To try to get my head 'round the fact and ramifications of this accounting-related announcement, I sent an email to TTAC's Deep Throat. "Effectively, a company keeps two sets of books: one for financial disclosure and one for the taxman. The tax credits created by depreciating assets accumulate faster/look smaller on the tax books than on the financial books. The difference between the two creates a tax credit (a.k.a. an asset). Assuming static business, over time, as the financial books catch up with the tax books, the credits get "used up." If a company grows, those deferred tax credits also grow. But the tax credits cannot exist forever; they must get paid. With this move, GM is essentially saying its accountants can no longer justify carrying these tax credits as an asset; they reckon their employer's future growth is limited. All that said, the $39b announcement may not necessarily result in a cash payout because of the way the tax code works. It's very arcane stuff that few people really understand. My guess is that this will have some cash consequences, but we'll have to wait and see if, when and how much. Meanwhile, it's safe to say this announcement will raise concerns about GM's prospects in the credit markets given the further fragility of GM's balance sheet." [NB: Accounting and high finance experts are invited to add their perspective, as long as they do so in something resembling plain English.]
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So, no other real losses are going to be hidden in this one time $39B charge? Also, wtf?
A dollar is still a dollar even when it’s on paper. GM can’t escape the fact they don’t selle nough cars at a enough profit to afford the luxery of a bloated workforce and retirement crew.
Basically, from what I gather, the situation is more or less like this:
1) In the past, GM booked a large number of what were essentially tax deductions. So many, in fact, that they couldn’t use them all up in the years they took them — that is, they had more deductions than profits.
(Note that while actual business losses are a typical deduction, it is entirely possible to book more deductions than profits in a sound business. A typical reason is that the tax code allows you to depreciate assets — factories, machinery, etc. — faster than they actually wear out or go obsolete. Thus, if you buy a machine with a 15 year lifespan, but get to deduct its entire cost spread over just the first five years of its life, it will appear as if you lost a lot of money in the first five years and made a whole lot in the last ten, while a more fair view — depreciating the machine over its actual lifespan — would be to say that you earned a moderate amount of money each year.)
2) When you have more deductions than profits, you get to save up those deductions and use them against profits in a future year. You can estimate the “cash value” of these deductions by taking the amount of the deduction and multiplying it by the tax rate that you pay. You get to count the cash value of those future deductions as an asset.
(Illustration: You earn $100. Your tax rate is 35%, so you pay $35 in tax. A $10 deduction against income means you get taxed as if you earned only $90, so you pay only $31.5 in tax. The deduction lead to paying $3.5 less taxes, so a $10 deduction is worth $3.5 cash.)
3) Those deductions only really have a cash value if you can reasonably assume that you will actually make a profit in the coming years, since all they serve to do is eliminate the tax that you would otherwise have had to pay on that profit. You can’t just mail them into the government and get a big fat check. Based on its past performance over the past few years, GM has dediced that it can no longer assume that it will make a profit in the coming years, and thus can no longer assume that it will get to make any actual use of the credits. Also, under the rules, you can’t just sell the credits on the open market like you can sell widgets. If you can’t use them or sell them, they are worthless to you. If you own something that was previously valuable but is now worthless, you have to write down that value on your balance sheet.
(Note: I’m not entirely certain whether the decision to assume that you will not be making a profit anytime soon is one made on the company’s / accountant’s best guess regarding the future prospects of the business, or whether it is a more mechanistic rule that forces you to extrapolate from past trends, even if you really think that you have a new killer product that’s about to turn things around dramatically.)
4) Companies that have a lot of “stranded” tax credits historically made tempting takeover targets for businesses that have a lot of steady cash profits. The reason is that while you cannot sell tax credits on the open market, if two whole companies merge, then you can apply existing credits to the future profits of the combined enterprise, even if the profits of the combined enterprise are really just the profits of the old profitable enterprise, and the old unprofitable enterprise acutally has its industrial activities pared down or shut entirely.
