Credit investors ponder GM-sized hole in universe

Via the estimable Mish, I note the following Reuters story. This is in the category of "things I don't understand that sound like they could hurt me".

Like the elephant in the living room, the decline of General Motors is a problem that investors don't want to think about but can't ignore.

The world's largest automaker, whose debt is close to the gross domestic product (GDP) of Belgium, lost more than $10 billion last year and is facing a bankruptcy that would reap devastation in the financial markets.

GM's (GM.N: Quote, Profile, Research) share price has halved in the past year, while its $100 billion of bonds have been cut to junk, confronting investors with the prospect of never getting their money back. Others in the highly-leveraged derivatives market face incalculable losses should a bankruptcy occur.

"A GM default would be absolutely huge," said Jonathan Loredo, of credit manager Cairn Capital. "It would be the biggest thing to hit the market in terms of losses and operational stress."

The story adds later:

The complex market in CDO squared, or CDOs of CDOs, also faces significant risk following a GM downgrade, one London-based hedge fund manager said.

"To be blunt -- it would be carnage," he said.

Obviously, few peak-oilers are going to be very bullish on a US car company that has made a central focus of extremely large and fuel-inefficient vehicles. But I'd love to have a better understanding of the credit market implications. The credit markets seem to be to be very important to understanding the whole deflation versus inflation post-peak question, as well as how the relative timing and impact of the housing bubble bursting versus peak oil, which has profound implications for oil prices.

But after spending an extended period over at the Wikipedia on Collateralized debt obligation, Credit derivatives etc, I have to confess that I'm not really there yet. I still don't understand why one corporation is so significant to these markets, or what it means.

Anyone out there got a good grip on this and care to explain it to us?

My heuristic understanding of this is that so much of the runup on the markets of late are due more to racetrack style gambling and speculation than real solid industrial growth (this is really an understatement). The derivatives create an extremely complex web of cause-and-effects in the case of big changes in valuations of important stocks. GM going tango uniform would result in a huge number of dominos falling, in a most unpredictable way.

Another point others might be able to enlighten on: is some of the meltdown due to the credit arm of GM taking a bath on some bad loans? It is a rumour I heard.

They had a story on the news this morning about how GM was hoping to spin off about 50% of GMAC, but there were financial irregularities that were recently discovered, and until those are understood nobody is going to touch it.

There is a second question.  GMAC is the big money behind - that highly annoying internet home loan thing that is advertised on TV all the time.  If the real estate market tanks, it could lead to losses for Ditech and GMAC.

See the comments at the bottom: thus far GMAC has been the profitable part of the equation.  Although I dabble in bankrutcy work, these issues are beyond me, except to say the obvious that creditors in bankruptcy might take as much or more of bath because of the automatic stay than cramdowns and other Chap 11 provisions.  Remember GM is the largest health care provider in the world and I beleive has the largest pension system after the U.S Gov't - (could be wrong on the latter assertion.) How a long Chapter 11 work-out would play out for the hedge funds and other creditors, bondholders, etc I don't think anyone can know. This is complex along the lines but not the scale of PO and Global Warming.

[Incidentally, Auto lease are increasingly complicated as they now include built-in service agreements and other consumer unfriendly provisions that offer substantial margins to the dealer and automaker over-time. Many (most?) lease are underwater for a time with consumers as the vehicle depreciates significantly before payments catch up.]

Surely GM can't be a bigger health-care provider than the big single-payer programs in other countries?
You are correct, it should be largest "private" provider.  I believe that slightly less than one in eight Americans are dependent on GM health coverage in some way, but I do not have the citation ready at hand.
Big enough, I guess.

The Wall Street Journal on Monday (3/27) and Tuesday has had three articles that relate to TOD. One was on GMC, one on tar sands, and one on nuke power plants & France. Someone there is thinking along our lines.

Hello TODers,

I recall that Warren Buffet of Berkshire Hathaway had a wonderful article explaining derivatives and societal risk.  I would look for the specific link, but I am simply bushed and needing shuteye from reading all the previous excellent posts.

Bob Shaw in Phx,AZ  Are Humans Smarter than Yeast?


Here's a copy of Buffet's letter on that topic. It helps but the entire derivatives scene is a story of taking risks on someone else's risks which were taken on someone else's risks. He also criticizes the inherent tendency to be optimistic, coupled with derivatives reporting earnings today whose full costs cannot be known until some tomorrow on the horizon.

WB returns to the topic in 2005 giving figures for the amount lost. Bear in mind that these losses are accruing to a well managed company winding up positions out of choice and in its own time. What could happen if such things are forced out was foreshadowed in the LTCM crisis a couple of years ago.
Whoops, I should add that its on Page 9 of the pdf, Page 10 of the report
Should have put this in my post above, but here is one article that got me thinking about this et=/money/2006/03/18/ixcitytop.html

(sorry if this was posted previously)

Isn't there a saying "As General Motors Goes, So Goes The Nation" ??

Not only do I agree with the first post in this thread, that a domino effect will occur if GM goes bankrupt.

There's also a fat chance that the emotional and psychological  reactions will effect many businesses, not only the ones with ties, directly or indirectly, to GM. GM has a symbolic value which is not to be underestimated.

The comment, from the CEO of GM in the 1950's was: "What's good for GM is good for America".  The remark was in relation to some discussion among senators that GM should be broken up, ie. it was getting too big and powerful in the US car industry.  How times have changed.
Thanks for clearing that one.
My recollection of what "Engine Charlie" Wilson said is:

"What's good for America is good for General Motors, and vice versa."

Then his remarks were twisted for politcal purposes to suggest that what he said was:
"What is good for GM is good for America!"

But he never said that.

Does anyone have access to a transcript of the exact words?

Whatever the wording, it's not even true. What's good for G.M. is lax CAFE standards, tax loopholes that encourage SUV ownership and high-ridership streetcars replaced with GM buses. What's good for America is the opposite of all that.
There's an article on GM in today's New York Times.  Highlights: GM makes about $1500 profit on an SUV, and loses over $1000 on a standard automobile.  They decided that since only SUVs are profitable, that they just have to make more attractive SUVs that everyone will want to buy.  This is the new lineup they're gambling on now.  (Sort of like the story about the drunk who lost his keys, and is searching around under the lamppost even though he thinks he lost them 30 feet away, somewhere in the dark; under the light is the only place he can see well enough to find them ... if they were there).

GMAC wants to spin off from GM because, the way it's currently structured, GM's crappy credit rating applies blanket-like to GMAC and that will kill the profitability of that division eventually.  So they have to separate to sufficient arm's length that they can command an independent credit rating.

GM is doing some dumb things.  You probably remember the Fortune magazine article, almost a year ago, about GM's billion $ investment in hydrogen fuel cells and research.  The last line of the article was a rather pessimistic guess that GM was gambling on a very risky adventure and I agree with that assessment.  To do the fuel-cell thing (with gov't assistance I'm sure) they and Ford walked away from a program to develop high-MPG car technology.  Now their hydrogen / fuel cell gamble is probably $1.5B and it's money down the toilet.  The so-called "hydrogen economy" will not happen.  Imagine if they had put the same money into hybrids, or even better a super-clean-burning diesel engine technology - which could be combined with hybrid / batteries and get a really attractive fuel-efficient vehicle.  Too late now.

That tsunami you see on the horizon right now, looking west from California, is the Chinese auto industry.  They are coming, they will be cheap, fuel-efficient, good-looking, and they will put the final nail in GM's coffin.

If you haven't read's "The Day After Tomorrow" series, check it out:

They call it a "short story" but it's not that short.  But it does have some interesting info on how hedge funds work, and it's more accessible than most of their stuff.

(I posted the link to the last part, because it has links to the previous three parts.)

