The WSJ mistrusts companies which pay down debt

December 15, 2010
Sharon Terlep's story on GM trying to pay down its debt is a great indicator of how the leverage-is-good meme simply refuses to die, even after the financial crisis.

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Sharon Terlep’s story on GM trying to pay down its debt is a great indicator of how the leverage-is-good meme simply refuses to die, even after the financial crisis.

What GM is doing is very simple. The main reason to carry debt is the tax advantages it gets, but GM already has all the tax advantages it will be able to use for the foreseeable future thanks to all the losses it made in previous years. Meanwhile, as GM vividly remembers, carrying a large debt load can be devastating in a cyclical downturn. So GM is trying to pay down its debt and carry as little of it as possible.

But Terlep just can’t seem to believe it’s as simple as that. And so we find:

GM, like its Detroit rivals, had long carried a large debt load to help finance the business through the industry’s periodic downturns.

This makes no sense. A large debt load is a bad thing, not a good thing, in a periodic downturn. If a car company loses money in any given year, it has to borrow that money. But borrowing money is much easier and much cheaper if you have a small debt load than if you have a large debt load.

Terlep seems desperate to find some kind of a downside here:

GM’s plan carries risks. Should the car market again fall severely, GM may not be able to keep funding new vehicles and other investments through current earnings alone.

I’m not sure that’s a risk. If the car market again falls severely, then GM’s lower debt load will make it easier to borrow money to keep funding investments in new autos. GM CFO Chris Liddell isn’t ruling out borrowing money in a crisis — he’s just announcing a baseline plan for paying down debt if there isn’t a crisis. Indeed, a few grafs later, Terlep contradicts herself:

In wiping out most debt, GM hopes to cut the tie between sales levels and its ability to invest in vehicles.

Which is it to be? Does the plan mean that GM won’t be able to invest in vehicles during a downturn, or does it mean that GM will be able to invest in vehicles during a downturn? The latter is surely the case, but Terlep does seem to want to have it both ways.

And this is surely a stretch way too far:

Anticipating GM may again borrow at least some money, Barclays Capital and Goldman Sachs on Tuesday began quoting prices for credit-default swaps for GM debt, a way for investors to insure against losses in any bonds GM may issue.

Does Terlep really think that investors are going to buy protection now against bonds which “GM may issue” some time in the future? Of course not: they’re buying protection now against bonds which are outstanding now. But more to the point, quoting CDS prices on GM in no way means that Barclays and Goldman are “anticipating GM may again borrow at least some money.” Indeed, a case can be made that the opposite is the case: if GM really is going to pay its debt down to essentially nothing, then a great way of getting free money is to write protection on GM debt now, and then just cash your insurance premiums for the next 3 or 5 years. It’s certainly a lot cheaper than buying outstanding bonds.

All of which makes me mistrust something Terlep says earlier on in the story:

“The new GM is trying to be the new GM,” said Gimme Credit analyst Kimberly Noland. Yet over the long term she sees GM needing to return to borrowing.

“Needing,” here, is a strong term: if GM is going to need to return to borrowing over the long term, that basically means it’s going to lose money over the long term. Is that really what Noland meant? Or did she just suggest that GM at some point will issue debt, on its own terms? Given the tone of the rest of this piece, I wouldn’t assume that Noland said what Terlep says she said.

(Crossposted at CJR)


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