What was saved by GM's bailout?...

What was saved by GM's bailout?... What happens when economics and politics intersect… GM is headed for bankruptcy again… The Obama administration broke the law and rewrote the laws of capitalism…

A wise and very wealthy mentor e-mailed me yesterday.

In the past, this man's given me what I consider to be the most valuable secrets to life and happiness. He's taught me to interpret the difference between what people say and what people do. If you have access to this window into the world, everything becomes vastly easier to understand.

Unfortunately, that's a subject for a much longer, much harder–to-write essay or book. Even if I tried, I don't think I'm old enough yet (turning 40 in a few days) to put it down into text. I bring it up so that you'll understand... when this man... one of my greatest mentors... asks me a question, I take it seriously. I know he's after real knowledge, not merely an argument to put in his quiver. This is a man who has no one left to argue with...

He asked me: "When my liberal friends claim that Obama saved Detroit... how should I respond? I understand the economics in theory (the parable of the broken window), but I don't know the nuts and bolts of what happened."

Now... before you click off this message and assume everything I'm about to write is a veiled political message... please let me tell you... I don't care for whom you vote. I really don't. My desire – that both of the major candidates would lose – will most likely never happen in my lifetime.

What I have to say about this question is truly not about politics. Both parties (Republicans and Democrats) were involved in the bailout of Detroit (GM and Chrysler). Specifically, George W. Bush first bailed out Detroit with gigantic loans from the Troubled Asset Relief Program (TARP) that was created, supposedly, to save Wall Street.

Had the managers of GM and Chrysler acted ethically and lived up to the fiduciary obligations to their existing creditors, they would have never accepted these loans. Taking billions from the government under onerous terms meant that their legitimate creditors were deeply subordinated and thus much, much less likely to ever be repaid.

The Obama administration followed these questionable actions with further legal abuses, essentially re-writing the rules of capitalism in America. I believe what happened set dangerous precedent. And for what? Why did we really do all these things? What has been accomplished?

I've studied this issue more than almost anyone else in America. That's because I recommended shorting GM prior to its bankruptcy. I wrote a series of acclaimed satirical letters, Letters from the Chairman of General Motors. Copies of my work were sent all around Wall Street – even to Warren Buffett. I've answered questions from investors about what would happen to General Motors for nearly a decade – and I've gotten it right. I've watched with fascination and horror as the company's problems have played out. With the Detroit bailout, we have a classic example of what always happens when politics intersects with economics.

The central truth of economics is simple: Economics is all about scarcity. There can never be enough of anything to satisfy everyone. But the central truth of politics in a democracy is exactly the opposite: To get elected, you must promise everything to everyone. The story of Detroit and the bailout of Chrysler and GM are what happens when these two powerful mandates collide. What this story says about our country... and our future... is ominous. I hope you'll read these facts and think carefully about the direction we're heading, regardless whom you vote for.

The facts of the bailout are a matter of public record. Although the sums in question are huge, they aren't hard to understand. With my analysis, I'll primarily stick to GM because I know the details very well. I'll give you my conclusion upfront: At the time of the bailout, GM simply wasn't a viable business. It wasn't viable because of massive global overcapacity in the auto sector and because of the wage and benefit expenses of the UAW union.

Before you send me a hateful message about how I don't care about American workers... please reconsider. GM had no chance of success then (and has no chance of success now) if everyone ignores the simple facts of the competitive landscape in which it must operate. It is a fact that GM's operating costs weren't competitive globally. GM's operating costs were way out of line with other American manufacturing companies, too. No government bailout will change this fact. And as you'll see, it is still a huge problem for the company.

The other critical fact is, the global automotive industry struggles with a vast amount of overcapacity. We know that by looking at the horrible returns on capital earned by the industry as a whole – even by the best carmakers. Economics was trying to tell us that the world didn't need GM, regardless of what we might make of that message. Again, no amount of government-granted capital is going to change this important fact.

In 2009, the year of the Obama bailout, GM sold 7.5 million vehicles in 120 countries around the world. GM was already primarily a foreign company: 72% of its sales were from outside the U.S., and most of its employees lived in another country. Almost 40% of its sales were from "emerging" markets, like Brazil, Russia, India, and China, where GM was actually growing.