If is not your thing, try Googling Long Term Capital Management (LTCM).  

As I understand it, hedge funds have exploded, because they can offer big gains even when the market is in a funk.  They do this, in part, with massive leverage.  If one of their bets goes bad, the whole thing can go down the tubes very quickly.  

It is strange, the world's largest car producer doesn't watch the development of fuel prices and comes in such a financial imbalance, almost bancruptcy. I can remember the 2004 ASPO meeting in Berlin which was - among others - sponsored by BMW. I was wondering, why people from BMW discuss such topics and still produce such cars. The answer is - in case of BMW - their customers don't care about higher fuel prices.

GM however, as a car producer for the average customer has made a lot of mistakes. Being dependent on such a volatile number like the oil price is, should result in a more diversified array of products and being enabled to offer cars which can compete with cars from Japan. Are managers really blind not to see the dark clouds on the horizon coming near?

Is GM a victim of the relatively low gas prices in the USA?

GM is an enormous bureaucracy - think us gov. Nearly everybody is thinking about their job, promotion and retirement - the few who might think about long term changes in fundamentals, like oil price, given the environment of cheap (almost free) oil, always lost out to those advocating short term profits.
BUt it is wrong to think of gm as a victim - the japanese companies have been gobbling up market share in the same environment that us ones are losing share because the former consistently offer better products. Mgmt's biggest concern has been unions demanding overly generous benefits, rather than any real interest in offering better products likely to meet their customer's present and future needs.
However, I suspect that european automakers would do worse against the japanese if it were not for the EU doing what it can to keep japanese cars out of their markets. US cars don't compare well with japanese cars on reliability, but they are significantly better than german luxury sedans - and this is no doubt specifically because the us does allow real competition. I suspect it will be easier for the (remaining) us companies to produce more fuel efficient cars than for the european companies to produce better ones.
I agree with you. There is a lot of bureaucracy in such big companies. I come originally from the city of Stuttgart, where is a very big car company (DaimlerChrysler) and a small one (Porsche).

Mercedes had a lot of quality problems and hence problems selling enough cars. Now this company wants to reduce bureaucracy. The interesting thing is, there is meanwhile a considerable technology exchange between Chrysler cars and Mercedes cars. As far as I can tell, Chrysler benefits from this.
Porsche has no problems and is very succesful these days. Porsche owners don't need to be concerned about fuel prices.

So it is a matter of size and a matter of the array of products?

I am not a motorist, I cannot evaluate the quality of cars. But I think both are almost the same. There is no difference between a french car, a german one and maybe only a little to japanes ones. American cars almost don't exist on the streets here in Europe. So do - still - chinese ones.

 The problem with the derivatives market is that nobody truly understands the financial wizardry involved. What is known is that they are typically highly leverged (not always the case as you may use one derivative here to protect yourself against a leverage exposure there but this creates a financial chain of indeterminate length). As  long as the growth spiral is positive all is good. As soon as the growth spiral looks to turn negative the parties begin to unwind their positions, everybody runs for the exits, and the entire house of cards comes tumbling down.

 I agree with Stuart that there is reason to be concerned, especially when the following are also taken into account.

 The first link is to a Wall St Journal article describing US/China trade relations on a "knife edge." mod=hpp_free_today

 The second article describes guidance coming from the Asian Development Bank cautioning its members in regard to a possible meltdown in the US dollar. The problem here is that once the parties begin to contemplate such a meltdown as within the realm of possibility then the reality tends to conform to that view and the meltdown occurs.

 From a PO perspective, a decline in the USD would have the effect of raising the cost to America of every bbl of imported energy while decreasing the cost to all nations with a currency appreciating against the dollar. America's foreign military adventures would suddenly become much more expensive, America's trade balance would be increasingly negative (it will not be possible to immediately re-source all the products made overseas; the American factories have been closed and the workers laid off), and America's creditors would be increasingly unlikely to finance America's debt. This would result in a significant jump in US interest rates. Persons living on the margin with large variable rate interest only mortgages would see a rise in all of their costs (transport, shelter, credit, consumer goods). The housing market would flatten, if not collapse completely from peak, mortgage loans would be greater than home equity, and the mortgage lenders may encounter severe financial problems. All of that is the good news.

 The truly bad news is that America's creditor nations may seek to impose stringent terms and conditions on America if they are to assist with the reflation of the American economy. This would be similar to the terms and conditions applied to correct the Mexican meltdown, or the Asian meltdown of a few years back. Or the truly distrubing occurs and the entire world economy goes into the toilet. Nobody wants that outcome so I do not think that likely.

 I do think there will be general questioning along the lines of "Why does the US think they are running things when they are morally and financially bankrupt? They don't give a damn for international law, or their own constitution, yet they want us to finance their extravgant debt. At the same time they seek to consume a dsiproportionate share of all the worlds energy, and callously export CHG while continuing to deny there is any problem at all with any of these behaviours.

 If any of the above comes to pass, it truly will be "Morning in America" and that strange aroma you smell will be something other than your morning coffee.

Hi BOP interesting comment.

How much Peak Oil has to do with the meltdown?

I think (from a non economist point of view) that the USD meltdown is finely bound to the Peak Oil event. The US has gone over the Hubbert Peak and instead of consuming kept consuming more and more every year, creating a monstrous Energy Deficit.

If we can establish a strong link between Peak Oil and the USD possible meltdown we can have a better picture of it.

I largely agree with HOD on this. The truly scarey part is that all the above can / may come about WITHOUT any consideration or influence from peak oil! Some have talked of the "perfect storm" of financial meltdown, climate change and peak energy and this is another brick in that wall.
I agree with the "Perfect Storm" concept, although I would like to point out that if the financial system crashes (which is looking more and more likely every day) in the US, with massive devaluation of the dollar a likely cause or outcome, the so "creditors" really won't have diddly to say to us because they'll be broke also.  Every country keeps the majority of it's foreign currency reserves in the dollar, and that represents a large percentage of wealth in China, India, etc.  This really isn't new news for anyone here.  But when we crash, they will crash, there's no doubt about it.  We'll default on our loans, and they will default on their loans, and everybody will owe everybody lots and lots of money, especially the US.  I'm pretty sure that in the end, we'll use our military leverage to force a sort of "reset" of the entire world market.

That's the much easier way to get rid of our 7 trillion dollar federal debt.  I think that's why the Bush administration has been spending like there's no tomorrow.  Because financially, there isn't.  Money today doesn't equal money tomorrow, and we're stealing as much from China as we can right now.  The problem we'll run into though is that after the "reset" it'll be a mad horse race in the manufacturing sector to build up wealth (or weapons) and that's something that the Chinese will easilly beat us at.  I think we're hedging on massive unrest and revolution in China and India.  It's just scary to imagine how they're planning to keep our population in check.

Anyway, that's why I almost welcome financial collapse.  If there was someone with an FDR-like vision for rebuilding society as oil-free, the bottom of a depression would be the easiest place to start.  A command economy is easier to direct that way than a free market.  That's my prognostication for the day.

"I'm pretty sure that in the end, we'll use our military leverage to force a sort of "reset" of the entire world market."

If we are going to keep using our military as an economic tool, I hope we've made sure our 'Military Credit Rating' is still in good standing.  I understand those dollars aren't as easy to print right now.

Oh, but believe me...  The military can always artificially inflate it's "Military Credit Rating", and has done so in a few situations, the most recent being the late 1960s, early 70s.  

When that happens, there's no doubt I'll be joining our fairer friends to the north.

Make your plan carefully.  Our friends to the north have changed the rules so draft resisters no longer have safe harbor.  

