Saturday, November 27, 2010

General Motors Pension Plan Problem

General Motors is currently being excitedly touted by Wall Street salespeople as a real opportunity for small investors. What a joke!

However, these sales people are conveniently ignoring one very big problem GM has – its giant pension fund.

As stated in my prior article, General Motors' pension fund is the largest private sector pension plan in the world with approximately $100 billion in liabilities.

Let's reiterate the essential flaw in the entire GM rescue. In order to keep the United Auto Workers union happy, the pension plan was transferred completely untouched to the 'new' General Motors.

GM is making no contributions to the pension fund now. But the company says it may have to put in $4.3 billion in 2014 and $5.7 billion in 2015. GM added that it will “possibly” have to add more funds in the future. Make that definitely!

Think about it...GM's second-quarter earnings were the highest since 2004. Even so, first-half operating income was only $2.9 billion. Double that for an annual figure and prospective pension plan payments would barely be covered. This leaves nothing to actually run the company.

Pension Plan Assumptions

General Motors' stated pension deficit is “only” $27 billion. However, GM is using the same flawed, optimisitc thinking that many US entities use in calculating pension costs. GM is assuming that its pension fund assets will return at least 8.5 per cent a year.

A closer look at GM's pension fund shows annual payments to its pensioners of $9.3 billion. On fund assets of $85 billion, that means GM actually needs a return on its pension fund of 10.9 per cent a year.

Investing the pension fund safely into US Treasuries would yield only $2.2 billion, leaving an annual shortfall of more than $7 billion. The planned $4.3 billion and $5.7 billion contributions will not plug the gap in GM's pension fund. At best, the company will kick the can down the road a ways.

It comes down to a numbers game for General Motors. At last count, the company had 531,500 pensioners and only 87,500 active workers in the United States. In other words, each worker has to support six pensioners. And that calculation leaves out the 83,500 people who have left the company and have yet to retire.

General Motors' pension plan situation is almost like a badly-run hedge fund with leverage working against the company. GM really will be run mainly to try to support the pension plan, with selling cars as a sideline business.

Speaking of hedge funds, GM's pension fund does look a bit like one. Pension consultant John Ralfe calculates that only 35 per cent of the fund's assets are in investment-grade bonds, either Treasury or corporate. The rest is spread across stocks, real estate, hedge funds, private equity funds, etc.

Investors thinking of investing into GM need only to look at the current dire situation that many US states such as Illinois are in. Illinois is being bled dry but its pension plan which is only 40 per cent funded.

Look at it another way – what GM is doing is the exact equivalent of taking out an unaffordable mortgage, then making insufficient annual payments on the premise that “something” will turn up before the repayment date. As many homeowners have found out, that simply does not work.

Bottom line - for investors contemplating an investment into General Motors – don't! Its pension plan liabilities will sink it again. GM's “comeback” is not as rosy as Wall Street is suggesting.

Saturday, November 20, 2010

The New General Motors

The stock market had a big rally on Thursday of this past week. It was due mainly to the successful initial public offering (IPO) from General Motors.

The auto company began trading again as a public company after filing for bankruptcy and being bailed out by Uncle Sam. The money realized from the IPO will add to the $9.5 billion already paid back to the US government by General Motors.

But GM will still owe the taxpayers plenty...Investors will recall that GM became 'Government Motors' after the multi-billion bailout from Uncle Sam.

The IPO's initial success is largely due to the fact that the IPO was priced to sell. After all, neither the company nor its majority owner – the US government – could afford to see the IPO flop. After the IPO, Uncle Sam's stake in the carmaker has fallen to about 40 per cent from its prior 61 per cent.

But is General Motors really much different from the company that went into bankruptcy?

General Motors restructured its operations and finances in last year's $60 billion government bailout. Thanks to the restructuring, GM in 2010 posted net profits and positive cash flow for the first three quarters of this year.

There are positive factors going for GM, such as its $33 billion in cash at the end of the second quarter. In addition, it will enjoy $45 billion in tax-loss carry-forwards which will shield its earnings from the IRS for awhile.

GM is still a major player in the auto industry. GM will hold on to its spot this year as the world's second-largest automaker after Toyota Motor.

And perhaps most importantly, General Motors is playing up its growing international business. GM sells more than two-thirds of its vehicles outside of North America.

In particular, the company emphasizes that it plans to continuing strengthening its international presence in emerging markets. GM has the top combined market share (13%)across the BRIC emerging markets of Brazil, Russia, India and China.

But GM is struggling in Europe. And its market share in the United States has slipped by nearly a point over the past year to 19 per cent in January through September.

However, the real “sword of Damocles” hanging over General Motors is the company's long-term pension obligations.....

The optimists on GM are quick to point out that the bankruptcy eliminated much of the company's debt. True enough, but they are ignoring the company's massive pension obligations.

General Motors' pension fund is the largest private sector pension plan in the world with approximately $100 billion in liabilities.

The essential flaw in the entire GM rescue was that, in order to keep the United Auto Workers union happy, the pension plan was transferred completely untouched to the 'new' General Motors.

GM is making no contributions to the pension fund now. But the company says it may have to put in $4.3 billion in 2014 and $5.7 billion in 2015. GM has said that it will “possibly” have to add even more funds in the future. Investors should change the word possibly to definitely.

That huge pension liability is a red flag. It may land General Motors right back in bankruptcy court some day down the road.

The future outlook for the 'new' General Motors may not be as rosy as the company, the government and Wall Street suggests. It looks likely that the 'new' GM may end up looking a lot like the 'old' GM.

Saturday, November 13, 2010

The Currency War Continues

By the end of this past week, the stock market seemed to be a little spooked. Perhaps it was the sighting of that missle off the coast of California.....