At the operating company level, this bailout was mostly about continuing to provide American technology and know-how to foreigners. If you want to argue with me, that's fine... but start with the facts above. Just ask yourself this question: Where did the lobbying muscle for the bailout really come from? A few bankrupt cities in the American Midwest... or Brazil, China, India, and Russia?

The other big beneficiary of the bailout was the UAW. Obama essentially stole GM from its legitimate owners and gave it to the UAW. I'll show you how below. But before we get to the details of how this happened, I'd like to ask an even more obvious question... was it worth it?

When you study the numbers, you'll find that the U.S. government invested about $80 billion into GM. Another $92.7 billion in debt was written off in the bankruptcy process. And there's another $30 billion or so of tax benefits that the company has yet to cash in. Altogether, the bailout of GM (as opposed to the liquidation of the company's assets) will probably cost more than $200 billion.

What did we get for all this money? Today, GM is still a globally uncompetitive business that's struggling to break even. It's earning about $2 billion a year in free cash flow on sales of $150 billion. At this rate, it would take the company about 100 years to repay the capital used in the bailout. That isn't going to happen, of course. In fact, the company is investing nearly all of its capital in China, India, Brazil, and Russia.

The reason is easy to understand. In most places outside the U.S., GM can manufacture vehicles profitably. Nearly half (43%) of GM's cars are made in low-cost manufacturing centers, where the company's wages and benefits total $15 per hour. In 2011, GM paid its hourly workers in the United States $56 per hour in total compensation, on average. That's almost twice what the average hourly manufacturing employee earns in the U.S. ($24 per hour). Steve Rattner, who was Obama's first "car czar," once bragged that during the bailout, he'd never asked a single UAW employee to take a wage cut.

Many people have argued that bailing out GM was necessary to avert a disaster in Detroit. Have you seen Detroit lately? Its premiere downtown office tower was just sold for $5 per square foot. Not rented, sold. The other argument commonly given was that a bailout was necessary to support GM's workers and retirees.

GM, in its current form, is not a viable business. Not even after the $200 billion in capital and benefits it got from the government. The company cannot generate enough earnings to support its 400,000 retirees while investing enough in new cars to be competitive. Consider the company's most important new product. No, not the Volt. That's a laughingstock and everyone knows it...

The most important segment of the U.S. passenger car market is known as the D-segment. This is where you find the Toyota Camry and the Honda Accord. This segment of the market makes up roughly 20% of all vehicle sales in the U.S., the single biggest market segment.

The March 2012 issue of Car and Driver magazine compared GM's D-segment automobile – the 2013 Chevy Malibu – with the Kia Optima, Honda Accord, Hyundai Sonata, Volkswagen Passat, and the best-selling Toyota Camry. The GM car came in dead last. In fact, the new design scored lower than the model it is replacing, the 2008 Malibu. GM is now making worse cars than it has ever made before.

Among the Malibu's most notable design blunders: the new design has a wheelbase that's shorter by 4.5 inches, giving the car the shortest wheelbase in the D-segment. Why would GM make the car smaller, when this segment of the market is designed for families? Because GM's drive train is woefully out of date. GM simply doesn't have engines that are as powerful and efficient as its competitors'.

Since 2007, GM's share of the U.S. market for total vehicles (cars and trucks) has fallen from 23% (before the bailout) to only 18%. The fall has been linear (lower every year) except for 2011, when Toyota suffered significant disruptions to its supply chain from the Fukushima Daiichi nuclear disaster. GM's products are slipping in quality because of a lack of investment capital. The company simply does not have a culture of product development excellence.

The former head of design and development, Bob Lutz, says publicly of the company's poor designs and shrinking market share: "Product strength is only one component of the market share equations. Other elements affecting share are transaction prices, marketing spend, and propensity to make market-share-enhancing, low-profit sales to daily rental fleets." Just imagine if Steve Jobs had believed the same.

Is GM likely to save itself by hiring great product development executives? I doubt it. The company recently named Robert Ferguson as head of the Cadillac division – its high-end brand. His previous job? The head lobbyist for GM in Washington D.C.

Were there any warnings that maybe spending another $200 billion on GM wasn't a good idea? Michael Jensen of the Harvard Business School studied 432 of the largest American companies between 1980 and 1990. Specifically, he studied whether the capital investments they made in their own businesses paid off. Anyone want to guess which company had the worst returns on its internal investments? Coming in dead last was GM. (Guess who was first… Wal-Mart.)

