, private creditors, sovereigns have political and economic recourse. And, after all, we will probably need to rely on some of these same actors to fund our current deficit.

For this reason, I am inclined to believe that we will be forced to guarantee the liabilities of banks we nationalize, a la Sweden.

And we wait.

I received an e-mail message yesterday from the folks at Weber Shandwick (GM’s PR firm) calling my attention to a recent blog post by Tom Wilkinson, GM’s news relations director (see Why Not Bankruptcy?).

In that post, Mr. Wilkinson objects to those who have called for bankruptcy reorganization as a viable option for GM. He writes:

Let me briefly review why we think a tough out-of-court reorganization is best for GM, the taxpayers, and other stakeholders.

Bankruptcy reorganization takes cash – lots of it. For a company like General Motors to operate in Chapter 11, it would need massive debtor-in-possession loans. With credit markets frozen, there is realistically only one source of such loans – the federal government. We estimate loans needed to reorganize GM in Chapter 11 could top $100 billion, far more than the out-of-court fix envisioned in our restructuring plan.

MY COMMENT: OK, what’s the problem with that? So the government becomes the de facto DIP financier. And perhaps it is to the tune of $100B (although I think that might be a bit overstated). But that money does not fall down a sinkhole. It is a loan that is collateralized by GM’s enterprise, whatever the value of that may be. The real question is not whether the federal government would have to pony up $100B now if it forced GM into bankruptcy. The government could easily reach (if not exceed) that amount under the current arrangement, only in $10-20B increments.

The real question is whether a GM turnaround would result more quickly, efficiently, and effectively via bankruptcy; whether GM emerges as a healthier organization after bankruptcy; and, whether the likelihood of the federal government getting paid back is higher as a result.

I am not necessarily opposed to additional out-of-court aid for GM, provided that it come with extremely strict terms. However, in many ways, bankruptcy allows GM greater flexibility to reorganize (see GM Plan, Pre-Packaged Bankruptcy, and Preventing Moral Hazard for details).

Mr. Wilkinson continues:

One reason this [$100B DIP financing] figure is so large is that GM’s revenues would plunge in bankruptcy. I ask: “Would [customers] buy a car or truck from a company in bankruptcy, when there are similar products available at another dealership right down the block?” I expect that if they were honest, they would answer “Probably not.” So why do they expect other shoppers to behave differently? The GM viability plan includes a detailed analysis of this revenue risk (Appendix L, Exhibit 3), an analysis bankruptcy advocates seem eager to dismiss or ignore.

MY COMMENT: I am not so sure the answer to Mr. Wilkinson’s question is “no”, or even “probably not”. And this is where I take some issue with the GM plan.

GM assumes that post-bankruptcy revenues for their products will fall by around 35%-40% (compared with the non-bankruptcy alternative). They use Daewoo’s experience as a benchmark. They also try to gauge potential consumer demand via survey instrument.

I am not sure that Daewoo is the right benchmark. Moreover, I am skeptical of the surveys. The fact is that a GM bankruptcy would be very different from a “traditional” bankruptcy. As Mr. Wilkinson points out, in the case of GM, the federal government will act as the DIP financier. With the federal government as the DIP financier, GM not only has the explicit backing of the US government, but the implicit guarantee that it shall continue as a going concern. Moreover, the federal government can stand behind GM warranties. Those stylized facts alone are enough to diminish consumer flight.

It’s no surprise that GM management is strongly advocating an out-of-court solution. After all, an out-of-court solution maximizes their chances of continued employment with GM.

With respect to GM’s position on the matter, the insight of Milgrom and Roberts (RAND, 1986) rings true: Beware (and be skeptical) of information provided by interested parties.

So, YES, GM could survive bankruptcy, and we needn’t be frightened by the prospects, …no matter how much GM tries to convince us that it would spell the apocalypse.

Thomas Oliver recently penned a piece for the Atlanta Journal Constitution in which he referred to my post Notable Bankruptcies of 2008. In The Year of Bankruptcy Mr. Oliver notes:

It has to happen. As painful as it is.

And there is no magic wand or legislative action or Federal Reserve printing press that can make it all right.

