Dark Clouds Over Detroit

GM plunged today to a 10 year low when it finally confessed just how bad its operations really are. The world's largest automaker said it now expects a loss of about $1.50 per share in the first quarter, well below its prior target calling for breakeven results or better. For 2005 as a whole, GM scaled back expectations and now anticipates earnings of $1 to $2 per share, not the $4 to $5 in expected previously. This is a company headed for bankruptcy but the Wall Street pimps will not admit it until the bitter end. According to the S&P, GM and their finance arm General Motors Acceptance Corp. had about $300 billion in outstanding debt at the end of 2004. That will be one heck of a lot of write offs when they happen.

The S&P affirmed its long-term "BBB-" ratings and its short-term "A-3" ratings on GM and GMAC, but the outlook was changed to "negative" from "stable." The change reflects S&P's "heightened concerns regarding the profit potential of GM's core North American automotive business in the wake of the company's dramatically revised earnings and cash flow guidance," analyst Scott Sprinzen wrote in a research note. "Confidence that performance will be bolstered by the eventual introduction of new products is diminished because sales of major new products it has introduced recently have generally not met expectations," he said. Moody's said it may cut ratings on GM and GMAC. The ratings agency currently rates GM's long-term debt as "Baa2," two notches above junk.

The real story in today's fiasco is NOT the GM implosion but the fact that Fitch, Moody's and the S&P have not and will not cut GM's rating to junk. I am openly calling for the SEC to crack down on the relationship with rating companies and their clients. No one wants to be the first to upset a relationship or to spook the equity markets with a downgrade on a company as large as GM. At the current pace they will put this off for as long as they can, just as they did with Worldcom and Enron. Ratings companies are now totally useless. The problem here is clear, ratings companies should NOT be allowed to have relationships with the companies they rate.

How many times do Moody's, Fitch, and the S&P have to prove they can not police themselves. The only hope for accurate rating is if the companies are totally independent.

The New York Times commented on this in their February 2005 article
"Wanted: Credit Ratings. Objective Ones, Please"
"I think it's fair to say that the oversight of the industry is insufficient," said Annette L. Nazareth, director of market regulation at the Securities and Exchange Commission. "We want the firms to commit to meet certain standards with respect to policies and procedures on conflicts of interest and solicitation of ratings. Right now we don't have that at all."

In 1975, the S.E.C. ruled that the laws relating to debt carried by banks and financial institutions refer only to ratings provided by agencies that it recognizes. Right now, these are the big three and a much smaller fourth, Dominion Bond Rating Service of Canada. What you have, in other words, is an oligopoly.

Even more troubling, this oligopoly earns its keep from fees charged to the companies whose debt it rates. This conflicted business model means that the paying customers for these agencies are the corporations they analyze, not the investors who look to the ratings for help in assessing a company's creditworthiness.

This is not the first time that Standard & Poor's, MOODY's and Fitch have been in the hot seat. When Enron and WORLDCOM failed, investors were stunned by how long it had taken the agencies to recognize the companies' declining fortunes. For example, all three agencies had rated Enron an investment-grade company until four days before it filed for bankruptcy. They had rated WORLDCOM similarly until a few months before it collapsed.

I am encouraging everyone to Email the SEC at:
SEC Center for Complaints and Enforcement Tips and complain about the obvious conflict of interest between ratings companies and their clients..

US bankruptcies are expected ‘to surge’ amid JUNK bond deluge
Most Likely To Default
# Mitsubishi Motors Corp
# Holley Performance Products
# Motor Coach Industries
# Granite Broadcasting
# American Lawyer Media Holdings
# Interep National Radio Sales
# Sports Club Co
# Levi Strauss & Co
# Salton Inc

How long before GM and Ford are on that list?

The problem is that they should ALREADY be on that list. GM's credit spreads prove it! GM's debt trades at junk levels. Ok, So what's the big deal then? The big deal is that everyone pretends that GM is not junk and GM bonds go into portfolios that are not suited for junk. Many funds have a requirement to NOT have junk bonds in their portfolios. Conservative investors purchasing such funds have tons of this stuff forced on them by bond fund managers speculating in issues that are clearly junk but is not rated as such. Investors buying those funds are treated to the risk of GM whether they want it or not.

The ratings companies do not want to downgrade GM because it might cause them future business and because it will flood the junk bond market. Although the corporate bond market is huge, the junk bond market is only a tiny piece of it. GM has an enormous amount of debt so no one wants to do the right thing and call a spade a spade (or junk junk). If GM was downgraded it would likely cause repercussions in the stock market as well as the junk bond market. So what? Non-junk Corporate bond holders deserve to hold non-junk. Why can't we have some semblance of honesty? Well today any bond funds holding GM took a big hit. Let's take a look:


NYSE Price % Losers 2005-03-16

12 of the top 16 losers today were GM related.
11 of them were GM bonds.
Will there be a lawsuit coming up by bondholders against Moody's, Fitch, or the S&P?
Will there be a lawsuit coming up by bondholders against non-junk rated bond funds holding junk?

Somehow I do not think we have seen the end of this mess.
In the meantime this is what you need to do:
Email the SEC at:
SEC Center for Complaints and Enforcement Tips and complain about the obvious conflict of interest between ratings companies and their clients.

Mish