Decades in the making, General Motors' (NYSE: GM ) careless ways finally caught up to it. Now bankrupt, what's being called the "New GM" will be owned by bondholders, the UAW's health-care trust, the Canadian government, and, well, you … the always-obliging taxpayer. When GM emerges from bankruptcy, taxpayers will own 60.8% of the company.
This New GM, we hear, will be a lean, mean, profitable Motown machine. Therefore, taxpayers' 60.8% ownership stake might be worth something meaningful. Maybe even enough to recoup a significant portion of their investment.
Maybe is the keyword there. Unlike most Wall Street banks, which issued debt-like preferred shares to the government, most of taxpayers' investment in GM will wind up as common stock. We lent money to the banks; we own General Motors. There's a big difference.
There's also a big difference in the outcome of these bailout structures. When you lend money to an otherwise autonomous company, they're quite inclined to pay you back (at least when they can). Indeed, Goldman Sachs (NYSE: GS ) , JPMorgan Chase (NYSE: JPM ) , American Express (NYSE: AXP ) , and Wells Fargo (NYSE: WFC ) are trying to repay taxpayer money in full, plus interest, as fast as humanly possible.
But when the government takes a direct ownership stake in a company, the outcomes are far different.
Good examples of just how different come from AIG, Freddie Mac, and Fannie Mae. Just like General Motors, taxpayers are majority owners of these companies' common equity.
Unlike some banks, where it looks like taxpayers will recoup a significant portion of their investments, AIG, Freddie, and Fannie are still pathetic disasters. True, this is mostly because their problems were far deeper than anyone else's. But it also stems from the shortcomings of direct government ownership.
To see what I mean, look no further than Fannie Mae's recent 10-K shareholder report, which states:
Prior to the conservatorship, our business was managed with a strategy to maximize shareholder returns. However, our conservator has directed us to focus primarily on fulfilling our mission of providing liquidity, stability, and affordability to the mortgage market and to provide assistance to struggling homeowners. In support of this focus on our mission, we may take, or be directed by the conservator to take, a variety of actions that could adversely affect our economic returns, possibly significantly.
The "conservator" here is, of course, the government.
An honest translation of this statement is this: "Because we're owned by the government, we have precisely zero incentive to make a profit ever again. In fact, it is insisting we don't even try."
Now, some would say this example isn't fair. Fannie and Freddie were already quasi-government companies to begin with. Furthermore, most would agree there's little reason to nurse them back to life, since their existence is now widely acknowledged as flawed.
So we turn to insurance giant AIG, in which taxpayers also directly own a 79.9% stake. As reported by the eminent blog Zero Hedge, a derivatives trader detailed how AIG dumped assets at unnecessarily low prices earlier this year. The sales were so inequitable that, as one investor on the other side of the trade apparently stated, "We have never done as big or as profitable trades -- ever."
He goes on to explain the rationale for such fire-sale trades: Knowing that its chief shareholder is the government -- devoted to unconditional support -- AIG had little incentive to properly price the products. It turned into a dispassionate machine. Also, by selling assets at unreasonably low prices, traders could transfer profits to buyers at the expense of taxpayers, so at least someone could make a private profit.
Surprised? Don't be. When your owners are as dutiful and forgiving as Uncle Sam, such behavior can hardly be blamed. That's the nature of incentives. And it reminds us that debt restructuring, layoffs, and asset sales often aren't enough to outshine the capitalistic incentive that creates profit. We'd be foolish to expect anything different from the New General Motors.
Stop expecting miracles
I'm not writing this because I necessarily disagree with our ownership stake in GM (even though I do). I've argued that taxpayer money given to Citigroup (NYSE: C ) and Bank of America (NYSE: BAC ) is (or would be) more beneficial as common equity. What's ideal isn't always what's necessary.
But we should keep our expectations realistic when discussing the "New GM." As it stands, we intend to transform a company utterly incapable of surviving in private hands into a viable, profit-making enterprise while majority-owned by the government. Correct me if I'm wrong, but history shows this is as close to improbable as it gets. Our track record with AIG, Fannie Mae, and Freddie Mac confirms this.
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