 Don't worry. We can always sneak him in. :-)
A large freight train begins its trip modestly, slowly
over time it accelerates. It does this in an orderly manner
with few problems to trouble it. Over time, more and more
energy is stored in the train until it is speeding down
the track at a remarkable pace. Then something begins to go
wrong, ominous noises are heard. The engineer applies the
brakes, but it take a long time to slow the train.
The train begins to shudder violently, then it derails
spectacularly. The only significant difference between the
train at the beginning of the day and before it derails is
its momentum.

This may seem like a silly analogy to our present situation,
but it helps me to better understand what is happening.

Well... if this is the tipping point, it is rich with irony. A superpower corporation, fundamentally misaligned with resource trends, managed by our best educated, but clueless, elite, offering the most wasteful and inefficient of consumer goods goes down. The symbolism is inescapable.  
Wonder if the small Saab subdivision in Sweden will survive? They seem to have bet their future on ethanol engines and cars.
Stuart, a timely post.

Don't focus on GM to understand the problem.  Investigate GMAC which is the loan and lending arm of the parent GM.  My understanding is that GM has been profitable since the mid 1980's ONLY because of the revenue stream of GMAC.  It has been like a bank lending money just to move cars, as well as other things.  GMAC gets their capital from many sources to originate their loans.  The interest on the loans is where all the profit is/was.

Recently no interest loans and steep discounts on GM cars stopped the GMAC profit center from keeping the parent GM in the black.  I believe that GMAC is for sale now, but without built in car sales where is the future income stream?

Other posters can confirm, deny, or clarify my understanding of where GM profits have come from.  But this is a symptom of our economy.  It is built on interest payments on loaned money, not on wealth created through manufacturing processes.

I think this is true of Ford, as well.  They make their money on the financing, not the cars.  That's why it's in their interest to sell big cars, like SUVs, rather than small ones.  Bigger loan, more profits.

That is probably true even with the "0% interest" offers.  You need perfect credit to qualify for those offers.  I suspect many of their customers do not qualify, and end up paying interest on their loans.

Of course, this means they'll be in up spit creek if people start defaulting on their loans.

One of my friends is a retired senior executive with Ford and he told me that the American auto makers lose money on all the low/mid end vehicles but actually make money on the SUV's, trucks, Hummers, etc.  Hence the focus on promoting the big gas guzzlers.
In any manufacturing operation, but especially one as complex as automobiles, you have a fixed and variable cost.

Just to pay the overhead piece for plant and equipment costs a similar amount, no matter the car.  In other words, it doesn't costs significantly more to build an excursion than it does an escort in terms of the depreciation on the building and the salary for the guy ordering parts.

So you'll have a given amount of sunk costs in a "vehicle," regardless of what it is.  Let's say that's $8,000 (it isn't, but that's an easy number)

Then you have your two vehicles, and one gets a bigger engine and leather seats and a power moonroof.  These parts cost more than a small engine and regular seats in the other car, but you get to charge a premium to the customer (everyone "knows" that leather seats add a couple thousand to the price of the car, sure).

So in the end if you sell your escort for $15,000 and your Excursion for $40,000, you will reap tremendously higher profit percentage on the bigger vehicle.  The problem, of course, is that the world only NEEDS or WANTS (your pick) so many $40,000 vehicles.  Once everyone who might want one has one, you have to have some new trick to get them to replace it.  

This, IMO, is where GM and Ford are losing it.  Look outside (at least here) there are TONS of big cars and trucks.  People have been buying them for the last five years, taking advantage of low interest rates and "employee pricing" or whatever.  Killing the profit to the company in terms of markup and interest income, but they still make money since the big trucks are so profitable (the materials and labor in an excursion is nowhere NEAR the $40-60K they are getting, even at a discount)

But nobody wants to replace the behemoths.  Not when gas is $2.50 and going up.

I'm certainly preaching to the choir about all this.  In my area easily 70% of vehicles are either a pickup truck or SUV.  This won't change anytime soon.  But folks will make these cars last a bit longer before they replace them, and when they ultimately DO replace them, they'll at least think about downsizing or getting something more efficient.  It will not make a significant impact on fuel consumption for many years, I don't think.

What's that old microeconomics maxim?

"Produce where marginal revenue equal marginal cost."

I'm sure that fits there.  I just don't know enough about the auto industry to say for sure.  

That's true.  There is also the factor that an SUV with the same engine and features as a car just looks bigger, and can command a higher price tag.
This is true of Ford as well.  In 2004, the automotive sector at Ford made $850 million before taxes.  During the same period, Ford credit made a pretax profit of of nearly $5 billion.  Credit companies for both Ford and GM go beyond auto financing.  They do mortgages, leases, and money market services as well
There is a long series called "General Motors Death Watch" at "The Truth About Cars".  The latest is number 62 here:

Clearly, nothing but a bailout is going to keep GM from bancruptcy at this point...there is no question about it.
Their debt, product mix, market position, and competative disadvantage is too large to overcome.

As I understand it, their credit arm has been quite profitable, helping to prop them up (along with SUV's) in the 1990's and 2000's.  GM would have sunk already without GMAC.  At the same time they have generated mountains of debt, as Stuart points out.  During the past few years they have borrowed huge sums money in the low-interest bond market to prop up their enormous pension funds and fund the their givaway buyer incentive plans (interest free loans and large rebates).  These programs were hugely successful in terms of sales volume, but they lost money with every sale.  

It's a great big ship to turn around under the best of circumstances.  Unfortunately, they are already full of water, they're sailing against the current, and oh, by the way, there's an iceberg dead ahead.

It will be instructive to watch the invisible hand at work.

Is there a future for corp's like GM in an oil constained world, or is this the first major step in the transition?

For myself, I believe if GM survives we are in deeper trouble than we can imagine. Millions of people working to support cars is not our future.

For sure, the pirates-of-finance will cry the end is nigh and that the collateral damage is catastrophic... there will be a lot of "be very afraid" propaganda from them soon.

But aren't these pirates the same folks who call us doom and gloom cultists?


This is more like "the invisible foot" of the not-so-free market at work.

You can bet that the Pirate Captain of the Day will meet with other pirates and try to deflect the swift kick to the seat of the pants away from themselves and toward the pewling spawn of the masses.

No doubt, this will all be written off as the fault of the unions and the workers.  The lesson of the day will be that 90% of the population should be grateful -- be very grateful -- for the opportunity to work for a bowl of thin gruel and a place in the workcamp sleeping huts.  No more of this "liberty and justice for all" nonsense!

This will also be blamed on the Chinese, Old Europe, Gays, Abortion, Divorce, Pornography, and upon any other thing that can be used to conjure up ancient fears and prejudices.

Interesting-er and interesting-er.
And so it goes.

Re: Total Public & Private US Debt as a Percentage of GDP

Because this is a ratio, it goes up if debt increases and/or GDP falls.

The previous peak for this graph, 294%, was in the depths of the Great Depression, when GDP collapsed.  The ratio then fell until the early Eighties, when it started climbing.  It is currently at about 304%.  

Today, the majority of Americans live off the discretionary income of other Americans (Starbucks comes to mind).  

In the Thirties, I wonder what percentage of Americans lived off the discretionary income of other Americans?  10%?  Probably close to 5%.  In other words, the GDP in the Thirties was fundamentally different from today.  If you could plot total debt as a percentage of nondiscretionary GDP, I think that it would probably have gone from something like 320% to close to 700%.  

The discretionary part of the US economy has the appearance of great economic activity, and consumes vast amounts of energy (think of all the leisure airline flights and cruise line trips to nowhere), but it does nothing to produce food, energy, clean water, basic shelter, basic transportation, basic health care, etc.

