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Auto Failure Could Fuel Credit Crisis
Carmakers Steeped In Bond Market

By Peter Whoriskey
Washington Post Staff Writer
Friday, November 21, 2008

With lawmakers weighing the possibility of allowing one of the nation's automakers to fail, some on Wall Street and in Detroit are arguing that the consequences of failure could reach far beyond the industry and into the broader economy.

Perhaps most critically, some analysts now say, failure would deepen the nation's credit crisis.

The risk arises in part because so many financial institutions hold bonds issued by the automakers. Moreover, an estimated $290 billion in credit-default swaps, which are contracts that function like insurance policies, have been written on that debt, according to the leading clearinghouse for such trades.

In a research note issued yesterday, J.P. Morgan Chase analyst Eric J. Selle suggested the automakers' failure would mark "Credit Crisis Part II," noting that bonds issued by General Motors, Ford and their lending companies make up about 10 percent of the high-yield bond market and that automakers represent one of the largest sectors in finance for banks.

Their troubles, Selle said, could have "magnified effects" in the credit-default swaps markets and "pose ramifications" for the ailing credit markets.

Exactly what a bankruptcy by one of Detroit's Big Three automakers would mean for the broader economy has become a key point in the dispute over whether the government should offer them a bailout.

Insurance giant American International Group won government support because officials thought it posed a systemic risk to the credit markets, which undergird the entire economy. For similar reasons, the Treasury Department invested in banks because their failure would have had far-reaching effects.

Supporters of an auto bailout see parallels.

"I think the systemic risk would be dramatic across the entire economy," Chrysler chief executive Robert L. Nardelli told Congress this week. "The lenders, the financial institutions would be at total risk relative to being able to recover their investments in this industry . . . . There would be tremendous impact on the financial institutions."

According to the Depository Trust & Clearing Corp., which processes financial transactions, more than $290 billion in credit-default swaps have been written on GM, Ford or their financing arms. As circumstances have worsened, the prices of those "insurance" contracts have jumped, doubling in the past two weeks.

Some analysts have cautioned against comparing the automakers to banks or AIG.

Unlike AIG or the banks, the automakers do not write credit-default swap contracts. Moreover, analysts note, the amount of money that would change hands in the event of the automakers' failure would be far less than $290 billion because so many of the credit-default swap contracts are issued by financial institutions that also purchase them. When those are cleared, the amount falls to about $16 billion, according to DTCC figures.

Sen. Charles E. Schumer (D-N.Y.) traces at least some of the ongoing troubles to the difficulties automakers are having in issuing auto loans.

"The auto industry is not a stand-alone problem. It affects the economy writ large," he said yesterday. "The trouble with the financing arms of the automakers and the shriveling up of auto-lending has produced a lot of the tumult in the economy."

Citing such effects, Schumer's office is drafting a letter asking the Federal Reserve to set up a special facility to lend against auto loans, a move meant to ensure credit for car purchases.

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