...the Big Three can, will and must be successful


The Federal bailout of the Big Three can, will and must be successful

Citing the Big Three’s need to restructure their labor, healthcare and retirement costs; manufacturing, distribution and selling networks; and miscellaneous contractual and financial obligations, critics of a Federal loan program assert that absent a formal Chapter 11 filing, the Big Three will surely be back to Congress hat-in-hand. Reasons given are that the Big Three lack the negotiating leverage and legal means to resolve their obligations otherwise, that the sense of urgency provided by a Chapter 11 filing is absent, and that a car czar will not be able to orchestrate a process under which the various constituents will agree to accept or be bound by necessary changes. To the contrary, it is clear from review of progress made by the Big Three to date, available restructuring alternatives, the history of Chrysler, and the importance of the Big Three to the greater economy, that Federal assistance to the Big Three can, will, and must be successful.

At the outset, it should be noted that the Big Three are not alone in their malaise, and that the difficulties they face are in no small part a function of the financial crisis. For all of 2008, U.S. auto sales fell 18 percent to 13.24 million vehicles, a level not seen since 1992, and the worst year-over-year decline since the 1970s. Individually, GM sales fell 23 percent, Ford’s, 20 percent, and Chrysler’s, 30 percent. Concurrently, Honda reported a decrease of 8 percent, Nissan, 11 percent, and Toyota, 15 percent. Moreover, Toyota reported an operating loss for 2008 of $1.7 billion, its first in 70 years.

Notwithstanding, the Big Three have made significant strides in resolving their problems outside of a formal bankruptcy proceeding. For example, with respect to labor costs, a focus of frequent debate though at most 10 percent of industry expenses; the UAW has accepted a two-tier wage structure in addition to health-care and retirement plan reductions. In contracts negotiated in 2007, wages for new workers were reduced by 50 percent, and they will not be guaranteed health care benefits, or participate in the traditional defined-benefit pension plan. The UAW further agreed to take responsibility for existing retiree health care benefits transferred from the automakers to the Voluntary Employee Benefits Association, an independent trust.

As for alternatives to a Chapter 11 filing, which could quickly turn into a Chapter 7 liquidation (with viable buyers in short supply) given the credit crunch and correspondent lack of sizeable and affordable DIP financing necessary to guarantee warranties and finance operating losses and customer purchases, a restructuring of the Big Three might best be accomplished through an out-of-court process financed with Federal loans. Such an approach offers significant advantages over a Chapter 11 filing. For instance, being voluntary, an out-of-court restructuring engenders greater cooperation, and facilitates better coordination and control by the parties directly involved, characteristics vital to a successful restructuring of the Big Three given the number of potential parties, interests, and complexity of the automakers. This inherent flexibility enables difficulties to be resolved more quickly as they arise, serves to enhance or preserve the value of the debtor, and results in significantly lower administrative costs as compared to a formal filing. For example, in the current Lehman Brothers case, it has been estimated that the filing may have cost creditors as much as $75 billion, while fees for lawyers, accountants and other professionals have been estimated to reach as high as $1.4 billion.

An out of court restructuring also provides strong incentives for the various parties to work proactively and expediently toward a mutually acceptable and realistic resolution by virtue of their own self economic interests. With a Chapter 11 filing, in addition to the damaging consequences to the Big Three’s brands, sales volumes, and market shares, it is highly probable that dealer-franchise contracts would be invalidated; incumbent management would be replaced; labor contracts would be terminated; healthcare and pension benefits would be reduced or eliminated; and facilities contracts would be rejected. Further, provided that certain voting thresholds were met, dissenting creditors could be compelled to accept ordinarily unacceptable terms and conditions, while rejecting creditors could be crammed down if certain valuation and distribution benchmarks were met.

And if it turns out that despite these incentives the holders and parties in interest are still unable to agree, the Auto Industry Financing and Restructuring Act as proposed provides the auto czar and The President with the tools necessary to bring about a resolution. The Act requires automakers to submit long range plans specifying how they intend to achieve and maintain long-term viability, including how costs, capital and capacity are to be rationalized; how current debt will be restructured; and how Federal loans will be repaid. Concurrently, the auto czar has the authority to establish how the automakers are to be evaluated, approve and report on their progress in meeting plan targets, and veto any transaction of $25 million or more. In the event the plans are not followed or there is insufficient progress, the auto czar can also call the loans.

That an out of court restructuring financed with Federal loans is economically preferable to a Chapter 11 filing is also clear from the history of Chrysler. The Chrysler Loan Guarantee Act of 1979 provided Chrysler with a loan guarantee of $1.5 billion over a ten year period. Chrysler ended up using $1.2 billion, repaid its obligations seven years early, and provided the government with a $350 million return on investment. The program now being considered offers similar potential, with the government to receive warrants equal to at least 20 percent, and perhaps more, of the value of the loans, exercisable for nonvoting common or preferred stock, or for regular voting stock if the government forgoes its voting rights.

Even if acceptable from a competition policy perspective, it is also evident from the Chrysler experience that a restructuring by sale to a foreign buyer is not the solution. The $37 billion takeover of Chrysler by Daimler-Benz was intended to meld two of the oldest names in automotive manufacturing into a global titan, with 442,000 employees, $132 billion in revenue, a market capitalization of $100 billion, and synergy savings of $3 billion annually in retail sales, purchasing, distribution, product design, and research and development. The synergies never materialized, however, due to fundamental, unresolvable differences in culture and related business practices, and in August 2007, after nine years, the merger was unwound with Cerberus’ acquisition of an 80.1 percent interest in the US business for $7.4 billion.

Last but surely not least, if the Big Three are allowed to fail, the direct and indirect losses to the larger economy will be enormous at a time when employment is necessary to stabilize and return the economy to healthy growth. According to the Center for Automotive Research, excluding the effect on pension funds, the level of Pension Benefit Guaranty Corporation obligations, and the U.S. healthcare system, the initial impact on the U.S. economy of a full or partial rationalization of the Big Three could amount to job losses approaching 3 million, a loss of personal income of up to $398 billion, and a combined loss of tax receipts and transfer payments of as much as $156 billion. Not included in this calculus are the losses of extensive R&D capability in transportation and alternative energy, and of an institutional knowledge, infrastructure, and capability that took a century to develop, and that would be very difficult if not impossible to recreate. For these reasons, those discussed above, and a host of other considerations too numerous and complex to enumerate here, a Federal loan program coupled with an out of court restructuring clearly has the greatest potential to restore the economic and competitive viability of the Big Three.

Boris J. Steffen, CPA, ASA, CDBV
Principal & Director
Navigant Economics, LLC

Date published: Jan 19, 2009


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