Who is David Walker, and why should we care? He’s the nation’s top accountant, the Comptroller General of the United States. He’s totaled up the government’s income, liabilities, and future obligations, and concluded that our current standard of living is unsustainable unless some drastic action is taken. He’s not alone.

It’s been called the “Dirty little secret everyone in Washington knows,” a set of financial truths so inconvenient that most elected officials don’t even want to talk about them, which is exactly why David Walker does.

David: I would argue that the most serious threat to the United States is not someone hiding in a cave in Afghanistan or Pakistan, but our own fiscal irresponsibility.

Steve: As Comptroller General of the United States, he runs the Government Accountability Office, the GAO, which audits the government’s books and serves as the investigative arm of the U.S. Congress.

David: I’m going to show you some numbers. They’re all big, and they’re all bad.

Steve: So bad that Walker has given up on elected officials, and taken his message directly to taxpayers and opinion makers.

Dave: Dave Walker, how are you? Good to see you.

Steve: Hoping to shape the debate in the next presidential election.

Dave: You know, the American people, I’ll tell you; we’ve been to thirteen cities out of Washington with this Fiscal Wakeup Tour. They are absolutely starved for two things, the truth, and leadership.

Steve: He calls it a Fiscal Wakeup Tour and he is telling civic groups, university forums, and newspaper editorial boards that the U.S. has spent, promised, and borrowed itself into such a deep hole, it will be unable to climb out if it doesn’t act now. As Walker sees it, the survival of the Republic is at stake.

David: What’s going on right now is that we’re spending more money than we make, we’re charging it to a credit card, and expecting our grandchildren to pay for it. That’s absolutely outrageous.

Steve: You’ve heard this before, from Ross Perot, fifteen years ago.

Ross: In 1950, when the dollar was worth a dollar…

Steve: You might have even thought the problem had been solved. Pres. Clinton: Tonight, I come before you to announce that the federal deficit will be simply zero.

David: Well, those days are gone. We’ve gone from surpluses to huge deficits, and our long-range situation is much worse.

Steve: President Bush would argue that the economy is in pretty good shape; unemployment is down, the deficit is actually less than expected.

David: The fact is that we don’t face an immediate crisis so people say, “What’s the problem?” The answer is we suffer from a fiscal cancer. It is growing within us. If we do not treat it, it could have catastrophic consequences for our country.

Steve: The cancer, Walker says, are massive entitlement programs we can no longer afford, exacerbated by a demographic glitch that began more than sixty years ago - a dramatic spike in the fertility rate, called the “baby boom.” Beginning next year, and for twenty years thereafter, seventy-eight million Americans will become pensioners and medical dependents of the U.S. taxpayer.

David: The first baby-boomer will reach sixty-two and be eligible for early retirement or social security, January 1, 2008. They’ll be eligible for Medicare, just three years later. When those boomers start retiring en masse, that will be a tsunami of spending that could swamp our ship of state if we don’t get serious.

Steve: To illustrate their impact, he uses a PowerPoint presentation to show what would happen in thirty years, if the U.S. maintains its current course, and fulfills all the promises politicians have made to the public, on things like social security and Medicare.

Steve: What happens in 2040, if nothing changes?

David: Well, if nothing changes, the federal government is not going to be able to do much more than pay interest on the mounting debt, and some entitlement benefits. It won’t have money left for anything else: national defense, homeland security, education, you name it.

Steve: Walker says you could eliminate all waste and fraud, and the entire Pentagon budget, and the long range financial projections barely change, in what’s shaping up as an actuarial nightmare. There’s not going to be enough wage earners to pay for the benefits of the baby boomers.

David: That’s part of the problem, but the real problem, Steve, is healthcare costs. Our healthcare problem is much more significant than social security?

Steve: What do you mean by that?

David: By that I mean that the Medicare problem is five-times greater than the social security problem.

Steve: The problem with Medicare, Walker says, is that people keep living longer and medical costs keep rising at twice the rate of inflation. But instead of dealing with the problem, he says the President and the Congress made things much worse, just three years ago, when they expanded the Medicare program to include prescription drug coverage.

David: The Prescription Drug Bill was probably the most fiscally irresponsible piece of legislation since the 1960’s. The imbalance -

Steve: Why?

David: Well, because we’ve promised way more than we can afford to keep. $8 trillion added to what was already a $15 -20 trillion underfunding; we’re not being realistic. We can’t afford the promises we’ve already made, much less to be able to pile on top of them.

Steve: With one stroke of the pen, Walker says the federal government increased existing Medicare obligations nearly 40% over the next seventy-five years.

David: We’d have to have $8 trillion today, invested at treasury rates, to deliver on that promise.

Steve: And how much do we have?

David: Zip

Steve: Walker says we have promised almost unlimited healthcare to senior citizens who never see the bills and the government is already borrowing money to pay them. He says the system is unsustainable.

David: It’s the number one fiscal challenge for the federal government. It’s the number one fiscal challenge for state governments, and it’s the number one competitiveness challenge for American business. We’re going to have to dramatically and fundamentally reform our healthcare system, in installments, over the next twenty years.

Steve: And if we don’t?

David: And if we don’t, it could bankrupt America.

Steve: You’re probably expecting to hear from someone who disagrees with the Comptroller General’s numbers, projections, and analysis, but hardly anyone does. He is accompanied on the wakeup tour by economists from The Conservative Heritage Foundation, the left-leaning Brookings Institution, and the non-partisan Concord Coalition.

David: Let’s go.

Steve: The only dissenters seem to be a small minority of economists who believe either that the U.S. can grow its way out of the problem, or that Walker is over stating it.

David: Unfortunately, they don’t get it. I don’t know anybody who has done their homework, has researched history, and who’s good at math, who would tell you that we can grow our way out of this problem.

Ben: Economic growth alone is unlikely to solve the nation’s impending fiscal problems

Steve: Federal Reserve Chairman, Ben Bernanke validated much of Walker’s take on the situation, at congressional hearings, this year. And so did ranking Republicans and Democrats on the Senate Budget Committee.

David: This is not just about numbers. We are mortgaging the future of our children and grandchildren at records rates, and that is not only an issue of fiscal irresponsibility, it’s an issue of immorality.

[ Close ]

