A surge for the big 3?

This provision in the reported Big 3 bailout deal-in-progress gave me deja vu:

Under the White House plan, the adviser would determine if the auto makers were sticking to their recovery plans before approving additional assistance. If the adviser determined the plan wasn't being executed, it would submit an alternative plan for the company to restructure through a Chapter 11 bankruptcy and require the firm to repay the government any bailout funds.

Remember those benchmarks upon which continuing the surge in Iraq were supposed to be contingent? And how, in September 2007, very few of those benchmarks had objectively been met, but Petraeus reported that significant progress had been made? And how events did bear him out over the next year?

It's very hard to imagine any "adviser" pulling the plug and triggering a bankruptcy plan. Still, such oversight provisions are essential politically, and perhaps generate useful pressure.

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A prior post brought together a chorus of credible voices arguing that a Big 3 bankruptcy would bring on economic catastrophe -- one of them, Wolfgang Munchau, spotlighting banks' exposure to credit default swaps purchased against a GM failure. More on that risk today--and related dominoes--from Thomas Palley, author of Post-Keynesian Economics, writing in FinancialWeek:

The Big Three and their auto finance associates (such as GMAC) are huge debtors whose liabilities are held throughout the financial system. If they go bankrupt, the insurance industry, which is likely a large holder of these debts, would quickly enter a spiral of collapse. Pension funds would also be hit, imposing further costs on the PBGC.

But the greatest damage may come from the credit default swaps market that brought down AIG. Huge bets have undoubtedly been placed on the bonds of GM, Ford, Chrysler and GMAC, and bankruptcy will be a CDS triggering event requiring repayment. Moreover, a Big Three bankruptcy will bankrupt other companies, risking a cascade of financial damage as their bonds and equities fall in value and further CDS events are triggered. This is the nightmare outcome that risks replicating the crash of 1929

Three circles of economic hell after a Big Three bankruptcy

As auto industry Armegeddon approaches, many are crying "let 'em eat coke." Let the Big Three go through bankruptcy hell and rise from the ashes, cleansed of their legacy labor costs, like the steel industry. Or keep on truckin' through bankruptcy, like the airlines.

Today, three separate sources brought home to me, in very different ways, the likely cataclysmic effects of auto industry failure.

1. On the Times op-ed page, former energy secretary Spencer Abraham argues that the airline and steel industry analogies are flawed. Bankrutpcy for an automaker will mean liquidation because

To purchase a car is to make a multiyear commitment: the buyer must have confidence that the manufacturer will survive to provide parts and service under warranty. With a declaration of bankruptcy, that confidence evaporates. Eighty percent of consumers would not even consider buying a car or truck from a bankrupt manufacturer, one recent survey indicates. So once a bankruptcy proceeding got started, the company’s revenue would plummet, leading it to hemorrhage cash to cover its high fixed costs.

No revenue means no DIP financing and no rebirth. Abraham ticks off the knock-on effects: a "cascade" of bankruptcies among parts makers, a squeeze on surviving automakers as suppliers fear to extend credit, liquidation of the Big 3, three million jobs gone in the first year, new burdens on government healthcare and pension guarantee services, enormous credit strains on banks holding auto loans.

2. Also into today's Times, Zachery Kouwe and Louise Story lay out the multiple levels of the financial sector's exposure to auto industry debt: $100 billion that the automakers owe directly to banks and bondholders; another $47 billion in loans to Big 3 affiliates backed by auto leases and loans; billions loaned to Cerberus in its leveraged buyout of Chrysler; untold billions more to parts suppliers, dealerships, and of course increasingly distressed consumers.

3. Finally, in today's FT, Wolfgang Munchau reminds us that in the wake of a big 3 bankruptcy credit default swaps would once again prove themselves, in Warren Buffet's phrase, financial weapons of mass destruction:

Naturally, [a carmaker bankruptcy] would be bad for the US car industry itself. But it might be even worse for the banks, especially those that got involved with credit default swaps – probably the most dangerous financial products ever invented. CDSs are unregulated shadow insurance products that investors buy to protect themselves against default of corporate and sovereign bonds. Protection against a default by General Motors was among the most sought-after contracts.

Some have called for a "managed bankruptcy." Looks to me like a managed bailout, with all stakeholders giving up something in advance, would be a lot less risky.

Wolf Munch Rock Award

Andrew Sullivan has announced the winners of his dyspeptic annual "awards," designed for the most part to highlight the dogmatism, intellectual dishonesty, mindless aggression, and self-promoting pretensions of our punditocracy.

As an antacid, let me introduce the first annual Wolf-Munch-Rock Award. Named for Financial Times columnists Martin Wolf, Wolfgang Munchau and Gideon Rachman, mainstays of that oasis of dispassionate analysis the FT Comment page, this award goes to an observer of world news and trends whose writings exhibit deep (if understated) expertise, fact- and evidence-based exposition, wide-angle perspective on large-scale trends, and theses based more on observation and analysis than ideology.

First year winners by decree: Martin Wolf, Wolfgang Munchau, Gideon Rachman. As an example of the way these guys deploy facts in support of a thesis --or plow through facts as they replay their search for a thesis - take Gideon Rachman's recent Five events that have defined 2007.

Rachman begins with a disarmingly modest, seemingly pedestrian justification for the 'exercise':

If you want to make sense of world affairs, it is useful to identify the most significant events. Also, I like making lists. So here goes.

Rachman's choices: 1) The surge, 2) Putin's Munich speech (accusing the Americans of "an almost uncontained hyper use of force ... that is plunging the world into an abyss of conflicts"), 3) the credit crunch, 4) Petrochina becoming the world's most valuable company (for a while), and 5) Musharrraf's 'mini-coup' in Pakistan. An odd mix of the military, the political, and the financial. Random? Bound only by his love of list-making? Not quite:

Is there a common theme linking these five events? Clearly. The link is the growing strain on the world's sole superpower. America is locked into a draining and demoralising war. Russia, an old adversary, is becoming more assertive. China, a new rival, is on the rise. Pakistan, a vital ally, threatens to fall apart. The US economy is under more strain than for years. Happy new year.

Surprise! A general unifying theory, delivered, again, with a modesty that implicitly acknowledges the complexity of events and the provisional nature of such judgments (as does the use of the perfect tense in the headline). This is not "the decline of the west," not a Jeremiad against American hubris, not a trump of doom - just a clear-headed look across disparate theaters at a "growing strain."

Wolf Munch Rock Award Part II is here
Part III is here