The laws of economics are stronger than any policy…

And so the deleveraging, or debt reduction, of the American economy continues…

Twenty years of excess leveraging can’t be worked out of the system in a normal recession…

I could not agree more with Mr. Oliver. As I explained in my post, I fully expect business bankruptcy filings to increase in 2009. Bankruptcies will likely increase to around 55,000. And as I expressed to Mr. Oliver, I would not be surprised to see bankruptcies surprise to the upside.

As with banks and financial institutions, for many firms in the broader economy, it’s not just a liquidity problem. It’s a solvency problem. Firms borrowed excessively, and at rates that were too cheap – not reflective of their inherent risk. All was fine as long as they were able to refinance the debt, and delay the day of reckoning.

But then the party ended.

We can analyze the situation and pretend that the problem affecting many of these firms is the lack of available credit; or, we can recognize the reality that, for many, their business strategies have serious flaws. I look at firms like Sirius XM (see So Long Sirius), Circuit City, Trump Entertainment, and Bearingpoint (among others) and can only conclude that these are not good firms suffering from unfortunate short-term liquidity problems. Rather, they are poorly managed firms in incredibly competitive markets. This makes their overall value propositions, market positions – or both – extremely unattractive.

Those are problems of the more permanent kind.

Today GM and Chrysler provided interim plans to the US Government in hopes of receiving additional aid (see GM and Chrysler Seek More Aid or GM and Chrysler Release Plans). According to reports, Chrysler is seeking an additional $5B in aid, while GM is currently asking for $16.6B.

You can read a copy of their respective plans here:

GM Restructuring Plan

Chrysler Restructuring Plan

I was impressed with GM’s offering. Truthfully, I expected far less. GM’s plan reads as if management believes it has something left to fight for: The plan is detailed, carefully constructed, and thoughtful. Certainly, GM faces significant hurdles in the form of the UAW, and its bondholders. In addition, the jury is out on whether current management deserves to remain in place. But that said, based on this proposal, I would be inclined to support some additional aid package for GM, …but with more strict provisions (see my previous posts Pre-Packaged Bankruptcy and Preventing Moral Hazard for details).

As for Chrysler, I am inclined to agree with Calculated Risk on this one. Chrysler’s plan is a sham. Chrysler is toast, and Cerberus knows it. Based on this plan, I see the likelihood of the US Government providing additional aid for Chrysler as remote. I would be shocked if the US Government were to continue to put taxpayer money at risk to prop up Cerberus, and its failed enterprise (see Aid for Chrysler? Just say No! and Is the End Nigh for Chrysler? for details).

But now that Chrysler and GM have submitted their plans, the real work for Team Obama begins here…

Several sources are reporting that Sirius XM Radio is on the precipice (see Sirius XM Prepares for Bankruptcy or Satellite Radio a Bad Business Model). This is not surprising news, as both Sirius and XM had been on the ropes predating their merger. As the New York Times reports:

Sirius XM…has hired advisers to prepare for a possible bankruptcy filing, people involved in the process said.

Sirius XM, which never turned a profit when both companies were independent, is laden with $3.25 billion in debt. Its business model has been dependent, in part, on the ability to roll over its enormous debts…at low rates for the foreseeable future until it could turn a profit.

MY COMMENT: Excessive debt was not unique to Sirius XM. It is an economy-wide epidemic. Expect to see many more bankruptcy stories with a similar plot as the year goes on (see my posts Notable Bankruptcies or Corporate Defaults).

Sirius XM hired Joseph A. Bondi of Alvarez & Marsal and Mark J. Thompson, a bankruptcy lawyer with Simpson, Thacher & Bartlett, to help prepare a Chapter 11 filing, these people said.

Documents and analysis are close to completion and a filing could come in days, according to a person familiar with the matter.

According to MarketWatch:

Sirius XM Radio, which reportedly is on the verge of declaring bankruptcy, has problems that go far beyond the dismal state of the economy.

The idea of charging consumers a modest fee in return for superior programming and sterling reception quality may not be viable. Perhaps the industry’s entire business model was flawed from the start and the nation had to experience this devastating recession before people reached that conclusion.

The Wall Street Journal reported on Wednesday that satellite mogul Charles Ergen of Dish Network Corp. has offered to restructure Sirius’ debt and inject several hundreds of millions of funding into the company if it will yield control to him.

