Moon of Alabama Brecht quote
April 24, 2005

Fallen Angels

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.


Posted by Jérôme à Paris on April 24, 2005 at 21:24 UTC | Permalink


what's bad for the U.S. economy, bad for the global economy.

Posted by: | Apr 24 2005 21:53 utc | 1

Jerome, would you kindly clarify something for the financial illiterates among us?

I read that GM's market cap. is $16B, but it's debt ~$300B. What is the relationship, if any, bet. Market Cap. & the value of it's assets? Why would the former be the key statistic rather than the latter. To my untutored mind, I would think they'd be okay if there assets were greater than their debt, yet I don't see discusssions mentioning this.

Another thing that no one mentions, is that the underlying problem is that our country has been taken over by Unca Miltie's Radical Right Economics, so that effectively we have no government left to step in when Corporations start heading down Disaster Lane.

(The reason this crap is coming out now, rather than several years ago as it should have - i.e. in time to prevent disaster - is 'cuz it's part of the Elite Agenda to destroy American system of medical care & pensions etc. for retired workers so they can more easily merge xUS w/Mexico.)

Posted by: jj | Apr 24 2005 22:01 utc | 2

Looks like Morgan Stanly is being ripped apart as well in clash of egos & Towering Arrogance

Posted by: jj | Apr 24 2005 22:17 utc | 3

i didnt know that germany, at about 1/3 population and struggling with the problems of reunification is exporting more than the US. i am awestruck.

somehow the stats and the comment on the crappy products by GM reflect on where the US has been led by successive demagogic regimes hateful of the working classes.

an insightful essay about the coalition of statist theocrats who currently control the US can be found here.

regarding the double-bind between the US economy and the rest of the world and which is pulling everybody towards the abyss, better an end with horror than horror without end.

Posted by: name | Apr 24 2005 22:35 utc | 4

Speaking of debt, I hear GMAC is bigger than the car division...they make more money financing those interest-only mortgages. Tell me, how is an interest-only loan really any different than a lease. You get low monthly payments at a low rate coupled with a crippling balloon payment at the end. At least they can't ding you with parking lot dings and "high mileage" charges, but if I know the real estate industry, they'll find a way.
I remember during good times (Clinton years again) that GM was doing so well because their pensions were overfunded and they were able to skim off of that. I guess I should say now we should have seen this coming, but hell, you really should be ready for bad times as well. It's the real reason for the obesity "epidemic"-our bodies know good times don't last...

Stock Market Slump Bleeding Traditional Pension Funds; Unions Can Expect Battles Over Pension Costs at the Bargaining Table (Oct. 17, 2002)

"General Motors, for instance, saw a $7 billion pension fund surplus in 1999 become a $9 billion deficit by 2001. As a result, in April, GM had to pay $2.2 billion into its pension fund (AP, 09/23/2002). "

Posted by: doug r | Apr 24 2005 23:00 utc | 5

jj - market cap is total value of all shares - market capitalization. Market cap is the investors net valuation of the company.

Jerome - GM seems to me a case in point of how banks do NOT do due diligence with any expertise before extending credit. How could GM repeatedly go back to the banks and get more money through Smith's crackpot robot schemes to the hydrigen car without someone stepping in and demanding some serious change?

Posted by: citizen k | Apr 25 2005 0:44 utc | 6

I have to agree that GM has problems, Pontiac has some quality problems, but my two Oldsmobiles have both lasted well, Many miles, that why I thought Olds should be kept and Pontiac cut. The 3800 v-6 in these cars is one of the best GM makes.

Also, GM, Ford and Dodge still hace great trucks. If they didn't Honda, Nissan and Toyota wouldn't be trying to grab that market. I can remeber when 50, 70, 100,000 miles was alot on an american made car or truck. Now 200,000 mile with hard use is very acheivable.

The legacy cost of the big three are a problem and cars don't seem to be their specialty, though the new Chryslers are nice.

The US must do a couple of things. First, we need national health care. Thats a must. Second, GM, Ford and Chrysler must do a better job of telling their story of how important they are to the US economy. Third, they must get better quality from their car units. GM and Ford are addicted to truck and SUV profits and must take the next step fast.

Further, the US auto industry will not do well under Bush. He hates the middle class, he don't care about US industry, all does is politics. We need a Dem, they have more sympathy with unions and seem more concern with US economic needs.

