Imagine you had a huge losing position in a stock that was falling fast and you desperately needed cash to pay your bills. You'd probably sell your stock.
Not so the federal government. While Uncle Sam readies new taxes and program cuts to address a burgeoning deficit, one can't help but wonder why it didn't start with its roughly 27% equity investment in General Motors (GM),
GM today reported that its profit nearly doubled in the second quarter to $2.4 billion. But with shares trading at $26 and change, GM has to rally nearly 103%, to $55, for the government to break even on its investment according to published reports. "We're going to lose money in the auto industry," acknowledged Treasury Secretary Timothy Geithner in April. Keep that in mind next time you hear what a success the auto bailouts have been.
As traders, we're often far too cocky, not only about our ability to predict markets but also our capacity for withstanding pain. With experience, one begins to understand that what matters isn't being "right," but making money. Think our government has the same goal?
The government fails to acknowledge a basic principle of portfolio management, succinctly observed by Nobel Laureate Myron Scholes while reflecting on the implosion of his own firm, Long Term Capital Management, back in 1998. When facing market losses, "there's always a tendency to reduce or sell your more liquid securities first. [But] if things go against you, then you're left with the more illiquid securities ... that's a very bad strategy indeed."
Despite the fact that GM's a large-cap, publicly traded stock, the government's stake of roughly 365 million shares of General Motors represents a very illiquid position. Not only is the position size substantial -- Washington's original loans were generously swapped for lower-ranked stock -- but because any sale would be publicly reviewed, the market would unquestionably anticipate the disposal.
Putting aside the politics -- I opposed the bailouts from the start -- one can expect increasing pressure for government to liquidate its stake, especially as the so-called "Super Congress" begins searching for $1 trillion in cuts. Not unlike Bank of England's infamous 2001 gold sale, their sales are likely to be done at the worst possible time for taxpayers. That's ideally when I'd cover my short.
Traders know the tape cannot be fought forever. Whether it's Penn Central or Cisco (CSCO),
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC. At the time of writing, Hoenig's fund was short shares of General Motors.