The Big Three: Bailout or Bankruptcy?

by jchambe4 March 7 2009, 14:21

I. Introduction

The auto industry’s troubles have recently come to light in mainstream American news. The big three automakers, comprised of GM, Chrysler and Ford, have seen slumping sales and are in need of major financial help to avoid going under. In 2008, GM’s sales were down 21% in North America. [1] Ford reported a loss of $14.6 billion dollars in the same year. [2] Chrysler’s sales were down 30% in 2008, which was the largest reported loss of the major auto makers last year. [3] Both GM and Chrysler have requested help in the form of federal loans from the US government, while Ford has made an effort to stay afloat without federal help. [4]

II. Government Intervention

The auto industry is a private industry and is thus driven by market forces. Generally, the government allows these market forces to determine which companies will thrive and which will fail. However, some have claimed that certain companies are just too large for the government to sit back and allow them to fail. GM, Chrysler and Ford would fall into this category. Because of this, the government stepped into the equation in September of 2008. In September, the U.S. Department of Energy promised to provide $25 billion in loan guarantees to auto makers that will be making more fuel efficient vehicles. [5] Auto makers were to submit requests for this money by the middle of December of 2008, and many have done so. [6] In December of 2008, the government also provided billions of dollars in loans to the struggling automakers. Chrysler received $4 billion in federal bridge loans. [7] In the same effort to revive the failing industry, GM was granted $9.4 billion in federal loans and a Treasury Department loan of $6 billion. [8] While Ford has taken a backseat to GM and Chrysler in this bailout, they too requested a $9 billion line of credit from Congress. [9] The auto makers were granted these loans on a promise that they would begin turning a profit by 2012.

While these loans are by no means small, they are only a small percentage of what will be required to keep these companies running. Because of this, the troubled automakers are requesting even more money from Congress. Congress and the current administration are determined to keep these companies afloat. In a recent speech to a joint session of Congress given in February, President Obama stated that “[he] believe[s] the nation that invented the automobile cannot walk away from it." [10] While this statement is incorrect, considering it was a German engineer, and not an American who invented the automobile, it demonstrates the current administration’s stance on the issue. [11] By March 31, 2009, GM and Chrysler will have to present a plan to congress laying out what steps it plans to take in order to remain viable, at which time Congress will again decide whether to loan the automakers more money. [12]

III. The Auto Industry’s Long Standing Problems

With all of the recent attention to the automaker’s financial troubles, it might be presumed that the financial problems are of a recent nature. The auto industry would like to tie its current problem into the recent economic downturn and have the public believe that their problems are economic in nature. Clearly this is not the entire truth. While the current economic crisis has surely affected the auto industry, their financial problems go back much further and deeper. Automakers have been reporting losses for the last several years and at different points throughout the last several decades. [13] These long term troubles stem from major defects in the way that the automakers are structured and their inability to effectively compete with foreign manufacturers. One of the biggest problems in the Big Three’s structure is their contract with The International Union, United Automobile, Aerospace and Agricultural Implement Workers of America (UAW). [14] The UAW is one of the largest unions in America, with approximately 513,000 active members. [15] The fact that the employees of the Big Three belong to this Union means that they have incredible bargaining power. If the Union decides to go on strike because of a disagreement, this greatly affects the auto industry’s ability to conduct business. Because of this fear, and because of a period of good business in the 1990’s, the UAW’s requirements of the automakers are far too demanding and cost the automakers far too much money. A huge portion of the Big Three’s expenses are benefits paid out to employees, former employees, and retirees. While job security is of course important, the UAW has gone too far in its demands, which have cost the auto industry dearly. [16] The increased costs that the Big Three incur due to the contracts with the UAW make it difficult to compete with foreign manufacturers dealing in this country. [17] With lower production costs, these foreign companies can create an equal car at far less cost to the consumer. While there is little likelihood the UAW will go anywhere anytime soon, especially if the government decides to bailout the industry, automakers must find a way to reduce the costs associated with UAW contracts. Further adding to the Big Three’s problem is their huge amount of products and dealers. With so many different products, and not enough demand, the companies will surely lose money in producing different vehicles, some of which do not sell.