Posted by: jdp | Apr 25 2005 1:38 utc | 7

When the Chinese produce a truck that's cheaper and stronger than Ford's (or Toyota's), I'll be sorely tempted to buy it. Tempted...

Posted by: alabama | Apr 25 2005 2:19 utc | 8

It tells you something about the insulated and ideological nature of the managerial class in the US that GM and Ford, facing billions of dollars in health care costs have remained safely republican. On the basis of their fiduciary duty to their stockholders, they should have been funneling PAC money to advocates of single payer health insurance.

Posted by: citizen k | Apr 25 2005 2:43 utc | 9

Read Mark A.R. Kleiman on GM:

It looks as if General Motors will be bankrupted by its health insurance obligations to retirees. That was predictable two decades ago.

It's hard to see the end of GM as anything but a gain for the art of automotive design, but it will be rather inconvenient for the shareholders, not to mention the employees and retirees.

The astonishing thing about the story is the fact that GM management was offered a way out, and turned it down. The Clinton health plan was disfigured by the inclusion of a provision that would have relieved the industrial dinosaurs, including GM, of the burden of their imprudence in promising health benefits when they were large that they could no longer afford after downsizing.

And this link from Kleiman site to Counterpunch

So much does General Motors love Canada's socialized, taxpayer-funded "single-payer" health care system, that the company's top executives in Canada, along with the top execs of Ford, Chrysler and a host of other U.S.-owned subsidiaries in Canada, actually have been lobbying the provincial and federal government to expand the system to include other services such as pharmacy and home health care-and to increase funding of what is known in Canada as "Medicare."

Just two years ago, GM Canada's CEO Michael Grimaldi sent a letter co-signed by Canadian Autoworkers Union president Buzz Hargrave to a Crown Commission considering reforms of Canada's 35-year-old national health program which said, "The public health care system significantly reduces total labour costs for automobile manufacturing firms, compared to their cost of equivalent private insurance services purchased by U.S.-based automakers." That letter also said it was "vitally important that the publicly funded health care system be preserved and renewed, on the existing principles of universality, accessibility, portability, comprehensiveness and public administration," and went on to call not just for preservation but for an "updated range of services." CEOs of the Canadian units of Ford and DaimlerChrysler wrote similar encomiums endorsing the national health system.

If the damn corporations can move to Canada, why the hell can't I? I agree with them that national health care is good for people and biz.

Posted by: fauxreal | Apr 25 2005 4:22 utc | 10

How Rick "The Rick" Wagoner didn't get fired over the Fiat fiasco is a question I'd like to see answered. $4.5B is about what it takes to bring 5 new platforms to market. GM needs to rework a few more than 5 models if it wants to survive.

Posted by: Tom DC/VA | Apr 25 2005 4:24 utc | 11

Thanks Fauxreal!

Posted by: stoy | Apr 25 2005 5:53 utc | 12

And Jerome!

Posted by: stoy | Apr 25 2005 5:54 utc | 13

jj - net entreprise value is the sum of equity and debt. Market cap is usually the value given by the market to the equity bit.

Market cap can be very low and the company still be valuable. In the case of GM, the value is in all those car loans provided by GMAC, the finance arm, which have a positive value - which is also a lot bigger than the value of the rest of the company, especially when you know that the company also has 26 billion dollars in cash...

citizen k - GM is effectively seen as a lending operation burdened by a car manufacturer, and thus a still acceptable risk. It's only now that the manufacturing part of the operations is becoming a real drain on the scheme that people start to worry.

jdp - it is precisely

Posted by: Jérôme | Apr 25 2005 6:38 utc | 14

Tom - re Fiat. I read that GM got access to Fiat's diesel engines (something they did not have and which is vital in the European market) out of the deal, as well as various platforms and cost-sharing arrangements, so the deal was not so bad for them (and that's why they agreed to shall 2 billion $ to Fiat to cancel the obligation to buy them - they had extracted the value, and would have been burdened by the rest otherwise)

Posted by: Jérôme | Apr 25 2005 6:41 utc | 15

Jérôme: I guess that since the banks have now pushed the debt onto the general market, it's not directly their problem that the debt has become volatile. But I believe that many banks are still quite entangled in GM debt due to derivatives and loans using GM debt as collateral.