I’ve blogged about Sirius Satellite Radio on several occasions (see Sirius-XM Merger, Sirius-XM Merger Update, or Lessons for Sirius for background). It was my opinion that the deal made a great deal of strategic sense. I wrote:

…there are some real cost saving opportunities to this merger. The synergies are real and tangible. Not only do the firms have the ability to economize on administrative costs (e.g., why do we need two sets of management to run these firms), but there are some obvious synergies in production (e.g., why do we need two sets of alternative rock stations when one will suffice).

…it [also] adds value for customers. Exclusivity contracts negotiated by these separate firms locked-in consumers. For example, fans of Major League Baseball were forced to choose XM while fans of Howard Stern only had Sirius as an option. Combining the firms allows fans of both to resolve issues of which service to choose…consumers who have chosen to wait for the uncertainty to resolve over which service would become the standard because they did not like having to choose between two options that are second-best (e.g., I want both Howard Stern and MLB, but I won’t choose until things get resolved) will no longer have to agonize over the decision of which service to select. With Sirius and XM merged…more consumers will likely opt for satellite radio.

Irrespective of today’s news, I still believe the deal makes sense, for as independent entities, Sirius and XM would be far worse off.

In addition, I argued at the time that the DOJ and the FCC were barking up the wrong tree by trying to prevent their union on the grounds that the deal was anti-competitive.

…they [Sirius/XM] do face substantial competition, not in the form of competitors in their existing space, but in the form of substitutes. They face threats from HD radio, traditional radio, iPod connectivity, internet streaming, etc. So this…will put a ceiling on their pricing power.

The initial DOJ and FCC objections now seem misguided, as Sirius XM certainly was not able to flex its pricing muscle, especially in a market in which consumers have a bevy of alternatives, in an economy mired in recession, and in an environment in which auto sales have fallen off a cliff.

Despite all its difficulties, I still believe that Sirius XM has a fighting chance. But the road ahead will not be an easy one, even with a debt reset. Sirius XM still faces the daunting task of convincing consumers that it offers a fairly priced service that provides value vis-a-vis its competitors. And as the MarketWatch article aptly concludes:

Hopefully Ergen — or someone else — can find a miracle cure for an industry that threatens to vanish right before our eyes.

Several sources reported yesterday that GM and Chrysler intend to make a fresh set of buyout offers to their union employees (see GM, Chrysler Set New Buyouts). They plan to offer packages valued at around $50,000-$100,000 per employee. According to analysts, this action allows GM and Chrysler to circumvent rigid union rules regarding layoffs, and provides the firms a relatively quick way to lower overall compensation costs (replacing expensive, experienced union employees with cheaper, inexperienced employees at the reduced rate of $14 per hour).

Here’s what I don’t understand: Why should GM and Chrysler use money loaned by the U.S. Government to transfer wealth from U.S. taxpayers to exiting GM/Chrysler employees? It’s one thing if a firm does that with the capital of its private shareholders, but quite another if they use public money toward that end.

Granted, UAW employees at GM and Chrysler earn far less than your typical investment bank executive, but I’m not so sure paying those employees an exit bonus is, in principle, different than John Thain paying bonuses to exiting Merrill employees in advance of its acquisition by Bank of America.

As a condition for receiving funds from the U.S. Government, GM and Chrysler are required to produce a plan detailing how they intend to pay back those loans, and ultimately, achieve profitability. In my opinion, there are more effective ways to reduce labor costs and preserve capital than to take U.S. taxpayer money and funnel it to employees: It’s through good old fashioned layoffs, of the uncompensated kind. Most other firms have them. GM and Chrysler should be no exception.

The UAW, and by implication GM and Chrysler management, just don’t get it. The alternative to buyouts is bankruptcy followed by layoffs. In bankruptcy, the automakers could effectively repudiate the terms of their UAW contracts and fire just about anyone without consequence. The UAW (and GM/Chrysler management) should become wise to this alternative, and become more willing to consider layoffs instead of buyouts.

As I watch this episode play out, it is becoming increasingly clear to me that the best remaining option for the U.S. Government is to call its loans in March and allow GM and Chrysler to declare bankruptcy. The U.S. Government could step in ex post to provide DIP financing for GM, …but not for Chrysler (see Pre-Packaged Bankruptcy, Preventing Moral Hazard, and Aid for Chrysler? Just say No! for background on my position on the GM versus Chrysler debate). Although I was initially supportive of offering government aid to GM (though not for Chrysler), the aid was not accompanied by provisions necessary to stave off disaster. At this point then, I believe bankruptcy offers the last best chance to salvage GM, and the U.S. auto industry.

