Auto Bailout: Money Now, Cuts Later

Bush announces a $17.4 billion financing package to keep GM, Chrysler alive to March. But the toughest conditions are still to be hashed out

Finally, after a month of hearings, rhetoric, and a dramatic showdown in Congress, Washington has reached a decision over what to do about America's failing carmakers: President George W. Bush announced on Dec. 19 the government will bail them out with a $17.4 billion loan package. The upshot is that taxpayers are now part owners of General Motors (GM) and Chrysler.

Perhaps the biggest surprise in the announcement is that after talk of "orderly" bankruptcy filings and tough conditions, the money will go to the two automakers with essentially no strings attached, but for the requirement that they won't get more money if they don't step up with realistic restructuring plans. If restructuring toward financial viability is not achieved and certified by the Treasury Dept., however, then the companies will be forced to prepare for a "prepackaged" Chapter 11 bankruptcy filing.

The $17.4 billion of loans should carry GM and Chrysler into next year. The two companies will divvy up $13.4 billion for December and January and $4 billion in February to avoid what the President called "a disorderly bankruptcy" and possible liquidation. Ford Motor (F) is not taking loans but is expected to receive a $9 billion line of credit from the Treasury after President-elect Obama takes office.

By the end of February, Obama and the new Congress that will be in place will be able to come up with a long-term plan for more financial assistance and a restructuring to make the companies competitive—and hence, a more secure borrower of tax funds—in the long run. But union officials are already calling on Obama to change the terms of labor concessions in the loan agreements.

Meeting Goals

The conditions of the Bush plan require that GM and Chrysler satisfy a number of restructuring goals spelled out in the legislation that failed to pass in the Senate earlier in December. The companies will have to reach a new wage and benefit agreement with the United Auto Workers and retirees that puts the automakers on parity with foreign companies manufacturing vehicles in the U.S., such as Toyota (TM) and Honda (HMC). Investors holding GM and Chrysler debt will also have to take a huge "cram-down" or discount on their bonds, reducing debt by two-thirds.

A "designee" of the White House, sometimes called a "car czar," will have the authority in the Obama Administration to certify by Mar. 31 that the plans and progress of the companies show financial viability. Unlike the terms of the bill that Congress failed to pass, though, the "car czar" and the White House will have a good deal of discretion to determine what "viability" means.

If the forced restructuring is handled correctly and the government enforces enough of a restructuring, the car companies could emerge stronger than before the credit crisis. Both their long-term debt burden and labor costs will be reduced. "It's a blueprint for a new GM," said GM Chairman and CEO G. Richard Wagoner Jr. "Our goal is to reinvent our company."

Money to Lend?

The companies have been brought to their knees by the worsening recession and credit crunch that has denied car loans to many consumers with good credit ratings. A Treasury official said Friday morning that measures the department and the Federal Reserve are taking will make it likely that banks and the auto companies' finance arms will have more money to lend starting in January.

The White House and Treasury Dept. have weighed an auto bailout since Dec. 11, when the Senate voted down a $14 billion loan plan using Energy Dept. funds originally earmarked for fuel-economy improvements. Bush will use cash from the Troubled Asset Relief Program, or TARP, which was set up to rescue banks.

Bush Administration officials had opposed using TARP funds for the auto companies, arguing that TARP wasn't set up to rescue industrial corporations. But after the Senate killed the auto-bailout proposal, Bush stepped in, saying he feared a collapse of the auto industry would damage the economy at its most fragile point. Bush said a carmaker crash would "exacerbate the economic crisis," and "leave the next President to confront the demise of a major American industry in his first days in office."

Sources close to the Senate discussions say the President also didn't want to see two major industries—first banks and financial institutions and then autos—collapse during his tenure. When Vice-President Dick Cheney tried to get Senate Republicans to vote for the first loan proposal, he told some of them that the Republican party would be tarred with the same brush as Herbert Hoover, whose failed initiatives saw the nation slide into the Great Depression in the late 1920s.

Safeguard Concerns

While the Administration has acted to backstop the carmakers, there are still some unanswered questions. The President said the companies using the funds would have until Mar. 31 to submit a restructuring plan. It must include a reworking of the automakers' debt and bring compensation in line with foreign-owned car factories in the U.S.