IV. Risk of Further Governmental Intervention

If the Big Three fails, it could be disastrous to the US economy, but a government bailout is not the only option. The failing automakers also have the option of filing bankruptcy with a comprehensive bankruptcy plan in place. While bankruptcy is a possible solution, the auto industry and the current administration have been arguing that receiving government loans is the auto industry’s best chance of surviving their financial disaster. [18] Automakers have already received a large governmental bailout, but Congress should refuse their further requests for more money. The risks involved in providing more bailout money are numerous and large. First, there is a giant risk to the automobile industry itself, in that a bailout plan would not require enough restructuring and oversight to actually fix the automakers problems. As shown above, the automakers do not simply need money. They need to completely restructure their current contracts with the UAW in order to be able to price their vehicles competitively with foreign automakers and turn a profit. A second major risk is that Americans will begin to assume that the government will involve itself whenever a large company fails. This would defeat the purpose of having a private sector and could just prolong the company’s problems rather than solve them. Further, when the government steps into the private sector, that sector becomes politicalized, something the private sector should not be. Another major risk is that the taxpayers will not be repaid the loan money, and that the automakers will still end up folding. This might impact the way the public views the government and whether they trust the government to make decisions with their tax dollars, especially since 75% of American’s already oppose the bailout. [19]

V. The Bankruptcy Option

The automakers claim that their other option, filing bankruptcy, would affect consumer confidence, further impacting their sales and hurting them even more. [20] They argue that consumers will be hesitant to purchase vehicles from a company that may not be around to honor warranties or be able to service those vehicles. While it is true that consumers may have less faith in a company who has declared bankruptcy, the automakers have already lost their consumer confidence. The public is well aware of the financial problems of these companies, and declaring bankruptcy would probably not further any consumer hesitance. Filing Chapter 11 bankruptcy would allow these automakers to restructure themselves and attempt to become profitable. [21] There are several Sections of Chapter 11 that are of particular significance to the failing automakers. The first is Section 363 which allows a debtor who files bankruptcy to sell off its assets free and clear of all liens, claims and encumbrances. [22] This would allow buyers to purchase GM and Chrysler’s distressed assets with clean title. This could not necessarily happen outside of a bankruptcy filing and could give consumers confidence in purchasing a Big Three product. Another important section is Section 365 which allows a debtor in bankruptcy to reject an executor contract release. [23] This is important because it would allow the automakers to breach some of the enormous amount of dealer agreements which are not easy to break outside of Bankruptcy. Breaking dealer agreements would benefit the automakers because there are currently many more dealers than necessary to supply the demand for vehicles.  Furthermore, Section 1113 would allow the automakers to deal with their collective bargaining agreements. [24] This means that they would have a chance to renegotiate their Union contracts or argue for a judicially imposed change in those agreements if the Union will not renegotiate.  Because these Union contracts are such a hindrance to generating profits for the Big Three, renegotiation of these contracts should place the automakers in a much better financial situation.

IV. Conclusion

Filing bankruptcy does not come without risk, but these risks are much more tolerable than those created if Congress provides the failing automakers with more loans financed with taxpayer dollars. The automakers will likely come out of bankruptcy smaller and able to provide fewer jobs. Losing some jobs is not the perfect solution, but it is the preferred solution when the other possibility is to lose all the jobs provided by the companies. Losing all the jobs provided by these companies is a real risk with the bailout plan because the bailout plan will only prolong the problem, not fix it. The risk that the companies will lose consumer confidence if bankruptcy is filed is greatly exaggerated by the automakers and is probably more of a fiction than reality here. Bankruptcy is the automakers’ best option, providing them with a chance to restructure their companies in a way that will make them sustainable and profitable in the long run.

 

Endnotes:

[1] Chris Isidore, GM Loses Sales Title to Toyota, CNN, Jan. 21, 2009, available at http://money.cnn.com/2009/01/21/news/companies/gm_toyota_sales/.

[2] Kimberly Johnson and Tom Krisher, Ford Posts $14.6B 2008 Loss, Still Won’t Seek Aid, YAHOO! FINANCE, Jan. 29, 2009, http://finance.yahoo.com/news/Ford-posts-146B-2008-loss-apf-14200493.html.

[3] Jeff Green and Keith Naughton, Chrysler Increases U.S. Aid Request to 9 Billion, BLOOMBERG, Feb. 17, 2009, available at http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=aR9ub_Rrfdic.

