Understanding the GM bankruptcy

Many of you are new to this blog since I wrote extensively about autos six weeks ago. As background, I coordinated the auto loan process for President Bush last fall as the Director of the White House National Economic Council (the position now held by Dr. Lawrence Summers). I wrote a series of posts on the auto loans beginning when the President made his late-March announcements, and continuing into the spring. For reference, here are those posts:

  1. Auto loans: a deadline looms
  2. Auto loans: options for the President
  3. Auto loans: the Bush approach
  4. Auto loans: Chrysler gets an ultimatum, GM gets a do-over
  5. Auto loans: the press forgot to ask about the cost to the taxpayer
  6. Should taxpayers subsidize Chrysler retiree pensions or health care?
  7. The Chrysler bankruptcy sale
  8. Mixed results on the Chrysler announcement

This morning I posted some basic facts on the General Motors announcement. Now it’s time for some analysis. Like my post Understanding the President’s CAFE announcement, this is a monster post. I hope you find it valuable despite its length.

I want to try to tease apart the various questions that get conflated in the public forum. My primary goal is to give you a structure for thinking about the issue. My secondary goal is to persuade you to agree with my views on each question. I will be satisfied if you give me credit for achieving only the primary goal.

Here is how I tease apart the questions:

  1. What are the arguments for further government intervention?
  2. Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?
  3. Is the pre-packaged bankruptcy likely to succeed?
  4. Is it fair?
  5. Did the government structure the taxpayer financing correctly?
  6. Will the Administration run GM?

Let’s take them one-by-one.


1. What are the arguments for further government intervention?

Today the President explained why he chose to put another $30.1 B of taxpayer funds at risk to prevent GM from liquidating now. Speaking about his decision on March 30th, he said today:

But I also recognized the importance of a viable auto industry to the well-being of families and communities across our industrial Midwest and across the United States. In the midst of a deep recession and financial crisis, the collapse of these companies would have been devastating for countless Americans, and done enormous damage to our economy — beyond the auto industry. It was also clear that if GM and Chrysler remade and retooled themselves for the 21st century, it would be good for American workers, good for American manufacturing, and good for America’s economy.

This is more expansive than what President Bush argued last December:

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.

The distinction is important. President Bush’s arguments were time-dependent: (a) we should try to prevent our weak economy from taking another big hit right now, and (b) let’s buy GM and Chrysler time to get ready to restructure. He also argued (c) that it was unfair to dump a liquidating auto industry on his successor (even if his successor might do something different than he would). It was a “too big to fail now” argument.

Today President Obama made it clear that he made the decision to commit additional funds, if his conditions were met, at the end of March. He then added new reasons to those expressed by President Bush: that America needs “a viable auto industry,” and that it would be good for America if GM and Chrysler survived. While he emphasizes what he would not do, “I refused to let these companies become permanent wards of the state,” President Obama defines a national interest in having auto manufacturers headquartered in the U.S. He reinforced that with his closing line, which was surreal:

And when that happens, we can truly say that what is good for General Motors and all who work there is good for the United States of America.

This is a big expansion of the justification for government intervention in the market. Ford is not failing, and Chrysler is emerging from bankruptcy. President Obama is arguing that American taxpayers need to fund the survival of a third (the biggest) U.S.-based auto manufacturer, because it is important “to the well-being of families and communities across our industrial Midwest and across the United States” and because “it would be good for American workers, good for American manufacturing, and good for America’s economy.” This argument could be extended to almost any large U.S. firm, at almost any time.

My view: I am extremely uncomfortable with the President’s expanded argument for further government intervention. Had the President instead argued, “The economy is beginning to recover, and we cannot jeopardize that with another major shock,” I would have been less uncomfortable with today’s commitment of additional taxpayer funds.


2. Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?

The public debate has evolved in the past two months. Earlier this year the question posed was, “Should the Administration bail out GM?” The basic options were “yes,” “no,” and “only if they enter bankruptcy, and if they do they should try to pre-package it.” The President chose the last of these options. The President decided to put $30.1 B of additional taxpayer funding at risk to help prevent GM from liquidating in the near future, and to help them through a restructuring process.

The benefits and costs are similar to what I described in late March. Here’s the updated version:

Benefits

  • If the firm survives the bankruptcy process intact, it has a higher probability of being viable in the long run (than in a restructuring outside of bankruptcy).
  • If the firm survives restructuring, the taxpayer has a higher probability of being repaid.
  • Old equity holders faced the full costs of the firm’s failure (by being wiped out). No additional moral hazard is created.

Costs

  • There are still significant risks to GM’s survival:
    • Will GM and the Administration defeat the objecting unsecured creditors in court? (however unfair that might be)
    • Will the bankruptcy process conclude quickly (within 90 days)?
    • Will GM continue to lose market share? Can GM make cars and trucks that people want to buy?
    • Will the new fuel economy and emissions rules restrict GM’s ability to make attractive vehicles?
  • This is a big new cash outlay from the taxpayer. This costs the taxpayer, and further constrains available TARP funds.

