5 May 2009 
The President’s Chrysler announcement last Thursday produced mixed results.
The agreement among Chrysler, Fiat, UAW, the Administration, and the large banks appears to increase the probability (from almost zero) that Chrysler will survive for the long run, albeit as a part of Fiat. This is clearly a good thing.Is it worth the cost to taxpayers and the broader damage caused by government interference in the economy?
Taxpayers will sustain Chrysler during its restructuring. (Fiat is putting up no cash.)The Administration has committed $8.1 billion of new taxpayer funding for a bankruptcy process that they think will take 60 days, followed by a transition period of unknown duration. I think the final cost will exceed this additional $8 B, in part because I doubt the 60-day timeframe. Since the Administration agreed to forgive about $4 B the taxpayer has already loaned to Chrysler, I am also pessimistic about the taxpayer’s chances of getting back this new $8+ B outlay of funds.
It appears the Administration reached agreement first with UAW and the big bank creditors, and then tried to “jam” the dissident creditors with a tough and possibly unfair take-it-or-leave-it offer. When those creditors rejected the Administration’s offer, the President publicly excoriated them.
The result may be a firm that survives, but there are serious adverse consequences of this process and dangerous precedents for the broader economy:
- Industrial policy–
- Leveraging TARP banks - It appears the Obama team pressured TARP-recipient big banks to forgive much of their loans to Chrysler. If so, they have taken a huge step toward making these banks instruments of public policy rather than private firms. This is a primary fear of “managed capitalism” – political leaders start leveraging one sector to influence another.
- Bypassing the capital structure and bankruptcy process - There is no such thing as a level playing field when the government negotiates with private parties. The Obama team set themselves up as both the arbiter of the negotiation and a participant in it. It now appears that they are trying an end-run around the Chapter 11 process through a section 363 sale. If they are successful, they will have interfered with the rights of others who thought they could rely on the traditional bankruptcy structure to protect their interests. The Obama team is introducing significant political risk into future business loans by undermining the traditional bankruptcy process. This makes future loans more expensive for firms.
- Leveraging Fiat to meet new and arbitrary fuel efficiency goals - The fuel efficiency goals mandated by CAFE come from legislative bargaining. The new targets for Fiat (e.g., a 40 mpg vehicle made in the US) were created from thin air by the Obama negotiators. Suppose they had said Fiat cannot make blue cars. Would that be OK? When combined with the apparent cross-sector leveraging of TARP banks, this suggests a scary level of micromanagement and political interference.
- The deal appears to favor the President’s political allies — UAW is part of the deal, “investment firms and hedge funds” are not. The fuel efficiency crowd is presumably happy with the new requirements imposed on Fiat. The appearance the Administration has created, reinforced by the President’s public bashing of the dissident creditors, is that they used carrots with their friends, threatened the big banks with a stick, and then hit the dissident creditors with that stick when they refused the Administration’s offer. If the reality reflects this appearance, then the Administration has abused its power in structuring the proposed deal.
- Demagoguery – The President attacked people for asking to be paid back the money they loaned. These “investment firms and hedge funds” have a legal right and a responsibility to the people whose money they invested.
It is easy to criticize the Administration’s approach and say what they should not have done. It is harder (and more responsible) to say what you would have done instead, and to accept responsibility for the downsides of that choice. If you disagree with what the President did, I challenge you to recommend an alternate path. I will give you five options. To make it hard, please assume the probabilities listed:
- Withhold all additional taxpayer funds. (99% chance Chrysler liquidates by July 1)
- Tell the negotiating team to set a goal (a viable firm without permanent taxpayer subsidies) and a limit on taxpayer funds, and then stay out of the negotiations among private parties. (70% chance Chrysler liquidates by January 1 because the Chapter 11 process drags on and Chrysler’s sales plummet)
- Do what the Obama team did, but don’t use the section 363 process to jam creditors and don’t publicly bash those creditors when they dissented. (50% chance Chrysler liquidates by January 1)
- Tell the negotiating team to lead /”help” the negotiations, but strictly instruct them not to pursue non-taxpayer goals (like fuel efficiency), and not to favor UAW over creditors. Use the section 363 process if necessary to jam an objecting party, but don’t publicly bash them. (30% chance Chrysler liquidates by January 1)
- Do what the Obama team did, and be willing to add more funds if necessary to keep Chrysler alive. (15% chance Chrysler liquidates by January 1)
Also, please assume that a Chrysler liquidation increases the chance of a GM liquidation by 10-20% through a chain reaction of parts suppliers failing.