IMO, The Great Unwinding has begun.  We are beginning to see a seismic shift in the US economy from an economy focused on meeing "wants" to an economy focused on meeting "needs."  This is going to have profound, wrenching changes on American workers and on their expectations for the future.  It will most profoundly affect the tidal wave of college graduates coming our way.  Peak High School Enrollment is only a couple of years away.  Think of all these college students entering the work force thinking that three Hummers in front an of a $500,000 mortgage is a normal way of life--and a virtual entitlement for Americans.

Going forward, the true capital is going to be measured in terms of energy--whether it's food or fossil/renewable sources of energy.   Everyone should strive toward being either a net food producer or a net energy producer.  The first step toward being a net energy producer is to reduce your consumption as much as possible.  

Finally, the absolutely last thing that you want to do as a parent of a high school/college student is to go into debt so that they can major in a degree that will not be useful in the hard times ahead.

Geez, WT, you should should take over for Tom Friedman. "The Great Unwinding" isn't too far from Krugman's "The Great Unraveling" though. I like that thought about being a net producer vs. a net consumer. That's the answer to some question someone will ask me some day. I'll have to memorize that. "Be a net producer, be a net producer,..." I have two kids who are about a decade away from college. Have we had a discussion about what will constitute a good degree to have? I suppose the short answer is something that will allow them to be a super net producer. I'd better keep it to myself for now though, they may take it literally and start making nets. :-0
I keep hearing this "no debt" meme, but it makes no sense to me.  If the economy collapses under our feet, there will be such a massive amount of debt being called in that nobody will be able to pay it back, be it a mortgage, college loans, credit card debt, or car loans.  And nobody will be in the position to pay that money back, and the courts will be completely entrenched to proceed over debt cases, much less enforce all of them (does anyone really imagine the police rounding up an entire neighborhood of suburbanites and forcing them out of their homes just so some banks can leave them empty?  especially when they're likely to live in the same kind of neighborhoods?)  

The lending agencies will collapse, the debt will vanish, and it will be hard for a few years to restart the economy as nobody's willing to lend money.  But we'll still have our house.  Does that not sound reasonable, or am I just being completely naive?

I think it depends on whether you expect an inflationary or deflationary environment.  There are good arguments for both, IMO.

During the Great Depression, it was not good to be in debt.  A lot of farmers lost their farms.  People who had lost their homes lived in tent camps outside of towns, desperately seeking jobs.  Rich people bought up real estate, heirlooms, jewelry, etc., at pennies on the dollar.

You know.. it's a shame that both of the national parties are completely entrenched to the needs of the elites instead of the needs of the people they serve.

I've often wondered that, especially after the lessons of the Great Depression, why there isn't some sort of failsafe point.  Say, if GDP falls to 70% of the previous year, homesteading rules go into effect, so that as long as you're living in your house, the bank nor the government can take it away.  That would be the smart thing to do.

Unfortunently, the major parties only feign populism when an angry mob knocks on the Congress building.  Perhaps it's that time again?

Call me simple minded but.....

That is why unions were set up, so people earned a fair wage for work and would spend it on goods maintaining the economy.

That is why all kinds of banking regulations were set up, to prevent inapproriate speculation and pyramid schemes.

That is why social security was set up so that old people would not be destitute and would spend it on goods maintaining the economy.

These practices all came out of the 1930's to act as governors (like in motors, not politics) on economic activity.  Keep as much of the money in the hands of as many people as possible.  They will spend it on real goods and grow the economy.  Unfortunately all these principles have been under attack by neocons during the last 20-30 years.  Policy and government regulation has shifted steadily to favor people who work with money instead of people who just work to produce a physical product.  The result is a system running away with respect to debt, stratification of wealth, etc.  

The built in regulation of the money supply has been removed from the majority of the populace and put into the fewer hands of lending institutions and rich peoples investments.  The rest of us don't make enough to live on without borrowing.

What killed those things (or at least their effectiveness) is globalization.  Our financial system was set up in the 1930s, and it just can't deal with today's global market.
Think of this not-very-good analogy:

A lot of people in New Orleans had their homes and lives washed away.  There were massive govt. subsidies to try and help, but they were mired in red tape and crooked politics.

There are corporations willing to buy entire neighborhoods, sight unseen, knowing that in a year or two they will own some prime property and can convert it to a casino or hotel or sell it so someone who will.

If our economy tanks, there will still be rich people.  There will still be landowners, and they will all still basically dictate to the government what to do.  Your home may be safe, or it may not.  Depends on if it is part of somebody's idea for a new development.  

My home isn't worth a lot, but it is in a GREAT location, and would be desirable to somebody with money to spend.  I'm sure that somebody could convince my bank to enforce existing laws were I to not pay my mortgage.

I will drink to that!
But what is and what is not useful?
And how do you know in advance?
Is Chemistry at a prestiuous university in the UK more useful than time-serving a plumbers course at a local college?
Please tell me your thoughts asap
Knowing how to skin rats with a flint knife might come in handy.
I'm still working on two books: "fooled by randomness" and "irrational exuberance."  Both excellent, though the first is a lighter read.

I'm not going to comment on the specific GM question, that's beyond me.  Kudos for trying to sort it out.

But to step back, my take-away from these books is that bubble burst for non-specific reasons.  Past "Black Mondays" (1929 or 1987) cannot really be traced to specific news items.  Instead it seems that a subconscious sentiment builds, and the population responds when some invisible tipping point is reached.

If the stock market or housing bubble pop, I'm sure it will be attributed to some recent news item, but such attributions are just the lies we tell ourselves (the pattern of our news-oriented reporting).

I think current conditions support a long term bear market in stocks and housing ... but it's up to the market if it wants to do that ;-)

 I have not touched the source texts for a long time but if memory serves correctly the "trigger event" for the 1929 crash had to do with an institution called the Bank of the United States located in NY. The bank was owned by Jewish interests and was therefore not deemed to be a respectable member of the  largely WASP financial community. In addition to racist sentiment the bank was also disliked due to its choice of name which implied a stature which was not deemed appropriate.

 The Bank experienced a small run on its deposits and requested the local branch of the Fed to provide it with the necessary liquidity. This request was refused. The outcome was  a run on all banks and a general exit from the markets as panic spread and everyone sought liquidity at the same time. The further tight money policies of the Fed exacerbated the problem and plunged the nation into financial crisis.

 The trigger event of 1987 had to do with concern over some european financial policy that resulted in everybody heading for the exits at the same time. By the time the crash was reported in the press it was largely under control.

The author of "irrational exuberance," is Robert Shiller, and he did a lot of work in the newspaper archives looking at what people were writing about right up until the crash.  I can't really capture it without quoting long passages, but to encapsulate it ... it's really about what happened that Monday, and why the market didn't bounce back Teusday.  There had been other brief panics in the months (and years?) leading up to that point, but in each case optimism returned.

The books (and "fooled by randomness") is worth a read.  There is a strong human tendancy to "pick a reason" for something that has happened.  This is obviously especially true for the big important things that happen.

Oh, I forgot there is an mp3 of the other author, Nassim Nicholas Taleb (link below) that talks about the random moves in the market that experts (want to?) ignore:

The 1987 crash on Oct 19th was 'triggered' by a comment from James Baker, the treasury secretary, about the US dollar which had been weakening throughout the year.  Pundits ascribed the dollar decline to the large trade deficit, and there were concerns that the Japanese would no longer purchase US treasuries.  Bond yields had risen from around 7% in January to over 10% in October due to concerns about importing inflation (a result of the weakening dollar).  The US was also running a huge fiscal deficit. Baker's comments were considered the final straw, and on Monday, Oct. 19th the Dow dropped more than 22% during that single day.

Presently the US is running another gargantuan trade deficit as well as a large fiscal deficit. Bond yields are just under 5% today, and the US dollar has been relatively stable. China and Japan continue to underpin the deficit by purchases of US debt (a giant vendor financing scheme), but if the US dollar weakens significantly funding may dry up and the stock markets would be vulnerable once again.