Kamal:             Hello there, this is Kamal Santa Maria.  A few years ago, if you’d suggested General Motors, America’s biggest car maker, not to mention a corporate icon, would eventually be filing for bankruptcy, you’d probably been laughed out of the petrol station.  But as they say, “In boom times, no one asks questions.”  Well, boom times are over now; GM’s all but collapsed, and we’re left with some pretty serious questions to be answered.
One’s already been answered though, and that’s, “Yes, it is going to be a very rough ride for this automotive giant.”  GM will be reorganized under Chapter 11 of the United States Bankruptcy Code.  This law, in a way, protects companies from shutting down; it allows them to sell their assets, restructure debt, cancel contracts, and close operations that normally would all have to keep going.
In a bid to rescue GM, the US Government will be investing $30 billion in the company, on top of the $20 billion already lent to it.  All up, this investment will give the US Government a 60% controlling stake, but if you listen to President Barak Obama, a controlling stake doesn’t mean all out control.
Pres. Obama: So, we are acting as “reluctant shareholders” because that is the only way to help GM succeed.  What we are not doing, what I have no interest in doing is running GM.  GM will be run by a private Board of Directors, and management team with a track record in American manufacturing, that reflects a commitment to innovation and quality.  They, and not the government, will call the shots and make the decisions about how to turn this company around.
Kamal:             So, where did it all go wrong?  Well, it’s obviously not just one thing, there are quite a number of factors, and we’re going to run through some ideas now.  GM’s cars, always well-known cars, but were they the best?  Some argue GM’s production took too long and it cost too much, leaving potential buyers cold.
GM’s also been accused of ignoring its competition.  Think back; 1954, 54% of the North American car market was what it had.  Last year, it was down to 19%.  That’s not to say it didn’t provide incentives, though, in fact, possibly too many. 
After 9/11, GM offered 0% financing on loans and then started offering rebates.  They went up, in some cases, to $8 thousand.  It was all about the deal but some say, “What about the car?”  What about the money, too?
GM’s financing arm, GMAC ended up making more money than the car business, but faced with a cash crunch in 2006, it has to hive off GMAC, thus limiting the company’s financing flexibility.  Limited flexibility, too, on the road after GM killed off its plans for a mass-produced electric car.  It was called the EV1.  Some would say just to please the big oil companies it did that.
GM had problems, too, beyond the US.  It bought a stake, for example, in Italy’s Fiat, but then when things went bad, it bought itself out for $2 billion.  So, Fiat used that money to turn itself around and, well, that’ll now be Chrysler’s new owner.  Perhaps a little bit of irony there.
So much to talk about though.  Don’t know if we’ll get through it all, but we’ll get into it, right now, with our guests.  Joining us from Providence, in Rhode Island, is Robert Farago.  He is the Publisher of The Truth About Cars.com.  From Berkeley, California, Harley Shaiken, he is a Professor at the University of California, and an expert on labor and free trade.  And rounding out our panel in London is Gareth Leather, an economist, and the Auto Industry Chief at The Economist Magazine.  Gentlemen, thank you for joining us here on Inside Story.
Robert Farago, in Providence, I’d like to come to you first.  Say that GM wasn’t saved in this manner.  Hundreds of thousands of jobs would go, a US icon would die, and a government would stand accused of standing idle while all this happened.  Surely, it was the right thing to do in the end, if that was the end result?
Robert:            Well, the argument is that it’s a kind of soft wind down as opposed to a cataclysmic end.  It’s not for the United Stated Government to intervene in private enterprise like this.  It sets a horrible precedent.  But even more than that, the important thing to remember is this isn’t going to work, so at the end of this, we’re going to be in the same place we would’ve been at the beginning except the American taxpayer is going to be out $50 billion, to $100 billion to $150 billion on the auto industry.  It’s a huge waste of money that has a wider negative impact on the United States economy, and sets a terrible precedent for the United States free market principles.  This whole thing is a huge mistake that they should’ve – nobody is too big to fail.  They should’ve been allowed to fail.
Kamal:             So you’re saying governments shouldn’t be intervening.  What about government responsibility, though, to the people who put them in office?  I mean, the argument in the banking sector, for example, with Lehman Brothers, was that Lehman Brothers – some people would say that Lehman Brothers should’ve been saved and that because it wasn’t saved, that was when the bottom really fell out of things.  I mean, it could’ve been the same for the car industry.  You don’t save GM, the whole thing falls out.
Robert:            The car industry only accounts for about 4% of the United States economy.  It’s not as big as people make it out to be.  And there was 40% over capacity in the market before all this crisis hit.  General Motors was excess to requirements in a market.  If the government intervenes, there are going to be negative repercussions – they have intervened.  There are going to be negative repercussions to this move.  This is a no-win situation but putting the United States Government in was the worst possible answer. 
Kamal:             Harley Shaiken, in California –
Robert:            They could’ve written a check to all the united auto workers for over $100 thousand.
Kamal:             Okay, I’m going to go to Harley Shaiken in California for a reaction from him.  I mean, Robert Farago makes a good point.  If the government starts stepping in here, where does it stop?   What if Walmart, which as I understand, is the biggest retailer in the world, actually, not just in the U.S.; what if it has its problems and it says, “We need money, as well”?  Where does it stop?
Harley:            Well I think clearly there’s a risk for President Obama going forward in this direction, but without what he did it would be a certainty that we would have an economic debacle of huge proportions right now.  So, I think there was no alternative but to go forward. 
We’re not breaking new ground here.  The Federal Government has bailed out literally hundreds of companies, over the years.  The closest precedent, of course, is the billion plus dollars that Washington put into a failing Chrysler Corporation in 1980.  That had to be paid back within ten years.  In fact, that billion plus was paid back seven years early, and Washington made $300 million on it.
It isn’t so much that GM is too big to fail; it is too linked to the industrial base of this country to fail.  If GM fails, you’d pull down a huge chunk of the industrial base.  The U.S. would become a second-rate manufacturing country and the social costs, in places like Detroit, would be catastrophic.  The current unemployment in the city of Detroit, formerly known as the “Motor City,” is over 22%.  A GM failure could push that up to 35-40%.  That’s not tenable.  It’s not tenable for Michigan, for much of the Midwest.  In the midst of a recession we could create, absent this aid, a depression that would be long in recovering from.
Kamal:             So, you’re basically saying it’s sort of extraordinary times call for extraordinary measures.  Because again, as Robert pointed out, this is not technically government responsibility.  If we’ve got a free market, it’s not the government’s place, really, to be jumping in and saving it.
Harvey:           Well, I think that’s a very rigid view of what a free market’s all about.  What we’re really looking at, in a very complex world, is a public/private partnership.  By that logic, we should’ve let the entire financial system collapse.  If we make the argument that the financial system is so vital to the broader economic health of this country, that the government should step in - and I believe that was a correct decision; with all the problems it may have, then we certainly need to make that argument for the lynch pin of the entire manufacturing base in this country.
We settled this, in a way, a long time ago with the Great Depression.  The government may have been reluctant, but what FDR really forged in the United States is a public/private partnership where we retain the power of the market, but where we have the government, the public purpose, setting the rules and ensuring that the system moves forward.
This is hardly a new task and unless we embrace this in creative and bold ways right now, we could have far more problems than we’re currently confronting.
Kamal:             Very quick reply from Robert Farago and then I would like to bring Gareth Leather into the conversation. 
Robert:            It’s – the logic here is like an obsessive/compulsive person, somebody who suffers from the idea that if you check the gas constantly, the house doesn’t blow up.  Then when the house doesn’t blow up, that justifies the fact that you checked the gas constantly.
You can’t simply say that if we hadn’t done this, bad things would’ve happened.  Bad things happen.  Capitalism is creative destruction.  It is the strength and the backbone of this country, and General Motors isn’t that big anymore.  Their market share is small.  Their contribution to the economy is small, and they screwed it up. They have to be allowed to fail in order to recreate themselves. 
This is just propping up a zombie automaker.  They’re a dead automaker walking, and they are not going to recover under federal protection.  The Federal Government doesn’t know how to build cars.  It doesn’t know how to run an efficient enterprise.  It’s bankrupt, itself.  Combining these two is like a cocaine addict having a coke dealer for a sponsor.  It makes no sense, at all.
Kamal:             Some great example there from Robert Farago.  Let’s bring Gareth Leather, in London into our conversation.  Barak Obama, we’ve heard him already in this program.  Now, he’s saying he wants a quick out.  Realistically, how quick can he get the government out of this because 60% is pretty deep in?
Gareth:            It’s going to be quite difficult for the government.  First of all, the company has got to get out of Chapter 11 administration.  And that, people think, will take about three months minimum; if you look at Chrysler it took even less time.  Then, the problem for the government is going to be what it actually does with GM when it actually owns it, as a company.  It’s going to take quite a long time, I think, because it’s going to take some time, at least, for General Motors to kind of properly restructure along the way it wants to.  Then it’s going to be dependent on recovering car sales in the U.S.  It’s going to be quite some time, I think.
Another maybe important, more important point is how much the government is going to be liable for because it seems very unlikely that it’s going to be able to sell its 60% stake for anything like enough that it needs to cover the 100 or so billion U.S. dollars, which were invested in the company.
Kamal:             If I’m to be a bit cynical, as well, if we stay with the U.S. Government angle here, from being a bit cynical, it’s actually a good opportunity for Barak Obama, isn’t it?  He campaigned on an idea of more fuel efficiency, less dependency on oil to kind of mold General Motors into the model type of car company for the future, if he wanted.