These probabilities are my somewhat-wild guesses. If you find yourself arguing with me in the comments about the probabilities, you are missing the point of the exercise. Please assume these probabilities (even if you disagree with them) and tell us what you would do, not just what you would not do.
I will start the bidding by choosing (B).
I choose Option A.
Triage suggests we shoot Chrysler and try to save GM in some form. Liquidation of Chrysler sets the stage for renegotiations with the UAW. If we have to spend $4 billion on cleaning up the mess post liquidation, so be it. Better to spend it after the correction, when you know what you are getting for your dollars.
There is too much car-making capacity in the world. Option A is the only choice if you believe my assertion to be the case. Propping up a failed company, even portions of it, with too much capacity as a backdrop only kicks the can down the road.
Option A has the added benefit of undoing some of the damage the President has done by his demagoguery.
Auto sales in the u.s. since 1990 have trended up (until 2008) which would indicate reasonable demand for autos in general. The major problem with the Chrysler and GM brands appear to be costs, not types of vehicles they build (Toyota, Nissan, Honda, etc. are all selling large, luxury, and pickups). Nor, I think, is there that much quality difference between them. I have a 2005 Dodge PU and love it, and most of the vehicles I see around me are new or new-er. This “not building cars that people want” litany is unadulterated BS.
So, whether or not Chrysler or GM build the vehicles the demand is there so someone will build them. If they’re not replaced by American brands, then the foreign brands will see increased sales and they will likely be made in this country. Either way more cars will be built and sold. Just because these old brands disappear doesn’t change that calculation. That’s the whole idea of creative destruction. Therefore, though those thrown out of work may have to move to another state to get another auto industry job, or settle for a less lucrative contract, or whatever. I will always support an alternative that keeps the govt. out of private business to the maximum extent possible. I vote for A but could accept B since the process is already cocked up to a fair-thee-well.
Seems I learned in econ 101 that sunk costs are gone and you don’t make decisions based on them. We’ve lost several billion. Cut it off there and move on.
There is still another option which is close to B and probably should have been allowed to happen in December. That is a regular Chapter 11 filing with the current management proposing its reorganization plan and the U.S. Government providing the DIP financing. This would have given Chrysler the option to “right-size” its business, amend or reject contracts and leases, etc.
By the way, none of the options solve the problem of designing and building cars anyone wants to buy. It will be two years or more before any product will hit the showrooms. 70% chance of liquidation is probably optimistic.
A, and for good measure I say President Bush, Hank Paulson, and company pay back as much as possible (which, admittedly, isn’t much) of the initial $13b they extended. The US government isn’t a car company, and no matter how unfortunate that is for Chrysler, the government must not go around attempting to correct every perceived unfairness which occurs in the world. The government’s role in business is to make sure the laws are observed, and to effect justice (as prescribed by law) when those laws are violated. Unfortunate as it may be, it is not against the law for Chrysler or any other company to go bankrupt, at least not yet…
I’m with ThomasL. It was a mistake for the Bush Admin to involve itself in the auto industry in the first place.
I lived, briefly, in pre-Thatcher England, which is what Obama seems to have in mind for this country. We won’t like it.
I, too, agree with ThomasL. All of what you (Mr Hennessey) propose is built on the assumption that Chrysler is too valuable to let go. I really feel for the workers, but how many other companies have failed and laid off their entire workforce, too? Chrysler’s problems are, fundamentally, not related to the market downturn. The market’s direction is EXACERBATING Chrysler’s problem, but the root problems — lack of product depth and corresponding lack of consumer demand — were there well before this crash. This is especially true of the current owners of Chrysler, Cerberus (a private corporation), who have cut products, reduced design spending, etc. under the notably poor leadership of Robert Nardelli. The trucks and minivans plus the Jeep label are really the only parts of the company worth saving.
Option F. It is impossible to save the union or the company. Save the brand. Put all the equipment on railcars and haul it to Tennessee and set up shop there. Imitate Honda.
Eshrdlu
There you go! I can get behind F as well. Maybe Honda or Toyota would be interested in the brand. That happened to both Colt and Winchester. Colt is hanging on with govt. contracts, but Winchester has a new lease on life in (I think) North Carolina.
