AIG Drives GM Bankrupt

General Motors is going bankrupt.

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By now everybody knows that GM will not survive without a bankruptcy reorganization. President Obama has said that he will expect (require?) the bankruptcy soon.

Why?

GM makes plenty of money. It uses various accounting practices to avoid reporting a profit from its annual sales. And these practices are normal, ordinary, and legal. There is nothing wrong with reporting their income the way that GM reports theirs.

But it does make them look a lot less profitable than they really are.

It is worth noting, also, that GM make most of their sales during certain months of the year. In the autumn when new models are released, the make money. And they make money during the summer when people are out driving about and feeling good and prosperous. They don't make much money in the dead of winter. And they don't make much money in the last weeks just before the new models are released.

During the times when GM's sales are high they make enough money to keep them going for the entire year. But it is real hard to use this revenue to meet their day to day costs for the whole year. The available cash is just too bumpy and unpredictable.

That is why they use short term loans - to provide a constant availability of cash for the operational use of the company.

Corporate bonds are a great instrument. They are bought and sold through well regulated markets and their values are expressed in terms we all know how to understand and use.

A bond is issued at a specific value, say $100. This is its par value. It is sold at a price which is less than its par value, for example $70. This is its discount value. At the end of the bond's term it is bought back at full par value. Corporations can also buy them back early at markdown rates based upon market conditions.

Discount values for corporate bonds fluctuate as rapidly and as sharply as pork bellies or any other commodity. Banks don't like corporate bonds because of the fluctuation in their discount values.

During the last several years, banks have been combining corporate bonds under the CDO (Collateralized Debt Obligation) umbrella. CDOs are virtually illiquid. Mostly you can buy or sell them only with the entity that created them. Banks love CDOs because they are stable in value.

How does AIG come into this picture?

CDOs have another neat feature for banks. You can insure the value of a CDO by buying a CDS (Credit Debt Swap). A CDS is an insurance account for the par value of a CDO.

This is like an insurance policy on your home if it offers "full replacement coverage" against disaster.

It is a smart idea to buy a CDS for each CDO you own.

AIG wrote most if not all of the CDSs for the CDOs that were derived from GM bonds.

How is this driving GM into bankruptcy?

Last year the US government bailed out GM from a short term cash flow crisis and gave them instructions to reorganize their debts.

The thinking was that all of the holders of General Motors' corporate bonds would be forced to take a markdown in the discount value of their bonds.

Finances are supposed to work like that.

But the holders of CDOs derived from GM corporate bonds were insured for their full par value by AIG CDSs. And all AIG CDSs were guaranteed by the US government for their full par value. Therefore the holders of these CDOs said, "No, we're not going to take any markdowns. We are insured for the full value."

As a result, GM could not force the discount value of their bonds down and they could not buy them back at a low market value rate.

When you can't pay your creditors off, they come to collect. This is what has happened to GM.

So think about this:

If AIG did not insure the value of the CDOs derived from GM bonds, their value and the value of GM bonds would naturally decline. And GM could buy them back at a lower rate, and preserve enough cash to continue to operate. But the United States has guaranteed the value of the CDSs issued by AIG against those CDOs, so their value cannot decline. As a result, GM has no takers when they offer to buy back their corporate bonds at a discount value less than they were initially sold.

That's why General Motors is being forced into bankruptcy.

This is a case where the US government should get out of the market.

PPIP is a fraud - What Really should be done

The newest attempt by the U.S. Treasury department to bailout the mortgage crisis is just another failure.

In theory it encourages investments into worthless Collateralized Debt Obligations (CDO) by using a combination of public and private money to purchase them at auction.

In fact, the private money can be as little as 7% of the total purchase price and the "auction" has little to do with what you and I consider to be an auction.

What will happen in reality is the CDOs that still have value will be purchased at a deep discount by leveraged offerings of a little bit of private money and a lot of public money. The private investor will make a killing.

Meanwhile the worthless CDOs aill be purchased by a little bit of private money and a lot of public money and the originating mortgage owner will still default. The CDOs will become very worthless and will be sold on the secondary market to debt and bill collectors who will end up with the property. If the secondary market investor is the same as the auction purchaser, he will make a huge killing after he collects the defaulted property. Even if they are distinct entities, the auction purchaser will only lose 7% of his total investment and the seconday market investor will still make a killing on the property claim.

As you can see, nothing happens to reduce the evictions of home owners. Nothing happens to protect the taxpayer. And nothing happens to make credit actually flow again.

Here is what should be done.

Let's start by asking several questions:

1. How many CDOs have been issued?
2. What is the issuing value of each?
3. What mortgages were combined to costruct each CDO?
4. How much is each mortgage worth now?

Answering these questions is called unwinding the CDOs.

When you have unwound each CDO, you can compute it's remaining value. Some of them have the same remaining value as they had when they were issued. Some of them are worthless.

All CDOs should be rated accurately as to how much value they still have. If all of the mortgages which back the security have paid 100% on time, the CDO should be given a 100 rating. If all of the mortgages which back the security have defaulted, the CDO should be given a 0 rating. If half have defaulted but half have paid and are paying fully and on time, the CDO should be rated 50. And so on.

CDOs which are rated like this have a value and can be publicly and honestly traded. CDOs which have no rating have no value.

We must establish a public system of rating financial instruments.

How Many Toxic Assets Are There?

Has anyone counted this stuff?

I am dumbfounded daily at the reporting and journaling of the "financial crisis" that we are in.

We know that Collateralized Debt Obligations (CDOs) are the root of our current problems. We don't know 2 very important things:

1. What is the combined worth of the CDOs that have been issued?
2. How many CDOs were actually issued?

Have you heard either of these two issues discussed in any analysis of this stuff?

Exactly how much is the dollar value of all of the CDOs that were produced? It is always given as more than 3, 10, or 18 trillion dollars. Tweny trillion dollars is greater than each of those numbers, and so is 18 trillion and 1 dollar.

So, what is the actual dollar value of the CDOs that were written? (It is sufficient to report par value at this point.)

And how many CDOs were written? Was it one CDO or was it 18 trillion?

Finally, how many CDOs were bad, i.e. had at least one of its constituent mortgages defaulted upon?

Not every CDO is constructed from defaulted mortgages. Not every CDO is actually worthless.

When Western Union Bank unwound their CDOs and sold them at market value, they went for an average of 19% of their par value. That's not bad.

All notes are sold at discounted values from their par value. Even U.S. Treasury notes are sold at discounted values.

Let me ask again, just one last time, how many are there and what is their aggregate value?