The President made clear his answer to this question on March 30th. At that time he laid out the conditions under which he would provide additional funding, and those conditions were met. No one should be surprised that he is now putting more taxpayer funding at risk. I am surprised that they only need $30 B.

My view: We crossed this bridge back in late March. It is not a new decision today to put more taxpayer funding at risk. I don’t like it, but I am at least glad that some incentives have been restored: the firm has to go through a bankruptcy process, shareholders are wiped out, and management was fired. I remember arguments from last fall and earlier this year that GM should get more taxpayer dollars outside of a bankruptcy process. That would have been far worse, and today’s actions mitigate some moral hazard.

Given the relative strength of the U.S. economy now compared to last December, I would have preferred an outcome of a pre-packaged bankruptcy + private DIP financing, and not exposing taxpayers to any additional risk. If GM is really as viable as GM and the President claim it now is, then they should have no problem convincing capital markets to provide them with short-term financing. (Judge Richard Posner argues this.) I will guess that this was not actually a viable option, because the pre-packaging could only come together with the direct involvement of the government. I think the real options would have been expose taxpayers to $30B more risk, or allow GM to liquidate. I would go with the latter: if GM can’t find private financing, they’re on their own. I assume this means they would liquidate. This would have been harsh and painful for those affected. I believe the consequences of further intervention now are worse for a larger number of people in the long run.


3. Is the pre-packaged bankruptcy likely to succeed?

There are two components to this question:

  • Is the bankruptcy process likely to be quick and successful?
  • Will the resulting company succeed without additional taxpayer aid?

I do not feel well-qualified to comment on the first question. The talking heads all repeat that “GM’s bankruptcy is more complicated than Chrysler’s,” with little detail about why. I would point out that the Administration is one for one in this process. Their use of this part of the bankruptcy code (section 363), and the process where the old GM sells the good stuff to a new GM, and then the remaining parts are liquidated, appears to have worked for Chrysler. From my perspective, the burden of proof now shifts to those who argue this bankruptcy will take more than 90 days. I didn’t like it because of the precedent it set, but I wouldn’t bet against the Administration succeeding again.

Other than the “good for GM is good for America” quote, the biggest surprise in the President’s remarks was how heavily he was betting that a restructured GM will succeed. He could easily have taken the posture, “GM has made some hard decisions, and they have a tough road ahead if they want to survive and succeed.” Instead, he attached his own credibility to GM’s future success and said:

So I’m confident that the steps I’m announcing today will mark the end of an old GM, and the beginning of a new GM; a new GM that can produce the high-quality, safe, and fuel-efficient cars of tomorrow; that can lead America towards an energy independent future; and that is once more a symbol of America’s success.

Even with a cleaned up balance sheet and more taxpayer funding, it is by no means certain that GM will survive for the long run. If GM fails in the next few years, the taxpayers will have lost an additional $30.1 B that the President committed today. In addition, the above quote will come back to haunt the President. I understand wanting to set a positive and optimistic tone. I am confused why he did so at such great political risk to himself.

I found it useful to return to my first post on the autos and review what this new pre-packaged bankruptcy + DIP financing does to the wide range of challenges faced by GM:

Revenues

  • The economic slowdown means fewer vehicles are being purchased from all auto manufacturers, foreign and domestic.
  • Even apart from the economic slowdown, U.S. auto manufacturers have been losing market share over time.
  • This is in part because they made a bet on light trucks versus smaller cars. This product mix doesn’t work when gas prices are high. Think of the proliferation of SUVs in the past 10 years. (Note that this was in part the fault of U.S. government policies. SUVs are technically light trucks, and so they qualify for lower fuel economy requirements.)

Costs & productivity

  • The Detroit 3’s ongoing labor costs are higher than those of foreign-based firms. This is still true when you compare an American worker in a GM plant in Michigan, for instance, with an American worker in a Nissan plant in Mississippi.
  • Productivity is lower in U.S. plants of U.S. firms than it is in U.S. plants of foreign-based firms. Some of this is because of the UAW contract that mandates certain inefficiencies. Some of it is poor management.
  • The Detroit 3 have huge dealer networks that are costly to the manufacturers. These dealer franchises are often protected by state laws that make it hard for the manufacturers to make these networks smaller and more efficient.
  • Auto manufacturers face a burdensome and unpredictable legislative and regulatory environment.

Balance sheets

  • The Detroit 3 have enormous legacy costs from their retirees. Past UAW contracts provided generous benefits that continue to burden these firms. This drains profits (when they earn them) away from productivity-enhancing investments.

So can GM survive, and for how long? Can they profit and flourish, as the President suggests they will?