Gareth:            I think that’s the big danger, that ideally if Barak Obama wanted to get rid of General Motors as quickly as possible and for the best price possible, then he really would let it – that policy in the company be decided by the executives that he’s got there running that.
However, at the same time, when he was elected, he ran on a campaign of cutting America’s dependence on imported oil, and also on reducing greenhouse gas emissions.  Now transport, and particularly the passenger car in the U.S., is one of the main emitters of greenhouse gases, and one of the main consumers of oil.  So, if it really wanted – if Barak Obama really wanted to make progress on fulfilling those pledges, then it would mean putting more pressure on companies like General Motors and also Chrysler, to produce more fuel-efficient cars.  However, that’s not necessarily what would be needed for General Motors to maximize its profits.
Kamal:             We’re talking General Motors, today, the end of GM as we knew it, with our guests Robert Farago in Rhode Island, Harley Shaiken in California, and Gareth Leather in London. 
What we want to do now, gentlemen, is essentially look at the winners and the losers.  There are both.  Some will actually benefit from the fall of GM, namely, its competitors who have a chance to fill the breech which the giant manufacturer is out of action.
Korean car manufacturers should do particularly well from the gap in the market, as they are cheaper than both European and Japanese alternatives.  But the company that may benefit the most is GM itself.  The U.S. rescue plan should mean, given time, it’ll become competitive and profitable again.
On the flipside though, some of the world’s biggest investors have been stung by all this, including Barclays and Goldman Sachs, though sympathy for the banking sector isn’t exactly high these days.  What is very important to remember, though, the thousands of everyday people who will be unemployed and the ensuing fallout on local economies.
As if to underline and remind us all, President Obama had this to say on just how difficult the recovery will be.
Pres. Obama: But I want to be honest with you.  Building a leaner GM will come at a cost.  It will take a painful toll on many Americans who have relied on General Motors throughout the generations.  So I want to say a word directly to all the men and women watching today, wondering what all this will mean as far as their own lives are concerned.
I know you’ve already seen more than your fair share of hard times.  We saw 400 thousand jobs lost in the auto industry in the year before this restructuring even began.  I will not pretend the hard times are over.  Difficult days lie ahead.  More jobs will be lost, more plants will close.  More dealerships will shut their doors and so will many parts suppliers.
Kamal:             Harley Shaiken in California, we hear Barak Obama there.  He’s being, I guess, realistic about the situation and preparing people that this is not a quick fix, that there is a long road to go, yet.  Do you share his optimism, though, that this can really come right; after the down, that there will be a solid up after that?
Harley:            Oh, I certainly do share his optimism.  It is, it will be, it is and it will be a horribly difficult road, but at the end of the day, GM has some of the most talented designers, engineers, and blue-collar workers in the world.  It is already producing fuel-efficient cars that are finding a market.  It is in a crisis today, because of years of mismanagement, to be sure, but principally because of the collapse of the entire financial market and the slippage of the U.S. economy.
The first quarter of this year, Toyota, which almost all agree is a very well-run company, lost more money than General Motors.  So, it isn’t simply GM or Chrysler that are failing; we have a huge collapse that is pushing down on all automakers but I think GM has the internal resources, with this federal aid, to once again be a very competitive automaker in the future.
President Obama is not going to be using GM as a test case for ideas related to a whole range of things.  Perhaps he should more, but he’s certainly not planning to.  What the purpose of the Federal Government is in this case, as he’s articulated, is to get in and out as quickly as possible, and to leave in its wake a viable, competitive, world-class automaker.  I think that’s certainly possible, but we ought not to ignore the fact that there is huge amounts of pain out there as this transition is being made.
Kamal:             One thing is that we’ve been looking very much at this in terms of the United States.  But there is no way this is solely a U.S. problem.  I’m just going to show our viewers a map right now, illustrating that fact.  Ten years ago, GM was the world’s biggest company.  Right now, it is found, as you look on this map there, in one form or another, GM is in 140 countries, some of which are now having to plan their own rescue packages because of this. 
Robert Farago, in Rhode Island, this has got to be, has there not, an issue of responsibility here if GM, the parent company, has gone down this road and taken itself down this road and there’s companies in 140 countries that are going to suffer as a result?
Robert:            Well first of all, I want to refer back to the clip that you played of President Obama.  For a man who says he doesn’t want to run a car company, he sounds an awful lot like a CEO of a car company.
The second thing is that your other guest is sounding like an apologist that we’ve heard from, from Detroit, for a decade now.  GM was going out of business five years ago, fifteen years ago.  They were in deep, deep trouble, were looking at bankruptcy long before the credit meltdown, long before the United States auto market tanked. 
This company has been mismanaged for more than thirty years, and no matter who much talent is locked up in it, which I agree; there is talent locked up in it, it’s not going to get out because the management that is in there now is the same management that drove this company into the dirt. 
As far as the international market is concerned, those companies would be better off with local control.  The only reason why those countries that GM has controlled, has been in before has been successful, is because the corporate mother ship full of these mismanagers hasn’t had its thumb on top of them.  So, they haven’t been able to run themselves into the ground like they have in the U.S.
I would say to you this; that unless there is a complete, clean sweep of the management at the top, replaced with some better quality people, there isn’t a hope in you-know-where that GM is going to come anywhere near repaying this money.  It just isn’t going to happen.
Kamal:             Harley Shaiken, quick reply from you.  You were called an apologist there, for Detroit.
Harley:            Well this is the first time that has ever happened.  I’ve frequently been very critical of Detroit, so in this context I take it as a compliment.  Look, I agree there’s been more than its share of mismanagement at GM, in terms of strategic direction, in terms of a very short-sighted approach.  I think that’s going to be addressed.  I think to allow the second-largest automaker in the world simply to collapse – even at this weakened state, GM still sells one out of every five vehicles in the U.S.  It is still the largest seller of cars in the U.S. market.  There’s a lot here that’s critical for the future.
I would point out; in 2007, the Detroit automakers, GM, Ford, and Chrysler put $12 billion into the U.S. economy, in terms of research and development, from Palo Alto in California, to Warren, Michigan, and the outskirts of Detroit.  It’s those kinds of linkages that any healthy economy needs.  And where we have an issue of this complexity and urgency precipitated by a broader financial collapse, a public/private partnership is, I think, vital going forward.  And we will see, I think, good results coming out of it.  It has high risks but the certainty would be a debacle, absent this route.
Kamal:             Gareth Leather, perhaps you can give me the perspective from Europe?  I showed the viewers that map before, just to show the spread of GM and we know that it has its presence in Europe and in that part of the world, as well.  Are those subsidiaries, are those elements in a strong enough position to deal with this on their own now, their own recovery plans?  Can they move forward whilst GM repairs itself in the U.S.?
Gareth:            Yes, certainly General Motors is one of the most globalized companies in the world and it has operations in very many countries in [0:20:20.4 these?].  The – how the different parts of the operation are doing depends on which country you’re in.  For example, in China, General Motors is doing very well indeed, and is probably the most profitable part of the company.  In Europe, where it’s two brands are Opal and Voxel, things are not as good as they are in China, but they’re certainly a little better than they are in the U.S.
With the announcement last week that the Canadian car parts maker, Magna, is going to buy Opel from General Motors, there’s kind of hope that at least General Motors operations overseas will be able to keep running as they were before.  But I think even in Europe where sales have probably fallen by as much as they have done in the U.S., there’s going to need to be kind of deep-seated change, which is going to involve factory closures and more unemployment as well, unfortunately.
Kamal:             And what about this idea of filling the void, that I brought up a little bit earlier when we were talking about winners and losers?  In theory, there’s a whole stack of car companies and companies from different countries which could fill the void but I wonder; in the current economic climate, whether they’re even in a position to do such a thing?
Gareth:            Certainly in Europe you know; there was no shortage or there are at least two people or two companies willing to buy GM’s operations there.  And in the U.S., there’s no shortage of companies with operations there.  All of the big Japanese companies have big operations in the U.S., while Ford will probably be hoping to gain market share at General Motors’ expense, as well.  There will be no shortage of carmakers around, over the next few years, I don’t think. 
Kamal:             Robert Farago, I’ve got about a minute left on the program.  I’m going to leave the final word to you.  Let’s gaze into the crystal ball here and let’s say I interview you in a year’s time on this topic.  Where do you honestly think GM will be after this injection from the U.S. government?
Robert:            There’ll be in the same place that they’ve been for the last ten years; smaller, less competitive, with less sales.  They won’t have any real – they won’t have any profits to show.  The CEO of the company won’t even say when they’ll return to profitability. 
They’ll be just as clueless in a year as they are now.  This is like leeches attached to the body.  They won’t even drop off, though, when they’re gorged.  It’s just a travesty.  The whole thing is a travesty.
Kamal:             And of course, we hope for the hundreds of thousands of employees, that that is not the case.  Gentlemen, thank you for joining us on Inside Story.  Really appreciate your thoughts, Robert Farago in Rhode Island, Harley Shaiken in Berkeley, California and Gareth Leather joining us from London.  Great discussion, thank you gentlemen.
Thank you, our viewers, always, for joining us here on Inside Story.  If you’ve got a comment on today’s show or a suggestion for a future show, you can send it to us; email it even.  insidestory@aljazeera.net is our email address.  From the whole team though, it’s goodbye for now. [ Close ]