For what it's worth here is the summary from the Brady Commission investigation into the crash, made at the request of President Reagan:

The precipitous market decline of mid-October was "triggered" by specific events: an unexpectedly high merchandise trade deficit which pushed interest rates to new high levels, and proposed tax legislation which led to the collapse of the stocks of a number of takeover candidates. This initial decline ignited mechanical, price-insensitive selling by a number of institutions employing portfolio 3~, insurance strategies and a small number of mutual fund groups reacting to redemptions. The selling by these investors, and the prospect of further selling by them, encouraged a number of aggresvsive trading-oriented institutions to sell in anticipation of further market declines. These institutions included, in addition to hedge funds, a small number of pension and endowment funds, money management firms and investment banking houses. This selling, in turn, stimulated further reactive selling by portfolio insurers and mutual funds.

Such post-facto expert opinion of causes have to be viewed with caution.  Certainly bad fundimentals set the stage ... but the market has the ability to ignore bad news for years.

In terms of economic theory, the best (and correct) thing to do would be to let GM go under, close its plants and idle its workers, because far too much land, labor and capital (meaning machinery, tools, buildings, etc.) is now in the auto industry. In other words, the big problem is excess capacity, excess supply.

Thus economics dictates the elimination of GM.

But economics does not rule. Politics rules.

I fear that GM is "too big to fail." Thus my guess is that the lawyers will wipe out GM's debts, cover up the gross fraud in GMAC in which bad car loans were made by the million through concealing the "upside down" condition of car buyers on their trade-ins, wiping out the stockholders, of course, and allow a re-organized GM to emerge from bankruptcy. In other words, what the bankruptcy courts have done for the airlines, they can do also for the car companies.

Of course it is possible that I am wrong in my guess, and I fervently hope that good capitalist economics will bury and drive a stake through the heart of GM--but the way our political system works, it is almost getting to be almost as bad as in the old Soviet system, where politics kept horribly unprofitable firms going for decades of gross inefficiency and enormous misallocation of resources.

Don, I agree that we have far too much tied up in the auto industry.  This seems to me to be a huge, fundamental error.

If GM were allowed to tank, but an organised effort were made to re-employ workers and factories to produce a variety of sustainable transportation devices -- from bikes to rail cars to plugin hybrids to electric urban cars.  Would that be a way of turning the situation around?

Also, it seems that a massive effort to re-employ folks in a relocalisation scheme regarding food and manufacture would help to ameliorate the impact....?

We are economically locked into making products that destroy our habitat.  How do we go cold turkey and still survive?

That sounds like socialism!  We don't do socialism here, good sir!  

I would love for there to be some sort of work program for the workers of a dead GM, instead of simply proping GM up again.  

I think one of the more important things though to remember is that if GM falls, the government has to assume GM's pension obligations, which (the data may be a bit off) right now is around $77 billion dollars, $59b of which is unfunded. Plus, there will be settlements during the bankruptcy proceedings, I'm sure, for the workers who haven't made pension yet.  Really, that's not exactly an undo-able amount of money for the government, especially spread over many years, but it's exactly the kind of thing that makes the market panic.

If the federal government felt that relatively small Chrsler was "too big to fail" during its financial crisis in the early 1980s, then I fear it will feel the same way about GM, which is now about an order of magnitude larger than Chrysler was at the time of its bailout.  

What with a budget deficit of $400 billion (?), an Iraq war costing about $100 billion a year, a ballooning trade deficit that has foreign creditors getting increasingly nervous, a federal bailout of an ill-managed dinosaur like GM is just what we all need!

I agree: pull the plug on the respiratory and put GM out of its misery!

Letting GM fail would be tantamount to detonating a thermonuclear cluster bomb. That's becuse a million workers with middle-class wages would suddenly lose everything as they take up crappy-paying jobs that can't support their mortgages.  That means a tsunami of a million forclosures all in one big pulse. Worse, those foreclosures will be concentrated in Michigan, turning practically the whole state into a Flint Michigan.

Flint, made famous by Michael Moore, now looks like a nuke hit it. The "nuke" was purely financial. GM by closing a plant, used a financial WMD, and the politicians all know that letting GM fail would put blood on their hands for letting a financial nuclear first strike hit red states. Obviously, the GOP dreads the fallout. But it is all but inevitable and probably necessary. But it is still a ticking WMD. Who is going to be the one to give the orders that "presses the button"?

You seem to argue that there is a choise. How deep into debt is it possible to go before other financial obligations fail? Not bailing out GM is not the biggest possible disaster.

The local Swedish experiences with trying to bail out failing industries are bad. It seems to lead to prolonged agony and higher taxation and higher intrest rates wich hurts healthy companies. It was done with the warf and textile and clothing industries in the 70:s. There has been some small successes like fairly ruthless rationalization of steel industries combined with large investments in equipment for producing high margin products. Some of these investments have been productive for 20 years and are still going strong.

There are right now Swedish state subsidized investments of about a G$ trying to get the small GM part Saab to survive by ASAP building every piece of rail and road infrastructure GM wished for near their Swedish plants and investing in development and research that can be usefull for GM:s development and production. But as far as I know not a dollar is given directly to GM and most of the investments are such that they can be used by other companies if GM closes the Swedish Saab factory and car development. The aim seems to be to make the plant location and regional knowledge as valuble as possible so that GM or whatever comes after GM would like to enjoy this location.

Latest on GM/GMAC's woes.
You know, before I did some quick research, I was going to guess that even GM is small compared to the size of the derivatives market and that GM's direction is so well understood that there isn't likely to be much of a problem in the derivatives world.

As I said, that was before looking some things up. See: GM Bankruptcy Risk Exposes Imbalance in Booming Default Swaps (3/16/06)

"With more credit derivatives being traded than bonds available, a default by GM could spark panic buying of the company's bonds, driving up prices. The contracts would be worthless if prices rose to 100 cents on the dollar because investors would have to pay the same amount for the bonds as they received in payouts."


Credit derivatives rocked by loss at GM finance arm (3/18/06)

Concern that General Motors may now be sliding towards the brink - linked to an estimated $200bn in credit derivatives - has renewed fears that the over-heated credit swap market could seize up in a crisis.

for instance. At this point, I would still guess that GM's looming bankruptcy is most likely to be a problem for the poor saps who hold onto their stock and bonds, the many present GM employees or retirees, companies that are related to GM, and those who have bought GM products. However, that probably depends on how quickly GM implodes.

Many people seem to forget that Ford isn't really in any better shape than GM. Deals on the edge of the precipice (2/16/06)

A downgrading of the creditworthiness of the bonds issued by Ford and General Motors to so-called junk status last May caused another big shock to the market. The two companies have bonds worth $450 billion (£259 billion) between them and the move triggered turmoil in both the market for the bonds and their credit derivatives. Once again this was resolved without the market failing but the Bank of International Settlements says the system came close to a serious meltdown.

One version of Buffet's take on derivatives is at Buffett warns on investment 'time bomb' (3/4/03)

The rapidly growing trade in derivatives poses a "mega-catastrophic risk" for the economy and most shares are still "too expensive", legendary investor Warren Buffett has warned.

We in Michigan would appreciate your prayers.

From that first link:

As many as 150 bankers and investors have been meeting since December to develop new rules for credit derivatives, the fastest growing part of $270 trillion derivatives market. The New York- based International Swaps and Derivatives Association plans to have a cash settlement system in place by June 20.

Credit-default swaps were designed to protect creditors against non-payment of debts, and some investors now use them to bet on a company's credit quality. Contract buyers pay an annual fee and receive the full amount insured if a borrower defaults. Under the current system, buyers are obliged to deliver the defaulted loans or bonds to the insurer.