  • The Administration and GM argue that a restructured GM can break even in a national market of only 10m vehicles sold in America each year. (We’re now around 9.5m/year. “Normal” is around 16m/year.) If accurate, this is astonishing.This would appear to address all three of the bullets under revenues. Addressed? I’m skeptical. I need to review the assumptions in GM’s new plan, especially about market share.
  • I have seen no evidence that GM and UAW have reduced significantly GM’s ongoing labor costs to be competitive with the transplants. Maybe I have missed it. Unaddressed.
  • Productivity is still lower in U.S. plants of U.S. firms that it is in U.S. plants of foreign-based firms. As a result of high compensation costs per worker and low productivity, it appears that labor cost per vehicle produced will still be uncompetitive with the transplants. Unaddressed.
  • GM’s dealer network is being dramatically reduced. Addressed.
  • The CAFE and emissions requirements are even more burdensome than predicted, but now have at least some degree of stability, given the national standards. On net, worse than before.
  • The balance sheets will be relieved of enormous debt and legacy health and pension obligations. Addressed.

My view: I need to look more at what GM is assuming for market share. The removal of the legacy obligations, combined with a big chunk of taxpayer change, will buy then many months of survival.

The Administration is stressing the balance sheet improvements, and they deserve credit for that. Conservative critics focus on the additional burdens of the fuel economy and emissions rules, and they’re right, too.

I would focus even more on the questions asked by several commenters: “Will people want to buy GM cars and trucks?” Additionally, can GM make a profit with still high labor costs, still low productivity, still burdensome work rules, and still slow product development cycles?

I want to GM to survive and be profitable in the long run. Their chances are now drastically improved, assuming they survive bankruptcy. But I don’t know if that’s an improvement from a 1% chance to a 20% chance, or from a 1% chance to an 80% chance. A lot more needs to change beyond just cleaning up the balance sheet, and many of those needed changes are deep-seated in the culture, structures, and processes of America’s third-largest company.


4. Is the pre-packaged bankruptcy fair?

Absolutely not. But I want to be precise in my criticism.

The easiest thing to do in Washington is to criticize the negotiator. “I could have gotten a better deal,” we say. I should begin my expressing my sympathy and offering my congratulations to Steven Rattner and the Obama team for closing what was undoubtedly a complex and difficult set of negotiations. I’m sure this one was not easy, and theirs was a thankless task.

At the same time, I share the concerns of many that the deal was not even-handed, and that the precedent will damage future business lending. I have grave concerns about how far they were willing to stretch bankruptcy processes and the traditional capital structure to get a deal.

First I need to correct the Administration, as well as some bad reporting today by the Washington Post. In last night’s background briefing for the press, an unnamed Senior Administration Official claimed (emphasis added):

Secondly, as you know, the UAW has reached a new agreement with GM and that agreement has been ratified that involves significant concessions by the UAW … concessions that are in virtually every respect more aggressive than what the previous administration demanded in its loan agreement.

In the term sheet for the December loan we (the Bush Administration) made to General Motors, we set out “targets,” which we took directly from the Corker amendment offered the week prior on the Senate floor:

  1. Reduce outstanding unsecured debt by not less than 2/3 through conversion into equity or other debt;
  2. Reduce the total amount of compensation, including wages and benefits, paid to their U.S. employees so that, by no later than December 31, 2009, the average of such total amount, per hour and per person, is an amount that is competitive with the average total amount of such compensation, as certified by the Secretary of Labor, paid per hour and per person to employees of Nissan Motor Company, Toyota Motor Corporation, or American Honda Motor Company whose site of employment is in the United States.
  3. Eliminate the jobs bank.
  4. Apply work rules no later than 12/31/09 “in a manner that is competitive with Nissan … Toyota or Honda in the U.S.”
  5. Not less than half of their VEBA payment should be in the form of stock.

As best I can tell:

  • They more than accomplished target #1.
  • They did little to nothing on #2. I have seen no evidence that compensation of current workers has been changed. UAW Chief Ron Gettelfinger claimed in a message to his members, “For our active members these tentative changes mean no loss in your base hourly pay, no reduction in your health care, and no reduction in pensions.” Maybe there’s a distinction between this statement and “total compensation.” If so, it would be great if someone could help me understand this. But it appears GM and UAW did nothing to address target #2.
  • UAW agreed to #3 in late March.
  • They made no apparent progress on target #4. I have neither seen nor heard evidence that the work rules have been relaxed. I am happy to be corrected.
  • They accomplished #5.

It was incorrect for the Senior Administration Official to call these “demands” of the Bush Administration. They were targets, not hard conditions. It is an overstatement to say that they “are in virtually every respect more aggressive than what the previous Administration demanded,” unless “virtually every respect” means “except for compensation and work rules.” (I am happy to be corrected if I have just missed the changes.)

The Washington Post then further flubbed it by writing:

Critics say it is unfair that the restructuring plan gives the union health trust a larger share of the new GM than the bondholders. But administration officials defend the plan, offering several justifications.

First, they note that the terms of the proposed GM restructuring echo the terms laid out by the Bush administration in December, when it extended $13.4 billion in loans to GM.