   A White House official said, “The hedge funds had failed to act in either their own economic interests or the national interests.”  Joining me now to discuss the implications for Chrysler and the rest of the U.S. car industry is Max Keiser, who is an independent financial analyst and the founder of Karmabank.com.  Thanks very much for being on the program.
Max:                Sure
Male:               What exactly is Chapter 11 bankruptcy?
Max:                First of all, before we get to that, let’s examine what you just said, which is a very revealing statement.  You said that the bankruptcy was approved on some levels but rejected by the hedge funds in America.  Why are the hedge funds dictating policy in America?  They’re complete speculative pools of capital, unregulated, without any oversight from any government agency, at all.  They’re in fact rogue agents in the economy and then they dictate the economy. 
Hedge funds, they’ve become what I call the “divine right” of hedge funds.  They consider themselves God-like.  They obey no one.  Here they are slamming all these workers, the Chrysler workers and the parts of cars - the companies that supply parts to Chrysler, and the entire auto industry is being completely rearranged by these marauding hedge funds. 
What’s really pathetic are the American workers.  The American workers are pathetic.  They don’t do anything to defend themselves.  They just roll over and take it.  America has become a nation of whining crybabies.  They refuse to stand up for themselves and the workers should be given no respect, whatsoever.  To answer your question, what is Chapter 11, it’s a way for -
Male:               Did they have no choice but to go for Chapter 11, once the hedge funds had decided not to play ball with Barak Obama’s proposal?
Max:                Well, the hedge funds are saying that they make more money with Chrysler dead, than alive, because the hedge funds made bets that Chrysler would collapse.  It’s more valuable to them; they make more money if these bets pay off, that Chrysler goes out of business.  They made a bet using credit default swaps that Chrysler goes out of business.  They’re using this global casino model.  They’re really just speculating on the corpses. 
It’s like the people - a lot of brokers who were working in the Twin Towers during the 9/11 incident were actually making bets against airlines exploding.  They were making bets on their own demise.  Here, hedge funds are making bets against the demise of Chrysler workers.  Capitalism is not eating itself in America.  It’s swallowing itself.  It’s destroying itself because they’re going after the last crumbs on the table as the American economy implodes.
Male:               To go back to the original question, what is -
Max:                Chapter 11
Male:               Chapter 11 protection?
Max:                It’s - the two major bankruptcy scenarios are Chapter 11 and Chapter 7.  Chapter 11 allows for a workout to take place with the company still operating, on some basis.  Let’s say Chapter 7 is they shut the doors and it’s all over.  So, Chapter 11 allows for a workout to take place.  They’ll be - the lights will still be on and they’ll be working through these issues under Chapter 11.
Male:               In the short term, Barak Obama says jobs will be saved.  Is he right?
Max:                But these workers’ jobs - the workers aren’t getting any representation at all.  They’re going to fire millions of workers in the entire auto industry, Chrysler, Ford, General Motors.  Chrysler has something called Chrysler Financial, which is their lending arm.  They want to merge that with General Motors’ lending arm.  Again, that’s great for the banks but the workers get nothing.  The workers are just being completely “X’d” out of the equation. 
It’s not like France.  In France, workers actually have representation.  They can kidnap the boss in France.  They can get away with that.  In America, if they try to kidnap the boss, they’d be gunned down by the American Homeland Security.  They have no ability to protest in America, the workers.  They’re just cogs in the wheel.  They’re treated like complete mud.
Male:               Why don’t we just switch the direction, a little bit.  Part of this deal is that Fiat is going to get a 20% stake in Chrysler.  What does Fiat bring to the table?
Max:                They bring the ability to offload a lot of debt on the international debt markets, basically.  Behind the scenes this is just a banking deal.  Fiat, they have a dealership involvement.  They want to save their dealership to some degree.  Pretty much, you have to look at this purely from the banking perspective and they’ve got banking relationships in Europe.  As you know, a lot of the money that came from the federal government to bail out Chrysler went mostly into the pockets of foreign banks Fiat’s connected to, European banks, and so it’s again great for the bankers.  It cannot be said that this does anything for the workers.
Male:               Fiat had its own problems with insolvency just a couple of years back, didn’t it?
Max:                That’s right so again, you’re putting together dying corporations in an attempt to make more fees, to extract just yet more banking fees.  This is the key.  These companies are very sick because they’ve been run into the ground.  Now, as they’re falling apart, there is an attempt to merge them and restructure them to get out that last fee. 
The people who are doing these bailouts supposedly, imagine they’re like Dracula and the sun’s about to come up and they haven’t had their fix yet.  Dracula is starving for blood.  They go in there -
Male:               In your opinion the notion -
Max:                … and they extract that last bit of blood.
Male:               In your opinion, the notion that Fiat could rescue Chrysler by providing this small car technology is completely illusory?
Max:                No, because it’s a drowning person trying to save another drowning person.  They’re all drowning because there’s no representation of the people who are doing the jobs.  They refuse to stand up and get any kind of say in this process.  They’re allowing the bankers and the hedge funds to tell them what they should do and the bankers and the hedge funds - their interest has nothing to do with the workers’ interest. 
They want to eliminate the entire middle classes in America because they’re in the way of the bankers.  They want to return to a two-tier economy, with elites and [0:06:44.3 prolls?].  This is what they’re going to.  They want to get rid of the whole thing that happened in 1776.  That was very inconvenient for the aristocrats in America.
Male:               Very briefly, how scary is this news for the rest of the car industry in the United States?
Max:                The car industry in the United States is being completely destroyed because of these hedge funds and bankers who see the workers - they see the workers as weak so they’re going to continue to destroy them.  They’re weak and this “savage capitalism” as it’s called there in the United States, as long as the workers refuse to stand up for themselves, you’re going to have hedge funds continuing to take advantage of them and beat them.
Male:               At that point, [0:07:25.5 ?] have to stop you.  I’m afraid we’ve run out of time, but do join us again next week for another edition… [ Close ]