(Note: I’m not sure what current practice is on this point — whether this sort of thing continues to be done regularly, or whether it has become harder to really make efficient use of such credits due to changes in the law. Should look it up.)
5) The only problem is, tempting as it may be for Microsoft to buy out GM to raid the tax credit kitty, they would then be left with an ailing car business on their hands, a lot of creditors lined up at the door, and a ton of union employees whom they would have a hard time sacking. Maybe GM is prepping itself for a sale timed to coincide with the end of the new labor contract? Wild speculation.
Coupled with the payment promised to the UAW for the new VEBA this is a hefty lump of green GM just lost. Unless, of course, this $39B was the VEBA payment.
NBK, your explanation is right on and clearly points out the bean counters at GM realize the gig is about up.
I believe the accounting rules dictate that these credits can only be carried on the books for a fixed length of time. I’ll need to look it up since I think the time frame has changed. It’s a very complex accounting issue and GM is getting trapped up on some of these issues. I’m convinced GM has played around with their numbers for more than a few years to make things look better than they really are, although I don’t know if this is a fact.
Bill – It’s not so much a question of whether or not GM can be profitable. It’s a question of whether or not they can be profitable enough to take advantage of nearly 40 billion in tax credits. That would mean at a 35% tax rate GM would have to earn $114 billion in profits. Even if GM made a few billion every year, it would take half a century to earn those credits. My guess is that there are still credits on their books. The value of the credits on their balance sheet is much less than their actual book value. Hence the write-off.
A point to emphasize: although the $39 Billion charge was not an actual historical cash expense, it DOES represent $39 billion in actual cash that GM would have been able to retain from its cash flow in the future, if it had become profitable enough to owe income tax. This does indeed cost GM $39 billion of real cash, in the long run.
It’s like casually throwing away that silly Powerball ticket Grandma gave you, and then finding next Saturday night that it had the winning number on it.
Thanks to all for the explanations.
It seems pretty clear that GM’s hocus-pocus act is about to get the shepherd’s hook off-stage.
Coming at the same time as Toyota’s announcement of record profits, it’s a tale of two companies, one in free-fall and the other seemingly on an unstoppable ascent.
Don’t know jack about accounting rules, but while searching news last night for stuff that wasn’t a regurgitated press release, these 3 quotes came up:
thestreet.com:
http://www.thestreet.com/s/gm-to-take-39-billion-hit/newsanalysis/automakers/10388719.html
GM’s third-quarter report, due Wednesday morning, was already expected to be weak amid troubles at GMAC’s mortgage unit and bleak sales in North America, but the charge will plunge the automaker’s results far deeper in the red than Wall Street expected.
NY Times: http://www.nytimes.com/2007/11/07/business/07cnd-auto.html
Analysts said the step reflected the likelihood that G.M. would not earn significant profits on its automotive or finance operations in the near future. The deferred assets could have been used to offset taxes on future profits.
“What this says right now is that, at least according to an accounting interpretation, the outlook for earnings in their U.S. business has diminished from where it was,” said John Casesa, an industry analyst with the Casesa Shapiro Group.
Forbes: http://www.forbes.com/topstories/hom…markets43.html
David Healy, a Burnham Securities analyst, said that the charge is an indication that GM’s outlook is not as strong as it was a few months ago. “It’s a deterioration in their short-term outlook,” he said.
GMAC suffered a large loss in the third quarter and the provisions GM took were not sufficient, Healy said, which may mean further write-downs are expected.
Warning — Long, winding post ahead. Use caution…
I’m not an accountant, so I could be wrong about aspects of this and I am open to correction. But I’d say that combining Compy386’s response to NBK’s explanation leads you to the right answer.