The Bush administration’s loan agreement required a 50 percent reduction or “haircut” for the union trust, but a 66 percent cut for the bondholders. The Obama deal requires larger cuts for both sides, though more for the bondholders.

The agreement does more than meet three of the five targets laid out by the Administration. It appears to make no progress on the other two targets. Thus the terms do not “echo the terms laid out by the Bush administration in December.”

More importantly, the targets we (Bush team) laid out said nothing about the distribution of equity shares. The criticism is not that the deal doesn’t cut the VEBA enough, or reduce unsecured debt enough. The criticism is that someone lower in the capital structure (UAW’s VEBA) got a much greater equity share than someone higher in the structure (unsecured creditors). It is disingenuous to point to the targets in the Bush Administration’s December loans to justify this inequity.

The deal is unfair to unsecured creditors, because they get a worse deal than someone standing behind them in line (the UAW’s VEBA). It has nothing to do with who those parties are (labor vs. creditors). It is about the importance of maintaining a stable and predictable set of rules to govern the capital structure of a firm, and the value that stability creates for firms’ ability to raise capital. All these arguments boil down to the cardinal rule of waiting in line for the kindergarten bus: it’s not fair to cut in line. If that rule is broken too often, chaos ensues.

The Administration could be arguing, “Sure it’s unfair, but UAW had more leverage on us than the creditors, so we struck the best deal that we could. We needed UAW to sign onto the deal, while we thought we could roll the creditors in court.” This would better justify the disproportionate equity shares than claiming, “This is a fair deal.”

The objecting creditors will now defend their rights in court. If the Chrysler precedent is an example, you should bet against them. It is interesting that the President did not attack them as “speculators” this time, so at least the rhetorical leverage against them is weakened.

My view: I am more concerned with the signals this unfair treatment sends to future investors. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain firms. I wish I knew whether a different prepackaging was possible, one which would have maintained the precedence of the capital structure and did not stretch the bankruptcy process again. Unfortunately, it is impossible to know.


5. Did the government structure the taxpayer financing correctly?

Judge Richard Posner argues the government should have provided a loan rather than taken an equity stake in GM. The President suggested one reason why they preferred an equity stake: a loan would further burden GM with a stream of near-term interest payments to the government.

I think Judge Posner strikes a nerve with his suggestion. It seems that much of the public discomfort comes from the government now being the owner of GM. It’s the 60% number that made me gasp. It highlights a tradeoff between two goals on which conservatives focus: value for the taxpayer, and avoiding government interference and control. There is a tradeoff between the two.

I believe the U.S. government could auction its equity shares late this year and divest itself completely from General Motors.This would solve the government ownership problem. In doing so, I presume that taxpayers would recoup far less than the $30 B of cash provided.

Question for conservatives: How much of a loss are you willing to take on the $30 B to get the U.S. government out of GM quickly?

My view: I assume there is a non-trivial chance that GM may still fail in the next several years. I like the President’s and his team’s strong language today that this $30 B is the last taxpayer aid, but I would like to reinforce that by ending the government’s ongoing involvement in GM as quickly as possible. I am willing to sacrifice a significant portion of the $30 B to achieve that goal. I therefore recommend that, if GM emerges from bankruptcy, the Administration then establish a much more rapid timetable for selling its equity stake, even if that means the taxpayer loses much of the $30 B. Get us out of GM before the end of 2010. This will strengthen the bulwark against providing additional taxpayer funds if GM fails again.

Note:

  • Under current law, the authority to provide any firm with additional TARP funding expires December 31, 2009. Correction: Secretary Geithner can, after notifying Congress, extend the TARP authorities to October 3, 2010.
  • The “set a timeline” argument has direct parallels to a certain national security debate.

6. Will the Administration run GM?

Here I give the Administration credit for good intent and good initial execution. I take at face value the President’s statement that he does not want to run or control GM, and I give him points for saying so explicitly. I am sure there are others, including some in his Administration and some on Capitol Hill, that would love to run GM as Government Motors. I will trust the President when he says he is not one of those people.

I further give the Administration credit for the “Principles for Managing Ownership Stake” they released in today’s fact sheet. While they are being released in the specific context of the U.S. government’s new equity stake in GM, the White House writes more generally “(T)he Obama Administration has established four core principles that will guide the government’s management of ownership interests in private firms.”

  • The government has no desire to own equity stakes in companies any longer than necessary, and will seek to dispose of its ownership interests as soon as practicable. Our goal is to promote strong and viable companies that can quickly be profitable and contribute to economic growth and jobs without government involvement.
  • In exceptional cases where the U.S. government feels it is necessary to respond to a company’s request for substantial assistance, the government will reserve the right to set upfront conditions to protect taxpayers, promote financial stability and encourage growth. When necessary, these conditions may include restructurings similar to that now underway at GM as well as changes to ensure a strong board of directors that selects management with a sound long-term vision to restore their companies to profitability and to end the need for government support as quickly as is practically feasible.
  • After any up-front conditions are in place, the government will protect the taxpayers’ investment by managing its ownership stake in a hands-off, commercial manner. The government will not interfere with or exert control over day-to-day company operations. No government employees will serve on the boards or be employed by these companies.
  • As a common shareholder, the government will only vote on core governance issues, including the selection of a company’s board of directors and major corporate events or transactions. While protecting taxpayer resources, the government intends to be extremely disciplined as to how it intends to use even these limited rights.