To me capital allocation is a peculiar system distorted by centralization. Why is it that new business must resort to usurial venture capital, at best, while banks pour money into firms that are pointed directly at failure? HP's first finance came from a bank loan - not from a VC investment. To me, that initial loan was sounder than the huge debt infusion provided to allow the compaq merger. But it was a loan of a type that may not be possible in a far more concentrated financial market.

Posted by: citizen k | Apr 25 2005 10:47 utc | 16

interesting financial term there, fallen angel. the implicit assumption for one just reading that definition would be that companies or financial products with investment grade ratings then qualify as angels. however, in financial lingo, angels are "Individuals providing venture capital".

Posted by: b real | Apr 25 2005 15:52 utc | 17

Jerome (or anyone who might know),
if GM goes bancrupt will the good parts likely:

a) form a new company

b) be split up into different car companies

c) be bought up by a existing huge car company (Ford perhaps)

or d) none or a mixture of the above?

I realise any answer is a guess but a guess based on knowledge is better then mine.

Posted by: A swedish kind of death | Apr 25 2005 16:35 utc | 18

GM recalls 2 million vehicles

Posted by: Nugget | Apr 25 2005 17:10 utc | 19

They will try the great ripoff
- push the pension and medic insurance oblication over to the public purse
- reestablish as GM just like before

Ford has the same trouble than GM - no hope that they would try a buy out

Posted by: b | Apr 25 2005 18:40 utc | 20

slightly OT

Roach rips Greenspan a new one:

Original Sin

In all my years in this business, never before have I seen a central bank attempt to spin the debate as America’s Federal Reserve has over the past six or seven years. From the New Paradigm mantra of the late 1990s to today’s new theories of the current-account adjustment, the US central bank has led the charge in attempting to rewrite conventional macroeconomics and in making an effort to convince market participants of the wisdom of its revisionist theories. The problem is that this recasting of macro is very self-serving. It is a concentrated effort on the part of the Fed to exonerate itself from the Original Sin of failing to address asset bubbles. The result is an ever-deepening moral hazard dilemma that poses grave threats to financial markets.

Posted by: b | Apr 25 2005 18:42 utc | 21

GM will do what the airlines have been doing for years- use bkrtcy to rid themselves of the pension and retiree healthcare liabilities, break union contracts, and drive down wages.

I don't think the data show that "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." I think they show something very different: when union and management are bargaining, the easiest way to bridge a gap is to make a promise to pay something in the future, rather than to increase wages in the present. Future costs can always be underestimated, and future income to pay those costs can be overestimated. It's finally time to pay the price for many years of wishful thinking.

Posted by: jr | Apr 25 2005 19:59 utc | 22

.....For the 2004 campaign, Kerry moved to the center, following the well-worn path of the corporate Democrats before him, downplaying any "liberal" economic positions that might cost him among the funders and affirming his support for the Iraq invasion even after the official justifications for that exercise had been utterly discredited. Kerry's pallid strategy offered little to motivate the party's traditional liberal and working-class base, but revulsion against Bush was assumed to be reason enough to get out and vote. And besides, such an approach was supposed to protect the Democrat from the inevitable charges of insufficient toughness.

A newcomer to American politics, after observing this strategy in action in 2004, would have been justified in believing that the Democrats were the party in power, so complacent did they seem and so unwilling were they to criticize the actual occupant of the White House. Republicans, meanwhile, were playing another game entirely. The hallmark of a "backlash conservative" is that he or she approaches politics not as a defender of the existing order or as a genteel aristocrat but as an average working person offended by the arrogance of the (liberal) upper class. The sensibility was perfectly caught during the campaign by onetime Republican presidential candidate Gary Bauer, who explained it to The New York Times like this: "Joe Six-Pack doesn't understand why the world and his culture are changing and why he doesn't have a say in it." These are powerful words, the sort of phrase that could once have been a slogan of the fighting, egalitarian left. Today, though, it was conservatives who claimed to be fighting for the little guy, assailing the powerful, and shrieking in outrage at the direction in which the world is irresistibly sliding.....

What's the Matter with Liberals?

Perception management, that's the key.