The credit-derivatives market, dominated by credit-default swaps, is unregulated, with contracts traded over-the-counter and no requirement for investors to disclose their holdings.

With more credit derivatives being traded than bonds available, a default by GM could spark panic buying of the company's bonds, driving up prices. The contracts would be worthless if prices rose to 100 cents on the dollar because investors would have to pay the same amount for the bonds as they received in payouts.

That does sound extremely bizarre.  That default would trigger panic buying of the bonds suggests something is FUBAR.

The $270 trillion size of the market is eye-popping too.  I'm guessing that number is the total dollar value of transactions annually.  If so, it it's about 5 times world GDP, which was $55 trillion in 2004.

$270 trillion? Can that be right? Or, as Sadly No (or was it World'O Crap) says, are primitive Earth numbers not up to the task here?

 I suspect the forced buying of bonds is due to something similar to a short squeeze.

 Someone sells a stock short (they sell a stock in anticipation of a re-purchase at a lower price point) and if the market moves against them they are then forced to purchase higher priced shares to close out the transaction.

 If the short percentage is high and the stock is thinly traded then all the shorts end up competing against each other for a small available supply of stock.

 It sounds like credit derivatives may create a similar situation where one party seeks to purchase the available bonds to close out their end of a transaction. Since all parties on the same end of the position are doing the same the result hits someone hard in the pocketbook.

The $270 trillion is not the value of annual transactions; it's the notional value of outstanding contracts. New York Fed President Timothy Geithner discussed some of these issues in this recent speech.
The scale of the over-the-counter derivatives markets is very large. Although the notional total value of these contracts, now approaching $300 trillion, is not a particularly useful measure of the underlying economic exposure at stake, the size of gross exposures and the extraordinarily large number of contracts suggest the scale of the unwinding challenge the market would confront in the event of the exit of a major counterparty. The process of closing out those positions and replacing them could add stress to markets and possibly intensify the direct damage caused by exposure to the exiting institution.
To get an idea of the actual underlying credit risk on those notional values:
The net credit exposures in OTC derivatives, after accounting for collateral, are a small fraction of the gross notional values. The ten largest U.S. bank holding companies, for example, report about $600 billion of potential credit exposure from their entire derivatives positions, the total gross notional values of which are about $95 trillion.
Of course Buffett thinks the risk is greater than this. Derivatives are often very hard to value, and he points out that the counterparties each tend to value the contract in a manner which looks most favourable for them, resulting in a non-neutral risk exposure in aggregate.

Geithner also mentions the issue of credit derivatives being written on a much smaller underlying securities base, which highlights the GM anomaly:

Credit derivatives, where the gaps in the infrastructure and risk management systems are most conspicuous, are less than 10 percent, and perhaps less than 5 percent, of the total OTC derivatives universe, but are growing much more rapidly. Large notional values are written on a much smaller base of underlying debt issuance. The same names show up in multiple types of positions--singles-name, index and structured products such as CDOs. These create the potential for squeezes in cash markets and greater volatility across instruments in the event of a default, magnifying the risk of adverse market dynamics.
Even if you rapidly become an expert on the derivatives market Stuart (and we know how quickly you can assimilate such knowledge), I'm not sure it's going to help you much in the inflation/deflation debate. It still boils down to how world central banks would react to a systemic meltdown in the market.

If they stand by and let investment banks fall in a domino effect then we get deflation as the money supply rapidly contracts. Conversely, if they try and stem the tide and go for a bail-out then we risk inflation from the huge liquidity injection and monetising of debt.

Your bet's as good as anyone else's as to how such a scenario would pan out, expert or not.

I'm not sure the possible bankruptcy of GM would be the financial cataclysm that some would guess.

First of all, this has been coming a long time (I was first short the automaker's debt in 2000), and few market participants would be truly surprised.  The long decline of the company's fortunes, credit ratings, etc., has been accompanied by a cheapening of their outstanding debt, as well as all the credit derivatives related to that debt.  A decent possibility of a bankruptcy is already well-factored into the pricing, and although more money would be lost in that eventuality, most of the value of the debt has already been eroded and professional portfolios have already marked those losses to market.

Second, this is a very large debt issuer, and so the pricing of GM and GMAC debt and credit derivatives are very well known--this fact makes it less likely that some derivatives trader would have hidden a bunch of tickets somewhere.  In short, the nightmare isn't GM's size, but a the potential for a failure of risk management--the size of GM's problem and the market's knowledge and focus thereon actually makes such a portfolio problem less likely.

Finally, there isn't any great mystery about credit derivatives--they trade like the debt of the underlying company.  They are just another financial innovation that could allow you to make a levered bet--and your levered bet could go very wrong.  At any point in any market that allows leverage, this is possible.  Therefore, credit derivatives aren't unusually risky, nor do they pose an unusual risk to the financial system.  Bad/non-existant risk management might, but it would be unlikely to be a systemic financial failure.

Did anyone else see and remember the name of that great BBC faux documentary about an investment bank that went under because it had betted that oil prices would decline and then a Saudi oil facility was attacted, oil prices rocketed upwards, and not only did that bank go under, but so did many others.  The show explained how financial systems were inter-connected through these hedge funds.  They spread risk but they also allow for the spread of failure.  It did a pretty good job of helping to understand the new world of finance through a concrete example that those on TOD should relate to.  

Wish I could remember the name!  Came out 1-2 years ago.

The Man who Broke Britain.
I posted a link to the GM story twice within the last week, but I suppose it got buried in the comments section. As you say above, Stuart, this is indeed independent of peak oil and cannot help but impact upon it. The distinction between inflationary and deflationary futures is crucial, and the derivatives market has a huge part to play in the outcome as it it both global and a highly leveraged house of cards  - a Ponzi scheme essentially. GM is just the beginning.

The scale of the derivatives market has dwarfed that of the productive economy for a long time. I find it inconceivable that any lender of last resort could have deep enough pockets to bail it out. See this for instance from before the great mania sent the derivatives market into the stratosphere (from At the Crest of the Tidal Wave, Robert Prechter, 1995):

The total value of all monitored futures and options contracts traded in the US alone in 1993 was $217 trillion, which is ten times the total value of all private real estate and publicly held companies in the entire country.

Here's an explanation of the nature of deflation from a book I would definitely recommend. From Conquer the Crash (2002) by Robert Prechter:

The Primary Condition of Deflation

Deflation requires a precondition: a major societal buildup of credit and its flip side, the assumption of debt). Austrian economists Ludwig von Mises and Friedrich Hayek warned of the consequences of credit expansion, as have a handful of other economists, who today are mostly ignored.

Self-liquidating credit is a loan that is paid back, with interest, in a moderately short time from production. Production facilitated by the loan generates the financial return that makes repayment possible. The full transaction adds value to the economy.

Non-selfliquidating credit is a loan that is not tied to production and tends to stay in the system. When financial instituions lend for consumer purchases such as cars, boats or homes, or for speculation such as the purchase of stock certificates, no production effort is tied to the loan. Interest payments on such loans stress some other source of income. Contrary to nearly ubiquitous belief, such lending is almost always counter-productive; it adds costs to the economy, not value. If somene needs a cheap car to get to work, the a loan to buy i adds value to the economy; if someone wants a new SUV to consume, then a loan to buy it does not add value to the economy. Advocates claim that such loans "stimulate production", but they ignore the cost of the required debt service, which burdens production. They also ignore the subtle deterioration in the quality of spending choices due to the shift in buying power from people who have demonstrated a superior ability to invest or produce (creditors) to those who have demonstrated primarily a superior ability to consume (debtors).