Bankruptcy protection would allow GM (and potentially Chrysler, provided it can find financing) to more quickly and efficiently streamline operations. It provides the degrees of freedom necessary to shutter plants, rationalize brands, layoff redundant employees, and reduce the number of dealerships. More importantly, it would once and for all allow for the wholesale sacking of management – a management seemingly insistent on squandering taxpayer resources.

In mid-August I predicted that “major” bankruptcies for 2008 would reach 225 (see Bankruptcies Revisited). Through October there had been 172 such bankruptcies, as reported by Bankrupctydata.com. That implied a pace of around 210 bankruptcies, well short of my prediction.

At the time however, I suggested that the filing pace was likely to quicken in November and December as the economy deteriorated at a more rapid clip. Sure enough, the final numbers bear out my prediction. According to Bankruptcydata.com, “major” filings reached 231 in 2008.

231 bankruptcies falls far short of the 289 “major” bankruptcies in 2000 and 383 in 2001 (the dotcom bust). However, I would not be surprised to see 2009 challenge the 383 mark from 2001. In fact, if we believe the predictions of my colleague Edward Altman, we should not be surprised to see the number of “major” bankruptcies exceed 400 (see NYU’s Altman Sees 2009 Default Rate Doubling). Obviously default is not the same thing as bankruptcy; however, they trend together.

Below you can find an updated list of what I see as the “noteworthy” bankruptcies of 2008 (as reported by Bankrupctydata.com). New additions since November appear in RED (please note that this is not an exhaustive list):

• AIG (insurance)****
• Agriprocessors, Inc. (food services)
• Aloha Airlines (airline)
• American Color Graphics (newspaper)
• Ascendia Brands (retail)
  
• ATA (airline)
• Bear Stearns (banking)****
• Bill Heard Enterprises (auto)
  
• Bluepoint RE (insurance)
  
• Blue Water Holdings (auto)
• Boscov’s (retail)
• Brooke Corporation (insurance)
  
• Buffets Holdings (restaurants)
• CDX Gas, LLC (energy)
• Chesapeake Corporation (packaging products)
  
• Ciena Capital (real estate)
• Circuit City (electronics retail)
  
• Comfort Co. (bedding)
• DBSI Inc. (real estate)
  
• Downey Financial (banking)
• Dreier LLP (legal services)
  
• Dynamic Leisure (travel)
• Eclipse Aviation (airplane manufacturer)
  
• Education Resource Institute (insurance)
• Empire Land (real estate)
• Eos Airlines (airline)
• Equity Media Holdings Corporation (media)
• EZ Lube, LLC (auto services)
  
• Fashion House Holdings (retail)
• Flying J (trucking and transportation services)
  
• Fortunoff (retail)
• Franklin Bank Corp. (banking)
  
• Friedman’s Jewelers (retail)
• Fred Leighton Holdings (retail)
• Fremont General (banking)
  
• Frontier Airlines (airline)
• Gainey Corporation (trucking)
  
• Gemini Air Cargo (air delivery/freight)
• GETRAG Transmission Manufacturing LLC (auto manufacturing)
  
• Goody’s (retail)
• Greatwide Logistics (trucking)
  
• Greektown Holdings (casino)
• Hawaiin Telecom Communications, Inc. (telecom)
  
• Hospital Partners of America (healthcare)
• HRP Myrtle Beach Holdings (entertainment)
  
• Indymac (banking)
• Integra Hospital Plano, LLC (healthcare)
• Integrity Bancshares, Inc. (banking)
  
• JHT Holdings (trucking/transportation)
• KB Toys, Inc. (retail)
• Key Plastics, LLC (auto manufacturer)
• Laketown Wharf (real estate)
• LandAmerica Financial Group (insurance)
  
• Land Resource, LLC (real estate)
  
• Landsource (real estate)
  
• Legends Gaming (casino)
• Lehman Brothers (banking)
• Lenox Group (tableware)
  
• Lillian Vernon (retail)
• Linens n’ Things (retail)
• Luminent Mortgage Capital (banking)
  
