Given the real possibility of the bankruptcy of GM, Ford and Chrysler, the bonds for these listings are at levels that are tough to ignore. These bonds are yielding at extreme junk bond levels. This is tough to ignore because you can quadruple your money in a few years if the companies recover, but also tough to ignore because institutional investors are dumping them for 25 cents on the dollar because they are pricing in bankruptcy. Which side of this bet do you want to be on?

On a day when the Dow broke through 5-year lows below 8,000, Congress readied to pass on the opportunity to save the automakers during the current lame duck session. The topic is now likely to go to unaddressed until next year. In a game of chicken of sorts, Senate majority leader Reid cited Treasury Secretary Paulson's ability to use the TARP funds to provide the $25 billion loan being requested. However, if I recall, there was no mention of automakers when that bill was passed. Paulson's already under fire for changing course on the TARP once post passage. This one would draw significant ire. Where would it end? The airlines? Dotcoms? The funds weren't meant to bail out floundering industries. Today, congressional leaders focused on grandstanding, questioning whether the auto executives were going to sell their corporate jets and fly back to Detroit coach...anything to get a sound bite. At least they're not repricing their employee stock options like Silicon Valley!

Bankrupty Implications

By many estimates, just one of the big three going down would result in the loss of 2.5 million workers. We would fast approach a double digit unemployment rate in this scenario. As unthinkable as this is, bankruptcy is not the end. Recall what happened to the steel industry upon emergence from bankruptcy? They shed the unions, shoved pension commitments on taxpayers and emerged surprisingly strong, able to compete with Japan dumping and emerging market competitors (not much to show for the share price this year of course, but there were some great years to own US steelmakers).

The ripple effect would be enormous. It's a surprising small family when considering the shared supply chain, community, dealers, etc. I don't doubt estimates ranging in the millions for total job losses as a result of a single bankruptcy filing.

Valuations

Ford and GM shares are now yielding low single digits, losing almost all of their value in just a few short years. Don't even think about buying these for the high yields showing in YahooFinance; you're not getting any dividends out of these dogs. Bonds are trading well below par, at about 20-25 cents on the dollar. According to cbsmarketwatch, prices at these levels, or about one-fifth of the bond's face value, are similar to the recovery rate bondholders often see after a company goes through bankruptcy and indicate investors think a government bailout unlikely. If these companies actually recover, you could see a 4x return or more on your bonds during your holding period. If they fail, you could end up either losing your money, perhaps getting the recovery fee of anywhere from 10-30%, or you may end up with equity in the restructured shares of the entity that emerges from bankruptcy.

Unions

It's interesting to see that the unions haven't really talked about concessions at all. I heard some typical finger pointing on the radio today without saying anything like, "we're going to work on a new contract to make this work" of "we need to sacrifice too to save jobs". The leader said, "maybe they'll learn their lesson for their poor management...". This debacle clearly can't be blamed solely on unions. Poor quality, designs, missing the fuel-efficiency trend, etc. didn't help. And management did in fact avoid strike after strike by signing on to ever more restrictive contract terms (isn't the whole incentive of a union leader to get everything you can for your members?). Now, they're saddled with 95% payouts to idle plant workers, which economically, forces plants to continue to churn out models that aren't even selling because they're paying close to full salary for idling plants. These models then lose $3000-4000 per unit in legacy costs to union healthcare, pensions and benefits.

If bankruptcy is the end game, the companies get to shed the pension obligations and taxpayers pick up the bill. So, as incensed as taxpayers are about the potential bailout of yet another industry, the Pension Guarantee Insurance Corp ends up taking up these obligations and it draws from taxpayer dollars.

Disclosure: No position in any equities or bonds mentioned in this article at time of publishing.

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