Near the end of a major expansion, few creditors expect default, which is why they lend freely to weak borrowers. Few borrowers expect their fortunes to change, which is why they borrow freely. Deflation involves a substantial amount if involuntary debt liquidation because almost no one expects deflation before it starts.

What Triggers the Change to Deflation

A trend of credit expansion has two components: the general willingness to lend and borrow and the general ability of the borrowers to pay interest and principal.These components depend respectively upon (1) the trend of people's confidence (ie whether both creditors and debtors think that debtors will be able to pay, and (2) the trend of production, which makes it easier or harder in actuality for debtors to pay. So long as confidence and productivity increase, the supply of credit tends to expand. The expansion of credit ends when the desire or the ability to sustain the trend can no longer be maintained. As confidence and productivity decrease, the supply of credit contracts.

The psychological aspect of deflation and depression cannot be overstated. When the social mood trend changes from optimism to pessimism, creditors, debtors, producers and consumers change their primary orientation from expansion to conservation. As creditors become more conservative, they slow their lending. As debtors and potential debtors become more conservative, they borrow less or not at all. as producer become more conservative, they reduce expansion plans. As consumers become more conservative, they save more and spend less. These behaviours reduce the 'velocity' of money (ie the speed with which it circulates to make purchases), thus putting downside pressure on prices. These forces reverse the former trend.

The structural aspect of deflation and depression is also crucial. The ability of the financial system to sustain increasing levels of of credit rests upon a vibrant economy. At some point a rising debt level requires so much energy to sustain - in terms of meeting interest payments, monitoring credit ratings, chasing delinquent borroers and writing off bad loans - that it slows overall economic performance. A high-debt situation becomes unsustainable when the rate of economic growth falls beneath the prevailing rate of interest on money owed and creditors refuse to underwrite the interest payments with more credit.

When the burden becomes too great for the economy to support and the trend reverses, reductions in lending, spending and production cause debtors to earn less money with which to pay off their debts, so defaults rise. Default and fear of default exacerbate the new trend in psychology, which in turn causes creditors to reduce lending further. A downward 'spiral' begins, feeding on pessimism just as the previous boom fed on optimism. The resulting cascade of debt liquidation is a deflationary crash. Debts are retired by paying them
off, 'restructuring' or default. In the first case, no value is lost; in the second, some value; in the third, all value. In desperately trying to raise cash to pay off loans, borrowers bring all kinds of assets to market, including stocks, bonds, commodities and real estate, causing their prices to plummet. The process ends only after the supply of credit falls to a level at which it is collateralized acceptably to the surviving creditors.

Why Deflationary Crashes and Depressions Go Together

A deflationary crash is characterized in part by a persistent, sustained, deep, general decline in people's desire and ability to lend and borrow. A depression is characterized in part by a persisten, sstained, deep, general decline in production.. Since a decline in production reduces debtors' means to repay and service debt, a depression suports deflation. since a decline in credit reduces new investments in economic activity, deflation supports depression. Because both credit and production support prces form investment assest, their prices fall in a deflationary depression. As asset prices fall, people lose wealth, which reduces their ability to offer credit, service debt and support production. This mix of forces is self-reinforcing.

The US has experienced two major deflationary depressions, which lasted from 1835 to 1842 and from 1929 to 1932 respectively. Each one followed a period of substantial credit expansion. Credit expansion schemes have always ended in bust. The credit expansion scheme fostered by wordwide central banking is the greatest ever. The bust, however long it takes, will be commensurate. If my outlook is correct, the deflationary crash that lies ahead will be even bigger than the two largest such episodes of the past 200 years.

Can it get any worse?

Has GM bought off Judges to polish GMAC for sale?

GM has been accused of buying off Michigan judges to keep GMAC looking attractive to buyers.  

Homecomings Financial Corp. a part of GMAC has been evading a lawsuit that proves it manipulated the posting of borrower's payments so that it could charge late fees.  (Illegal fees collected under threat of foreclosure is extortion.)  A case filed in the Michigan Supreme Court (March 24: case #130774) shows that judges as high as the Court of Appeals have broken the law to protect Homecomings from these charges.  

The Supreme Court case attributes the judicial corruption to GM's political clout.  It alleges that GM has been desperate for the cashflow and has threatened to blackball the judges or promised support to get their protection.

Court of Appeals Judge Neff is accused of preserving fraud on the record so that Homecomings can use the falsified information to win the April 6 hearing.

This is a link to the court's online docket, yr=0&yr=0&SubmitBtn=Search

It is fact on court records that these judges have broken the law to protect Homecomings, and in so doing have benefited GM who is the only one powerful enough to get 5 separate judges to defy the law.

I can PDF the filed complaint to anyone who is interested.

I don't know how much traction this proposal will get, but FEASTA is proposing monetary reform to cope with peak oil, greenhouse gas emmissions reductions, and financial instability.  Richard Heinberg's upcoming book should discuss this approach.

Read about it here:

What is the problem? If things become really deadly, GM will press our govt with that hundreds of thousands jobs it provides... Our govt will print a treasury bill with 11 zeros on it and will dump it to the Chinese. They know it will not be worthed the paper when it comes due, so why risk the elections because of such a detail?
I've been lurking at TOD from about 6-9 months, but finally decided that I'd jump in and give my 2 cents.

I do not claim to be a financial expert, but I have been reading a lot about the topic lately, so I'll see if I can help.  If someone has more clarification, please jump in.

In the purest sense of the word, a derivative is financial instrument that is based purely off another financial instrument.  Stocks, bonds, and future contracts are not derivatives because they represent underlying primary assets.  Options on a stock or options on a futures contract would be considered types of derivatives, because the loss or gain on the option is based off of the loss or gain of another financial asset.

Derivatives are considered an investment class and there are many different types of derivatives linked to many different types of financial instruments.  I believe the specific derivatives that most investors are worried in regards to GM are Credit Default Swaps.

The concept behind a Credit Default Swap is that a holder of bonds can hedge against potential bankruptcy by entering a contract with a counter party that agrees to buy the bonds for a fixed price, should bankruptcy be declared.  For example a pension fund manager who owns a portfolio of $100MM of GM bonds can minimize his risk that his $100MM would be completely lost if GM went into bankruptcy, by entering into a Credit Default Swap that states that the counter party to the Swap will pay you $50MM should GM declare bankruptcy.  It is like an insurance policy that pays out if a certain action happens (e.g. GM declares bankruptcy).  In order to claim the Credit Default Swap (insurance policy), the bond holder must actually deliver the bonds to the counter party and then the counter party pays the stated amount in the contract.  This is critical because the bonds have value (not much) and in bankruptcy they may be settled for some amount of money.  So the counter party is going to want to get their bonds.

The counter party to the Credit Default Swap assumes the default risk by accepting payment to enter the contract (similar to an insurance premium).  In the case of GM, hedge funds and other investors entered into Credit Default Swaps with GM bond holders under the assumption that GM would never go bankrupt and that they would be able to keep the "premium" paid as profit.

The relationship between the bond holder and counter party is fine, in itself.  Where things get tricky is that investment banks, hedge funds, and other investors entered into Credit Default Swaps in the position of the bond holder, without possession of the bonds, speculating that if GM goes bankrupt, they will profit from the Credit Default Swap payout and profit from buying the bankrupt bonds on the open market for pennies on the dollar and turning them into the counter party to get payout.  

The issue now is that you have more derivative contracts outstanding than there are underlying bonds that are required to cover the contracts should GM go bankrupt.  Each of the parties to the Credit Default Swap also probably entered into other derivative contracts to mitigate the risk of the original derivative contract entered.  The flood in the market to snap up GM bonds to cover the Credit Default Swaps and the triggering of other derivative contracts based off of the original GM contracts is what will cause confusion in the market that everyone fears.