It might help to first explain what a “balance sheet” is. A balance sheet is basically a list of what a company owns (assets) and what it owes (liabilities.) On the left sit the assets, which include cash in the bank, money owed to the company by customers, plant and equipment, etc. On the right sit the liabilities, such as loans and debt taken out by the company, unpaid wage and pension obligations, and so forth.
The left and the right side of the balance sheet have to match — that’s why it’s called a balance sheet. As you would guess, it would be rare for assets and liabilities to be exactly the same as each other, there is typically a difference in the two amounts. The difference between these two is called “owner’s equity” (or something similar) and is located on the right side of the balance sheet, along with the liabilities. This is where the gap between assets and liabilities gets filled, and it represents the net worth of the company. The assets should generally exceed the liabilities, as you might have guessed, which would result in a positive net worth. (That’s a highly simplified explanation of owner’s equity, but will do for our purposes here.)
Here’s where the tax thing comes in. GM has been losing money, so it has been generating tax write offs that it earned but couldn’t use because it didn’t owe enough taxes in prior years due to the losses being so large. Those losses can be used in future years to offset taxes that it would otherwise have to pay. Those have been sitting on the balance sheet as assets on the left side. To make things balance out, they also must go somewhere on the right side of the balance sheet, which means that owner’s equity (the company’s book value) went up to offset it. So the net value of the company to the shareholders had effectively been increased by those unused tax writeoffs.
The beancounters are required to do a reasonableness test to project whether those losses will ever be used — if they can’t be used, then they aren’t the valuable asset that the balance sheet would have lead you to believe and are supposed to be written down so that their value isn’t overstated. There should be both GAAP standards and IRS rules for what is considered to be reasonable, and the accountants concluded that a big chunk of losses will not be usable, after all.
Of course, the company could eventually benefit from these losses if it ends up owing taxes in the future from a profitable business – these assets are like holding a bargain coupon for future discounts with the IRS. But companies that don’t generate earnings soon enough won’t owe any taxes within the timeframe that those losses are good for, and therefore won’t be able to use those losses. (In fact, if they keep losing money, they will generate even more tax deferred assets by the money that the lose in the future.)
If you look at GM’s most recent balance sheet dated June 30, it was carrying about $32B in these deferred income taxes as an asset. Owner’s equity was already negative, at -$3.55B. GM is an unhealthy company, with its liabilities actually exceeding its assets. (It owes more to others than the value of its assets.)
So here’s my conclusion —
-GM has been losing a lot of money to have earned all of those losses. Well, no surprise there — anyone who reads the papers knows this has been ongoing. So that part of the news is no big deal, the fact that they are on the books is a matter of historical performance that we already know about.
-The resulting reduction to the asset is almost certainly going to reduce owner’s equity by a near equal amount to make it more negative than it was. A lot more negative. (Remember, the balance sheet has to balance, and we’re talking about $32B of assets out of a total of about $187B — these tax assets are the second largest asset on GM’s balance sheet.) It could be unnerving to the markets to see the company’s net worth take such a huge hit, although ultimately, it’s a paper loss, not a real one.
-The fact that they are forecasting that the losses can’t be used tells you that their internal profit expectations are low. These assets get written down when it is expected that they can’t be used.
If there is a story here, it’s mostly in the third bullet point. To flush that out precisely would require an understanding of the GAAP rules (an understanding that I don’t have) to know what determines the reasonableness for carrying these deferred tax assets on the books.
It is possible that it is not a big deal. But I suspect that it is, given the size of the write-off — it’s more than the total deferred tax asset amount on the June 2007 balance sheet, and about 20% of the company’s total assets as of last June.
So I believe that this is probably yet another acknowledgment that the turnaround plan is not working, and possibly a sign that GMAC is a bigger bleeder than anyone may have realized, and that the finance department knows it. The accountants are caught between in a rock and a hard place because they want to present happy results, but can only do so much slicing and dicing before the SEC starts getting interested.