Rumor was that the missle was fired by Ben Bernanke as a big blow in the ongoing global currency war. Maybe it was filled with freshly printed dollar bills and on its way to China.

All kidding aside, the United States is exporting inflation to China and other emerging markets quicker than you can say Mao Tse Tung. And as mentioned in last week's article, the rest of the world is not happy about the Federal Reserve's massive money printing.

The latest announcement by the Fed of another $600 billion, brings the grand total of "magic" money creation to $2.3 trillion printed in the past 24 months!!

No wonder that US Treasury Secretary Timothy Geithner was laughed out the room at the G20 summit when he said that the US was not "intentionally" trying to weaken the US dollar.

The German Finance Minister said that "The United States has lived on borrowed money for too long, inflating its financial sector unnecessarily and neglecting its small and mid-sized industrial companies."

Minister Schauble went on: "It's inconsistent for the Americans to accuse the Chinese manipulating exchange rates and then to artificially depress the dollar exchange rate by printing money."

For good measure, he added that the US Treasury and the Federal Reserve were "clueless".

Speaking of China...its debt ratings agency Dagong downgraded US debt. In speaking of the downgrade, it had this gem: "It is likely for the current loose monetary policy to postpone the occurence of difficulties. Yet in the long run, it will be proven to be a practice resembling drinking poison to quench thirst."

The list of countries goes on - the UK, France, India, Brazil, etc. The rest of the world is growing tired of the US trying to dump its problems on the rest of the world by printing dollars, thereby creating global inflation.

Perhaps the US should consider austerity measures like the UK has taken instead of creating massive new government entitlements. A "diet" and some belt-tightening is the right prescription. But also the most unlikely one.

Saturday, November 6, 2010

Emerging Markets and the Federal Reserve

Most investors are by now well aware that the Federal Reserve's QE2 has set sail, to the tune of $600 billion.

In simple terms, the Fed has announced that it will “create” another $600 billion out of thin air with which to purchase a like amount of longer-term Treasury bonds by the middle of next year.

However, there is no truth to the rumor that Ben Bernanke will be writing an updated global version of Dale Carnegie's classic self-help book “How to Win Friends and Influence People”.

Mr. Bernanke's policies may be influencing people on Wall Street, but he is certainly not winning any friends globally. Especially in emerging market countries. The very strong perception there is that the Federal Reserve is trying to export the US woes overseas by printing so many dollars.

The 1997 Asian Crisis...In Reverse

Thanks to the Fed's QE2, there is now even more money sloshing around the global financial system in search of higher returns than available in the US.

What we are seeing right now in the global financial markets are echoes of the 1997 Asian crisis. But in reverse. The economies targeted by speculators are now those that are strong, not ones that are weak.

That period of panic in 1997 saw speculators swamp developing markets with sell orders. Once again today, we see many emerging countries trying to block overseas speculators.

But this time from buying their assets and currencies, not selling them. This is the exact opposite of 1997.

Easy credit policies in the US have further fueled speculation in the currencies of developing economies in strong balance-of-payments positions. And the largest speculative prize of all remains an anticipated upward revaluation of China's renminbi, followed by other Asian currencies.

Emerging Markets Tightening

But the emerging countries are not standing by idly, waiting for the tsunami of US dollars and speculators to devastate their economies. They are taking action.....

The Financial Times calls it QT2. The QT stands for quantitative tightening.

These are measures taken by emerging market countries to counter the effects on their economies of vast capital inflows – that tsunami of Federal Reserve paper.

As the US dollar falls and developing nations see speculators pushing up their exchange rates, more and more countries are discussing stringent restrictions on incoming capital flows. A string of governments in Asia and Latin America have either already implemented, or are considering implementing soon, capital controls to stem the nasty side effects of inflows.

Emerging markets are affected in several ways by the so-called US dollar carry trade. For investors not familiar with what a carry trade is, here is a basic definition. A carry trade can be described simply as when money moves from a low interest rate environment to a higher interest rate environment.

Such speculative inflows contribute little to capital formation or employment. But they do price a country's exporters out of foreign markets. And such inflows can be suddenly reversed if speculators pull out, disrupting trade patterns.

According to a recent research note by HSBC, loose monetary policy in the United States will lead to capital controls across the developing world. In other words, capital controls will follow the weak dollar as inevitably as sunset follows sunrise.

Emerging markets are struggling with what HSBC calls the “impossible trinity”. This is an inability to allow free flows of capital while simultaneously maintaining a grip over interest rates and exchange rates. HSBC went on say “The more the west pursues quantitative easing, the more the emerging world, via capital controls, will pursue quantitative tightening.”

Danger to the US

There is a real long-term threat to the United States from all the Fed's quantitative easing. The danger is that the world breaks into two competing financial blocs. One bloc would still be centered on the dollar. The other bloc centered on the emerging nations. Particularly the large nations such as China, India, Brazil and others.

Tentative steps in that direction already occurred last year. China, India and Russia among others took early steps to use their own currencies for trade, rather than the US dollar.

China took a simpler path last month when it supported a Russian proposal to start using the renminbi and the rouble for trading between the two countries. China has also negotiated similar deals with Brazil and Turkey.

It looks like more and more of the developing countries will be moving down a similar path very soon to protect their own currencies and their economies.....

If these countries do implement such policies, it will have been largely due to US policy short-sightedness. A policy designed to please Wall Street speculators and conducted without concern for its effect on emerging economies around the globe.

This policy may ultimately isolate the United States, the dollar and its users from the rest of the globe. And to the long-term detriment of the United States and its citizens as America will no longer have the central role in the global economy.