As the current administration continues to scold hedge fund "speculators" and blame them for potentially forcing Chrysler into bankruptcy for not accepting a deep discount on their debt (before they finally relented), those same firms may now hold more keys to the success of some of the programs being pushed by the same folks doing the scolding (see Bloomberg article). While smaller in numbers and size than just one year ago, hedge funds are still in many instances those with the most capital and risk tolerance to participate in programs such as the TALF and PPIP. Yet, while hedge funds like making money, they hate losing it even more, especially when those losses are driven in part by the rules of the game being changed. Given the recent move to ignore and subordinate more senior debt to a status lower than other parties, hedge funds may be more cautious with future investments opportunities.

Such program participation may soon get another test as hedge funds weight their options as GM goes through its own restructuring. Holders of GM bonds have just a few weeks to decide if they want to swap their debt for a 10 percent equity stake in the company - while the government and the United Auto Workers union-run health care funds get 50 and 39 percent, respectively. While not only getting the short end of the stick, those debt holders who also hold CDS contracts would most likely favor a bankruptcy filing (see Financial Times article). Estimates have investors holding $34 billion in CDS on GM, with profits on the order of $2.4 billion if GM were to default. In what is not much of a surprise, current CDS prices are indicating that a bankruptcy filing is likely. The complicated and extensive lines of debt and derivatives will make both a GM bankruptcy, and any strong arm tactics, much more difficult to execute. Given less of an incentive to participate in the next restructuring, hedge funds may find others offering a little more cooperation, and maybe even a seat at the table going forward. At some point, you cannot keep slapping the hand that may save you.

It appears that efforts by the central bank to encourage investors to purchase corporate debt are not having much success (see CNN Money article). While it is often the case that companies are hesitant in the fourth quarter of a fiscal year to purchase debt for fear of creating problems on their balance sheets, this year the policy decisions of the Fed also appear to be having an impact. Currently, the Fed is offering a much lower borrowing rate than the market, with rates as low as 1.55 percent for three-month paper. The market is offering closer to 2.6 percent for similar debt. Until the market rates are lower, or the Fed rates become higher, it is not likely that investors will take the extra risk of buying corporate debt.

In a seemingly unrelated story, automakers are apparently unhappy with the $25 billion in loans they are set to receive for making more fuel efficient cars, with paperwork and administrative hurdles delaying the money (see Reuters article). As a result, the industry is continuing to burn through cash at a faster pace, causing GM to warn that the industry is now "near collapse," requiring further assistance. New aid is now being demanded, possibly up to another $25 billion in loans. The difference is that now these loans would come with no strings attached, with the expectation is that the companies would use the money to pay retiree health care obligations.

As the current financial crisis continues to unfold, one can expect that similar market circumstances (interest in cheaper Fed debt) and stimulus requests (taxpayers covering operating costs) will continue. At some point the response to such request will have to be no, and the results of such decision will have to be felt. Unfortunately, the longer that requests are accepted and government intervention occurs, that longer it will take to separate business from government and allow the free markets to get back to doing what they do best - rewarding with cheaper capital those companies that are managed well and properly positioned, while punishing those that aren't.

As of now, the Fannie and Freddie story is pretty well known, and has been looked at from a number of different angles (see various articles and posts here, here, here, and here). Now we find out that the auto industry is set to press Congress for $50 billion in low-interest auto loans (see CNN Money article). The government loans are expected to be used to help modernize plants and help the car companies make more fuel efficient vehicles. Congress had already authorized $25 billion in loans last year, but apparently that is now not enough. It is believed that the loans would have rates between 4-5 percent. Even though market rates are fairly low already, the credit ratings of both Ford and GM have fallen below investment grade, making it difficult to borrow anywhere near 5 percent.

This of course makes one wonder at which point all of this stops. Sure, it is important to keep Fannie and Freddie and the general housing mess from bringing down the financial markets, but at what cost? Starbucks has fallen on hard times. Should they get some type of bailout or support? What about Sears Holdings, with the struggling Sears and K-Mart retailers? Is it time for the airlines to go back to the well? The argument of course is usually attached to the financial sector, talking about things like contagion, or national interest, for industries such as defense and manufacturing. But where is the consistency? Just as loans are being requested to help build hybrids, electric cars, and other alternatives, other measures to increase low cost electricity or reduce our energy independence are met with resistance. Even more unsettling is that by choosing to bailout Fannie and Freddie, we (the taxpayers) are now all investors in the mortgage markets, whether we choose so or not. To add insult to injury, we can even lose more than our initial investment.