Given that I trust the President’s statements on this point, the risks here are unintended consequences, from within his own Administration and from the Congress. They are big risks, and these are dangerous waters. I hope the Administration treads carefully.

My view: Given the undesirable situation of government equity stakes in, and even controlling ownership of, firms like GM and AIG, as well as potentially Citigroup and other banks, these are good principles. They are also easy to monitor. It is interesting and good that the White House fact sheet says, “The [UAW's] VEBA will have the right to select one independent director and will have no right to vote its shares or other governance rights.” (emphasis added)

I urge the President to:

  • Enshrine the principles from today’s fact sheet in the term sheets for the taxpayer investments in GM (and other firms). We did this last December in the GM and Chrysler term sheets. Tie yourself to the mast. This will give you an easy excuse later when someone pressures you to vote those shares in a way that conflicts with the taxpayer’s interest.
  • Set clear rules for Administration contacts with GM – it’s probably best to funnel all contacts through specific Treasury or NEC officials on the autos task force. No freelancing phone calls to the Administration-appointed directors or “informal chats” with them from White House staff, or from DOT, EPA, USTR, DOE, even State. Put a firewall around interactions with GM.
  • Come out hard and quickly against the first proposal from a Member of Congress to leverage the ownership stake for a non-taxpayer goal. Nip it in the bud, especially if the idea comes from a friend.

It’s easy to criticize a huge decision like the one made by the President today. I strongly disagree with where we are headed, and I am concerned with the precedent that this deal sets for capital investment in American firms. The alternative, however, is that you have to be willing to allow GM to fail. I would be willing to do so, and it is therefore easy for me to express my views. In summary, they are:

  1. I am extremely uncomfortable with the President’s expanded argument for today’s government intervention.
  2. My first choice would have been to push GM to get private DIP financing. Assuming that was infeasible, I would have recommended denying GM the DIP financing, even if that meant they would liquidate. The economy is sufficiently healthier now than it was last December that I would be willing to risk the additional shock. But I agree the President crossed this bridge at the end of March.
  3. I would bet in favor of GM emerging from bankruptcy, and against them surviving as an intact firm for 5 years without additional taxpayer funding.
  4. The pre-packaging deal was unfair to unsecured creditors, to the benefit of UAW retirees. The Administration loses credibility with me by trying to argue this was a fair deal. They would have been more credible if they had argued it was the only deal they could get. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain U.S. firms.
  5. If a loan rather than an equity purchase had been possible, I would have preferred that – I find Judge Posner’s arguments persuasive. Given the equity investment, I urge the Administration to divest as quickly as possible, even if it means a loss to the taxpayer.
  6. Given the undesirable situation of the U.S. government owning GM and other large firms, the Administration’s new “Principles for Managing Ownership Stake” are solid. They need to lock them in, and corral or beat back all those people who work in the Executive Branch and Congress who have other goals in mind for GM and will be tempted to exert some leverage.

I thank you for making it through this extremely long post, and again want to thank all of the fantastic commenters. If you dislike the President’s announcement, I urge you to consider this question: Suppose the deal announced today were the only possible pre-packaged bankruptcy, and your choice was to take it or allow GM to liquidate now. What would you do?

51 responses

  1. I agree with your observation that it does not appear that GM has addressed their labor costs in any meaningful way. Given that, I don’t see how GM can possibly exist as an independent entity.

    From what I remember, it cost GM around 1500 per vehicle just to pay the benefit and pension cost. This was at a time when it was selling 40K SUVs into a 16M vehicle pool. The new GM will sell half as many cars, and they will be 20K gas sippers. So how can GM’s vehicles compete in the open market when their car will have a 2500 price penalty? In other words, 10% more expensive than the competition.

  2. Keith – very good post. Don’t agree with all of it, but I particularly like your three urgings to the President. I just don’t see them happening. Politicians can’t stand NOT using something for personal gain…

  3. I am a reired Michigan labor lawyer representing management. i have no doubt there will substaqntial wiggle room for the UAW on both compensation and work rules. Although unrelated to the work rules question, I have not seen anything aobut the company’s right to close plants.All the compensation reductions in the world won’t matter if the company doesn’t have a free hand to close redundant plants.

    I also want to know how long is the term of the new contract. When it expires, GM will have to renegotiate and nothing will keep the union from exserting all of their economic power to recover the “give backs”

    Finally whether or not the government keeps its hand in GM’s pocket ultimately the Feds will face tremendous pressure to subsidize GM to the tune of thousands of dollars per car if GM can’t sell its ecocars.