• Kimball Hill (real estate)
• Landsource Community Development (real estate)
• Matrix Development Corporation (real estate)
• Mervyn’s (retail)
• Mortgages Ltd. (banking)
• Motorcoach Industries International (transportation)
• MPC Corporation (computers)
  
• MPF Corp. (transportation)
• Mrs. Fields Famous Brands (food services)
• National Wholesale Liquidators, Inc. (retail)
• NetVersant Solutions (IT services)
  
• PFF Bancorp, Inc. (banking)
  
• Pierre Foods (food services)
• Pilgrim’s Pride Corporation (food services)
  
• Pope & Talbot, Inc. (pulp/wood products)
• PPI Holdings, Inc. (auto manufacturer)
  
• PRC LLC (business services consulting)
• Propext (textiles)
• Quebecor World (USA), Inc. (office services/printing)
• Red Envelope (retail)
• Rock Well Petroleum, Inc. (energy)
  
• Sharper Image (retail)
• Silverjet Airlines (airline)
• Sirva (moving services)
• Skybus (airline)
• STA Restaurants – Bennigan’s (restaurants)
  
• Steakhouse Partners (restaurants)
• Steve and Barry’s (retail)
• Storm Cat Energy Corporation (energy)
• SunCal Bickford Ranch, LLC (real estate)
  
• Syntax-Brillian – Olevia (electronics)
• Taro Properties (real estate)
• Tribune Company (media)
  
• Tropicana (casinos)
• Vail Plaza Development (real estate)
• Value City Department Stores (retail)
• VeraSun Energy (alternative energy)
  
• Vicorp (restaurants)
• Village Homes of Colorado, Inc. (real estate)
  
• Washington Mutual (banking)
  
• WCI (real estate)
• Whitehall Jewelers (jewelry)
• WHM Copper Mountain Investments (investment company)
  
• Wickes Furniture (retail)
• Woodside Group (real estate)
• WorldSpace, Inc. (satellite broadcasting)
  
• Ziff Davis (media)

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. For the twelve months ending June 2008, there had been 33,822 business filings versus 23,889 for the same period in 2007 (a 42% increase).

The chart above presents annual (calendar year) business bankruptcy filings from 1990-2007 (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 2008 and 2009, with total business bankruptcies reaching 45,000 in 2008 and 55,000 in 2009. I will update these data when the final 2008 numbers are released, which should be sometime in March.

Back in May of 2007 I expressed incredulity over the level of M&A activity, the premia that were being paid, and the amount of debt used to finance those deals (see The Future of Corporate Performance and Dumbfounded by the Data). I predicted that many of the deals fueled by cheap, and excessive, debt (and supported by specious strategic and economic logic) would end in failure. I wrote:

It seems that hardly a day goes by that I don’t pick up a paper and see a headline about a deal (whether a private equity deal or a deal involving a [strategic] buyer) that doesn’t make me scratch my head…the sheer volume of deals and the premia that firms are paying these days are eye popping.

[W]hen (and how) will this madness end? I wouldn’t be surprised to see this episode end ugly…it’s just a matter of time before we witness an increase in distressed companies, an increase in default loans, and an increase in insolvency. At some point firms will be unable to service their monstrous debt obligations.

Although not all of these deals will end in failure, the sheer quantity (and volume) of deals makes me wonder if in a few years we’ll wonder what the heck we were thinking. My guess: YES!

I specifically mentioned Sam Zell’s April 2007 acquisition of the Tribune Company.

I’ll be interested to see how a firm like The Tribune Company, under the leadership of Sam Zell, will be able to pay off its debt – at 10.7 times earnings – in a business (newspapers) where cash flows have been steadily declining.

Well, yesterday, we got our answer. The Tribune Company won’t be paying off its debt.

As reported by Reuters (see Tribune Files for Bankruptcy):

The publisher of the Chicago Tribune and the Los Angeles Times declared bankruptcy on Monday as the U.S. newspaper industry’s unrelenting loss of readers and advertisers claimed its biggest victim yet.

Tribune Co, which owns eight major daily newspapers and several television stations, filed for Chapter 11 bankruptcy protection after collapsing under a heavy debt load just a year after real estate mogul Sam Zell took it private.

