Auto loans, part 3: the Bush approach

Auto loans, part 3: the Bush approach

The White House press office announced this evening that the President will speak about the auto industry tomorrow (Monday), at 11 AM, in the Grand Foyer of the White House.

The press is reporting that General Motors CEO Rick Wagoner has agreed to step down at the request of the Administration.

If you have read the first two parts of this series, then you have some background, and you understand the cost and benefits of the options the President faces.

As you hear news about the President’s announcement tomorrow, it may help you to consider the approach taken by President Bush. The loans we provided in December set the initial conditions and context for President Obama’s decision.

Here are President Bush’s remarks from December 19th when he announced the loans. First, he talks about the hard choice:

This is a difficult situation that involves fundamental questions about the proper role of government. On the one hand, government has a responsibility not to undermine the private enterprise system. On the other hand, government has a responsibility to safeguard the broader health and stability of our economy.

Addressing the challenges in the auto industry requires us to balance these two responsibilities. If we were to allow the free market to take its course now, it would almost certainly lead to disorderly bankruptcy and liquidation for the automakers. Under ordinary economic circumstances, I would say this is the price that failed companies must pay — and I would not favor intervening to prevent the automakers from going out of business.

But these are not ordinary circumstances. In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action. The question is how we can best give it a chance to succeed. Some argue the wisest path is to allow the auto companies to reorganize through Chapter 11 provisions of our bankruptcy laws — and provide federal loans to keep them operating while they try to restructure under the supervision of a bankruptcy court. But given the current state of the auto industry and the economy, Chapter 11 is unlikely to work for American automakers at this time.

Now he highlights an important concern that existed in December, but should no longer exist. This is an important change that should affect President Obama’s consideration:

Additionally, the financial crisis brought the auto companies to the brink of bankruptcy much faster than they could have anticipated — and they have not made the legal and financial preparations necessary to carry out an orderly bankruptcy proceeding that could lead to a successful restructuring.

We (President Bush’s advisors) counseled him in December that a Chapter 11 bankruptcy/restructuring filing was highly likely to lead to liquidation, because the firms (especially GM) weren’t ready for it. Everyone wants the companies to restructure successfully outside of bankruptcy, but they may be unable to do that with their stakeholders. To maximize your chance of a successful restructuring through bankruptcy, you need to prepare a legal, financial, and operations strategy for a Chapter 11 filing. I was astonished that a firm whose management had approached us in October about a possible bankruptcy filing (GM) had not yet prepared for it, but they had not. This meant that a DIP-financing option, implemented in late December, had an extremely high probability of leading to rapid liquidation. Here’s President Bush again:

The convergence of these factors means there’s too great a risk that bankruptcy now would lead to a disorderly liquidation of American auto companies. My economic advisors believe that such a collapse would deal an unacceptably painful blow to hardworking Americans far beyond the auto industry. It would worsen a weak job market and exacerbate the financial crisis. It could send our suffering economy into a deeper and longer recession. And it would leave the next President to confront the demise of a major American industry in his first days of office.

And so President Bush decided to provide loans to GM and Chrysler, and to their finance companies. Notice both points — they’re important:

A more responsible option is to give the auto companies an incentive to restructure outside of bankruptcy — and a brief window in which to do it.

… These loans will provide help in two ways. First, they will give automakers three months to put in place plans to restructure into viable companies — which we believe they are capable of doing. Second, if restructuring cannot be accomplished outside of bankruptcy, the loans will provide time for companies to make the legal and financial preparations necessary for an orderly Chapter 11 process that offers a better prospect of long-term success — and gives consumers confidence that they can continue to buy American cars.

These companies have now had “a brief window” to put in place plans to restructure into viable companies. We defined a “viable firm” in the loan terms as a firm that has a positive net present value without additional taxpayer assistance — in other words, the firm would be worth something if the taxpayers were to stop subsidizing it. If it were to meet this test, we believed that it could get private financing for its short-term operations.

The Obama Administration is required by the terms of the existing loans to determine whether they think the firms’ plans meet that test. By Tuesday, or by late April if the President so chooses, the Obama Administration must determine whether these firms can survive without additional ongoing taxpayer funding.

The companies have also had time to prepare for an “orderly Chapter 11 process,” so the DIP financing option (#2) should now be feasible, when it was not in December.

What we tried to do was set a hard deadline of March 31st, with only the flexibility to extend it to April 30th. To put it in the context of the options described in part two, we were implementing option 1 to buy the companies time to both negotiate with their stakeholders, and to prepare for a DIP-financing Chapter 11 restructuring if those negotiations failed to produce a company that could survive without ongoing taxpayer funding.

Our hope was that the Obama team would be able to use the deadline of our loans as a bad cop to force tough negotiations. We’ll see tomorrow how they did.

I imagine the news, and possibly the President’s remarks, will focus on the hard choices that have been made in the negotiations. Rick Wagoner’s resignation is a part of that story. If the changes are significant, then the Obama team should be complimented for them. I argue, however, that “look at how far we have come” is the incorrect metric. What matters instead is, “Do the companies still need taxpayer funding to maintain ongoing operations? If so, for how long is the President willing to provide those taxpayer funds? Is there a limit, in time or in dollars?”

We all want the companies to make the hard choices needed to restructure and become profitable again. The hard question is, “For how long are you willing to continue subsidizing them, if they’ve done a lot, but still not enough to stand on their own?”

8 responses

  1. Pingback: KeithHennessey.com » Auto loans, part 3: the Bush approach | Auto Loans

  2. very helpful! I don't fully understand the Wagoner resignation, and how it relates to an Administration decision about using more taxpayer dollars to keep GM alive.

  3. Pingback: KeithHennessey.com » Welcome, Instapundit, Wall Street Journal, Greg Mankiw, and National Review readers!

  4. I wonder how much weight is given to the apparent precedent being set when these kinds of decisions are taken by an administration, and how much that changes as an administration comes to its end. For instance, it appears that Chrysler and GM are getting much better deals than would two random companies because they are structured in such a way that their failure would cause a lot of both economic and political pain. This signals to other big companies that there is value in structuring themselves in a similar way. It particularly struck me that GM appears to be being rewarded for having the foresight NOT to make plans (or at least appear not to have made plans) for an orderly bankruptcy–it (correctly) anticipated that this would better its chances for government support. Again, this encourages brashness and brinksmanship by other companies in the future whenever they think they might be able to get the government to intervene to their benefit. That cost should properly be added to the cost-benefit tally.

  5. Pingback: The Financial Crisis Inquiry Commission – Blog Title  |  KeithHennessey.com

  6. Just on instinct, I wouldn't credit GM with being that smart. Perhaps they have taken this tack in the past six months, but it was not a fundamental decision. It appears that the finance world did implicitly take such a view starting some years back, believing that the industry as a whole would be relieved by lower interest rates if need be and that some "essential" firms would be bailed out. As it turns out this was broadly true, though some individual firms were out of their chair when the music stopped.

    Both the post and above comment are more substantive than the spew I see in the Times, WSJ etc.

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