  4. It’s good to see a professional opinion w/o the bllinders of left and right. In a discussion with auto journalists, at the Chicago Auto Show, a TV type mentioned pay & health care as the primary issues facing the automakers and the rejoinder of the rest of us was, ‘Work rules!’ I had hoped that work rules would have been addressed and in some of the preliminary documentation from the administration’s car board, it was mentioned. If the follow-up was poor then shame on them. But work rules is the long run concern from my perspective.

    Now I need to go read your comments on the CAFE standards . . . be back in a bit. ; -)

  5. Pingback: Keith Hennessey On The GM Bankruptcy: A Must Read | But Then What

  6. Thanks for the post Keith. I’ve been reading daily from the week your site went up, and it sort of makes me feel guilty, believe it or not–it’s like I’m getting a graduate degree in policy for free. Truly, it is a service to citizens you provide.

    As for your hypothetical, let me say this. Back when you guys in the Bush administration were considering the auto bailouts, some conservatives (myself included) were not so much against it on libertarian grounds–your prudential point (“too big to fail NOW”) is sensible–but on grounds of 1) precedent, and, much more importantly, 2) the fact that we were about to get the most leftist government in our history.

    If you’ll pardon the crudeness of the way I’ll put the point, it really boils down to this: I basically trusted the Bush administration to muddle through a thankless task, even it turned out to be a waste. Waste is bad, and I’m against it (and for apple pie, blah blah), but it is usually not catastrophic. On the other hand, I did not (still do not) trust the Democratic supermajority to do the same–to be content with muddling through, perhaps wasting a lot of money, but without siccing the leviathan on the private sector. Therefore, reasoning backwards from my distrust, I was against the bailouts, even though I understood all of the prudential considerations (more or less Posner’s, as set out on his blog).

    (However, pace my point, the Democrats could just as well have advanced their corporatist case based on the perceived disaster of “do-nothing” Republicans had Bush & Co. let the autos fail).

    I suppose what I would do now is what you recommended. Take the deal–which was arguably necessary, definitely not fair–and sell the equity as soon as possible. Compared to 1.9 trillion bucks, losing a chunk of our investment in the autos is bearable, and it’s best thought of as paying off the government to compensate it for giving up a kind of power that could ruin us in the future. I’m not bothered by losing the money, so long as the government gets out. Our priorities are out of whack right now, and the unfairness of the deal only highlights that. If a union is goldbricking and management is incompetent plus overburdened with laws an litigation, then that status quo needs to go. Union, management, and statutory arrangement–bye bye. Let Nissan ring.

    Anyway, isn’t there a third option? Couldn’t you let the company liquidate and then use the money you planned to commit to help out the unemployed workers (I don’t know, pay transportation costs if they want to move to a place with jobs? Pay for retraining? Compensate for a bundle of the contracts voided by the liquidation?).

    One more thing: Don’t you think that the Obama administration knows what negative effects its comprehensive energy/climate change program will have? Point is, it would be better to have a solid phalanx of corporatist enterprises if they really want to go through with it, since it’s a safe bet you’ll need something that works like a cartel.

    I am, thus, far more dubious about the sincerity of Obama’s words than you are. (And how often has he been sincere, after all? But that’s another debate).

  7. Thank you for this interesting article. It seems to me that if there have not been significant concessions from the UAW in terms of compensation and their idiotic work rules, GM has no chance of surviving — unless they continue to receive huge infusions of cash from the federal government, which seems likely since Obama has now staked his political fortunes to GM’s success.

    As for your exit question, I would have chosen to let GM liquidate now. Yes, it would be painful for many, but it would be the better choice in the long run. We simply can’t afford to keep propping up failed companies with money we don’t have.

  8. I am a little confused by part of your explanation. In your points #’s 2 & 4 you repeatedly refer to “unsecured creditors” and “unsecured debt” being placed in a lower priority than the UAW’ VEBA, etc. I was under the assumption that the ones being ripped off for the benefit of the UAW were bond holders, and that their debt was “secured debt” under the law. Thus at least part of the outrage, and the deleterious effect on future corporate finance as no investor can rely on the law being followed when dealing with a unionized firm. Was that a typo or am I missing something critical here?

    Secondly, while I do not have the experience of dealing with such weighty matters, I have to say that after watching Obama I would not place any faith in either his stated intent not to run American businesses, or his compliance with the 4 stated principles. Your mileage may vary.

    Finally, the concept of any sort of financial recovery by the branches of Government Motors is dependent on the detail of selling their vehicles to Americans. There is now a significant portion of the population that will not now, in the absence of major government compulsion, ever purchase any vehicle from GM, Chrysler, or any other firms which are taken over by the government and/or made by the UAW. Has the concept of people voting by withholding their dollars, or some form of compulsion been figured into the mix?

    As for your choices, rather than creating both a Corporatist state entity, and a government owned union to funnel campaign funds for one party; I’d sell the entire lot off.