He’s totally different from most of the people that we talk to. He gained his fame on YouTube, of all places, where people go to see how he explains things that many of us frankly don’t understand. Let’s start with the basics, Sal Khan, thanks so much for being with us, from the Khan Academy, by the way. Basic question, explain to our viewers, explain to the million people out there, what is actually broken that we need to fix? Sal: Right, and right now we have so many – the stock market goes down every day, and people having foreclosures, and banks are stopping lending, and so it’s really hard for people to keep track of what is the problem. Are these just causes of the problem, or are they the actual problem? I think we need to take a step back, and I’ve drawn a little diagram here.  Rick: Let’s put it up. Sal: I’ve done a little diagram here and I think there’s a basic, fundamental question that we all have to ask; and what does the financial system do? They make a lot of money. Hopefully they add some value to our economy, and this diagram, essentially explains what the financial system does. In a capitalist economy, you have a lot of people with capital. That could be land; that could be gold; that could be – I don’t know, animals; that could be cash. What you need to do in order to make the economy grow is invest that capital into projects. Build factories, plow seeds, hire people.  What the financial system does, the banks, and the markets, they take that capital, and hopefully they allocate it on projects that actually put people to work, hire people, and grow our GDP. The problem right now is as opposed to the financial system actually putting more capital into the real world, it’s for the most part, more concerned with self preservation, at the moment. They’re kind of in survival mode, and because they’re in survival mode, you don’t have this flow of capital going from whoever has it, to the financial system, and then to the projects. You pretty much have everything just going back into the financial system because it’s in, essentially, survival mode. Rick: I see the financial system in the middle. Why is that piece broken? Draw that one up for us. Sal: Sure, and here I’m going to attempt to give everyone a five-minute MBA, but essentially, what I’ve drawn here are balance sheets for some banks. It might sound like a complicated term, but a balance sheet is, I think, something that most people are fairly familiar with when they talk about home equity.  If I were to draw a balance sheet for someone’s house, it would look something like this. The asset would be your house, whatever it’s worth, and then your liability, and I’ll call that “A” for asset, and then you’re liability would be your mortgage. You’re liability would be the loan.  If your house is worth $1 million and your loan, let’s say you owe $800 thousand on your loan; whatever is left over is your equity. Rick: Right Sal: That’s a balance sheet. That’s a balance sheet that I think most people are fairly familiar with. For corporations they have the exact same notion, and I think this is an important point to realize when people talk about the stock market, and what does it mean for a company’s stock to go to zero.  When you buy a stock in a company, you’re essentially – you’re not buying a share in all of its assets. You’re buying a share in its equity. So, if you look at – I drew two banks here and we’ll talk a little bit more about what’s broken. A bank has assets and a bank has liabilities. If you take the sum of the assets and you subtract out the liabilities, what’s left over is essentially the equity. When you buy stock in a bank or any company, you’re essentially taking a share of that. What’s broken here is through the housing bubble, a lot of these banks, in order to facilitate this whole securitization – I can go into more detail what that is – they essentially accumulated these assets on their balance sheets. This has been the central focus of the entire bailout plan. There’s been a lot of talk about toxic CDOs and what are they worth. I just want to show you what they do to a bank’s balance sheet, and why it’s so important that we figure out what these things are worth.  You see here, I drew the – you can kind of view the height of this left hand side as the asset. The height on the right hand side is the liabilities. What’s left over is the equity. If these toxic CDOs are worth nothing, if this disappeared, then all of a sudden you’re assets are worth less than your liabilities. If your house is worth less than your mortgage, then you have no equity. In that situation, your stock would be worthless. In that situation, there is no reason why anyone should be lending to you because you’re essentially throwing good money after bad. Rick: So eventually, the situation that the banks find themselves in is the same that homeowners had found themselves in as a result of this. Sal: Pretty much, the homeowners, you have an asset that’s worth less than your liabilities; what do you do? Do you try to get someone to bail you out and buy your asset for more than it’s worth, or do you just declare bankruptcy?  Rick: Let’s hold off right there; we’re going to come back in just a little bit and we’re going to continue that conversation. And we’re also going to be bringing you something today that’s an exclusive to this particular hour on CNN. The story of “Curveball.” Who is Curveball? He may just be the only person that the Bush administration used as their source for going to war in Iraq, or certainly, as much as anyone else. Was he right? No. Who is he? No one’s known, up to now – an exclusive interview with Curveball. Stay with us. We’ll be right back. [music] Rick: [0:05:51.9?]/ Rick Sanchez, CNN. So many of you, 23,000 I believe, when we last checked, are talking to us, watching this newscast as well as on MySpace and Facebook. In fact, there is somebody on MySpace right now. She’s watching our show and she just wanted us to know this. She said, “My son is 17-years old, and excited about college. I’m worried that we won’t be able to get a loan to send him now. My husband’s hours have been cut back from work, as well. This absolutely affects all of America.” That’s why we’re doing what we’re trying to do for you. Let’s go back now, and bring in Sal, if we can, Sal Khan. He explained to us moments ago what it is that is actually the problem, what it is that is broken. Let’s take the next step. Let’s try and understand because everyone seems to be wondering, “I don’t understand this bailout/rescue plan that the government’s been in.” What is the government actually doing? Explain that to us so we can understand it like at fifth grader. Sal: The main problem, just to get the big picture, was that no one’s lending to each other. What the government at least said that they wanted to do is try to get the lending started again. Their bailout plan was essentially, “Let’s buyout these toxic CDOs.” Let’s say I’m a good bank that didn’t get involved in this. If bank A is holding these toxic CDOs, I’m not sure if bank A should be bankrupt, if the toxic CDOs are worth nothing; or maybe they are good for the money. There’s a lot of uncertainty on what these are worth. The government, at least what they said they would do, is if they went in and essentially did these reverse auctions and bought these assets, then that all of a sudden would give confidence in these banks. There wouldn’t be uncertainty as to whether you could loan them money, and maybe that will free up the credit, the whole system again. Rick: Will it work? Sal: Probably not. If you think about what’s going to happen, psychologically, bank A – let’s say if you were to switch to this toxic CDOs and if you were to just turn that back into cash because the government just bought it for exactly what bank A says it’s worth, if you just turn this into cash, the question is; is bank A all of a sudden going to start lending? There are a couple of things to start thinking about. Besides that toxic CDO, there were other things on its balance sheet, and frankly, a lot of these things are starting to get a little bit toxic. No one’s really talking about them right now because if you have a dead skunk in your house, you’re not going to notice the milk’s gone bad.  Essentially, you have a lot of assets on your balance sheet right here, that if you’re a prudent bank manager, you’re going to see; you’re going to say, “Boy, I should just keep that cash, because if these turn toxic, because the economy might be turning south or for whatever reason, I should just hold onto that cash so that I don’t go bankrupt.” Everyone is in complete survival mode, even the good banks. If somehow you were to give them capital, and Paulson’s new version of the plan is that essentially, they’ll inject equities so buy stocks. If you buy stock, you’ll essentially make this pie bigger and put some cash here. But even this guy, the good bank, it’s not so clear to me that he’ll actually start lending. Everyone is in survival mode. This isn’t a time to make new loans and take on new risks. Rick: So it seems like the government went in and they have decided, “You know what we’re going to do; we’re going to go in there and help these guys out, and as soon as we help them out, everybody will realize that now they have the government’s backing so other people will be interested in helping them. More people will give them their money.” That hasn’t worked. The people and other investors haven’t bought into that. When we come back, I want to hear your idea of what perhaps the government should have done or could still do to rescue this. It’s unique. It’s different, and you and I talked about it earlier but I want you to be able to share it with our viewers. Also, Curveball, the story that we’ve been telling you about, this is going to be a CNN exclusive to this hour, about one particular individual who no one has ever talked to before. He only speaks German and Arab. You’ll hear his conversation here, in the next ten minutes. Stay with us. We’ll be right back. [music] Rick: So we understand now what actually is broken. We’ve got a sense of what the government tried to do to fix it, but it doesn’t seem to be working because enough people/investors and regular folk don’t seem to be buying into it. Let’s bring in Sal Khan once again, from the Khan Academy, and talk about what may be done, either would have been the original plan that would have worked a lot better, or something we can still do now. And that is: Sal: So going back to the big picture, is that the financial system, no one is lending through, right? And every bailout plan so far, the government is just – it just keeps injecting money in, either through loans, either through buying assets for maybe more than their worth, or now buying stock. The logic here is maybe that will start up the lending. But most probably, any new money that you put into the system, to a large degree is going to go into survival mode, or it’s going to go to essentially make up mistakes that have already been made. One idea, and this actually came from a friend of mine, Todd Plutsky [ph], and I actually think it sounded crazy when he first said it, but it actually sounds like a really good idea; take that $700 billion and remember, the problem isn’t – you’re not trying to save the financial system. You’re trying to save the pipe that goes from the capital to the projects.  Why not take the $700 billion and capitalize a brand new financial system? And one thing that Todd had pointed out; $700 billion is an astronomical amount of money. That’s more than the book value of the equity. Book equity is this piece on the balance sheet, than J.P. Morgan, Morgan Stanley, Goldman Sachs, Washington Mutual, Wachovia, and Bank of America combined. The government could, overnight, create banks bigger than those banks, although I don’t think they should concentrate it all in five or six banks. They should – Rick: So in other words, you’re saying why try and put money into something that is so absolutely messed up? If they’re half dead, let them die. Create a new system all together. Wouldn’t that be a problem too, because then wouldn’t those banks be owned by the government? Do we want that? Sal: No, and this is the solution. First of all, just to make a point clear; the Paulson’s current solution involves government ownership. This plan, what you could do is the government could capitalize the banks, maybe twenty or thirty banks around the country, with the $700 billion, and then each of those banks could have 300 million shares and they could give 1 share to every American.  Rick: New banks, totally new banks, interesting. Sal Khan, thanks so much. We’ll keep you on. We’re going to be talking about this throughout the hour, obviously. We’re trying to get people to explain some of these things for us and what’s the market doing right now? Let’s make that as big as we possibly can. Down 71, a lot better than we were looking at an hour ago. Maybe you helped, Sal, in some ways. Hopefully. We’re going to come back to that in just a little bit, but obviously one of the key stories we’ve been saving for you today, the story of Curveball, the man who seemed to have been the source or the influence in the invasion of Iraq. As we expected, Sal Khan is a bit of a hit. He does things kind of differently, doesn’t he? A lot of people have a lot of comments and a lot of questions for him, including this one. Let’s go ahead and take the Twitter board if we possibly can. This one comes in from “sanchfan”. He watches this show a lot, like every day. He says, “Keep Khan talking! The market is going up!!!!” Apparently it had been. I hadn’t even noticed that, I was so engaged in the conversation.  Let’s do this real quick. I want to just step away from this for a moment. Sal Khan standing by. Sal, tell us if you could, I guess bring us back to basics. How are we being affected by what we’re seeing in the news every day, the credit crunch, and the situation with the market? Sal: If we don’t unclog the credit system, we know that everyone’s going to unlever their debt, so we’re going to have deleverage. That’s essentially everyone unwinding their loans. Deleverage – and this is I think a critical point because I think there’s been a lot of misinformation out there. That actually contracts the money supply. So a lot of people out there are worried about inflation, these deficits that lead to inflation. When you have deleverage, and this is what happened in Japan; this is what happened in the ‘30s. The money supply contracts. That’s our printing press. Leverage is our printing press, in a fractional reserve system. That’s going to lead to deflation. I think a lot of people are worried about are we going to see inflation, are we going to see deflation, and if we don’t fix the problem, we’re going to see what Japan saw and we’re going to see deflation. Rick: Deflation means what, concretely to me and you? Sal: Things get cheaper, the opposite of inflation, so unfortunately, maybe salaries will go down. But on the plus side, we’ll have a lot of assets. People buying a house, they’ll get cheaper even. I know that probably won’t be a good thing in the short term. Rick: Exactly, not with what the situation is right now. Thanks so much Sal Khan. You’ve been a great guest. What an original way of being able to explain things. We’re going to be right back with a closing bell, which looks to be somewhere in the middle of [audio ends] [ Close ]

