ON the eve of the Shanghai Motor Show a fortnight ago, top executives from General Motors hosted a cocktail reception and dinner at Laris, a chic restaurant that looks out on the city’s glittering skyline.

The mood was celebratory; after a rough few years, the assembled GM powerbrokers felt that a new range of cars was finally going to stop the slide and restore the company to its rightful position as king of the automotive jungle.

Ed Welburn, GM’s head of global design, was fired up. He had presided over days of meetings in Shanghai aimed at turning GM’s disparate design offices worldwide into a single machine. Clutching a champagne glass, he introduced the senior GM execs to the assembled crowd, gushing: “We have had just a great, great week.”

Only Bob Lutz, GM’s head of product development, a motor-industry veteran, had doubts. Swirling his martini, he muttered about the crippling costs put on every car to pay the healthcare and pension bills of current and former staff. “Do you know,” he growled, “that GM is now the biggest healthcare company in America?”

A day later, even after GM’s shares dived in response to woeful first-quarter results, the suits were bullish. “There is no way GM is going bust,” said one excited exec over dinner. “I am going to see how many shares I am allowed to buy.”

Hopefully he never followed through on his plans. Last week Standard & Poor’s (S&P), the credit-rating agency, said both GM and Ford, its long-time rival, no longer deserved to be treated as “investment-grade” companies. They were now, to use the market jargon, “junk” — meaning they would have to pay much higher interest rates on their borrowings.

The news sent GM’s shares plunging, but the damage was limited by an intervention from famed corporate raider Kirk Kirkorian, who earlier in the week had made a tender offer for up to 9% of GM’s shares.

Downgrades by credit-rating agencies are common occurrences, and normally pass without comment outside the confines of the City and Wall Street. But this was seismic.

GM and Ford are symbols of American manufacturing might. GM, which makes Vauxhall cars in Britain, was for decades after the second world war the world’s biggest company, and now has the dubious honour of being the largest company ever to get junk-bond status. Ford in turn is famous as the family- controlled enterprise that invented mass production and in the process put the world on wheels.

The move to junk was a final confirmation that the two giants were in big trouble, and might not survive in their present form.

It may also, financial analysts say, signal the end of an era of cheap credit that has stoked corporate America and trigger a period of turbulence in credit markets as they struggle to digest the sudden change in status of huge sums of capital.

The amount of debt involved is staggering. GM and its financial subsidiary, GMAC (the 12th largest mortgage lender in the UK, doing £6 billion worth of business last year), together have borrowings of $292 billion (£154 billion). Ford and its financial arm, Ford Credit, have borrowed $161.3 billion. Credit traders feared the downgrade would prompt a flood of selling that would swamp the junk-bond market. Many institutions are prevented from holding securities that are not investment grade, making them forced sellers.

Although there was a flurry of trading immediately after the announcement, with the price of Ford and GM debt falling, markets recovered on Friday as the complexities sank in. Neither of the other main rating agencies, Fitch and Moody’s, has yet followed S&P’s lead, which means that the companies can stay in investment-grade indexes of some market-making banks, but not others.

One London-based credit strategist said the blow had been eased by institutions having flexibility in their investment rules, and by the assumption that the two finance companies, which account for the majority of the borrowing, have solid assets backing their loans.

Sean Egan, founder of the rating agency Egan-Jones, which predicted the downgrade, said the companies now faced big problems in paying for their financing. “GM’s borrowing is probably up 2% now. They have $300 billion of debt, so that’s $6 billion extra for a company that earned $2.8 billion last year,” said Egan. “Funding alone is enough to make GM go belly up.”

The S&P downgrade left no doubt Ford and GM face a parlous future. Scott Sprinzen of S&P said it reflected “scepticism” about their management strategies. Ford and GM’s big problem is the weight of costs left by their long history of carmaking in North America.

Particularly painful are labour contracts that make them liable for the healthcare and pension costs of their retired workforces. Some estimates put GM’s legacy costs per car at $1,600, with a similar number at Ford. On top of that, both companies have been offering $3,000-$4,000 per car in customer incentives to keep factories working and avoid the expense of paying idle workers.

Even these generous incentives have not been enough to maintain market share. In the US, GM has dipped to 25% from more than 30% 20 years ago as customers have gone for Japanese models. In an effort to redress the balance, US carmakers are stepping up pressure for a revaluation of Asian currencies. Indications were growing this weekend that China might allow the yuan to rise in value against the dollar, a move that would lead to a rise in the Japanese and Korean currencies.

“The fact is they (GM and Ford) suck,” said Egan. “The strengths of the US manufacturers used to be attractive products, efficient manufacturing and efficient distribution. They are not offering that now.” Some industry experts say the only solution is Chapter 11 — the bankruptcy proceedings under which US airlines have dealt with legacy costs.

The chances of GM ever returning to its glory days were slim, said Egan. “This isn’t cyclical, it’s a structural change. Seventy years ago there were 30 US car companies. GM and Ford won through, then they became fat, stupid and complacent. The seeds of destruction were sown not in the last couple of years, but decades ago.”

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