The cost of insuring against default (credit default swaps) had been falling from its extreme highs in the midst of the credit crisis in October 2008. However, even as the state of banks’ balance sheets had achieved some clarity and the extremes of the crisis seem to have subsided, other problems, like the U.S. automakers kept the prices of credit default swaps high. Now, with Chrysler’s bankruptcy and eventual sale to a group including Italian auto maker Fiat and General Motor’s expected bankruptcy filing this morning, the price of credit default swaps is easing.
According to a report by Bloomberg News, the price of credit default swaps fell to a new low since October 2008, on speculation that GM’s bankruptcy will be orderly and that the worst of the recession has passed. Credit-default swaps on the Markit iTraxx Crossover Index of 45 companies with mostly high-risk, high-yield credit ratings dropped 20 basis points to 704, the lowest since Oct. 14, 2008, according to JPMorgan Chase & Co. prices at 12:10 p.m. in London.
Generally, a major company’s bankruptcy would not bode well for the corporate credit market, but the circumstances in which the GM bankruptcy has arisen are unique. Since October 2008, the market has expected the worst. Prices for protecting against corporate defaults rose to such heights and remained elevated due to fear and uncertainty about the toll the recession would take.
Now, however, “If GM’s bankruptcy turns out to be pain free like Chrysler’s looks like it’ll be, then that’s good news for the market,” said Andrea Cicione, a credit strategist at BNP Paribas SA in London. “It could have been a messy filing or more orderly, and the latter turned out to be the case.”
Under the reorganization plan for General Motors, the U.S. government will spend a bit more than $30 billion to fund the bankruptcy and in exchange receive 60% of GM’s stock, while the Canadian government will put in $9.5 billion for a 12% stake, senior administration officials said.
Over the weekend, owners of a majority of $27 billion in GM unsecured bonds agreed to a sweetened offer to trade their investment for stock. Days earlier, the United Auto Workers union signed off on a range of concessions.
So, if a company that has burned through more than $30 billion dollars in cash the last four years can file bankruptcy and have a real chance of surviving, the corporate bond market should be elated because the odds of other defaults will be greatly reduced. Investors who would like to take advantage of this may look to purchase individual corporate bonds, of course, but there are also two exchange-traded funds which help to diversify risk while remaining liquid: iShares IBoxx Investment Grade Corporate Bonds (LQD) and iShares IBoxx High Yield Corporate Bonds (HYG).
For those giddy about equity markets following GM’s bankruptcy, one should keep in mind that the consumer discretionary, though it has done well during the rally, may not be able to continue its run. Job losses caused by the automakers bankruptcies and increase gasoline prices may put a further damper on consumer spending. Under the worst-case scenario, the economy would see an additional 1.3 million job losses this year, according to the nonprofit Center for Automotive Research in Ann Arbor, Mich. — enough to push the unemployment rate up by nearly a full percentage point. Of those, 203,800 would be lost because the supply chain to U.S. plants owned by Ford Motor Co. and foreign car makers would be disrupted. To that, add 460,700 jobs lost at firms that supply goods and services to auto and auto-parts makers and 659,500 jobs lost because of reduced spending by laid-off workers. Next year, there would be an additional loss of 446,700 total U.S. jobs. The center’s estimates only partially capture the effects on dealership employment.
Gregg D. Killoren
victoria1014
