It looks almost certain that the U.S. Government will provide aid to the Big Three automakers, and as early as next week (see Frank’s Plan Gives Ford, GM, Chrysler $25 Billion). Although I am ordinarily opposed to government involvement in the private sector, I am willing to concede that these are anything but “ordinary” times. Therefore, I would not oppose some form of aid to auto manufacturers.
In fact, in earlier posts I suggested that the government should provide funding directly to General Motors instead of providing funds to support a GM-Chrysler merger (see GM and Chrysler Near and Agreement, More GM and Chrysler Shenanigans, A Disastrous Deal, and GM + Chrysler = Ugh! for background). I argued that direct capital injections into GM would accomplish far more than funding an unwise merger with Chrysler. I wrote:
I do not view a combination of GM and Chrysler as a welcome development. In fact, turning these two struggling companies with weak balance sheets into one solid company with a strong balance sheet would require so much reorganization that the amount of layoffs, plant closures, and product/brand rationalizations required to achieve that end would effectively eliminate a company the size of Chrysler from the marketplace.
Instead, I believe that money would be better spent on GM alone. My counter-proposal, therefore, was to pump $10B directly into GM (in exchange for warrants or shares) to help it weather the crisis.
My belief is that we will get more bang for our buck from an investment in GM alone than we would from an investment in a combined GM and Chrysler. GM is more systemically important than Chrysler and it is in a much better operational position looking forward.
Although I am not opposed to the idea of providing aid to the auto manufacturers, there is a difference between an investment and an expense. Injecting capital into GM and Ford represents more of an investment. An injection of capital into Chrysler would represent nothing more than an expense.
Ford and GM are on stronger footing than Chrysler in terms of design, quality, operations, global footprint, and so on. Therefore, the plight of GM and Ford bear greater resemblance to a liquidity problem. By providing capital to those two firms, we are making an investment in firms whose products are more fundamentally sound, but that find themselves temporally underfunded. The money would therefore help tide them over until the crisis abates.
By contrast, Chrysler is closer to insolvency than its larger brethren (see Is the End Nigh for Chrysler for details). Any money invested in Chrysler is therefore likely only to delay the inevitable. Moreover, Chrysler is less systemically important than either Ford or GM. It is not even 1/3rd the size of Ford. It’s owners are not dispersed individuals and institutions to which many American pensions are tied. Rather, it is owned by Cerberus, a private investment firm. This raises another issue – whether the use of taxpayer money to bail out Cerberus, a private investment company that was the poster-boy for excess during the credit-fueled private equity binge, is justified in the first place.
For all these reasons (and more), the U.S. taxpayer would be better served making an investment in GM and Ford, and leaving Chrysler to its own devices.
But now the question becomes: How do we best structure the terms that go along with the capital infusion to insure that GM and Ford don’t become serial beggars?
For the capital injections to work, they must contain provisions that provide GM and Ford incentives to right their respective ships. This means a moratorium on any acquisitions (whether with Chrysler, or otherwise). This means rationalizing operations. Both automakers need to reduce the number of brands and models it offers. Both automakers need to retrench, and shut down a variety of plants. Both automakers also need to restructure relationships with the UAW to make them more competitive vis-a-vis their global competitors. Incentives should be provided to build more fuel efficient automobiles. Finally, the GM and Ford should be explicitly encouraged to divest themselves of marginal brands (e.g., Saab, Volvo).
In addition to the operational covenants that I have proposed, the U.S. taxpayers should receive additional protection through the deal’s capital structure (either via senior debt, or some kind of super-senior preferred equity).
In sum, any capital provided to automakers should come with provisions that incentivize them to see through important operational changes, and that impose sufficiently painful investment terms. It is only by imposing discipline of this sort that we improve the chances of achieving a return on our investment, and insure that we do not see these borrowers several months from now begging for more.