There’s a couple of ways you can generate assets.  You can get investors through equity, and we’ve done several videos on that.  You start with the angel investors or maybe your rich uncle, and then you eventually get venture capitalists and then you do an initial public offering.  Then you can do follow on offerings, and so on and so forth.
Now, we see governments will buy equity in you if you are a bank that’s too big to fail but we’ll do a whole playlist on that.  Equity, that’s one way that you can get cash or get capital so that you can buy assets to run your business. 
The other way is you can borrow money from people.  So, the equity holders become - these are actually the owners of the company so you might have been part of the equity holder and you have to sell some of the equity or sell some shares in your company for someone else to give money.  Then they become kind of like your partner. 
The other way is you can borrow money.  Let me draw that.  That we’ll put just put generally as liability.  Debt isn’t the only kind of liability but that’s a pretty reasonable simplification for now.  There are other things.  General liability means you owe something to somebody in the future.
These are liabilities.  We’ll assume right now that your debt is your main liability.  You might have other liabilities.  You might have some type of legal liability where someone is suing you or you had sprayed asbestos on a bunch of playgrounds, thinking it was actually good for the playground equipment and now there’s all of this liability because - you get the idea.  For now on, we’ll have the simplification that debt is your liability.
We said there are different kinds of debt.  If you securitize it, it’s often a bond.  That would be a certificate that says it’s an IOU from a company and it will pay you coupons or interest, and so forth.  You could also just get regular bank debt, where you owe the bank money.
I left you with a question the last time around.  I said, “Let’s say this company goes into bankruptcy, and let’s say these assets aren’t worth what we think they are.”  In this world, if we just have to sell off these assets, fine; the equity, the debt guys would get paid off and the equity guys would get left over with whatever else.
Let’s say this was - if on our books, so whenever you hear things like “book value” and I’ve done a couple of videos on book value versus market value.  The book value is essentially what you have on your accounting books.  You say that this is worth $10 million.  Let’s say we’ve bought land, factories, and whatever else worth $10 million.  Let’s say your debt is $6 million.  Your equity would be worth $4 million. 
Let’s say, for whatever reason, the economy turns south, or maybe this was some type of business that’s now not viable.  It’s going to go into bankruptcy.  I’ll get a bit more specific on the different types of bankruptcy.  We’re assuming liquidation.  Actually, I’ll just get specific right now.
When we say “bankruptcy” and bankruptcy is probably - it’s a very common word and I think most people have a general sense of what it means.  They know it’s bad and it means to some degree that a company can’t operate as it was before.  But, there’s a lot of confusion over what it means.
There are actually two types of bankruptcy.  There’s” liquidation,” and that’s essentially saying, “You know what; this business doesn’t make any sense.  It doesn’t make sense to have the employees and run the factories.  You’re never going to make any money, so you might as well just sell everything you have.”  You liquidate it all.  That’s one type and that falls under the category of Chapter 7. 
We’re just talking about corporate bankruptcy, right now.  There’s also personal bankruptcy.  Maybe we’ll do a couple of videos on that.  It might be especially relevant in this economy.
The other type is “reorganization” or “restructuring.”  Restructuring says, “You know what; this factory here is actually making something useful. It’s actually generating money, and we can get more value for what we have here if we keep it running.  We’ll keep it running and we’ll restructure the company.”  That usually means changing this side of it, so maybe we’ll cancel some debt and I’ll show you how that’s done in a reasonably fair way.  Just to understand kind of a simplified scenario, let’s take liquidation into consideration.    
Let’s say this was my website selling shoes online and all of a sudden people have stopped wearing shoes.  It’s just gone out of fashion, so it makes no sense anymore to sell shoes online.  I’m just going to liquidate my assets, my real estate that I might have, my warehouses, etc.  My question I left you with on the last video is who gets it? 
Let’s say when we liquidate it, we go into bankruptcy, and essentially, all of the assets are taken into possession by the bankruptcy court.  They’re going to sell these assets and let’s say when they sell them, they don’t get $10 million for these assets.  They only get $5 million for them.  I paid for them, thinking that they were useful in some way, but they end up not to be, so my assets - I just realized when I talked earlier about there’s two ways to raise capital.  There’s a third way to raise capital.  You can sell shares, you can issue debt, you can borrow money, and then obviously, the third way is actually to just make money.
Once you start a company, hopefully you generate earnings, and that will also generate cash or capital that you can reinvest into the business.  We’ll talk about that but I just wanted to make it clear that that’s obviously the best way to generate capital for your business, when the business itself generates capital.
Let’s say these assets, when you actually sell them off, aren’t worth $10 million anymore.  They’re worth $5 million.  My question in the last video is who gets this $5 million?  Do you somehow split it evenly between all of these people or does one of them get more of it or one of them get less of it?  I think you’ll get a sense, but based on where I took the $5 million out of, who gets the money.
It’s the debt holders.  The way I drew it right here, you can kind of view it as you go up in this direction, you’re getting more senior.  Or, if you’re going down in this way, you’re getting more junior.  Seniority, when you talk about a company’s capital structure, it’s just if there is anything left, who gets their money first?  Even within the debt, you’ll have different layers of debt.
There might be different debt holders, who have different levels of seniority.  This one might be called “Senior Secured Debt.”  Senior means they’re high up on the stack.  They’re one of the first people to get their money.  Secured means that there is actually some collateral on the asset side that they get if the company can’t pay.  Maybe this is like a piece of land. 
Just in our everyday personal finance world, your mortgage is actually a secured debt.  It’s secured by the collateral of your home.  If you can’t pay the debt, the bank comes and takes your home; it forecloses on the property.  That’s what secured means.  It means that there is some collateral and in the event of a bankruptcy, this guy can immediately go and get the collateral that his debt is secured by.  This is considered a very senior form of debt, “Senior Secured.” 
Then here you might have “Senior Unsecured” and there are a lot of words around senior, junior, subordinate, and all of that.  Just get a sense that there’s a hierarchy here.  Some people are the first people to get the money and then whatever money is left goes to this person; then if there’s any money left it goes to  this person and if there’s anything left, it goes to this person.
Once you’re in bankruptcy court, it does tend to be a negotiation between the different - you could almost view them as buckets of debt.  We’ll do a more complicated example in the future on that.  We’ll actually delve into the details of bankruptcy, but this is a general notion; that the senior guys get made whole first.  Then, the more junior guys get whatever is left, and so on and so forth.  And if there is no money for the equity, there’s no money for the equity.  That makes sense, right? 
The debt holders, all they were getting, their upside was just interest.  They also should get limited downside, in the event things turn bad.  Equity holders kind of took a gamble.  If things were great, they would get all the upside, and now that things turn bad, they take a lot of the downside.  It’s actually lucky that they don’t owe money.  That’s actually the beauty of a corporate structure, that you have limited liability. 
In some times in history, these people would actually owe the difference.  They would  actually this extra million dollars that they can’t - and they’d all go to debtor’s prison and all that.  We’ll talk more about that in the future.
Anyway, just going back on the different trenches of debt, or buckets of debt, we could call this “Senior Unsecured” and that means they’re still senior.  They’re still fairly high up the seniority ladder, but they’re unsecured.   There are no particular assets they can go run but as long as there’s enough for them, they’ll get it. 
Let me put some numbers here.  Let’s say there was $1 million of senior secured.  Let’s say there’s $2 million of senior unsecured, and let’s say this is $2 million of subordinated unsecured - subordinated just means they’re not senior. 
In this reality, what would happen is the bankruptcy court, they liquidate all this stuff, and then they’ll hand it out in order of seniority.  These guys get their million dollars back.  They’re made whole, and they probably charged a lower interest rate because they didn’t perceive their risk that high to begin with. 
These guys right here, the senior unsecured, they’ll get the next $2 million.  Then there’s $1 million left.  That $1 million will go to the subordinated debt.  They’ll get 50% of their money back.  They took a little bit of a hit but that’s okay because when things were good, they probably got higher interest to compensate them for their risk.  Usually, as you get more and more junior and you take on more risk, you get more upside or more interest. 
In this case, the equity holders get nothing.  They get wiped out.  It just goes to zero.  That’s the answer to the question I said; who gets the money?  It’s the debt holders get first dibs and if there was actually $7 million instead of $5 million, you would have paid the $6 million off completely, and then the equity holders would have gotten $1 million.  They would have gotten something if there was enough money to hand it to them. 
Anyway, in the next video, I’ll cover - this was liquidation.  We just say this isn’t worth running, let’s just give it all away or let’s sell it and give it back to our creditors.  In the next video, I’ll talk about reorganization, where we say, “You know what; this business is a good business.  It just has too many liabilities.”  See you in the next video. [ Close ]