Of course the real issue of concern may not be whether or not a specific industry or company is receiving low interest loans or a nice government contract, or whether we are being forced to invest in risky companies against our will, but whether the trend of privatizing profits and socializing risk is really good for free markets. As readers know, I often discuss the need for risk management, but unfortunately for many companies their idea of risk management is simply letting the government take the reins when things go bad. Again, the point is not specifically about the current problems or plan proposed by Secretary Paulson. It appears that he had no other choice, and as he stated on CNBC: "played the hand he was dealt." Yet, should it have gotten to this point?

As is now obvious, banks kept making loans without worry of whether homeowners would pay them back. They could simply sell the loans off to Fannie and Freddie, sponsored in part by the government. While Fannie and Freddie were indeed "just" sponsored entities, there was always a "wink-wink" understanding that the government would step up in times of need. As such, both risk and return were adjusted accordingly. Yet, this was part of the problem. By having in place what amounted to a zero deductible insurance policy, Fannie and Freddie could go off and look for ways to juice returns by creating portfolios that really had no purpose other than to help meet quarterly numbers and make Wall Street and shareholders happy - all the while knowing that if things got bad, Uncle Sam was there to save the day. Well, that day has come, and now the government is left with few options, tax payers are left with more risks and unwanted investments, and the free-markets are a little less free. Where does it stop?

The New York Mercantile Exchange is planning to introduce a futures contract that is based on U.S. Midwest market prices for hot-rolled steel coil (see WSJ article). The steel contracts are expected to be offered later this year in the fourth quarter, and be settled against an index developed by CRU Indices Ltd. The futures contracts offer a new way to price steel, which is typically bought through direct negotiations. The move comes at an interesting time considering that many in Congress and elsewhere are blaming speculators in part for the recent moves in crude oil price. Some steel company executives have also resisted steel futures since they too feel that the new futures market will only benefit speculators. On the other hand, a futures market will allow for more consistent pricing and less dumping into competitive markets. The futures market may also keep companies from bidding against themselves, not to mention allow smaller companies without negotiating power to work on a more level playing field.

Of course, beyond helping to eliminate the dumping of steel, a futures market will open up the potential for companies to hedge their steel cost. Given the increased costs of the energy, coking coal, and other raw materials needed to produce steel, the ability the hedge steel cost could not come at a better time for the automobile makers, aerospace industry, and other large users of steel. Therefore, while a potentially good development for companies such General Motors (GM), Ford (F), and Boeing (BA), the move towards steel futures is probably less good news for larger steel makers, such as U.S. Steel (X), Arcelor Mittal (MT), and Nucor (NUE).

Chrysler has announced that it will stop offering leases through its leading facility (see WSJ article). The move comes as Chrysler and other car companies are seeing their borrowing cost rise (typically Libor plus a spread of 1% or more for Chrysler - with Libor around 2.8%). Higher borrowing cost make it more difficult for the car companies to make money on low interest rate loans, or absorb write-offs for 0% loans that are often used to increase sales of higher-margin or low selling vehicles. The old joke of "we lose money on every sale, but make it up in volume" may not even apply here. The first part still holds, but volume may not increase unless they can find ways to help customers purchase their vehicles. Customers have basically quit buying the higher margin vehicles, such as trucks and SUVs. To make matters worse, even if customers do purchase these vehicles, and the car companies finance or lease them, the car company may be stuck with a bad loan which has an asset that has depreciated below the current loan value.

Issues such as these have led to the recent decision by Chrysler to quit offering leases. But does this solve the problem, or simply make things worse? Sure, by eliminating poorly performing loans and leases, as well as reducing the company's dependency on higher borrowing cost, the company can scale back poor performing assets, which is good. Unfortunately, they may also be scaling back sales in the process, in what amounts to shooting themselves in the foot. Typically, buyers will utilize the dealer credit facilities if they are unable to get a better deal at a bank or local credit union (most likely due to weak credit). Even with good credit, they may still decide to take the loan or lease with the car credit facility when it is tied with incentives, such as rebates or low financing. By eliminate this line of credit for customers, you are essentially preventing the weaker credit customers that need the facility from purchasing your vehicles. For those with good credit who can obtain low interest loans elsewhere, you now lose another carrot that might help get them in the door to buy the higher-margin vehicles that make you the most money. In a sense, you have reduced credit risk by introducing sales risk, resulting in lower revenues and lower valuation.

Of course, this is not to say that Chrysler made the wrong move. They may have had no other choice given the credit markets, and car loans themselves may be the next shoe to drop, bringing down not only the car makers, but the banks underwriting the credit as well. Nonetheless, it does tell you how serious their problems are, and another reason their competitors, such as Ford (F) and General Motors (GM), and even Toyota Motors (TM) to some extent, are getting marked down in the stock market. They are in a bind, and there are not really any easy answers. I am just not sure that making it harder for your customers to buy your product is the answer.