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Saving America’s Storied Automakers

Just in time for the holidays, the White House agreed to a much anticipated rescue of American automakers. Chrysler LLC and General Motors Corp. would immediately receive $13.4 billion in short-term loans from TARP (Troubled Assets Relief Program), followed by potentially $4 billion more in February.

The White House offered to help the automakers after Congress was unable to agree on a rescue effort of its own. The automakers had appealed for Washington’s help to prevent their looming bankruptcies.

In addition to the cash infusion, the terms and conditions established by the Treasury provide a framework for restructuring and call for proof of viability by March 31, 2009. At present, it’s unclear whether the loans will act as a bridge to a new and improved domestic auto industry or simply postpone its eventual demise. One way or the other, the fate of the Big Three will have serious implications for the overall economy and possibly the lives of millions of Americans.

The Road to Ruin

The banking crisis that hit in September made it harder to obtain credit and damaged consumer confidence, which took a toll on sales. In November, auto sales dropped 37% from the prior year to their lowest rate since 1982. U.S. manufacturers have also struggled with declining market share over the last two decades and higher employment costs than their foreign competitors.

Manufacturers had already cut production in response to falling demand, and GM and Chrysler extended holiday factory shutdowns to a month or more to reduce costs and keep unsold inventories from building further.

Ford Motor Co., which borrowed against its property and assets two years ago, said it may have enough cash to weather the crisis through 2009 without federal assistance. However, it called for the rescue of its competitors Chrysler and GM to lessen the fallout on suppliers, the industry, and the economy as a whole in the event of any monumental failure.

An auto industry collapse would have far-reaching effects on the U.S. economy because it accounts for 4% of gross domestic product (GDP) and 20% of manufacturing GDP. According to the White House, the domestic auto industry’s failure would slow annual GDP growth by 1% and cost the economy roughly 1.1 million jobs.

Rescue Requirements

In return for the short-term loans, loan recipients must have a positive net present value by March 31, 2009, to be considered viable, or risk having the loans recalled. The government will receive stock warrants, and the companies must make taxpayers senior to other debt holders. Federal officials will have access to corporate books and records, as well as the power to block any transaction over $100 million. Firms are also forced to accept limits on executive compensation, eliminate perks such as corporate jets, and stop paying dividends until the loans are repaid.

The administration also set some specific restructuring targets that include:

  • Reduce unsecured debt by two-thirds through a debt-for-equity exchange with bondholders.
  • Renegotiate wage agreements and work rules to make them more competitive with foreign-owned car makers that build vehicles in the United States by the end of 2009.
  • Eliminate the jobs bank that continues to pay employees after they are laid off.
  • Make half of a payment to an employee health program in the form of stock.

In effect, the loans deal with short-term liquidity issues and keep the firms alive until the new administration can enforce longer-term restructuring.

What’s Ahead?

It’s possible that the financing arms of the U.S. automakers will also need bailout funds in order to continue offering credit to potential car buyers.

Moody’s.com chief economist Mark Zandi believes that the actual price of saving the domestic auto industry could climb much higher. However, he also suggests that a failed industry would cost even more as the effects ripple through the troubled economy and cause as many as 2.5 million job losses. He estimated that such a level of unemployment would cost the federal government $240 billion.

Critics say it could be difficult to get the agreements needed for a meaningful restructuring, and that the companies could eventually fail anyway if the credit markets do not improve and/or the recession lingers.

It’s difficult to imagine a future without some version of the all-American Ford Mustang or Chevy pickup on our roads. The nation will certainly be watching to see whether Chrysler, GM, and Ford can survive challenging times and emerge as more competitive on the other side.

Let us hear your thoughts below:

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