We learned that the debt holders were actually more senior to the equity holders and they get paid first.  If there wasn’t enough money to pay all of the debt holders, then the equity holders got nothing.  That was called Chapter 7.  We’re just focusing on the corporate world right now.  Maybe we’ll do personal soon.  That’s Chapter 7 liquidation.  That was the last video. 

I think that’s what most people associate when you say that a company has gone bankrupt, that it will just disappear.  The people just say, “Okay, these assets don’t make any sense.  They can’t pay these guys.  We’re just going to take these into possession by the courts, and then just liquidate the assets. 

That raises kind of an obvious question of what if these assets are worth something?  What if I sell a socks website and socks have socks have gotten even more popular, and the only problem is I just can’t pay all of the interest that I owe on the debt?  Maybe, for whatever reason, I took out a really crazy loan that was variable rate, or for some reason I have to pay back some loans because I messed – and I’ll talk more about covenants and things like that. 

Covenants are pretty much a bunch of rules that the debt holders say, “Look, you’re good but if any of these X, Y, or Z things happen, we can take you into bankruptcy, and we can force you into bankruptcy.  Maybe because of that I’m in bankruptcy, but it’s determined that these assets right here are actually worth more as an operating entity than they are if you were to liquidate them.

A good example might be a car company.  Let’s actually take this example as a car company.  It’s very salient, at least was – I’ve heard a lot less about the auto bailouts but it was very salient at the end of last year.  Let’s say these are car factories and land and whatever else.
If we’re the debt holders, and let’s say it goes into bankruptcy.  Let’s say it only went into bankruptcy.  Let’s say this is generating cash.  I’ll teach you in a future video how do you see; what is the cash being generated by the assets and then you have to subtract out the cash that has to be used to pay the debt holders.  You’re paying interest, and then what’s left over for equity.  I’ll show you how to do that on an income statement.
Let’s say this is generating a lot of cash.  Let’s say these guys eat up interest so some of the cash will go to the debt holders as interest.  Let’s say for whatever reason, either interest rates went up or they had a bad quarter or bad year and they just didn’t generate enough cash.  Let’s say they couldn’t pay off one of the debt holders and that debt holder says, “Hey, you couldn’t pay my interest payment or you couldn’t pay the principal payment; I’m taking you into bankruptcy.” 