Rick Wagoner’s claim has been that by selling off assets to raise cash, reducing labor costs and liabilities, reducing intended fleet sales percentages and building shiny new trucks that GM could be saved. The accounting department might not think so. In a big way. Because I don’t think that they would have been likely to have written off that quantity of tax write offs if it was just a matter of making some modest adjustments for the sake of complying with GAAP rules or IRS regulations.
As I see it, the issue here isn’t the writeoff, per se, but the magnitude of the write off. The fact that it is that large is troubling. If it was just a few billion, no big deal, but here they seem to be chucking the entire asset out the window. It would appear to me that their future loss projections must be substantial for them to dump these assets now, and in this amount.
If GM was going to be profitable again soon, those writeoffs would be helpful to keep on the books. To put things in perspective, Toyota’s provision for income tax liability on its most recent operating statement was over $7.5 billion, which shows you that a profitable automaker of that size should owe a lot of taxes if things are going well.
But again, I am open to correction by an accountant familiar with whatever reasonableness tests come into play here. For GM’s most recent financial statements, including the last balance sheet, you’ll find it here: http://www.sec.gov/Archives/edgar/data/40730/000095012407004011/k17334e10vq.htm#101
From a source that wishes to remain anonymous:
I’m pleasantly surprised at the degree of accounting literacy on this site!
The rules for intangible assets vary by country, but they always essentially boil down to the same thing: If the present value of the future benefit of the asset is less than its carrying value it should generally be written down.
Regarding a tax asset held by a company not expecting to sell its shares or amalgamate with another company, the future value of such an asset lies in the company’s ability to apply the asset to future profits much in the same way a local business owner can carry-foward his business losses provided he has a reasonable expectation of future profit.
If the company has a reasonable expectation of future profit, no write-down is needed. (So when a write-down is taken, the logical implication is that the company does not expect profits in the near future…)
Writing down a tax asset has no cash impact on the company, but what it does do for an unprofitable company is remove an accrual accounting element from its financial statements and may make their statements present reality more fairly. The “other side” of the write-down is a charge against income, which flows through to the equity / retained earnings section of the balance sheet.
Therefore, it decreases over-all equity and presents the company as less valuable than before the original charge on an equity-valuation basis.
One of the things I like about this site, as well as hearing the Truth about Cars you can get a decent education as well. I learned a lot about accounting today thanks to y’all.
Here’s a short post to clear the palate:
Smoke and mirrors accounting doesn’t hide poor leadership and subpar product pipeline. I wonder when the Chinese will start picking at GM’s dead carcass dealer network.
Could it be that it is not the lack of future profits, but the long history of loss, that triggered this? In other words, the credits are simply expiring.
I wonder if the IRS has a rule about how long a company can sit on a credit hoping for profit to apply against. 5 years? 10 years? 100 years? I am sure there must be a clock on these things.
When a company “banks” a credit, does that credit have a shelf life? Is that life calculated on when they expect to use it? Or does it have a fixed life with a fixed expiration?
Since GM has not a enough profit for a long, long time, did the clock run out?
Also, if GM has been banking credits every year, and the credits have expiration dates, then would GM expect to have to write down the expiring credits off the asset sheet every year (until it starts making enough money to actually use them).
So this announcement should be an annual occurrence for the next few years.
Kevin: This is not the case. They still have the future tax deductions to use if they make money, they just have to write down their current value on their balance sheet. If they manage to start making money again they will presumably (at some distant point in the future) mark the value of the tax asset back up and book a gain of $39B at that time.
More simply, you don’t have to forfeit the assets just because you think they are now worth less (or worthless).
Could it be that it is not the lack of future profits, but the long history of loss, that triggered this? In other words, the credits are simply expiring.
You would need to know the IRS and GAAP rules to answer that question with any precision — carryforwards do have a limited shelf life.
But I suspect that the answer in this case is “no”, because of the amount involved. Again, they are going to take a $39 billion charge when the amount accrued as of June 30 was not even as much as that ($32 billion.) That’s the whole thing, and then some.