Thank you for the thoughtful comments. In response to Basil, my intent is to present the options as objectively as I can and let you choose. I do not presume that Chrysler is too valuable to let go. At the same time, I think it’s a non-trivial judgment call, and that the loss of up to 1.1 million jobs (if GM and Chrysler were both to fail) combined with a devastating regional impact make it at least worth going through the thought process of explicitly weighing the costs and benefits of each option.
The options I listed were intended to present a spectrum, from immediate failure and no more government intervention in (A) up to doing what the Obama team has done in (E). Part of my job in the White House was to present options as objectively as I can, and then push people to think hard and weigh the tradeoffs. That’s all I’m trying to do here.
Again, thanks to all for reading and commenting!
After thinking about B, I went back to A.
I am in the investment business with experience as a creditor in bankruptcy. There are many problems with the Obama approach. One is that the governments involvement has discouraged the company from responsibly sorting its problems out, or at least enabled them to procrastinate.
I can assure you that every creditor in the market is watching these developments closely. A lot of damage has already been done. Lenders will not want to get involved in anything where the government is involved or where there are strong unions. This is already a concern with investors that are considering participating in TALF and PPIP, which are the governments big ideas to get credit markets going. It’s like doing business with Tony Saprano.
The main argument for the governments involvement is a current lack of Debtor in Possession (DIP) financing. However, we see other bankruptcy cases happening now, where the existing sr. creditors understand that DIP financing is not available, so they step up and provide it themselves to protect their interests. In this case a majority of the sr. debt is held by big banks, many of which provide DIP financing under normal circumstances. They may have less of an appetite for that now, but they certainly know how to do it. Having received TARP money, which was supposed to get them back in the lending business, it seems reasonable to expect they would provide the DIP financing. If the prospects are so bad that they are not willing to do it to protect their own sr. loan interest, why should taxpayers? I can see no good argument for taxpayers to be involved in any of the auto companies.
Another exaggerated argument is that if Chrysler goes down, then suppliers go down. Two responses – first, if someone needs or want to buy a car and Chrysler is not around, then they will buy it from another company to which the suppliers will provide parts. Second, Chapter 11 is available to sort the suppliers out if necessary.
Looks like I’m too late but I’d go with D. The unions can be jammed, they don’t have that much leverage and as for the dissident creditors, I sympathize, but blood always gets spilled in a BK. If you cut back the union equity and throw it to the creditors they at least have an outside chance of eventually recouping something.
For the record, the Obama administration confirmed that Chrysler will not repay the $4 billion originally loaned to them nor the $3.2 billion DIP financing. Here’s the link.http://money.cnn.com/2009/05/05/news/companies/chrysler_loans/index.htm
I look forward to the debate on GM where the circumstances are more complicated. There are sr. lenders, bondholders who are subordinated to the sr. lenders, and a large union claim that is pari passu with the bondholders (subordinated to sr. creditors). A large enough percentage of the bonds are held by individual retail investors, which creates technical difficulties with out of court restructuring, not to mention political barriers to vilifying creditors as was done in Chrysler. Further, the debt is not primarily owned by the TARP banks, so the government will not have that avenue of coercion. The governments proposal is completely outrageous. The bondholder group has made a reasonable proposal which has been rejected by the government. It is very difficult to see how GM is going to avoid Chapter 11, if for no other reason than the retail bondholders.
Option A
No one has made a convincing case why government should pick survivors and not letting bankruptcy process work. Most of airlines and steel companies had made a trip through bankruptcy court and we still havve both airling and steel industries vibrant and functioning.
Option A. I reject the new paradigm that government should pick winners and losers in the private sector and do it with our money. My company went through Chapter 11 and emerged reorganized and better than ever. The automakers aren’t “too big to fail”.
Option A. The interested parties need to find a way to make the company viable. If it can’t happen without taxpayer funds, the company has failed. We deal with implications of the liquidation temporarily until the economy adjusts and demand shifts to create new jobs.
The implications of the Obama could be devastating. Who’s lending to organizations where the government could claim an interest in protecting? And those do will have to raise rates? Throwing out established law has consequences far greater than a Chrysler liquidation.