Tribune’s bankruptcy filing is the latest chapter in the unraveling of the leveraged buyout boom which saw many companies bought by private equity firms and other investors ending up with massive debt loads.

Sadly, this is not the end of this story, but only the beginning. Expect to see similarly debt-saddled companies declare bankruptcy in the months and years ahead.

For those of you who follow this blog, you know where I stand with respect to aid for GM versus aid for Chrysler. For GM, I have not opposed some form of aid – be it before, or after, bankruptcy (see Pre-packaged Bankruptcy for GM Unlikely). However, I support aid to GM only on the condition that ample taxpayer protection is in place. I wrote:

I have been adamant that whatever aid the taxpayer provides comes with properly structured terms, with properly structured incentives, and at a hefty price to current shareholders, creditors, and management.

In particular, in the case of GM, conditions for the receipt of aid could include:

1. The ousting of current top management
2. A moratorium on mergers and acquisitions
3. A renegotiation of employment terms with the UAW, …with all options on the table
4. The rationalization of brands – for GM my suggestion would be to keep only Chevrolet, Cadillac, Opel, and potentially, Buick (given its standing in the China market)
5. A shutdown of all plants tied to brands that GM will no longer manufacture, and a consolidation of the remaining brands into a few, select plants
6. Incentives (in the form of tax credits) to produce smaller, more fuel-efficient automobiles

Although these terms seem fairly onerous, such terms (or variants thereof) provide the only reasonable chance left to derive some value from GM.

I have been an advocate for aid to GM because of its systemic importance to the U.S. economy (see Preventing Moral Hazard in the Auto Industry). I wrote:

Ford and GM are on stronger footing than Chrysler in terms of design, quality, operations, global footprint, and so on. Therefore, the plight of GM and Ford bear greater resemblance to a liquidity problem. By providing capital to those two firms, we are making an investment in firms whose products are more fundamentally sound, but that find themselves temporally underfunded. The money would therefore help tide them over until the crisis abates.

By contrast, Chrysler is closer to insolvency than its larger brethren (see Is the End Nigh for Chrysler for details). Any money invested in Chrysler is therefore likely only to delay the inevitable. Moreover, Chrysler is less systemically important than either Ford or GM. It is not even 1/3rd the size of Ford. It’s owners are not dispersed individuals and institutions to which many American pensions are tied. Rather, it is owned by Cerberus, a private investment firm. This raises another issue – whether the use of taxpayer money to bail out Cerberus, a private investment company that was the poster-boy for excess during the credit-fueled private equity binge, is justified in the first place.

For these reasons, I do not support the use of taxpayer funds for Chrysler, which has requested $7 Billion in initial aid (see Chrysler seeks $7 Billion).

As far as I am concerned, Cerberus should be left to reap what it has sown. If it wants money to invest in Chrysler, it should do so itself, or find private sources of external funding.

Sure enough, Cerberus has engaged in its own method of crying for capital. First, Cerberus offered to forego profit on its investment should the U.S. government inject capital into Chrysler (see A Benevolent Cerberus). Next, Cerberus tried to assign blame for Chrysler’s fiasco to Daimler (see Cerberus Claims It was Misled, …hat tip Tom). According to the Connecticut Post:

Relations between Chrysler’s current and former owners turned ugly Wednesday when private equity firm Cerberus Capital Management LP accused Daimler AG of “intentionally and materially” misleading Cerberus before the German automaker sold Chrysler last year.

These tactics are not only transparent, but reek of desperation. They attempt to mask the true, underlying problem: Cerberus made a lousy investment in a severely troubled auto manufacturer.

In my opinion therefore, before the taxpayer seriously considers an injection of capital into Chrysler, Cerberus’s investment ought to be completely wiped out. That would only happen in bankruptcy. Then, and only then, might the U.S. taxpayer reconsider.

Until that happens, the answer to Chrysler should be an unequivocal, and steadfast, “NO!”

Today GM presented its case for a taxpayer funded bailout (see GM Asks for $18 Billion). While GM’s plan of action comes close to addressing the concerns that plague GM, I am not certain that it goes far enough.

Last week I detailed what I thought it would take to right GM (see Pre-packaged Bankruptcy Unlikely). I wrote:

I have been adamant that whatever aid the taxpayer provides comes with properly structured terms, with properly structured incentives, and at a hefty price to current shareholders, creditors, and management.

