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.

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.

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?

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/03/18/cngm18.xml&menuId=242&sShe et=/money/2006/03/18/ixcitytop.html

(sorry if this was posted previously)

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.

http://www.financialsense.com/stormwatch/2005/1123.html

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 FinancialSense.com 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.  

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?

 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."

http://online.wsj.com/public/article/SB114347098996009022-OvMpyiZqlZWNvS3qXzgBYErA7aI_20070328.html? 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.

http://english.aljazeera.net/NR/exeres/50B0028B-B417-4FDE-866C-842CB3280A4F.htm

 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.

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.

http://www.thetruthaboutcars.com/content/1142087337934924044/

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.

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.

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 ;-)

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.

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."

and

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.

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.

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

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.

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, http://courtofappeals.mijud.net/resources/asp/viewdocket.asp?casenumber=130774&inqtype=sdoc& 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.  Enigmanomalous@AirPost.net

Read about it here:

http://www.feasta.org/documents/moneyecology/moneyproposals.htm

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.

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."

Thanks for the inservice on derivatives.