[4] Chris Isidore, Auto Bailout Tab Could Top $130 Billion, CNN, Feb. 18, 2009, available at http://money.cnn.com/2009/02/18/news/companies/auto_bailout/index.htm [hereinafter Chris Isidore, Auto Bailout Tab Could Top $130 Billion].

[5] Joseph R. Szczesny, The Auto Bailout Keeps Growing, and Growing, TIME, Jan. 14, 2009, available at http://www.time.com/time/business/article/0,8599,1871519,00.html.

[6] Id.

[7] Id.

[8] Id.

[9] Isidore, Auto Bailout Tab Could Top $130 Billion, supra note 4.

[10] Todd Spangler, Obama: ‘The nation that invented the automobile cannot walk away from it,’ FREEP,  http://www.freep.com/article/20090224/NEWS15/90224099/1285/Obama+++The+nation+that+invented+ the+automobile+cannot+walk+away+from+it+.

[11] Madalina Iancu, Obama: We Invented the Automobile! No, Actually…, AUTO EVOLUTION, Feb. 25, 2009, http://www.autoevolution.com/news/obama-we-invented-the-automobile-no-actually-4470.html.

[12] Zac Bissonette, Bait and Switch: GM Slashes Sales Forcast, BLOGGINGSTOCKS, Jan. 15, 2009, http://www.bloggingstocks.com/2009/01/15/bait-and-switch-gm-slashes-sales-forecast/.

[13] Jeff Dulgar, Bloated, Over-demanding UAW Suffocates American Auto Industry, DAILY NEXUS, Oct. 16, 2007, available at http://www.dailynexus.com/article.php?a=14738.

[14] Paul Mongerson, UAW is Cause of the Auto Problem, OUR BLOOK, http://www.ourblook.com/Auto-Bailout/UAW-is-a-cause-of-the-auto-problem.html (last visited Mar. 4, 2009).

[15] UWA Who We Are, available at http://www.uaw.org/about/uawmembership.html (last visited Mar. 4, 2009).

[16] Mongerson, supra note 14.

[17] Richard W. Evens, UAW (Not Auto Industry) Bailout, ECONOSSEUR, Dec. 9, 2008, available at http://www.econosseur.com/2008/12/uaw-not-auto-industry-bailout.html.

[18] Ken Thomas, Auto Task Force Balks at Bankruptcy Option, TIME, Feb. 24, 2009, available at http://www.time.com/time/business/article/0,8599,1881501,00.html.

[19] James R. Healey, Support Wanes for Additional Automakers Aid, USA TODAY, Feb. 24, 2009, available at http://www.usatoday.com/money/autos/2009-02-24-aid-support-automakers_N.html.

[20] Ray Wert, Why GM Doesn’t Want Bankruptcy, JALOPNIK Feb. 18, 2009, available at http://jalopnik.com/tag/gm-bankruptcy/?id=5155616.

[21] Id.

[22] 11 U.S.C. § 363 (2006).

[23] 11 U.S.C. § 365 (2006).

[24] 11 U.S.C. § 1113 (2006).

Comments (5) -

5/17/2012 12:04:06 PM #

nieruchomości Poznań

Good article, keep them alive.

nieruchomości Poznań Netherlands

5/20/2012 4:54:38 AM #

<a href="http://forextradingforbeginners101.com">George</a>

Although some people were against the bailout of the Big Three, as it turned, it was good that the government bailed out.  The Big Three are now making good profits and contributing to the US economy and jobs.

<a href="http://forextradingforbeginners101.com">George</a> United States

5/21/2012 8:48:21 AM #

Jennifer

As it turned out, it was a great move by the big three automakers.

Jennifer United States

6/8/2012 11:25:09 AM #

H. Pylori

It's fair to say that the auto industries form a critical part of the manufacturing infrastructure of the most of the worlds developed economies, from a financial, jobs and prestige perspectives. Governments just have to step in when these industries are troubled, no point worrying about it and giving yourself ulcers, it's a simple fact.    

H. Pylori United Kingdom

6/9/2012 3:43:57 AM #

Persian Kittens For Sale

The blog was absolutely fantastic! Lots of great information and inspiration, both of which we all need!

Persian Kittens For Sale United States

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