In particular, in the case of GM, conditions for the receipt of aid could include:

1. The ousting of current top management
2. A moratorium on mergers and acquisitions
3. A renegotiation of employment terms with the UAW, …with all options on the table
4. The rationalization of brands – for GM my suggestion would be to keep only Chevrolet, Cadillac, Opel, and potentially, Buick (given its standing in the China market)
5. A shutdown of all plants tied to brands that GM will no longer manufacture, and a consolidation of the remaining brands into a few, select plants
6. Incentives (in the form of tax credits) to produce smaller, more fuel-efficient automobiles

Although these terms seem fairly onerous, such terms (or variants thereof) provide the only reasonable chance left to derive some value from GM.

Although GM’s plan does not go as far as that which I proffered, I have to admit that it represents a step in the right direction. As reported by the New York Times:

G.M., the world’s largest automaker for decades, said Tuesday that it was in such dire straits that it would deeply cut jobs, factories, brands and executive pay as part of its plea to get $12 billion in federal loans and an additional $6 billion line of credit.

To get the loans, G.M. is taking an ax to its money-losing North American operations from top to bottom.

G.M. said it planned to focus on four core brands — Chevrolet, Cadillac, Buick and GMC — and either sell, eliminate or consolidate the Saturn, Saab, Hummer and Pontiac brands.

Despite having radically downsized its operations in the last three years, G.M. said it would cut another 20 percent of its factories and jobs, seek to renegotiate the terms of $66 billion in debt, and push to reopen contract talks with the United Auto Workers to reduce labor costs.

The cutbacks will extend into the executive ranks as well. G.M.’s chairman, Mr. Wagoner, and its board members will reduce their compensation to $1 in 2009.

The company said it would sell its Hummer and Saab brands, shrink its Pontiac brand into a specialty, niche-vehicle division, and explore opportunities to sell, close or consolidate the Saturn brand…

G.M. said it planned to reduce the number of salaried and hourly workers in the United States to 65,000 to 75,000 by 2012 from the current 96,000. The company also said it would reduce its number of factories to 36 from 47.As it moves to shrink its operations, G.M. is setting up tough negotiations ahead with its debtholders and the United Auto Workers union.

Mr. Henderson said that G.M. would try to negotiate a reduction in its debt to about $35 billion from $66 billion. While he would not go into specifics, the company is expected to ask bondholders to take equity in exchange for reducing their payout on long-term bonds.

G.M. will also seek to cut its labor costs by re-opening its contract with the U.A.W. Crucial targets for cost cuts in the contract include eliminating the so-called “jobs bank” that pays idled workers when their plants close, and other job security provisions.

My proposal, and GM’s offer, differ in a few key areas.

GM has proposed to keep the GMC brand, presumably to preserve its line of light trucks. That I can understand. However, it is my opinion that Saturn and Pontiac should not be rolled into other brands or become niche products. They should be eliminated!

GM has also agreed to reduce the number of factories from 46 to 37. That is not nearly enough. The target number should be closer to 30 than 40. In addition to plant closures, GM suggested that it would reduce headcount by 20,000-30,000, …but only sometime within the next 4 years. They need to be more aggressive on that end. In my opninion, they should shed 20,000-30,000 in staff by 2010 (the latest), and aim for a total reduction of 40,000 by 2011.

With respect to the UAW contracts, the details that I saw addressed the “job banks” program. The union needs to get realistic. If it thinks it can get through this episode with the “job banks” program as its only concession, it is deluding itself. All options need to be on the table including health benefits and hourly wage rates for current (and not just future) GM-UAW employees.

And while I appreciate the “symbolic” gesture of Mr. Wagoner to accept $1 in remuneration for his services, I see no reason why he, Bob Lutz, and the rest of the executive team should remain in place. Should we trust them to engineer a successful restructuring of GM when they had been unable to do so on several previous attempts? It’s high time that management move on.

Finally, there is the issue of taxpayer protection. I saw nothing detailing how the taxpayers would be protected should they provide funding. I would like to see GM be more forthcoming about the precise terms (deal structure) it is willing to accept in exchange for this $18 Billion capital infusion.

But to be fair, for all the derision leveled at GM over the past several months, this offer was not half bad. We’re now just waiting for the other half, …which will come only at the insistence of the taxpayer.