    Subotai Bahadur

  9. I think we can expect some pushback from the judiciary. The executive is taking their power.

    When a businuss goes bad, the role of government is “referee” and the judiciary is the responsible branch. It is appalling to see the rule of law so arrogantly discarded by the executive branch (and it started many administrations ago. Obama is only the most appalling manifestation so far).

    AIG got H*** for paying the people who allegedly ruined the company. Now, it’s GM and the UAW gets the biggest share, to which they are not entitled. Unlike the AIG investors (many of whom are pensioners), the President insists that we can’t let the UAW pensioners suffer. BUT: the UAW people sitting back & collecting those pensions are the people who did ruin GM. To my ears the difference in treatment of the two companies has a name and the name is spelled a-r-b-i-t-r-a-r-y- and -c-a-p-r-i-c-i-o-u-s, the very essence of.

    I am not so young that I have no emphathy for being too old to earn my daily bread (I’m 60). But your analysis fails to convince me that the Executive OR the Legislative branches should have anything to do with this. It belongs in the judiciary, played out according to the rule of law.

    You may not mean to, but you do make it sound like the executive & legislative branches are forced to do this. Nothing could be further from the truth. No one will invest in companies at risk of having arbitrary political motives interfere with business. I certainly won’t. Little things like, who has most leverage? How do we get the “best deal?” Well, if we continue down this path, the only thing we can count on is, the president’s cronies will get the best deal. AIG had no union. UAW does. This is appalling. It is disasterous for the rule of law.

    Nora Hamilton
    Grand Junction Colorado

  10. The American people are on the hook today because of President Bush’s ill-advised efforts. He opened the flood gates for this terrible expansion of power by the Executive. How will the genie be put back in the bottle and how many trillion will it cost the American people?

  11. I second Nora Hamilton above: Now, it’s GM and the UAW gets the biggest share, to which they are not entitled.

    In both the Chrysler and the GM bankruptcies, it is felt by the administration that the UAW is entitled to an expanded share of the wreckage, at the expense of secured creditors and others who might precede UAW in the normal order of a liquidation or restructuring.

    There’s an argument against that position, which is this: the UAW in its wisdom has demanded for decades, and gotten from management, constantly expanding wages and benefits, despite the obvious decline in the ability of GM to compete in the marketplace, and even to remain profitable. It is clear from this selfish demand to receive the golden eggs sooner, rather than a piece of the goose later, that in the event of bankruptcy the UAW has already pocketed all its feasible rewards, and should fairly settle now for the mere fact of continued employment.

    I leave unprobed the reflections on the favored treatment of UAW by an administration which holds a near-monopoly on the votes of its members.

  12. Would the US government have a controlling interest in GM, if it were required to follow the same accounting rules as business?

    If Berkshire Hathaway owned 50 percent or more of GM, Berkshire would be required to issue a consolidated income and balance sheet statement that included GM. GM’s assets, debts and earnings would be added to the comparable Berkshire accounts, subject to the removal of any transfers between the two entities.

    The US investment in GM will result in the US owning 60 percent of the equity of GM. That is higher than the level of ownership required for issuing consolidated accounting statements under generally accepted accounting standards.

    A consolidation into US’s financial reports would replace the equity investment in GM with the auto company’s assets and debts, and the increase in US debt needed to invest in GM. The consolidated US budget would include GM losses or profits. Additionally, the government’s purchase of GM cars would become an intra-entity transfer and not a sale.

    The trend these days is to issue consolidated statements in business. For example, rules are changing so that bank accounting statements include the off balance sheet entities that hold their securitized mortgages.

    Statement of Federal Financial Accounting Standards No. 24 requires government agencies to follow generally accepted accounting standards unless specifically excluded. SFFAS No. 24 requires the government to publish a Consolidated Financial Report of the United States Government. I have not reviewed the relevant law for the US’s investment in GM and the ownership of its 60 percent equity stake, but I am assuming it exempted the US from treating the investment in GM like a business would.

    If the US had to consolidate a GM entity into its financial statements, there probably would have been more transparency about the benefit and nature of the investment and there would have been more criticism of the GM investment.

  13. You’ve got to be kidding. The Obama regime has plunged the U.S. into marxism. Ended the rule of law. Brought back protectionism. Destroyed the U.S. auto industy, including the “other” makers. And now they are going to be “hands off”? This cabal has already “promised” $7500 in “tax credits” for buyers of the non-existent Government Motors “volt”. What’s next? Require local government and fleets to buy Government Motors cars and trucks or loose federal money? Already it seems that most of the dealerships that were dis-invented were owned by people that DID NOT CONTRIBUTE to the Obama machine. What is next? Is Obama going to start buying “news outlets”, like failing newspapers, to promote his “hope and change” MARXISM? And we have not even scratched the surface of his power grab. Your next car better get more than 35 MPG or it will be TAXED. If you use electricity, it will be TAXED to “save the planet” from non-existent human caused “global warming”. And health care? Well, trillions will be needed to create the rationed socialist “health care” system. Even PRAVDA is amazed at the U.S. descent into marxism. And says DON’T DO IT!