So there is something more going on than that. This bit of PR spin from the article linked above makes me wonder:
Spokeswoman Renee Rashid-Merem added: “It’s not that we don’t anticipate profitability. It’s that we can’t say when or how much.”
Really? Why not?
Maybe get rid of the corporate tax since a corporation is not a human slave entity. A proper “progressive” tax would be to tax the heck out of the poor and leave the rich alone. The incentive to become rich increases causing “progress”.
Robert Farago wrote (quoting an nameless source, I think): “I’m pleasantly surprised at the degree of accounting literacy on this site!”
Moral of the story: Don’t denigrate bean-counters too much here, unless you want to offend the silent majority!
More seriously, I’m not an accountant, but I recognize the value of their work, at least in moderate doses.
Although I can’t say for certain, it looks like GM’s profit estimates were probably too high – probably because of how the market has changed in the last year (higher commodity prices, lack of pricing power, sinking demand across all automakers) and the loan write-offs and collapse in mortgage lending related to GMAC.
I think the SEC requires a balance of positive and negative objective and subjective costs in order to justify earnings outlook and therefore the carry-forward of these tax assets. My guess is that the negatives in both the objective (actual losses posted – most of it from GMAC) and subjective (the overall market) have both gotten much worse.
I agree that the most disturbing thing is the size of the write-down. It’s not that the books were hidden in fog or necessarily grossly overstated, but this implies that GM’s structural and variable costs are probably too high (rising faster than thought?) for current market, it expects weak revenues, and/or their exposure to subprime mortgages is too high (I remember when everyone was criticizing Ford Credit for not getting involved in mortgages like GMAC).
Ultimately, there is no cash involved in this. And in the future, if GM is profitable, they will have more and more tax assets booked once again. So, what is most worrying is not that they took a $39 billion charge but that it was that large meaning future income and cash flow is probably going to be weaker than expected – even in the medium-term. What’s worse is that it will make GM’s balance sheet look weaker right when it may need some access to financing to rid itself of RHC liabilities (the removal of which won’t even completely offset this loss in assets).
It’s not bad from a cash perspective or necessarily an income perspective (although we can expect lower than expected income levels), but it looks really bad on the balance sheet at a time when GM certainly needs a better balance sheet.
Fun With Finance:
I decided to take a quick look at GM’s balance sheet and see if I can implicitly get back to their write-off decision.
GM’s current market cap. is about 19 billion and had a deferred tax asset of 43 billion as of last quarter and a deferred tax liability of less than 1 billion.
I roughly estimated GM making 1.1 next year growing at 4% per year. Discounted at 10% that gets GM’s valuation to about 19 billion (market cap).
Using these numbers I figured that GM’s deferred tax asset would be exhausted in 2050 and have a present value of less than 6 billion. That means that the asset is overstated on the balance sheet about 37 billion (close to the actual write-off). You can question some of those details but it gets you to a close estimation. With that said, I did all of these calculations based on data available last quarter. This write-off should not have come to a surprise to anyone. Ford (which I own stock in) has only a 4 billion deferred tax asset and 3 billion in deferred tax liability. I don’t expect a similar announcement from Ford tomorrow (reason why I did this math in the first place).
A loss is a loss! And this one is mind-boggling!
Suppose you spread out this $39B loss over the last 10 years. You will now get an additional $3.9B loss for every year in addition to the large losses and feeble profits GM has reported for those years.
Suppose GM had reported $4B loss each year for the last 10 years? How would you have felt about them?
Stated differently, GM has massively overstated profits in past years (by recording tax credits that are not really usable).
Now, let’s get to the next disaster at GM: GMAC.
GM has been shrewd enough to offload half of GMAC onto poor and unwitting Cerberus, just in time before The Great Mortgage Meltdown.
WTF? Who knew that GM has been putting itself at tremendous risk by being one of the largest subprime mortgage lenders in the USA?
