Bailout of Big 3 Automakers Risky, Likely Disaster; Restructuring Bankruptcy Better Solution

Everyday is like Halloween in DC with politicians handing out dollars like candy.

After a discussion with MOMocrat Kady about the Big 3 automaker proposed bailout, it's clear reform is in order instead of throwing more bailout money after bad.

Here's a transcript of our chat/interview---feel the privilege here, my friends, because I'm letting you in on the backchannel chatter. This is what MOMocrats sound like offline (sometimes, anyway, the G version, edited for public consumption)...

(I'm in italics, asking Qs, and Kady is regular font, answering.)

Q: On NPR, an expert said bankruptcy doesn't really affect the car manufacturers because if they build cars people like, people will buy them.

(a) But aren't layoffs eminent in bankruptcy, during reorganization and haven't car manufacturers already been closing plants and doing layoffs and pension contribution cuts? Isn't that the part that affects people? How will a bailout help that, help the people, or is it just to keep the companies in motion?

Right off the bat, there are two kinds of bankruptcies, reorganization and liquidation. 

Almost everyone is talking reorganization, which means that the company gets to take what is roughly equal to a time-out, where their creditors are not allowed to harass them for payment, and they get to make the company leaner (so as to survive once they are out of bankruptcy). 

Generally, to get leaner, they have to cut costs substantially, which can mean, among other things, layoffs. Now, when a company is in reorganization, it is possible that they can't "fix" things and will then go into the 2nd kind of bankruptcy, liquidation. Workers/employees really really don't want this b/c then they absolutely will be out of a job. So this becomes a point of leverage for the car company, they can do things like get the Union workers to back off on previous agreed upon things like wages, benefits, pension.

Just for a point of reference for discussion further down, in a chapter 11 bankruptcy, the existing shareholders can be wiped out with creditors come in as equity owners.  The creditors can then do all the shareholder-y things like vote for board of directors (which can then keep or reject the existing managers to act as trustee of the bankrupt company).

I think the problem that GM is referring to is that IF they are a bankrupt company, then people won't want to buy their cars. This may be legitimate because cars come with warranties, etc... and need brand specific parts. If the car company doesn't come out of reorganization and is instead liquidated, then it becomes very difficult to service the car. I don't know if this problem outweighs the problems of government intervention.

Q: (b) is that really an accurate assessment of buying habits, especially in a slow economy with low trust by consumers? won't people make their current cars last longer? don't car sales habitually slow during slow economies?

I agree with you.  I'm not sure "re-tooling" is much of a short term solution (depending on how long this recession lasts). I would say there is excessive inventory in the system, and it will take us lots of time just to get through that. However, in the long run, it should make them a more viable company.

Q: How close to the brink do car companies go during sales slow downs? Don't they often shut down plants and cut back on manufacturing to match demand? Ebb and flow is a common corporate trend. How and what effect does this shut down and cut back have now and in the future when they need to increase production? is level production better? or responsive production?

Right now the problem is that every month, it costs the US car companies more to run their business than they take in in revenue. Shutting down plants, etc. will help, but there are actually huge costs involved with that kind of effort (look at most recent Starbucks numbers, which reflect the enormous costs to Starbucks due to its closing shops). Most car companies have less than a year worth of cash before they are insolvent. They probably don't have enough to sustain them through a non-bankruptcy reorganization (i.e. what you described). 

Q: Are the manufacturing plants out of date?

I'm not a car expert but I would say yes. Most of the US car companies have spent the last few years gearing up their SUV/Truck plants. They are enormously behind the Japanese in hybrid technology. Even the Volt, which some think is the end all/be all for the next generation of US cars is mostly just a gimmick at this point.  It took Toyota several years to work out the kinks of the original Prius. I'm just not convinced that GM will introduce the Volt and it will be all smooth sailing.

Q: Are the cars out of date? As in, do we need more efficient vehicles, more fuel efficiency and flexibility?

I don't like government interfering in what kinds of cars we need. The market (what people will buy) should dictate that. When gas was above $100/gallon, the American companies clearly suffered by NOT having fuel efficient cars. Certainly, if it turns out that we give the car industry its bailout money, it must come with the condition that we are immediately improving federal emission standards/ fuel efficiency standards. Then let the car companies decide how to fix their cars to achieve those standards.

Q: Should the bailout be more restrictive than the bank bailout? Should it require new development?

Again, I don't like government interference. Generally speaking, it's hard to just say, yo, innovate, and then, wham, it happens. However, given that the bank bailout has been not restrictive at all, I find it difficult to imagine that the car bailout won't be more restrictive.

Q: What form would the bailout take? How much? Who will it really help? How will the government get back the money, if they do?

It will help Union workers (again, w/o Chapter 11 bankruptcy, they will keep their very decent wages/benefits, which does make the car companies less competitive). It will help the management. It will help all the small and medium size parts and machine suppliers to the auto industry.

I think the worst of all worlds is happening right now. I believe that Paulson said either yesterday or today (been busy, not keeping close track) that although they're not going to give dollars to car companies directly, they may fund the credit arms of the companies with TARP money (you'll have to check on this). 

