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December 19, 2008

Bush decides to bailout the auto industry

The NY Times reports that Bush Approves $17.4 Billion Auto Bailout. It will go only to Chrysler and GM (in worse shape than Ford) for now.
Important details:

The loan deal also requires the companies to quickly reduce their debt by two-thirds, mostly through debt-for-equity swaps, and to reach an agreement with the United Auto Workers union to cut wages and benefits so they are competitive with those of employees of foreign-based automakers working in the United States.

To gain access to the emergency loans, G.M. and Chrysler must agree to a range of concessions, including limits on executive pay and the elimination of their private corporate jets.

The plan announced on Friday by Mr. Bush offered a compromise between those positions, by making the requirements non-binding, allowing the automakers to reach different arrangements with the union, provided that they explain how those alternative plans will keep them on a path toward financial viability.
...
If, by March 30, the two companies cannot meet that standard -- and clearly they could not meet it today -- the $13.5 billion in Treasury loans would be "called" for immediate repayment, with the government placed in priority, ahead of all other creditors.

I was so happy with Republican opposition to the bailout that I was considering making a donation to the Republican party in appreciation. Now I won't be doing that. If there is a silver lining, it must be that to get the funds to do this deal, he needs to go back to the congress to get the next few hundred billion from the TARP. That means that congressmen opposed to the bailout can try to prevent the next release of funds or adding riders prohibiting their use for automotive firms. I don't expect that to happen, but I can hope. Alas, "[b]y law, once Mr. Paulson makes a formal request, Congress has 15 days to reject it and deny the additional money.", so it looks like the burden is on congress to get the majority to pass the bill, and there isn't that kind of opposition around.

I expect the government to rubber stamp whatever plans the car companies have put together. While it seemed possible for a time that the government would allow the auto firms to fail by inaction, there is no way that that they will take an overt action (like failing to certify they are on a path toward financial viability) that would bankrupt them immediately. It is impossible to believe that these conditions will have any bite. Whatever the car companies do will be certified as on the right path. It won't be until years and many billions of dollars from now that we finally allow them to fail.

As I mentioned before, there may be constitution problems with government funded loans that are superior to other claims on firm assets because of the rule that Congress shall make no law impairing the obligations of contract. If this clause means anything (and of course, IANAL) then firms can issue the government new debt that is superior to all other debt only to the extent that the firms do not already have covenants on existing debt requiring that the firms not issue more senior debt, They can sell off a firm's assets to repay such a debt to the extent that they are not already pledged against other assets. To lend them a huge pile and then once they inevitably fail, if we end up at the end of the creditor line instead of the front it will be good for a dark laugh.

Felix Salmon is worried that this isn't structured to give the firms enough leverage over their creditors.

[T]his is going to make things very hard on the automakers' managers, who need to impose a swingeing 67% haircut on their bondholders without having the help of a bankruptcy judge to enforce such a thing. I'll be very interested to see how they try to do that; expect a huge fight, and no guarantee of success. Yes, the bondholders are well aware that if they say no, the only other option is liquidation, and zero payout. But that doesn't mean they'll be remotely complaisant.

Paulson Grasps the Automaker Nettle
We know that this requires accepting the government as a most senior creditor. Other debtors may not be interested in that deal, especially if they don't think they can get the right concessions out of management and labor. Some creditors, especially senior ones, could rather take their chances on liquidation.

According to one source, global excess car production capacity is about 20 million units. That probably can't be true because global production is just 72 million units. But if GM and Chrysler failed, and only the brands Sorkin thinks should make it make it, then we'd see a massive global production reduction (though not the full 20 million). Which would be excellent for all the remaining car companies, and probably good for whatever smaller firms emerge from the wreckage of GM and Chrysler.

Posted by OneEyedMan at December 19, 2008 8:09 AM

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