Stated differently, GM has massively overstated profits in past years (by recording tax credits that are not really usable).
I don’t follow that point. These tax benefits are currently an asset that were generated through prior period losses that would have been previously reported.
The assets have effectively been overvalued on the balance sheet (see description above), not on the income statement.
The quote from the GM representative effectively signals that this is the result of lowered expectations for future performance.
The question to ask here is why did they take this write off now, and why write off this much? There are a few possibilities that I can think of:
-They should have done it already and stalled for as long as possible, in order to deliver some positive quarters as they did during quarters 1 and 2 of this year, but could not get away with stalling anymore. (GM would have certainly wanted that to appease Wall Street and to assure them of all of that marvelous progress that they’d like to be making.)
-The situation changed and became worse than they expected, so they were forced to revise their balance sheet accordingly.
-A combination of the two.
I’ll vote for the last of the three. I’ll bet that GMAC isn’t looking so terrific these days (it did report a loss), plus Wagoner would have been highly motivated to prop up the financial charade for as long as possible.
I personally that the GM “turnaround” is a house of cards that will come crashing down soon enough. The fleet sales will remain high, the margins will remain low, market share is declining notably, and the products that were supposed to be hits aren’t proving to be hits.
Eventually, the Street will wake up, see that things are not going as well as hoped (all those UAW cuts were ultimately meaningless in fixing the branding and product deficiencies that are the basis for the problems), and punish the stock accordingly. And if/when it does, Rick is gonna have some ‘splainin’ to do. The year-end statements will be audited, unlike the interim quarterly statements, so the level of disclosure will increase and the problems will become more evident, so the EOY 2007 or 2008 reports will help to shed the emperor of his new clothes.
For those that don’t know, not counting any special items like this one, GM still posted a loss for the third quarter. So much for the turnaround going well.
Normally I love commenting on stories like this, but I’m starting to get bored of all the explanations regarding tax (I was never any good at maths).
Could someone put it a little more succinctly for me?
Is GM boned or not?
Is GM boned or not?
Maybe. You’ll have to wait and see.
I think that this is probably more of a symptom of a problem than the problem itself. The ultimate issue is here is probably about what future performance will look like. My guess is that it won’t look so good.
Could someone put it a little more succinctly for me?
Sure. Yesterday GM had a total corporate value of $20 billion dollars.
And today they officially eliminated another $39 billion of value from their corporation.
So if I know my arithmetic, GM is now worth negative $19 billion. That means I can buy out GM and THEY’D owe ME $19 billion for the trouble.
Actually I think I’ll pass.
Juicy analysis from WSJ:
http://online.wsj.com/article/SB119254528073860596.html?mod=hpp_us_whats_news
The massive setback comes even though GM has cut tens of thousands of jobs in North American and Europe, launched a volley of new models and boosted boost revenue in the quarter to $43 billion, a record level.
The results indicate GM based its 2005 restructuring plan on assumptions that didn’t pan out, particularly about expected profits from its GMAC Financial Services unit and U.S. auto sales. In scrambling to respond, the company is finding it can’t cut costs fast enough to offset declining industry sales in its core North American and European markets, and can’t sell assets fast enough to cover the cash it is using up.
As a former beancounter, I too congratulate those who have contributed understandable explanations of the intricacies of tax deferral calculations. When I was a young CPA my firm sent me to several days of training that included discussion of the then-new rules for figuring tax deferrals. As the instructor took the class through a complex example of several years’ worth of posting and unposting debits and credits, at one point we all broke into laughter. We felt like Alice visiting Wonderland.
But reporting future tax liabilities or benefits is neither hocus pocus nor smoke and mirrors. Accounting is both art and science. Tax liabilities, like allowances for bad receivables, etc., involve estimates. GM’s finance staff and external auditors all have to make reasoned judgments. Companies naturally want to present a positive picture, while auditors fear being sued for failing to disclose something ugly. It seems that during the past quarter the staff (perhaps at the auditors’ insistence) decided it was no longer appropriate to carry that $39B of future benefits.