The simple fact is, American consumers don't need eight different new model D-segment sedans. There is massive overcapacity in the world today for car manufacturing. And America isn't competitive with the rest of the world when it comes to this particular business. Truth be told, the car industry isn't competitive with the rest of domestic American manufacturing. Those are simple facts. They might be unpleasant, politically... but that won't change them. And until the economics of the car business improve, no amount of additional capital will save GM.

Unfortunately, we didn't merely waste money when we bailed out GM. We also destroyed some of the most important laws and precedents. In order to "save" GM and Chrysler without benefiting wealthy investors, the Obama administration broke the law. It abridged the clear contracts of Chrysler's secured creditors (stealing their collateral and repaying them pennies on the dollar) and broke bankruptcy laws by awarding far more benefits ($17.8 billion) to GM's unionized creditors than it did to the company's bondholders ($8.1 billion). The inequities of these grants have gotten far worse over time, thanks to the privileged status of the union's GM-preferred stock, which pays a 9% annual dividend and consumes the lion's share of the company's operating profit.

In short... The government wasted hundreds of billions of dollars in capital to save a company whose products are mostly sold in other markets and aren't competitive in the U.S. And in doing so, it destroyed several hundred years of legal precedent that provides the foundation of capitalism in America.

No matter what else you believe about the importance of GM or its workers, that wasn't a good decision. That $200 billion could have (and should have) been spent in a far more productive way. In time, the profound consequences of these poor choices will become abundantly clear.

GM will go bankrupt again, that's almost certain. It is, even as I write this, heading straight back down the path of borrowing enormous sums from Wall Street. It has re-launched its financial division and is, once again, making loans and leases to people who can't afford its cars. It is, once again, selling huge quantities of poorly made vehicles to rental-car companies, which wipes out the resale value of its automobiles and makes consumers far less likely to pay full price for them. It is, once again, "stuffing" the channel – forcing dealers to buy too many cars that they can't sell. It is doing all of the same things that drove it into bankruptcy the first time… the very same things.

One last point to ponder... all of the information above is public information. It is all part of the public record. How many of the candidates or members of the media are willing to discuss the plain facts of this situation? What does that mean for the future of our country... where even public investments of this size and magnitude are not understood or discussed openly by all serious media outlets? If we can't figure out what to do with our carmakers... how will we ever figure out what to do with the world's most powerful army... with the world's largest debts?

The best way to protect yourself from our country's problems is to own gold and gold stocks... The best person in the world at analyzing gold stocks is our longtime friend John Doody, editor of Gold Stock Analyst. As a portfolio, his Top 10 list of gold-producer stocks returned more than 1,032% between 2001 and 2011... an average of 40.6% a year. To learn more about John and his method for picking winning gold stocks, click here.

New 52-week highs (as of 11/1/2012): iShares Dow Jones U.S. Home Construction Fund (ITB), Sandstorm Metals & Energy (SND.V), Guggenheim China Real Estate Fund (TAO), Prestige Brand Holdings (PBH), Consolidated Tomoka Land (CTO), Silver Wheaton (SLW), Kohlberg Kravis Roberts (KKR), and Southern Copper (SCCO).

In today's mailbag… a couple readers share their experience using our advice on options and real estate. Send your e-mail to feedback@stansberryresearch.com.

"I am retired and now on a fixed income, which is pretty scary, knowing what inflation will inevitably do to my lifestyle. That's why I took up trading. It is so much fun that for the first time in my life, I LOVE saving money. Case in point; I started selling MSFT puts. When Microsoft plunged, I had the NOV 29 in play. It made me very happy to think of owning Microsoft for less than $28.40. The price plunged even more and so I sold a NOV 28 as well. I am elated to have scooped the low-hanging fruit, now that MSFT is back nearly to 30 and I never got called out, but a little disappointed that I didn't get any for less than twenty-eight dollars. What fun! When my stocks go down, the VIX goes up and it's party time again." – Paid-up subscriber Theo Knapp

"I have seen that big money is buying single family homes here in central Texas, as my realtor, who goes to the court house foreclosure sale every month has watched over half the houses go to the same two cash buyers for months now, leaving us poor investors to dry our tears with the soon to be outdated pre approval letters." – Paid-up subscriber Robert Johnson

Regards,