Posted by: Nugget | Apr 25 2005 20:05 utc | 23

imho the private passenger automobile is a dead technology anyway... it just hasn't realised this yet. dead tech walking.

as to all the above, why assume that banks are more rational than any other psychotic, delusional actor in the marketplace? banks gamble on bubbles just as individuals do. they're not supposed to -- they're supposed to be straitlaced, cautious, models of probity etc. but banking has been radically deregulated from the Reagan era on, iirc, and banks are not the stuffy, prim financial institutions they once were. like many institutions in the US, banks don't seem to serve the function they're advertised as serving.

media isn't about selling information to viewers/readers -- it's about renting viewer/reader attention span to advertisers, by the second. Yellow Cab isn't in the business of providing transportation -- they make their money on renting yellow-painted cars to aspiring cab drivers, most of whom don't make a success of it. I suspect that more money is made in our "medical care" system by denying care and paper-shuffling than by actually providing care. most of what we "farm" isn't really human food, but feedstock for industrial processes. and banks are not about protecting Mom and Pop's savings account. there's a lot of "repurposing" of institutions; sometimes it seems as if no one is really doing what they say they're doing, but every aspect of public and financial life is a sham, a show, a shell game to distract from the real business [enriching the armies of middlemen? perfecting capital accumulation for the top dogs? or what?]...

Posted by: DeAnander | Apr 25 2005 20:36 utc | 24

sometimes it seems as if no one is really doing what they say they're doing, but every aspect of public and financial life is a sham, a show, a shell game to distract from the real business

PowerPointRanger-ocracy is peculiar indeed. My not particularly original theory is that markets work only when anchored by both competition and regulation. In our economy, both are ridiculously weak so bank management can just write down huge debts from Worldcom without fear of either destruction by competitors who did not make such insane loans or retribution from regulators who are supposed to remove crooks from the market. Nobody has to learn anything from failure because they operate in a closed system suspended 50,000 meters above the grubby details of making and transporting goods. Let 100 GOSPLANs bloom.

Posted by: citizen k | Apr 25 2005 21:20 utc | 25

While the most astute among us have long ago devined that it is HEALTH CARE COSTS that are at the root of all this disclocation,no one is addressing the WHY of this equation. WHY is the cost of health care so disproportionate to service provided in 21st century America? Like all else, it would seem the problem lies in not thinking of the care and maintenence of the health of our population as a "commons" not unlike the concept of public park. While corporate America views this area as a HUGE profit center, and thus has creted the entire crisis, we as the consumers need to wake up to the reality that our public health care should be controlled and dictated by US as a consumer class, not dictated TO by the purveyors.
The sooner control of this "industry " is reasserted by the "assets" the better.

Posted by: mikehickerson | Apr 25 2005 23:54 utc | 26>Unsustainability in Pictures

I'll say one thing for sat imagery: it really shows us what we have wrought.

Posted by: DeAnander | Apr 26 2005 1:28 utc | 27

One comment that I have after reading all of this is that the FT article touches on then leaves the issue of why GM is in such a mess. A couple people commented on the fact that GM is addicted to truck and SUV profits. Well, the reason that GM wasted R&D money on hydrogen and did not look to innovate to hybrids is precisely for that reason. GM saw their SUV profits as economic rent and spent their resources trying to protect that economic rent by trying to protect CAFE standards for SUV's instead of working to innovate.

This is something that I remember from the 80's when Japan was all the rage. The argument was that US firms were only focussed on the next quarter and that Japanese firms were focussed on the next year. It seems that this short sightedness in corporate strategy is again coming back to haunt and begs the question of whether corporate haunchos have learned nothing or whether the 90's boom convinced everyone of their infallibility.

As for another point on the truck/SUV angle. In terms of global market share, the Japanese firms and particularly Toyota have a much greater share of the global truck market than any US manufacturer. Just go to S. America or Africa and look around (I have been to Congo and Ecuador a bit this past year). You'll see a lot of Land Cruisers and 4-door Toyota trucks. I have yet to see any US trucks of any recent vintage.

The only thing the Japanese firms are trying to do in the US market is to make their otherwise global dominance complete. And I have to say, they are doing a good job of it. Just ask yourself this question, would you rather drive a Toyota truck or a GM truck into the middle of a tropical forest? It answers itself. Quality trumps all.

Posted by: Bubb Rubb | Apr 27 2005 22:52 utc | 28

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