GMAC, GM, Covered Bonds and GDP

July 31

GMAC Reports $2.5 Billion Loss on Auto, Housing Slump (July 31 - Bloomberg)

GMAC LLC, the auto and mortgage finance company majority owned by Cerberus Capital Management LP, reported a $2.5 billion loss as car leasing shrank and the housing slump boosted foreclosures.

The second-quarter loss, GMAC's fourth straight, compares with profit of $293 million a year earlier, the Detroit-based company said today in a statement. Losses at the Residential Capital LLC home lending unit jumped to $1.86 billion from $254 million a year earlier, and ResCap suspended almost all production outside the U.S.

If GM, as it is said, is a finance company with a car company bolted to it, the above is dismal news.

Because now the car company AND the finance company are both bleeding red ink. For GMAC, part of the problem is, of course, all the bad mortgage loans made by GMAC subsidiary ResCap, better known as the parent company of Ditech (“Where getting a loan is easier than getting a pizza!”).

However, auto leases are a new problem, with people returning gas guzzling SUVs in record numbers, SUVs which are now worth less than the residual value of the lease. Which means GM is losing money, first when it makes the car and later on when it takes it back.

Oddly enough, GM’s stock price is mildly green today. Whoever is buying that stock today is not reading the same news that I am. Nor, apparently, are the bond investors.

GM's debt protection costs hit new record (July 31 - Reuters NEW YORK)

The cost to insure the debt of General Motors Corp (GM.N: Quote, Profile, Research, Stock Buzz) hit record highs on Thursday after finance company GMAC LLC reported a $2.48 billion loss for the second quarter and one day before the automaker reports its second-quarter results.

GM's benchmark long bonds hit a record low below 50 cents on the dollar, pushing their yields past 17 percent.

Five-year credit default swaps on GM's debt jumped to 41.5 percent of the sum insured, from 38.35 percent on Wednesday, plus annual premiums of 500 basis points, according to Markit Intraday. This means it would cost $4.15 million in a lump sum to insure $10 million in debt for five years, in addition to annual payments of $500,000.

Now this is the sort of reaction I would have expected from the terrible GMAC news. What this article is saying is that the holders of GM bonds that want to insure themselves against the possibility of a bankruptcy or default event by GM over the next five years have to pay 41.5% of the bonds' face value up front PLUS an additional 5% each year. This means that the bond holders, who are first in line for repayment in the event of a bankruptcy, are taking the prospect of a GM bankruptcy very, very seriously.

On the other hand, we have the GM stock buyers calmly buying up GMs stock, despite the fact that they’d lose everything with no recourse in the event of a bankruptcy. Something is very odd here…could it be that the general public pays more attention to stock prices than bond antics and that keeping the stock price elevated is a means of keeping confidence in the marketplace at a dicey time? Either that, or there are a whole lot of very unintelligent stock buyers out there...

U.S. Economy: Growth Rate Falls Short of Forecasts (July 31 - Bloomberg)

The U.S. economy shrank at the end of 2007 and grew less than forecast in this year's second quarter, signaling that the country is in worse shape than investors had anticipated.

"We're in a recession," Allen Sinai, chief economist at Decision Economics Inc. in New York, said in a Bloomberg Television interview. "It's going to widen, it's going to deepen."

Gross domestic product increased at a 1.9 percent annualized rate, the Commerce Department said in Washington, compared with the median projection of 2.3 percent in a Bloomberg News survey. The Labor Department said separately that more Americans filed claims for unemployment insurance last week than at any time in more than five years.

Yes, we’re in a recession, and, yes, corporate profits are going to fall, and, yes, corporate bankruptcies are going to rise as a result of the twin pressures of reduced economic activity and tighter credit conditions. Somehow, through all of this, the S&P 500 is up 75 points over the last 15 days. Either the stock market knows something I don’t (very possible), or it is behaving irrationally.
At any rate, this was about as ugly a report as could be expected. As you know, the GDP report is so heavily massaged with imputations and the use of an alternate inflation measure (that is itself a fraction of the widely discredited CPI measurement) that it is hardly useful as a barometer of anything more than the extent to which statistics can be tortured. Even with all the fluffing and buffing, this report reads very poorly, which tells those of us who read between the lines that the real economy is shrinking at a disturbing rate.

My theory here is that the stimulus checks and Fed-sponsored liquidity party are not going to boost the real economy at all. And I think this way mainly because I see daily shenanigans in the marketplace that lead me to believe that the vast majority of the money injections are siphoned off before they ever have a chance to get out into the real world where they could do some good.
I believe the SEC is fully aware of these shenanigans but has opted to look the other way, preferring to look busy on small-time matters of no relevance while the same game that brought us to this spot continues to be played.

Covered Bonds, Exposed Taxpayers (July 30 – Business Week)

Treasury Secretary Henry M. Paulson Jr. is promoting covered bonds, a mortgage-financing vehicle popular in Europe, as a safer way to raise money for home buying in the U.S. The question is, safer for whom? If covered bonds catch on, they will magnify the losses the Federal Deposit Insurance Corp. suffers in the case of bank failures, thus exposing taxpayers to the risk of more big bailouts.

To put it bluntly, covered bonds wouldn't reduce risk as much as transfer it from bond buyers to the U.S. taxpayer. Surprised? No wonder, since this hasn't been a big theme of the Treasury Dept.'s publicity blitz.

Here's where the risk to taxpayers comes in: If a bank goes belly-up for whatever reason, owners of the covered bonds stand in line for payment ahead of the FDIC. The FDIC must pay off the bondholders in full even if that means there's not enough money left to pay insured depositors. The FDIC has to make up the difference out of its own insurance fund. And, of course, if the insurance fund runs low, taxpayers have to ante up.

"Promoting covered bonds is really a way to compartmentalize and shift risk to the FDIC and uninsured depositors," argues Robert A. Eisenbeis, a former Federal Reserve and FDIC official who is chief monetary economist at Cumberland Advisors, a Vineland (N.J.) money manager.

No wonder Wall Street cheered the Covered Bond news with a big rally. It is just one more way for Hank Paulson, a former Wall Street Exec with Goldman Sachs, to help transfer risk to taxpayers. What a gross abuse of the public trust. I’ve got an idea:  Why don’t banks issue mortgages and hold them as assets? It’s a wacky idea, but it would work like this: A bank would be fully on the hook for the success of the loan, and so would be incentivized to assure that it was a safe investment. Hence, they’d probably make safer loans, and there would be less chance of the loans going bad and a better chance of the bank not going into FDIC receivership. You know what? That’s pretty much how it used to work.

Now? Things are so far over the edge that the Treasury Department and Wall Street cannot figure out any other way to ‘repair’ their mistakes other than to come up with new and more clever schemes to assure that their profits remain private while the risk becomes public. I am still waiting for the first ruling or proposal from the Treasury Department that does not stiff the taxpayer while helping Wall Street. Mr. Paulson has simply spent too much formative time working as a Wall Street insider to have any objectivity left. He probably truly believes that each of his proposals makes sense and is good for the country, and I can’t fault him for that.

What I can fault him for is failing to understand that 99% of the country has no concern over next year’s profitability for Wall Street firms and would prefer to have all that taxpayer money back so it could be spent on winter heating bills, bridge repairs, and alternative energy tax rebates.