  14. Thanks for the in-depth, thoughtful analysis. I’ve also enjoyed the readers’ comments. Although I didn’t follow all of these issues in fantastic detail, I did feel confident enough to write an op-ed column on the topic when the Bush administration authorized the first “bail out.”

    So far my earlier piece holds up (I think). I predicted that this would be the first of many perpetual bail outs. I also, I think, accurately stated that the bailout was actually not of GM, but of the UAW. By the time I wrote my piece, Obama had won the election and the UAW knew that it was payback time for their support of his candidacy (and, for decades, the Democratic party). The unions are certainly getting a fantastic return on their investments, which have been the ultimate survival insurance.

    Something else I remember writing: ‘Twas unions that killed G.M. (as a profit-making venture). They also killed (or nearly have killed) Delta, the grocery store chain in my state (Bruno’s), steel companies, Chrysler and countless other union-dominated firms. Right now the government can bail out, G.M., but who’s going to bail out the U.S. government when it can’t make its payments? And what is the most unionized sector of our economy now – with the greatest “legacy costs?” Government – Federal, State and Local. We are seeing a preview of what is going to happen to Uncle Sam and its hundreds of millions of pensioners in probably a decade or two.

    My two cents on your question: We should have let the company liquidate. Here’s my solution: Let G.M. declare bankruptcy, cease operations, surrender, give up, get out from under all union contracts and obligations … And start over. In, say, Alabama. GM DOES have some people who know how to make good cars and know how sell them. Pay the same labor rates as Hyundai, lose the legacy costs and they’ll make a killing.

    Can’t you start an auto company for scratch for $30 or $45 billion? I’m sure the state of Alabama could kick in some incentives. Wait. Card check is coming along with cap and trade. Bicycle plants, anyone?

    Bill Rice, Jr.
    Montgomery, AL

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  16. Who will buy Chryslers and Chevrolets? I would assume the overwhelming majority of potential buyers would prefer to help Ford in preference.

    Let me hasten to add that not me and not anyone I know works in the auto industry. I’m not shilling. Just seems many more people would be inclined to try to help a company trying to do it the right way than to support government intervention.

  17. Most of the coverage in the press has been about the balance sheet issues: realigning stock ownership and wiping out debt and VEBA obligations. All of this has been achieved fair or not.

    But as you point out nothing has really been done on the income statement side — the flaws in the basic business model. GM has been bleeding cash at the rate of 3 billion a month, most from lack of sales and costs that are too high. Without fixing this GM is now likely to be the most expensive (to the government) jobs program in history. At some point a miracle happens and Gm car sales recover to the point that they can cover their costs, or government subsidies continue until we through in the towel and kiss $100 billion good bye having achieved nothing.

    As for me, I owned my last GMC vehicle with a 1985 Cutlass Sierra and after that piece of crap I’ll never consider a GMC vehicle again.

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  19. Thanks for the work Keith. No-one seems to mention it, but the Brits let their automotive business liquidate and it is gone (along with all of the jobs and benefits). The French and Italians did not let their automotive businesses fail, and both have recovered well. If GM is allowed to fail it will be gone and re-establishing it is next to impossible. I think we have to follow the French and Italian models of not abandoning our automotive industry.

    A business runs on total margin with a business’ total margin being margin times volume. If the balance sheet is significantly strengthened, then the questions will be how much margin is earned per car and how many cars can GM sell – every other question will disappear. The Democratic party is very similar to the Republican party – the longer Obama is in office the more Bush policies he adopts – and the Dems will not run or nationalize GM – all of that talk is sensationalism. The question of how much margin is earned per car is directly linked to productivity and if GM is free enough of union restrictions to operate efficiently. The question of how many cars GM sells is directly linked to customers perception and acceptance.

    We bailed out Chrysler in the 80s and that all worked out well. At the time Chrysler did not have a decent car that anyone wanted to buy (we are talking about the company that brought us the Pacer :-)). GM’s quality appears to have improved significantly to me. The new Camaro is suppose to be a great car. I do not agree with Charlie – I have never liked the Ford interiors or tinny feeling. I think Charlie should take two hours and go drive a new Camaro – I think he would change your mind about GM versus Ford (although Charlie probably buys Toyota HaHa).

    Bottom line is that I have no idea if GM is free of the oppressive union rules (like workers getting full pay for playing cards all day). But I do think there are a lot of loyal customers and I do think that the new GM cars are significantly improved. So my guess is that GM will make it.

    The French did it, the Italians did it and we did it with Chrysler. It will work out but only because GM’s quality is significantly improved so people will keep buying GM cars and trucks. And Obama will liquidate the GM equity within 3 years – his people are smart enough to know that even selling at a loss will be preferred by the voters to owning GM in 2012.

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