I wholeheartedly agree with Dennis’ analysis, but I end up with Option D. GM and Chrysler make decent cars that people want to buy, and they even do it reasonably efficiently aside from the current and legacy cost of unionized labor. It would be a shame to let all of that intrinsic value go to waste. If you could cut the legacy health care and pension costs in half and cut hourly wages by a significant amount, I think GM and Chrysler could be profitable enterprises. If the government wants to pick up the tab on behalf of the unions, that’s a separate decision (although one that should be made in a transparent and honest way), but the restructured company must be free of current union contracts in order to be viable.
Apart from the administration’s continuing disregard for property rights, which will be the hallmark of this administration, I am skeptical of all of this. As long as the UAW exists it will suck the US auto industry dry. It is the UAW who destroyed the US auto industry like the steelworkers before them. Ford and GM are successful outside of the US because they are not burdened by the UAW. The most technologically advanced auto plant of any US automaker is in Brazil
http://detnews.com/article/20070822/AUTO01/708220407/0/SPECIAL/FORD+S+TEST+BED++Brazil+s+Camaçari+plant+is+model+for+the+future
but its structure would violate UAW rules. Toyota is building a total automation plant in Japan that has no line workers only computer and robotic technicians, knowledge workers. Such a plant would never pass UAW muster. The UAW has the US by the throat. I feel no sympathy for the workers they extorted their employer and assumed that the extortion would go on forever. Of course the democrats are giving the UAW a majority ownership in these companies to preserve the flow of blood money to retirees who participated in the original crime. This will go on for decades until the last retired auto worker is buried. If the UAW did not exist the automakers would have invested more capital per worker and raised the required skill level and required education of entry level workers. Today we would have a vibrant auto industry but instead we have outdated manufacturing capacity that is being shuttered for good. But this is all too late.
Of course management was also complicit in this. Never udnerestimate the incompetency of american management. They missed all major turning points in the auto culture in the US. But this can also be blamed on our lack of an energy policy. If we had had in place a system of gasoline taxes sufficiently large, demand for smaller more fuel efficient vehicles would have followed and the Japanese would have never gained a foothold here. Gasoline taxes sufficiently large insulate consumers from increased cost of crude on a percent basis. When you shrink the contribution of crude to final pump price you are ensuring that future oil shocks will not have the same magnitude effect on quantity demanded. These taxes act like tarriffs and are protective of domestic industry without violating free trade rules. Every other western nation has high gasoline taxes for exactly the reasons mentioned.
Chrysler does have products that have value (Jeep, the truck line, the 300 etc.) but this whole process seems to be an effort to turn it into something it has never been, a producer of profitable small cars, to sell a product that I don’t even think there is a market for. If we want to keep Chrysler around, we should allow it to produce the cars and trucks that actually are profitable, without forcing it to produce others just to meet fuel standards or maintain the size of the union workforce. If the administration is unwilling to do this, then allow the bankruptcy court to sell the profitable divisions of Chrysler to existing companies. We are pouring billions into a business without any real idea of its ability to ever produce a profit, and giving a foreign car company a free call option on a general rebound in the car business. I can’t say that I am very familiar with Fiat’s products but do they really compete effectively with Honda and Toyota outside of Italy? Is there any reason to think that they will be able to here? The money we are spending now stands an excellent chance of ending up in an unprofitable business and sometime down the road we will have the same choice; pour billions more in or risk unemployment to thousands. The money would be better spent making sure the valuable parts of Chrysler continue, either as a smaller independent, or part of a larger company, and offering retraining and assistance to displaced workers now.
Stephen Hales
Raising taxes is once more insinuating the government into the economy where it functions typically and primarily to exacerbate or extend the problems it was intended to solve. Politicians seem never to have heard of the law of unintended consequences.
The push for increased fuel efficiency comes from three sources: Shortage of fuel, Carbon dioxide pollution, and dependence on foreign oil. There is no shortage of carbon-based fuels available to this country and within this country (see: http://chiefio.wordpress.com/2009/03/20/there-is-no-energy-shortage/)and, absent more government intervention in the free access to real scientific information, it will (or could)be found that there is no danger to the earth from CO2. Without govt. intervention, the free market would be producing a wealth of efficient inexpensive fuel.
I think the public is far more aware of these facts than the government gives them credit for and consequently they continue to demand the vehicles that the auto manufacturers make. It is the continual finger-poking from the government that causes the problem.