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Call it what it is, pawn cars

By Martin Davies

23 February, 2009

The acronym GM should be renamed from General Motors to Gross Manipulation and while there are some that reckon I am heavy handed with my criticism of the US government response to the General Motors collapse, I stand by view.

Oh I hear the argument that if GM fails the outcome to the manufacturing supply chain may be devastating; huge job losses could amplify the broad decay of the US economy further (if that is possible with interest rates hovering above nothing) and lead the world to a deep seated recession as marginal retail consumption declines. Personally I believe the world is greater than General Motors however the domain I am going to pitch from in this article is NOT some rhetoric to argue this point.

I simply believe we should paint it as it is; an angel or a prostitute even though one can be both. It is in that, the inability to see ourselves for who we are or perhaps the lack of being honest with real outcome which is a major play on the entire financial crisis. No regulation can resolve what has and inevitably what is likely to be again unless we truly accept what is.

Without digressing too much, there are three key maxims that to me I question from a moral perspective. These need to be painted as they are even though they may be well intentioned.

The Structured Finance Maxim
In structured finance we have broadly three types of duration in funding: They are short, medium and long term funding. The exact delineation of when funding is short, medium or long has disparate consensus however nearly all agree that using long term funding for short term problems is a portentous decision.

You don`t finance capital expenditure projects on revolving credit such as an overdraft or plastic (please I would like to buy that house on a credit card) unless you are American.

Why? - Simply, the compounded risk priced hurdle rates destroy the intrinsic net present value from the working capital that pursues from the investment.

It thus follows that you don`t apply long term funding to short term liquidity issues because little intrinsic value is normally created from the funding. The result of which generally dampens the distant valuation of the firm while the liability remains.

The process of cash debt sweeping as it is often called generally does have a short term positive outcome as a real higher debt charge when measured as a single payment strip is spread across a long term commitment. In the end however, the firm will continually pay in the future for what it consumed deep in the past and the final or effective charge is normally higher reducing the ability of the business to re-borrow.

Put it another way, one has to be hopeful that cash debt sweeping meets the ends it is designed for as most businesses can only use this joker card once in a game.

Where does it lead us? In the light of a company such as GM which is clearly a cash addict (it did go to the senate with its pants around its ankles) probably to more handouts or additional support such as import protection, early tax redemptions or even exemptions.

The Capitalist Maxim
In communist government regimes, the line between the public and private sector is hazy. Now I am not going to defend either economic principle (there are benefits and pitfalls with both) but if you state you are a capitalist market free society then be true to yourself. What the market wanted to expel, short, liquidate and consolidate the government defends. Worse it does this with tax payers funds, the very tax payers that sold GM stock on the exchange in the first place.

Good or bad, makes no difference however it is what it is.

When you pay a tramp like GM; they will all start to come out from every dark damp corner of the market, begging with their hands out.

The porn industry has been hurt by the downturn like everyone else and they are going to ask for $5 billion from the US government
- CNN

How do we value the porn industry? - Does it really matter?
The US government clearly didn`t value much when it sent funds to GM but I tell you the porn industry is probably a lot more exciting than driving an overpriced mediocre automobile manufactured in Detroit.

Side Track Regulatory Maxim
Late last year GMAC won Federal Reserve Approval to become a bank enabling the auto lender to access funds that were `estimated` and set aside for the banking community.

Why should the banks have access to Federal Reserve funds and not private companies a lot of people ask me, surely that is inequality?

The Federal Reserve sole purpose today as it has always been is to support the banks and it does this in good and bad times to control the heating or cooling effect of the economy. By directly manipulating the money supply to banks and inevitably the producer and consumer, the change in interest rates will ultimately alter the savings function of the nation.

Back to our GMAC animal, it is all quite ironic really as this beast is an avid fan of the SPV securitization market and has a history playing with such things well back in the days of Enron. Now of course GMAC is a bank not a finance house and a bank which needs to hold capital, a bank that needs to implement lending practices like any other regulated entity and in GMAC`s case it needs to at least pretend to reach some form of regulated decorum as the others in the ostensible dib-dib-dib toffee banking club have done.

Ladies and gentlemen we have Freddie, Fannie and now a GMAC; all sordid creatures conceived in similar vein and I fair the story is going start all over again. Remember one thing though, you have to call it what it is otherwise the pain of the sub-prime crisis isn`t going to be a lesson.

About the Authors

Martin Davies is a principal consultant risk based banking SME and a managing partner within the business solutions competency at Causal Capital.

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