It goes into bankruptcy and in this situation, immediately we realize that it makes no sense to shutter this assets.  If we were to just shut down the factory and lay off the employees, we’re going to get nothing for these assets because the land is in a part of the country where there is no obvious buyer for the land, an empty car factory is pretty much useless, especially when the other people in the industry are in no mood to buy the factories from you.  Everyone decides that it’s in their best interest to keep this thing running.

What happens is that the debtor stays in possession of the assets.  You can kind of view the debtor as the equity holders and the management of the company.  They stay in possession of the assets and what actually happens – these guys didn’t have enough cash to pay off their debt holders.  They take on a new loan, called a “Debtor in Possession Loan” and this new loan is the most senior loan.  It’s called “DIP” financing.  It’s actually a great business although it’s become scarce recently.
It’s a great business because you’re at the top of the stack.  You’re more senior than even the senior guys.  It’s called DIP financing, Debtor in Possession financing.  What this provides is a company with some kind of cushion cash so that it can keep operating, so that it can keep the lights on.  It’s essentially a debt; it’s just a very senior type of debt. 
It happens once a company has entered bankruptcy.  This bankruptcy we’re going to talk about is Chapter 11 Restructuring.  In Chapter 11 Restructuring, you keep operating the company.  You might do some things on the left hand side of the equation; you might want to sell off some of the assets and all that but we won’t go into all that.  Most of what you do is you rearrange this side of the balance sheet.
This is why – every airlines, some of them have gone into bankruptcy multiple times but they still exist.  It’s not like when you go into bankruptcy, the company just disappears.  The assets will persist and all of this gets reorganized on this side.  A lot of times, when someone goes into Chapter 11 and they come out of it and they go back into it, they call that Chapter 22, and then Chapter 33, and I think you get the idea.
What happens in Chapter 11?  Essentially the assets – the bankruptcy court takes over and they hire some investment – they’ll get the Debtor in Possession financing so that the company has some cash to operate, pay the bills, and pay the employees and whatever else.  The company keeps operating as it always would so it can pay its suppliers, and operate as a regular business.

All of these guys hire a bunch of lawyers.  They start negotiating with each other.  Essentially, there will be a bank associated with the bankruptcy court, whose whole job – and it’s part of the negotiation, is to value this.  Maybe this debtor right here will hire one bank, this debtor will hire one bank, maybe the management will hire another bank, and everyone is going to come up with bankruptcy plans. 

Bankruptcy plans are usually of one or more varieties.  It’s essentially just saying, “We need to value these assets.   We’re not selling it so we’re not just going to get cash.  We’re going to hire some bankers.  (We’ll do a lot of videos on that in the future)  They’re just going to say, “Based on the prospects of this company, how fast it’s growing or how fast it’s not growing, or how much cash it’s generating in a year, they’re going to assign a value to it.

Let’s say that this guy up here hires a banker and this banker says – let’s say this was originally – the same situation as before.  This was $10 million.  Let’s say that the liabilities were $6 million, and that the original equity was $4 million.  Let’s say these bankers evaluate the business, they make detailed models, they take it into context with the current macro environment, and they say, “You know what; I think this company is actually only worth $5 million.  Given that it’s worth $5 million, and we think it can sustain only - it’s only worth $5 million and there is no way it can pay interest on $6 million of debt.  It doesn’t have enough cash to generate $6 million.  We think it can afford $2 million of debt.”
What will happen is the new company, and this is just a plan, and then once you have a plan everyone has to vote on it and there are things called “cram downs” and we’ll do that in more detail.  The plan will say, “The assets are worth $5 million and the company can only handle $2 million in debt, not $6 million of debt.  There will be $3 million left of equity.”  I’ll call this the “new equity” because sometimes this can get confusing.
Let’s just say for a second, and I want you to think about it; what’s everyone’s incentive?  This guy up here, his incentive is to value the company as lowly as possible.  Then he gets more of the company and I think that will be clear to you in a second.  This guys incentive is to say, “No, this company is worth a lot.  All of you guys are going to get paid back and then I get what’s left over,” and you’re probably asking, “What do you get paid back if there is not actual – if we’re not liquidating it?”  The answer is the new shares of the company.

What happens is this stock gets – let’s say this plan gets passed.  In this situation, these guys up here were the most senior.  Let’s say there were $2 million of senior debt up here.  What they’ll do is they’ll actually get $2 million of the new debt.  They’re most senior and then all of the other $4 million who are more junior, instead of getting any kind of cash or any kind of debt securities for having been owed this money, they’ll get the new stocks.  They’ll get $3 million of new stock. 

This $3 million of new equity will go to these guys, and this unsecured guy down here, he’s not going to get as much equity.  He’ll be impaired a little bit.  The old equity guys, the stocks going to go to zero.  They’re not going to get anything.  The old shareholders of the company are wiped out.  They go to zero and essentially, the debt holders become the new shareholders of the company. 

These guys become the new shareholders of the company and you’ll often see when a company goes into bankruptcy, but it’s getting reorganized, you’ll often see some people start to buy up this debt or these bonds right here.  You’ll see people buy up these bonds because they want to be the new equity holders.  When the company emerges from bankruptcy, let’s say that this is how it emerges from bankruptcy, they want to be these guys, the new equity holders.

Usually, when you value it, you want to undervalue it a little bit, at least these debt guys, especially the senior debt guys, they want to assign – they want to be safe.  They want to say, “We’ve already been hurt by this company.  They’re already not paying our debt.  We want to assign as low as possible value to the company as possible,” in this case $5 million, “so that we make sure…” hopefully the company ends up being worth $10 million again, in which case, these guys right here make out like bandits. 
If the company was really worth $10 but the bankruptcy values it at $5 million, these guys get all of the shares of the company; these guys get wiped out, even though the company really was worth something.  Let’s say the company emerges from bankruptcy like this, but it actually turns out there was $10 million.  Let’s say a year later the company starts doing well again and let’s say that someone could value the company again at $10 million.

Now it only has $2 million of debt and now you have $8 million worth of equity.  So these guys, maybe they were owed $2 or $3 million dollars before.  They got $3 million of the new equity.  They might have made out like bandits because now all of a sudden that equity can be worth a lot.  That’s not always the case, but that’s the view from the debt holder’s point of view.

The equity holders, you can imagine; they don’t want to be left with nothing.  They’ll hire their own bankers and their bankers will probably submit a plan that says, “No, this company is worth at least $8 million, and we think it can handle $4 million of debt.”  They’d want a scenario like that, where they think the company’s worth $8 million.  It can handle $4 million worth of debt, so it has $4 million worth of equity. 
Of course, the first $6 million of the value, so the $4 million of debt and then $2 million of the equity will go to the debt holders.  They were owed $6 million to begin with.  What’s left over which is essentially – this is $2 million of equity an then you’d have $2 million of equity here, this $2 million of new equity; the new shares of the company will be given to the old shareholders of the company.  That’s what the shareholders want.
I know this gets a little confusing but it all ends up being valuing the assets as you emerge from bankruptcy.  You say, “It’s generating cash.  It’s worth something,” and then you pay people off according to seniority.  First, you pay them off.  Then you say, “Okay, I still owe you some money, but this company can’t support $6 million of debt.  It can now support $2 million, and whatever is left, people are paid with actual new shares of the company, not the old shares.  The old shares will go to zero.
You can imagine a world where GM goes bankrupt.  Right now the old shares of GM go to zero.  but the assets keep operating.  That’s why some people are a little misleading in this whole automotive bankruptcy debate.  They’re kind of using scare tactics to say, “If GM goes bankrupt, these assets are going to disappear.”  No, they’ll just keep operating.  If it makes sense to operate them, they’ll keep operating.  The only people who will lose big are the old equity holders, and some of the unsecured, more junior levels of debt will probably lose some money.  If the assets are worth operating, they’ll continue to operate.  If the people, if it makes sense to have them employed, they’ll keep working.  See you in the next video. [ Close ]