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Interfluidity :: Insolvency is philosophy, illiquidity is fact
Insolvency is philosophy, illiquidity is fact

Take a look at a snippet of GM's last-quarter balance sheet (courtesy of Yahoo! Finance). It's the part that contains what accountants quaintly call "Shareholder Equity":

[Follow original link to see the graphic.]

Yes, the accounting value of the firm's equity is negative 41.7 billion dollars. Now, answer me this. Is GM insolvent?

There is no definitive answer. It's a philosophical question, a matter of opinion. The market says GM's equity is worth $15B dollars. All we can say with any confidence is that GM is liquid, it has not yet failed to pay its bills, it is capable of borrowing to finance its operational needs despite a balance sheet with no vital signs. The patient walks and breathes, so it is not dead. Somehow.

There is a meme going around the blogosphere, and now the mainstream-press-o-sphere, that the Fed is helpless in the current crisis because the problem is one of solvency, not liquidity. Here's Paul Krugman (hat tip Mark Thoma):

In past financial crises... the Fed has been able to wave its magic wand and make market turmoil disappear. But this time the magic isn't working... Why not? Because the problem with the markets isn't just a lack of liquidity -- there's also a fundamental problem of solvency.

Here, here, Dr. Krugman. And you too, Dr. Roubini. And Michael Shedlock. And Kevin Drum. I agree with you all. From the tiny legal entities known as asset-backed securities, way up through to a couple of large money center banks, there are a lot of entities out there which, by my Victorian standards, are simply insolvent. But by those standards, GM oughtn't be able to fog a mirror, let alone borrow money from people. It's the living dead, a zombie, to use a term fashionable when discussing Japan but never, ever appropriate to the hypercapitalist U.S. of A.

by Metatone (metatone [a|t] gmail (dot) com) on Sun Dec 16th, 2007 at 06:30:50 PM EST
There is some truth to it - the only thing we ever see is illiquidity, ie the inability by someone to pay a liability when due.

Then it's indeed a question of opinion as to what the inability means. But there is a conceptual difference between a temporary mismatch between resources and debts, and a long term inability to pay one's debts. The first kind can be solved by liquidity injection, the second cannot.

So, after the failure of the recent liquidity injections, one can infer that we are no longer in a temporary mismatch situation.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sun Dec 16th, 2007 at 06:40:16 PM EST
[ Parent ]
Unless it's a question of psychology and not of temporary mismatch or long term inability.
by vladimir on Mon Dec 17th, 2007 at 06:17:34 AM EST
[ Parent ]
GM hasn't made money making/selling automobiles for donkey's years.  They have been making money making loans to people to buy their automobiles through GMAC -- General Motors Acceptance Corporation.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Sun Dec 16th, 2007 at 07:27:54 PM EST
[ Parent ]
As I understood it, the GM group as a whole has been losing money.

i.e. GMAC profits are less than GM Auto losses.

by Metatone (metatone [a|t] gmail (dot) com) on Sun Dec 16th, 2007 at 07:50:32 PM EST
[ Parent ]
That is what they have been reporting.  The truth?  I don't know. I haven't looked at their financial statements in 20 years.

I do know they make crappy cars no one wants to buy, even with cheap loans as an inducement.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sun Dec 16th, 2007 at 08:16:34 PM EST
[ Parent ]
I do know they make crappy cars no one wants to buy, even with cheap loans as an inducement.

Amen.  Ditto Ford and Chrysler.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Mon Dec 17th, 2007 at 06:38:28 AM EST
[ Parent ]
That's my understanding as well.  I was under the impression that GMAC was being sold off though.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Mon Dec 17th, 2007 at 06:36:41 AM EST
[ Parent ]

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