The Good, the Bad and the Ugly: Auto Bailout Alternatives

Dec. 12, 2008— -- What does the future hold for the American auto industry now that Congress failed to pass a bailout package?

Will the White House be forced to reverse course and dip into the emergency TARP funds set aside for the banking and mortgage industry and divert some of it to the automakers?

The White House signaled that door may be reopened when it released a statement Thursday night after the Senate had killed the congressional aid package.

"We will evaluate our options in light of the breakdown in Congress," the statement said.

The White House released another statement this morning, this time specifically citing the use of TARP funds as a possible way "to prevent a collapse of troubled automakers."

Even if TARP funds are made available to the Big Three, would that save the automakers from bankruptcy, or just delay it?

Ford, General Motors and Chrysler have all predicted that without emergency loans or "bridge financing," dire consequences would ensue for both the auto industry and the U.S. economy. Ford has not requested emergency loans but supports the extension of such help to its rivals.

GM issued a statement Thursday night expressing disappointment that the Senate was unable to pass a rescue package. "We will assess all of our options to continue our restructuring and to obtain the means to weather the current economic crisis."

Chrysler also released a statement saying it would "continue to pursue a workable solution to help ensure the future viability of the company."

Industry analysts and scholars, meanwhile, have differing opinions on what awaits the industry should bailout legislation fail. The industry, they say, could follow several different paths.

Help Through TARP

Even without congressional approval, the White House has "full authority" to grant emergency loans to the automakers through the government's $700 billion financial rescue plan known as the Troubled Asset Relief Program or TARP, House Speaker Nancy Pelosi, D-Calif., insists.

It's a move that the Bush administration and Treasury rejected earlier but in a statement released this morning, the White House signalled that it was now open to the idea.

"Under normal economic conditions we would prefer that markets determine the ultimate fate of private firms," the administration said. "However, given the current weakened state of the U.S. economy, we will consider other options if necessary – including use of the TARP program -- to prevent a collapse of troubled automakers.

If the Bush administration does not make use of TARP, it's uncertain whether the succeeding Obama administration would react differently.

The president-elect expressed support Thursday for an emergency loan package from Congress, but whether he would support using TARP money for an auto bailout remains unclear.

Without immediate aid, the automakers may not survive long enough to benefit from an Obama decision. General Motors has said that it could go bankrupt before the end of the year, weeks before Obama takes office. The same could be true for Chrysler, experts say. Ford is widely regarded to be in better financial health than its crosstown rivals.

"If you take at face value what Chrysler and GM have said, I don't know how they avoid a near-term bankruptcy," said Craig Fitzgerald, an auto analyst at Plante & Moran PLLC in Southfield, Mich. "They've said they're running out of money and can't access external capital markets. … I don't see any alternative if the bridge loan does not come through and the situation is as dire as GM and Chrysler have said."

Not everyone is certain that bankruptcies by the two automakers will take place before Bush leaves office.

"It seems like we went from a mid-2009 estimated running-out-of-money to the end of December in a heartbeat," said Edward Altman, a finance professor at New York University's Stern School of Business.

Bankruptcy: A Road to Oblivion?

The automakers predicted that if one or more of them filed for bankruptcy, the resulting effect on their businesses and the American economy would be devastating.

In a submission to Congress, General Motors said that without government support "the company will default in the near term, very likely precipitating a total collapse of the domestic industry and its extensive supply chain, with a ripple effect that will have severe, long-term consequences to the U.S. economy."

While it's not uncommon for a company to file for bankruptcy, reorganize its businesses and then return to financial stability, the companies and some analysts have argued that such a scenario wouldn't prove true for the automakers.

The companies, said Rebecca Lindland, an analyst with IHS Global Insight in Lexington, Mass., would likely have to file for Chapter 7 bankruptcy protection, which requires a company's liquidation rather than restructuring.

"Part of the reason that we don't see that recovery is really viable is that people have consistently said they would not buy a car from a bankrupt company," Lindland said.

In its submission to Congress, GM said that market research showed more than 30 percent of consumers who had considered buying GM cars but ultimately decided to buy another brand cited the possibility of GM bankruptcy as their top reason.

Experts say that some consumers would worry that a bankrupt automaker wouldn't be able to honor its warranties or that parts needed for repairs wouldn't be available.

Ron Harbour, a Detroit-based auto industry analyst with the consulting firm Oliver Wyman, said it's also about image.

"Let's say that you buy that car from a company that is bankrupt," he said. "You drive it home and your neighbor goes, 'you bought a car from them? Why would you do that?'"

While experts say that, for now, Ford is less likely than GM and Chrysler to file for bankruptcy protection, they're not ruling it out. If one of its rivals files for bankruptcy, it would actually make Ford more likely to seek bankruptcy protection down the road, they say.

The company is dependent on many of the same auto parts suppliers as GM and Chrysler. If a GM or Chrysler bankruptcy forces parts manufacturers out of business, Ford may find it difficult to continue making cars. Ford has cited the parts issue as a reason why it supports aid for GM and Chrysler.

Ford may also suffer from a public relations problem if GM or Chrysler enters bankruptcy: Consumers could lose confidence in the U.S. auto industry overall, analysts said, and choose foreign automakers rather than Ford.

"If Chrysler and GM were gone tomorrow," Harbour asked, "would people look at Ford and say 'they're just like them'?"

Bankruptcy: A Road to Recovery?

While Fitzgerald believes that consequences of an automaker bankruptcy are "unimaginable," he said that Ford could actually benefit if GM or Chrysler went out of business. With one or two rivals out of the way, he said, the automaker would grab a greater market share.

Meanwhile, scholars like Altman and Richard D'Aveni, a professor of strategic management at the Tuck School of Business at Dartmouth College, say they believe bankruptcy is a better alternative to a government bailout.

"We are going to take the hit to the economy with the failure of the Big Three car companies sooner or later," D'Aveni said. "It's much better to do it now when there's something left to work with in the companies."

D'Aveni said that filing for bankruptcy -- specifically, restructuring under Chapter 11 bankruptcy protection -- would allow automakers the flexibility to dramatically renegotiate their labor contracts, eliminate redundant product offerings and improve the way they sell cars overall.

If GM and Ford were to file for bankruptcy, they would eventually emerge "smaller but stronger."

D'Aveni was less optimistic about Chrysler, which he called "the weaker sister" in the U.S. auto industry. Chrysler's size and its products, he said, make it less competitive in the world auto market than Ford and GM.

Altman said that for a successful Chapter 11 restructuring the companies would have to find what's known as "debtor-in-possession" or DIP financing that would fund the companies' restructuring efforts and also backstop consumers' warrantees.

Altman projected that such financing would amount to $40 billion to $50 billion in loans. Because of the massive amount of money involved, he said, the only lender to provide such funding would have be the federal government.

Riding Out the Worst

Being the DIP would entitle the government to be the first in line when the automakers start repaying their creditors.

The government, said Jack Williams, a scholar in residence at the American Bankruptcy Institute and a business reorganization professor at Georgia State University, would be "a secured creditor with super-priority lien."

That, he said, "would put taxpayers in the best case possible."

Altman said that while such a plan would be an unprecedented move by the government. It would be more successful than the less-expensive $14 billion emergency loan package now under discussion. A Chapter 11 restructuring -- along with government DIP financing -- could help the automakers avoid liquidation and, in the long run, would result in fewer job cuts, Altman said.

The safety net of a bankruptcy, he said, could help the automakers ride out the worst of the recession.

"In two years' time, when they come out of the bankruptcy, there's a better chance that the economy is going to be in better shape and the credit markets will be flowing again to help the companies," he said.