Monday, May 7, 2012

The GM and Chrysler Bail-Outs

 The U.S. government first extended emergency loans to GM and Chrysler in 2008 and 2009, and then stage-managed their 2009 bankruptcies. How is that working out? Thomas H. Klier and James Rubenstein tell the story in "Detroit back from the brink? Auto industry crisis and restructuring, 2008–11" in the second quarter issue of Economic Perspectives from the Federal Reserve Bank of Chicago. I'll lift facts and background from their more detailed and dispassionate description and tell the story my own way.

The story really starts in the late 1990s. The big three traditional U.S. automakers-- GM, Ford, and Chrysler--had held about 70-75% of the U.S. auto market through the 1980s and most of the 1990s, but then their market share began plunging, ultimately falling to just 45% of the market in 2009.   

When the Great Recession hit, demand for cars dropped off, financing dried up, and gasoline prices spiked all at the same time. All of the Big Three were experiencing large losses, but Ford had a larger cash reserve. GM and Chrysler weren't going to make it.

On December 19, 2008, the lame-duck President George W. Bush authorized the use of the Troubled Asset Relief Program to give loans to GM and Chrysler. For the record, the TARP legislation discussed support for "financial firms," and had nothing to say about helping manufacturing firms. After the Obama administration came to office in early 2009, it gave TARP loans to GM and Chysler, too. Klier and Rubenstein report: "GM ultimately received $50.2 billion through TARP, Chrysler $10.9 billion, and GMAC $17.2 billion."

But GM and Chrysler were still bleeding money, and so the federal government stage-managed their bankruptcies. Standard bankruptcy law, in a nutshell, is that the stockholders get wiped out and the debtors and bondholders take losses--but end up owning a restructured firm with renegotiated contracts and obligations. However, Chrysler and GM used a formerly obscure part of the U.S. Bankruptcy Code, Section 363(b), that had been used for the Lehman Brothers bankruptcy. Basically, a newly formed company would receive all the desirable assets from the company--properties, personnel, contracts--while the old company kept the toxic stuff. This approach created "new" Chrysler out of "old" Chrysler in a month; GM took five weeks.

The strategies for the two firms were quite different. The plan with Chrysler was basically to get Fiat to run the firm. The table shows the evolution of ownership of "new" Chrysler. In the table, VEBA stands for "voluntary employees' beneficiary association," which is the legal form of the trust fund for retirement and health care of the United Auto Workers union. The old sad joke used to be that the big U.S. car companies were really a retirement fund with a car company attached: under this plan, the arrangement became explicit. Fiat was given a 20% ownership share for no cash payment, but with an agreement that it would run the firm and develop new products. The U.S. and Canadian governments took small ownership shares in exchange for the earlier loans they had made. Bondholders of secured debt got 29 cents on the dollar.

Part of the arrangement was that if Fiat met certain targets (sales, exports, developing fuel-efficient cars), then it could expand its ownership share of the firm. In May 2011, Chrysler paid back its government loans and Fiat bought out the remaining government ownership. Chrysler is again a car company primarily owned by, well, a car company, rather than a retirement fund.

GM was a different matter. In this case, the U.S. took 60.8% ownership while Canadian governments took another 11.7%. Thus, the moniker "Government Motors" was fully deserved. The VEBA trust got 17.5% ownership.  The GM bondholders, who in a standard bankruptcy arrangement would have ended up owning the firm, got the smallest slice.

In November 2010, GM had a stock offering and raised $24 billion, allowing the government to get rid of a bunch of its shares. But ultimately, even after the government shouldered out the GM bondholders, it seems unlikely to recoup the TARP money it loaned. Klier and Rubenstein write: "In order for the government’s remaining 32 percent of the company to be worth $26.2 billion, representing all of the government’s remaining unrecovered investment, GM’s market capitalization would have to be approximately $81.9 billion. To achieve this market capitalization, the price of GM stock would have to exceed $52 per share, or more than twice its price in April 2012."

The bankruptcy did lead to dramatic changes. Here's a list of some changes (citations omitted):
  • "GM’s North American bill for hourly labor declined from $16 billion in 2005 to $5 billion in 2010 ...
  • "Old GM had 111,000 hourly employees in 2005 and 91,000 in 2008. New GM had 75,000 immediately after bankruptcy in 2009 and 50,000 in 2010 ...
  • "GM had closed 13 of the 47 U.S. assembly and parts plants it operated in 2008.  GM’s Pontiac, Saturn, and Hummer brands were terminated, and Saab was sold. GM retained four nameplates in North America: Chevrolet, its mass-market brand; Cadillac, its premium brand; Buick; and GMC. ...
  • "GM also reduced its dealer network by about 25 percent. ...
  • "Detroit’s labor costs were now competitive with foreign producers operating within North America. Hourly labor costs ranged from $58 at Ford to $52 at Chrysler, compared with $55 for Toyota ..."
The policy question about GM and Chrysler is sometimes phrased as "should they have been helped, or not." It's important to be clear that even though the two firms were helped, they still went into bankruptcy! If the firms hadn't received TARP loans, they would have gone into bankruptcy, too. Thus, the actual policy question here should be to compare the two stage-managed bankruptcy that did occur with what might have happened under a more standard bankruptcy procedure.

For example, it seems at least arguable that the accelerated bankruptcy process which occurred under extreme federal government pressure was faster and smoother than if the arrangements had been worked out in a standard bankruptcy court proceeding. It seems clear that the federal government shouldered out bondholders, who would have received more in a standard bankruptcy procedure, and thus created some uncertainty about how bondholders of other large firms might be treated in the future. On the other side, the UAW retirement funds did much better out of the stage-managed bankruptcy than they probably would have done in a standard bankruptcy. Fiat appears to have gotten a better deal under the stage-managed bankruptcy of Chrysler than it would have received in a standard bankruptcy. The stage-managed bankruptcy did lead to cost-cutting measures like plant closures, fewer employees, and more competitive wages for GM and Chrysler, but presumably these changes would have happened under a standard bankruptcy procedure, too--and perhaps they would have happened in a way that led to greater competitiveness for the firm moving forward.

The claim that the U.S. government "saved" GM and Chrysler is wildly overblown. The firms would have continued to exist if they had gone through a standard bankruptcy process. Were the TARP loans to GM and Chrysler and the government intervention in the bankruptcy process worth it? Part of the answer is the value you place on the faster bankruptcy process, or on how you feel about a process that gave bondholders less value and the UAW retirement fund more value than they probably would have received in a standard bankruptcy. But as another metric, let's say that the government ends up eventually losing $10 billion of its investment in GM, which has 50,000 hourly jobs in 2010. Say that in a standard bankruptcy, hourly jobs would have been slashed more sharply, down to 30,000. (Of course, it's possible that GM would have been managed differently under a standard bankruptcy, in such a way that jobs wouldn't have needed to be cut as sharply.) Saving 20,000 jobs at a cost of $10 billion works out to $500,000 in government spending per job saved.