This is my understanding of the issue with GM specific to Credit Default Swap derivatives.  If others can add more, please do.  If something is factually incorrect, please speak up.

Fascinating. And a good explanation.

So when the music stops and there are not enough bonds to go around why does that melt the market? That part is still unclear (to me). It's obvious a segment of financial managers are going to look foolish for not having bonds to redeem, but how does that spread to other deals?

The issue is that when the music stops (e.g. GM declares bankruptcy) there will not be enough GM bonds left to cover all the derivative contracts written.  The result is that Credit Default Swaps contracts will not be able to be executed because the if the holder of the swap contract representing the bond side does not physically own the bonds, consequently he can not claim his money from the counter party since he can not fulfill his contractual obligation of delivering the bonds of the now bankrupt company to the counterparty.

Not only will the contract not be able to be executed, since one of the parties will not be able to fulfill its obligations, but both of the parties probably also entered into other derivative contracts, each with their own obligations, to hedge their risk of the first derivative contract entered all based upon the original financial asset (GM bonds).  Many investment banks and hedge funds have complex investment positions in derivatives where they take both sides of the trade (bond holder and counter party) based on different investment strategies at different rates, bond prices, and duration.  

Since there are more derivative contracts written than there are bonds, once the bonds on the open market are sold, the bond holders will probably not sell for nearly any price.  (Those bonds need to be in possession of the bondholder to meet the obligations of the Credit Default Swap agreement).  Strange market activities will happen (i.e. bonds of a company in bankruptcy will be worth more than when it was a profit making ongoing business).

What you will essentially have will be a market lock up (a.k.a. cluster-F).  Contracts can not be fulfilled causing other contracts not to be fulfilled.  The process of figuring out what contracts are outstanding, fulfilling the contractual agreements, and straightening the whole thing out is known as "unwinding".

What I explained above is only one type of derivative and there are probably many others out there tied to GM bonds and stock.  Trying to comprehend how interconnected and its associated downstream impact is mind-blowing.

I really appreciate that post.  Kudos. For someone with only a minor understanding of the financials market like me, that really helps explain it.

Basically, the CDS are like reinsurance policies right?  And then there are reinsurance for the reinsurance policies, and this all escalates.  Now the figure that was quoted earlier in the thread of a near $300 trillion market in these things make sense.  I know that growth in recent years has increasingly relied on new finance tools, but I had no idea.  It's like these guys are taking the authority of the Fed to control the money supply into their own hands with these paper markets that don't represent physical wealth.  

I am now more convinced then ever that finance represents the most mentally challenged segment of society.  The Emperor has no clothes, and he KNOWS it.  

Thanks for that.  So can GM issue more bonds to help out the luckless derivative traders?  That would seem like it would help GM too (at least in the short term).  At a minimum, it seems like this would drive up the price of GM bonds, lowering the cost to GM of financing it's debt.

Why didn't price signals make it clear to market participants that too many people were trying to buy coverage for their non-existent bonds?

Rather than forcing GM to print more bonds, most likely what will happen is a government agency will step in (SEC?) and force parties without bonds to cover their position using a cash settlement.

For example a party representing the bond holder will pay the counter party in cash representing the current market cash value of GM bonds as promised in the Credit Default Swap contract.  However, the counter party probably would rather have possession of the GM bonds because they may need them for themselves to settle another hedged position, or perhaps there is future value in holding the bonds themselves (GM comes out of bankruptcy or maybe the bankruptcy judge settles with the bond holders for more than expected).  I am sure there are more reasons why the market would not like cash settlement; however, it goes beyond my knowledge on this topic.

The market is providing a sign to investors that there is more risk involved due to the danger of bankruptcy is higher and the lack of bonds to cover positions.  The prices that counter parties charge has gone up (i.e. the insurance premium) for bond holders to hedge their risk that GM will go bankrupt.  While I can not quote specific prices for the contracts, Jim Puplava on Financial Sense Online has mentioned this.  In addition, I believe that speculators are snapping up GM bonds, effectively lowering the bond yield, strategizing that the situation I described above will occur and the bonds will be worth more after bankruptcy.

Factual problem.

It would be highly unusual to have to deliver any bonds.  A standard credit derivative, like default insurance, is priced like a floating rate note based on a notional principal amount.  Eventual recovery by actual bondholders is always a factor in pricing anything, but the bonds themselves wouldn't be contractually linked.  

Most of what you read in the press about credit derivatives is misleading, but despite this--it ain't that complex.  If you sell someone default protection, you have the same exposure as if you bought a similar floating rate note, and you receive similar compensation.  

The difference is, unlike a bond, in the swap you have both company credit risk AND counterparty risk.  If your counterparty fails because of financial mismanagement or fraud/malfeaseance, you may not longer be able to collect on the contract.  However, the vast sums of notional derivatives are often partially cancelled out by each other, and the remaining balances are partially offset by the posting of collateral between counterparties.

Warren Buffet's big problem with the whole picture is that you may know what you have done with your counterparties, but you have no clue about how third parties are managing their counterparty exposure.  If you want to run Berkshire like a lower-risk institution, you shouldn't be the largest financial risk counterparty of them all--which Gen Re was, before they changed it around.  

Seriously though, the press has this stuff wrong because they aren't trying hard enough to get it right.  It isn't that complex, but it is obscure and scary sounding, which is perfect to sell a story.  

Thanks for the correction.
My own experiences re: GM.

When I moved here I needed a car. I knew one of the American makers would be happy to put me behind the wheel fairly cheaply, and no money down, which was good because I had just enough cash to get an apartment and had just spent that. I had about $80 to my name. I went to the local Ford place (I was driving a rental Ford Focus) and talked to them, they were jerks. I went down to the next dealer in the row and it was a Saturn dealer! Saturn! Of course! No hassle, great cars. I got an Ion, no problems, it was cheap, reliable, got the service plan and that was zero hassle, it was great. It was hard to put big stuff in, and carrying a bicycle was comical, and a few ppl I knew had the Saturn SUV so I decided to do a trade in and get one of those. I got one, and ended up hating it. Not fun to drive, hard to carry stuff in easily, still not as easy as it should be to stuff a bike in. Gas prices were just starting to take off too. I actually ended up concluding that I'd be best off selling it back to Saturn, which I doubt could be done today. I went car-free for a while just to prove to myself I could do it, then decided with my small biz I'm better off having a car and got one again. A non-GM. I had GMAC loans on the Ion and on the Vue, when I sold the Vue back GMAC lost out on a LOT of money.

Since Saturn is part of GM, a money-losing part I understand, the upcoming rise in gas prices is going to mean people are going to get rid of their GM cars and GM loans, the smarter ones before there's a glut on the market. The small Saturns are nice cars, people like 'em, but the way GM's set up they only make money on the big cars, SUVs, and stuff like tanks for the military. Yes, GM is a big military supplier.

I was talking with the guy at the gas station up at the corner and saying, "This isn't a real gas price/shortage problem, I know, because I'm old enough to have seen them. Where are all the bicycles and mopeds? There were TONS of mopeds. Mopeds were not only advertised heavily locally, but nationally, the Yamaha Yamahopper. Where are all the tiny cars? People went over to driving all these tiny cars, the Honda Civic and yes, the Ford Pinto, which I got some of my first driving lessons in. Until I see all that stuff, it ain't a gas problem."

Here's the kicker - since I've had a GMAC loan, I've gotten offers for house loans, signature loans, all kindsa stuff, from GMAC.
Had CAFÉ standards continued to rise through the 90's until present would GM be healthy today?  Did GM just miss-read the market, scoff at peak oil, or just get lazy?  GM exec's use this opportunity to blame unions and the burden of healthcare.  

Thanks for the inservice on derivatives.