Wednesday, May 6, 2009

Wipe Out (or Hanging 60 Billion)

Well it finally happened GM stockholders had the fork stuck in and the juice ran clear. Turkeys do that. Last night it was announced that GM will do a 100 to 1 reverse split. Own 100 shares? Now you're going to own 1 share.

"If the restructuring as currently contemplated occurs, there will be very substantial dilution to existing holders of GM common stock." I love a good understatement as found in the SEC filing.
Existing shareholders will have 1% of the company. The other 60 Billion new shares will be issued to pay off the debt of the U.S. Government, Bond holders and the United Auto Workers Union.

Whether this approach will be allowed to broach the banking system which is effectively insolvent remains to my mind the largest question facing the economy. The insolvency and question of toxic asset pricing could largely be answered with the conversion of debt to equity in the banks.

A leaked result of the bank stress test (which hasn't been particularly stressing) for Bank of America indicates a need for $34 billion in equity capital to be raised. I question whether the private sector will put up the $34 billion without restructuring and I am sure congress is not ready to foot the bill (dear God I hope not.) Expect some move toward ultimately diluting existing shareholder and removing debt similarly to GM. Otherwise the hole will devour the Fed and taxpayers with it.

John Barnyak