Top 15 For 2008 (No. 7): The Big 3 On Their Knees

January 8, 2009 5:57 PM EST

StreetInsider.com has put together its 'Top 15 For 2008' which chronicles our view of the most significant news on Wall Street during the tumultuous year.

Number 7: The Big 3 On Their Knees

With Detroit's Big 3 automakers already in a huge mess, the 2008 credit crisis brought two of them, General Motors (NYSE: GM) and Chrysler, to their knees. Both companies needed emergency loans from the government by year-end or they would have had to file bankruptcy. Ford (NYSE: F) also asked for some cash, but that was 'just in case the others fail.'

Heading into '08 the problems the Big 3 automakers were facing were widely known: unfavorable union contracts, bloated white collar workforce, insane health care costs, large legacy costs, bad products, and a horrible public image. Everyone knew that the companies were a slow-motion train wreck and were bad investments, but no one could have imagined what would play out.

At the beginning of the year automakers were dealing with gas prices over $3 per gallon, which were quickly heading to $4 and above. Due to the high gas prices, sales of big SUVs and trucks, the most profitable vehicles, were falling off a cliff. The Big 3 were caught with the completely wrong line-up of vehicles and were reeling. But what happened later in the year, from the credit crisis, pushed these already fragile companies to the edge.

For years, the automakers have been 'lease-happy', offering $50K SUVs for $300 per month, and extending credit to less-than-credit-worthy buyers. The automakers relied on their credit arms, GMAC, Ford Credit and Chrysler Finance, to finance the eager buyers. It was a great way to the sell over-priced hunks of metal. It was working great - until WHAM!

Not only were buyers no longer interested in buying new SUVs, the finance companies were getting hit when the returned leases turned out to be worth much less than anticipated due to the low demand and flooded market. In addition, the securitization market, which was fueling the easy money, seized-up due to the credit crisis. GMAC, 51% owned by Cerberus Capital, which was already struggling with its mortgage lending unit ResCap, was facing a major liquidity crisis forcing them to seriously cut back on all types of financing activities.

Needless to say, the financing difficulties push the slow-motion train wreck into fast forward. Losses were piling up quickly and cash was burning 'like the fires of hell'. The Big 3, which may have been able to hang on a few more years had the credit crisis not hit, finally got the point - they were dead men walking.

The Big 3 saw that the purse-strings of the U.S. government were wide-open and they leaped at the chance for their own piece of the pie. The Big 3's pitch for the money was easy, "If we go down, the whole economy is coming with us." Keep it Simple Stupid!

The Big 3 thought that with a Democratically controlled Congress it was going to be easy to get the money, but they were proved wrong. The first trip to Washington in November was a public relations nightmare. Instead of driving or taking commercial airlines to get to the hearings in DC, the automakers each took their own private jet. The public was outraged - "You mean you're begging for $25 billion of taxpayer money, but you are taking private jets!" It was bad - real bad. The Congress sent the automakers packing, without any money, and asked them to come back in December with a plan showing exactly how they would use federal funds to transform their industry.

When they returned in December all the CEOs drove to the meeting to avoid more backlash. They also had details of exactly how much they would need. GM said it needed $18 billion; Ford said it needed $9 billion, but only as a precaution if one of the others goes bankruptcy; Chrysler's said it needed $7 billion.

After passing the House, the auto bailout bill failed in the Senate and the Bush administration was forced to step-in. The administration accessed the TARP to provide $13.4 billion in emergency loans to keep GM and Chrysler solvent until a longer-term solution can be devised when the Obama administration takes over. GMAC also received $5 billion to help finance vehicles.

The saga was postponed...

Meanwhile, GM's stock is still trading with the hope that the common stock will be worth something when all is said and done. But, based on the terms of the emergency loans, GM will have to reduce their public indebtedness by not less than two-thirds through conversion of existing public debt into equity or debt (Bond Exchange) and other appropriate means. With $36 billion in long-term debt (plus billions in other liabilities and the government loans) and a current market cap of just $2.5 billion, this means that current GM common share holders will likely have to be wiped-out.

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Related Entities

• Chrysler LLC
• Cerberus Capital
• Bankruptcy
• GMAC
• Top 15 For 2008

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