Fallen Angels, in financial language, are companies that used to have an investment grade rating and have been downrated to “junk”. In normal language, they are companies which used to be a good risk as borrowers but are now considered by the rating agencies to be a poor risk (with a much higher chance that it will default on its debt).

(Yes, yet another graph of things improving under Clinton and falling apart under Bush)

GM is likely to become a Fallen Angel this year, and I would argue that the US economy is not far behind.

Well, GM has been put by Standard & Poor’s, one of the three main rating agencies, into a list of 50 companies (pdf, 10 pages) likely to become “fallen angels” this year. This came from S&P’s decision on March 16 to revise GM’s outlook from “stable” to “negative”, i.e. announcing that the next likey change in rating was downwards. 291 billion dollars of debt were thus put into a twilight zone, sending jitters through the markets on various occasions, especially following its latest bad news (a quarterly loss of 1.1 billion $) last week.

The interesting thing to note here is that the market is already behaving in some ways as if the downgrade had taken place: the interest rate required on GM bonds has shot up in recent weeks and is firmly in junk territory, i.e. it is becoming more and more expensive for GM to borrow money:

What has not changed yet is that, thanks to the fact that it still keeps its investment grade rating, GM can still have its bunds purchased by most fund managers, many of which have strict rules on what they can and cannot purchase, and “junk” bonds being a very frequent exclusion. Mant fear what would happen if 300 billion dollar worth of bonds switched turned into junk and a number of fund managers were forced to sell. That amount would constitute around 10% of the junk bond market and would be quite hard to absorb.

Despite soothing headlines in the US press (GM won’t face Cash Crisis If Ratings Get Cut, in the WSJ), you sense that the financial press is getting itchy, noting that GM’s financial costs amounted to 12 billion dollars in 2004, up 26% from 2003, and likely to increase significantly again this year.

Standard & Poor’s expect why you should worry: “fallen angels” are twice as likely (pdf, 29 pages) to default as companies that were rated “junk” (or “high yield” if you want to look at it with a positive spin) from the start.

British business papers put it more directly: How much worse can it get? in the Economist, and Rotten cars, not high costs, are driving GM to ruin in the Financial Times.

These two articles focus on what’s wrong with US car companies:

For the past two years the threat of collapse has hung in the Detroit air as America’s car firms have wrestled with falling sales, unprecedented competition at home and soaring retirement and health-care costs for current and former employees. No one really expects either GM or Ford to seek Chapter 11 bankruptcy protection this year or next, but the likelihood is growing fast that they will do so eventually.

GM’s cash outflow from its car business was $3 billion in the first quarter, 50% more than it had forecast for the whole year.

(…)

And the more that Detroit’s finest retrench, the greater the burden of their “legacy” retirement and health-care costs will become proportionately: GM now has 2.5 pensioners for every current employee. In 1999, a deal between Detroit’s big three carmakers and the United Auto Workers Union (UAW) included generous healthcare benefits for pensioners as well as workers. These are locked into labour deals that run until 2007.

The Economist focuses on the “legacy costs”, i.e. healthcare and pensions. Predicatbly in view of that paper’s laisser-faire ideology, they blame that fact on the Unions, which have made the car manufacturers unprofitable:

But at least they point to a real problem: companies are not very good at providing health care and pensions for their employees: either they do a decent job at a high cost, or they do a bad job.

The Financial Times is even more scathing and to the point: the companies are losing money and being downgraded because they make bad cars and no amount of financial engineering (the usual solution) will help here. Unions or pensions are just side shows, hiding the core problems:

GM’s problems stem not from its spiralling healthcare costs but from its inability to build cars worth buying.

The Grand Prix is a case in point: cheap plastics, uncomfortable seats, bone-jarring suspension, the exterior dimensions of a large car combined with the interior space of a small car.

The US car-buying public agrees.

(…)

Is lack of resources to blame for this procession of disappointing products? It does not help. Healthcare costs add $1,500 to the cost of each new GM vehicle, putting pressure on design engineers to use lower-grade materials and off-the-shelf components. Yet resource allocation remains by far a bigger problem. For example, while Toyota and Honda were investing in gasoline-electric “hybrid” engines, GM pumped research and development dollars into hydrogen-powered vehicles that remain years away from mass production. The result is that the world’s biggest carmaker has nothing to compete against the new breed of hybrid vehicles led by Toyota’s Prius.

Similarly, while the Japanese companies were investing in their core products, GM squandered capital on the acquisition of Saab, the niche Swedish car company, and a questionable investment in Fiat.

(…)

Yes, GM needs to find a way to reduce pensions and healthcare costs. But this is a necessary, not sufficient, condition for a turnround. A company happy to inflict the Pontiac Grand Prix on its customers does not deserve to thrive.

To be frank, this sounds just like the US economy as a whole: with an increasing, and increasingly worrying, debt burden (which, had it be borne by any Third World country in would have brought the IMF in), distractions about pensions, while the country’s competitivity keeps on going down.

Would you have guessed that France and the Netherlands together export as much as the US, with little over a quarter of the population and “sick” economies? Not to mention Germmany’s performance, of course…

What was good was GM was good for the US. What is wrong with GM is also what’s wrong with the US economy.

– when the business/economy slows down, flood it with cheap credit (“keeping America rolling”) and generally rely on financial tools and generous debtors to keep going;

– fragilised by the increasingly heavy burden of pensions and healthcare;

– most of all, totally dependent on the availability of cheap oil (fuelling SUVs, sprawl, McMansions and outsourcing to faraway suppliers)

As I wrote in recent diaries, these are not going to improve soon, and both GM and the US economy are likely to get into even direr straits in the near future.