WASHINGTON (Reuters) - Dire warnings of lost jobs and fading U.S. industrial might are driving the Detroit bailout bandwagon, but there’s a little-noticed passenger quaking in the backseat — the credit markets.
A bankruptcy or failure of General Motors Corp, Ford Motor Co or Chrysler LLC would threaten billions of dollars of financial instruments, with untold consequences, say credit market analysts and some pro-bailout lawmakers.
“A collapsed U.S. auto industry would lead to defaults on over $1 trillion in corporate bonds, credit default swaps and other financial instruments,” Michigan Democratic Sen. Carl Levin said in a statement provided to Reuters.
“Major additional damage to U.S. financial institution balance sheets would result, and another grenade would be tossed into our credit markets,” Levin said.
The threat is so serious that “Credit Crisis Part II” looms if the government doesn’t come to the aid of GM and Ford, said J.P. Morgan analyst Eric Selle, author of a research report that pro-bailout Democrats like Levin are citing.
Some Republicans remain skeptical and continue to oppose a bailout, even as the White House and Democratic negotiators are trying to hammer out a loan plan valued at about $15 billion.
The financial aspect of the bailout debate is important because it calls into question the administration’s refusal to use the $700 billion bank bailout fund to help Detroit. Known as the Troubled Asset Relief Program, or TARP, the fund is meant to help the financial sector only, not manufacturers, the administration has insisted for weeks.
In response, Democrats are trying to portray the automotive sector’s problems as posing a systemic financial risk, and therefore suitable for TARP funds.
A bankruptcy of Ford, GM or Chrysler “would greatly exacerbate the credit crisis,” Massachusetts Democratic Rep. Barney Frank said last week at a hearing on the issue.
On Thursday, Democratic leaders wrote to the White House urging usage of the TARP on the grounds that “the failure of the Big 3 would have a major direct and negative impact on the financial sector, not just on the economy as a whole.”
Part of the problem, analysts say, is the vast amount of debt issued over the years by GM, Ford and their related financing companies, GMAC and Ford Motor Credit.
For instance, 10 percent of the junk bond market is tied to GM, Ford and the financing companies, Selle said.
Bond markets have seen trouble coming from Detroit for years and have priced in considerable risk already, said Mark Oline, managing director at credit rating group Fitch Ratings.
“Some of the debt is trading at 20 or 30 cents on the dollar. Certainly there’s a high probability of default factored into those prices,” he said.
That built-in risk reassures some analysts that bond markets could absorb a Big Three failure.
But another layer of risk resides in the $250 billion of credit default swaps (CDS) written on Ford, GM, Ford Motor Credit and GMAC, according to data from the Depository Trust and Clearing Corp, a securities transactions clearinghouse.
One senior Wall Street credit analyst said: “An outright failure of the automakers would be problematic for credit markets, given the feedback on the regional real economy, as well as workout processes from CDS settlements.”
With a recession under way, analysts say, the biggest danger may be to auto parts suppliers, businesses around auto plants like restaurants and retailers, and state and local governments that depend on taxes from the auto sector.
“A bankruptcy would cause a domino effect and result in bankruptcies throughout the industry ... and further defaults throughout the supply chain,” Oline said. “It’s uncertain as to exactly what the extent of that chain of events would be.”
Additional reporting by Walden Siew in New York and John Crawley in Washington; Editing by Steve Orlofsky