I think this is significant. Might it be a clue that the viability of GM (in North America, at least) is now officially an issue? Some readers may recall my comments about the “going concern” presumption: that financial statements with a “clean” auditor’s opinion are based on the expectation that a firm will continue existing indefinitely. The year-end audited statements of both GM and Ford will be interesting.
Looking at their release, a couple of other things popped out at me that are worse than I’ve thought.
1) In the 3rd quarter, 38.1% of car sales were fleet compared to 33.9% last year. For trucks it went from 17.3% to 21.6%. YTD, there’s almost no change. So they may be sending fewer vehicles to fleets on an absolute basis but they are depending on fleet sales no less than before.
2) They shaved 14K hourly employees to a total of 78K but only shaved 1K salaried employees to a total of 32K?
bleah-The salaried vs. hourly employees makes sense.
The hourly employees are the ones that actually make the vehicles. If each model sells 20% less than the previous one, you need 20% less hourly employees (give or take).
BUT, you don’t eliminate any salaried employees. You still need the same number of engineers, the same number of accountants, the same number of secertaries, the same number of dealer reps, the same number of ad people, the same number of lawyers, the same number of…
Now, you could eliminate some engineers and ad people, etc., if you offered fewer models. But that doesn’t seem to be the case. The only GM brand that is shrinking signficantly, in the number of models offered, is Buick. And the number of models Saturn is offering growing by about the same amount. The only change is that each individual model is selling fewer.
This is not a good thing.
IMHO, a small company that used to be big is usually in a lot worse shape than a small company that’s always been small. The formerly big company’s fixed expenses (not just salaries) are higher, because they are designed around when the company was bigger and probably haven’t shrunk to match.
EJ: Stated differently, GM has massively overstated profits in past years (by recording tax credits that are not really usable).
Pch101 : I don’t follow that point.
Let’s look at an example. Suppose GM had a loss of $3B in a prior year. With a 35% tax rate they would only report a $2B loss, while the remaining $1B of loss is turned into a deferred tax credit.
So, we all thought: Oh great, only $2B loss instead of $3B.
Now that $1B is popping up, along with 38 others.
Ah well, pocket change for GM, right?
Sure. Yesterday GM had a total corporate value of $20 billion dollars.
And today they officially eliminated another $39 billion of value from their corporation.
Sorry, but this isn’t accurate. You are confusing book value with market capitalization.
Market cap is just the value of the stock, i.e. how much money would be needed to buy every single share of stock issued by the corporation. GM’s stock fell a bit more than 6% today, so its market cap as of this moment is over $19 billion. This is quite literally the market value of the company.
Book value is the difference between assets and liabilities on the balance sheet. As of June 30, 2007, that amount was a negative number of -$3.55 billion. (Apologies, I misstated the amount in my first post and have since corrected it.) I haven’t yet seen the latest balance sheet of September 30, but it’s probably something similar to the -$3.55 billion added to the inverse of the $39 billion amount mentioned in Mr. Farago’s blog entry. So we’ll see it soon enough, but the book value is probably something worse than negative $40 billion.
So the book value was negative before and after this charge off, it just got a lot worse. But the market cap did not fall by a corresponding amount. It’s an accounting value that does not directly correspond to the market value of the company (although I don’t wish to trivialize the potential gravity of the writedown discussed in the blog.
That’s doesn’t mean GM is out of the woods. Stocks are typically valued based upon a multiple of their expected earnings; these days, GM stock is a speculative play based largely upon what its potential value could be if the turnaround plan succeeds. If the market gets the signal that the plan is a flop, you would expect the stock to take a dive as the market finally wakes up. I’m guessing that it will begin slowly, but then snowball as investors put two and two together.