That's totally stupid. We do not need to be encouraging Americans to buy more gas guzzling cars that they cannot afford.

Megan McCardle (Atlantic) gave an example of who car credit helps: the person who has a car that still has $7k left on its loan wants to trade it in for a car worth $20k and the credit arm won't give him a $27k loan.

Outside of this, I imagine that any bailout money will probably be structured as a purchase of preferred stock in car company. Preferred stock is ownership in the car company w/o voting rights.  Gov'ts like to use preferred stock b/c actual stock reeks of socialism/nationalization, so we avoid it. The preferred stock of a company may or may not pay yearly dividends and will get more valuable if company gets more valuable.

I have no idea how much.  I guess that's really up to the car companies to tell the government how desperately it needs it (ie. lobbying)

Q: Who will oversee this?

I don't know; again, you can write any condition into a bailout you want. TARP is overseen by that Paulson stooge, they could put in a car stooge.

Again, this is why bailouts are bad ideas: you put someone who has absolutely no idea what he's doing in charge of watching over people who've been doing it for decades. Who do you think is going to have the wool pulled over their eyes.

In a bankruptcy, it is the creditors that have power (because it is the creditors who have personal interests that they have a right to protect). They can throw out the existing management, put in new management. They have the power to push the company into liquidation if they don't like what they see in the reorganization.

In bailout, the existing shareholders are still in control of the Board and of the company.

Q: Is a bailout the best answer? if not, what then?

I do not believe so, though I know there are many many interests in Michigan that think otherwise.  I agree with Joanne [in her recent post] that bankruptcy is the best option.  Unfortunately, I don't know that much about bankruptcy law, and I think there are some kinks in the system that are not really suited for the conditions we are in. 

But you know what? Congress could pass a new bankruptcy chapter to deal with the special circumstances of today. I thought they should have done that first with the financial companies.  It's, as they say in business, the "low-hanging fruit." But we seem to have politicians who are much more interested in printing money, which will have long-term disastrous effects on our country.

One additional way that government can help (w/o being full-on bailout): GM has been arguing that this is a terrible time to be bankrupt there is no debtor-in-possession (DIP) financing available. Well, if this is truly the situation, government could come in to provide DIP financing.

Note: What is DIP financing? When you are bankrupt, nobody should want to lend you the money you need to reorganize. However, there are certain protective rules in bankruptcy that says if a lender is willing to come in to fund the DIP, they will get priority on certain assets of the company if the bankruptcy ends in liquidation. This is still risky though, since if the company goes into liquidation, the lender will not likely come out fully paid. GE Capital  is one of the largest providers of DIP financing, but their purses have snapped shut b/c of the economic situations. 

MOMocrats Julie and Kady regularly discuss economics because Kady gets it and Julie really, really wants to, especially since this whole deal smells rotten, like worse than guests and fish after three days.

Comments

[TINYMARIE]

What if the Government used the BAIL OUT to give American made car buyers a rebate for buying American cars?
That would help the BIG 3...and help the little guy buy cars too....

[cynematic]

Kady said: "I think the worst of all worlds is happening right now. I believe that Paulson said either yesterday or today (been busy, not keeping close track) that although they're not going to give dollars to car companies directly, they may fund the credit arms of the companies with TARP money (you'll have to check on this)."

This is a bit of a sticking point with me. I'm no car industry analyst, but one thing I've seen in the popular business press is that GM became less about cars than a pseudo-bank with more profit on the loans for their cars than the actual cars themselves. (0% financing, anyone?)

So how is the public not getting stuck with crummy, defaulting consumer auto loans if TARP money goes to GM's credit arm?

Wouldn't it be better if the "rescue" money went to plant and production infrastructure? I mean, they could build metal robots as well as cars on the swing shift, for all I care, but shouldn't the money be used to get those plants making stuff with Americans making it?

[Linda]

I'm not writing as any kind of economics whiz, but as an average-Jane car buyer.

For many years, I had made it a point to buy American. But about three years ago, when we bought our last car, I pored through Consumer Reports auto reviews -- and found that almost all the American cars sucked. With this in mind, along with the fact that our cars kept crapping out by 120K miles, I was ready for a change.

The magazine gave a major thumbs-up to the Toyota Camry that we ended up buying. We love it.

So my question is: If American companies do not make cars well with the money they had in years past, what would guarantee that, with a fistful of bailout money, they would produce better cars that we would want to buy?

[marisela]

pretty wack!!

[Dr BLT]

I found your article on the bailout of the big 3 automakers highly informative and insightful.

The executives will fair just fine, but if the government simply turns a cold shoulder to the big 3 automakers, many more laborers will find that...

It's Long Road to Christmas (This Year)
Dr BLT
words and music by Dr BLT copyright 2008
http://www.drblt.net/music/LongRoadDemo2.mp3
Snow.

By the way, this song about the impact of the economy on the prospect of Christmas is from the forthcoming CD, Ice and Snow:
http://www.drblt.net

[hypotheek nieuws]

I think this report addresses very well the real differences between bankruptcy and the bailout. I think in the near future it will be quit clear that which financially compromised company is potential candidate for bailout option.