That leaves the Administration open to criticism that there aren't enough safeguards for taxpayers from the start. But it also leaves time to work out a real plan. "They did that with good reason," says David Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich. "They need to establish where the industry is and where these companies are headed."

Debt holders are key to GM satisfying the conditions of the government loans. In GM's case, that would slash its automotive debt of $43 billion to about $29 billion. Roughly speaking, it would cut GM's interest costs of more than $3 billion a year by about $2 billion. "That's a big deal," says Cole. "The bondholders are ensured of a big loss if they don't commit to the exchange."

Shareholders will also take a hit. Since the companies will issue warrants to the Treasury, stockholders will eventually be diluted. The UAW will also take equity in stead of cash to fund some healthcare obligations. That means stockholders can expect more dilution.

Chrysler owner Cerberus Capital Management also says it will give up to $2 billion to the automaker. The private equity firm hasn't invested any more cash to fix Chrysler since acquiring the company last year. Members of Congress criticized Cerberus for withholding its own investment dollars while asking for public funds. Cerberus says it will commit future profits of Chrysler Financial Services, the auto lender that is owned by Cerberus as a separate entity. But Cerberus is only committing future profits from the finance company. Spokesman Peter Duda said he didn't know if the lender is in the black, if it isn't then it's doubtful that Chrysler will see any cash from its parent for the foreseeable future.

The UAW will be asked to eliminate the JOBS bank, which pays workers most of their pay while they're on layoff. The union has already agreed to that. It will also be compelled to accept wage and work-rule changes that make Detroit companies "competitive" with foreign makers building cars in the U.S. such as Honda and Nissan (NSANY). Defining "competitive" will be up to the Labor Dept. But the terms of the government loans spell out that the UAW will have to accept half of the value of their health-care trust fund in stock. Last year the UAW and carmakers agreed to accept cash worth 68% of the long-term health-care liabilities to set up a fund that will cover union worker and retiree health care starting in 2010. After that, the carmakers would be out of the health coverage business for hourly workers.

Matching the Japanese

The trouble is the automakers don't have the cash to seed those funds. GM, for example, has to pay $7 billion on Jan. 1, 2010, and more later. By putting stock into the fund, the government ensures that tax dollars won't just set up a health-care fund for union workers and retirees.

The President will designate a car czar to oversee the plan and whether or not targets are met. Treasury officials said Friday the Obama Administration will be able to change any stipulations for the plan.

That's where the negotiating starts. UAW workers cost $78 an hour, which is about $20 an hour more than what Toyota pays its U.S. workers. But most of that cost gap is accounted for by the retiree benefits GM and the other U.S. automakers must pay, which will be greatly reduced by the health-care trust.

The government could make the union accept a lower wage. UAW workers are paid $29 an hour, and Toyota workers max out at $24. But UAW President Ron Gettelfinger countered in an interview with BusinessWeek that Toyota pays its workers bonuses that push per-hour wages over $30.

Plus, Gettelfinger said, the UAW agreed in 2007 that it will reset its starting wage to $14 an hour with a much cheaper benefits package. The carmakers, he maintains, just need to get through the economic crisis so they can start hiring new workers at the lower pay package. Then, he says, the Big Three would have a cost advantage over the Japanese and Korean factories. Says Gettelfinger: "That's why we need to get banks lending and get the economy going."

Gettelfinger said in the interview that the union has done quite a bit to restructure. But he may have to cut wages and benefits to satisfy the government's mandate for compensation parity. That could mean mandating higher premiums and co-pays for union workers on their health-care plan until the VEBA trust kicks in. Gettelfinger has opposed what he calls more "cost sharing." But he indicated the union would do what it takes to get a deal done.

That said, Gettelfinger issued a statement on Friday saying that the union would work with the Obama Administration to remove some of the union concessions from the loan terms. In a statement, the union boss said workers had been unfairly singled out.

The Administration's loan terms also call for total cost parity. So management and the union will have to negotiate how to get there. "We have big steps we have to take," Wagoner says. "We have to show that we can get this stuff done."

The carmakers may also need more money down the line if the economy worsens. Says Cole: "The biggest uncertainty is the recession and the credit markets."

Before it's here, it's on the Bloomberg Terminal. LEARN MORE