Automotive industry bailout during the financial crisis

Automotive Bailout:

The three major firms in the United States automotive industry asked the government for a bailout worth $34 billion in December 2008 in order to avoid bankruptcy. These companies asked for the bailout from government because their demise could result in approximately 3 million layoffs within a year, a measure that could plunge the American economy further into economic recession. These three major firms in the American automotive industry are General Motors, Ford, and Chrysler. The bailout of General Motors and Chrysler was to provide operating cash for both companies and to avail auto loans for car buyers. However, many people in the United States opposed the automotive bailout arguing that these American automakers brought the near-bankruptcy on themselves. They argued that these automakers inflicted the bankruptcy on themselves through failure to retool an energy-efficient era, which resulted in lessening their competitiveness in the global market.

Specifics about Automotive Bailout:

In addition to the bailout of Ford Motor Company, the bailout of General Motors and Chrysler totaled approximately $34 billion in government loans. These companies promised to accelerate development of energy-efficient car and consolidate operations. As part of the agreements, General Motors promised to streamline the number of brands they manufacture. These firms also won agreements from the UAW union to help them delay contributions to a health trust fund for retirees and lessen the payments made to laid-off workers (Amadeo, par, 5).

In the bailout, General Motors obtained $6 billion through GMAC that became a bank holding firm. The company requested for $18 billion in loans with which $4 billion was required to avoid bankruptcy before the end of that year. As part of this agreement, General Motors promised to provide the government with warrants for common stock, preferred stock, and to repay the governmental loan in 2012, when it expects to break even again. Furthermore, the company agreed the union health-care benefits would be paid to the retirees in 2010. It also included promises to selling some of its divisions like Saturn, Hummer, and Saad, lessen the number of the models its manufactures to 40, and reduce employment to 45,000 by 2012.

On the contrary, Chrysler's bailout involved a $1.5 billion EESA loan made to Chrysler Financial, a new financing corporation that was established for this purpose. This loan was subject to an interest rate of more than 1 point above London InterBank Offered Rate (LIBOR). On its part, Chrysler Financial promised to repay the government $75 million in notes and lessen executive bonuses by 40%. This will in turn enable car buyers to obtain 0% financing for some models in a period of five years.

While the automotive firm initially requested for $7 billion bridge loan, it received $4 billion. Furthermore, Chrysler requested for $6 billion from the Department of Energy to retool for more energy efficient vehicles. On the other hand, Cerberus, Chrysler's owner, promised to convert the firm's debt to equity. In addition, Chrysler wanted the three major automotive companies to partner with the federal government in a joint venture that is geared towards developing alternative energy vehicles. In the request for the governmental loan, Chrysler promised to introduce an electric vehicle in 2010 that will rise to 500,000 by 2013.

Differences in General Motors' and Chrysler's Bailout:

While General Motors and Chrysler requested for government loan during the same period in order to avoid bankruptcy, there are some differences in these bailouts such as:

Financial Position:

According to Levin & Christie, Chrysler's sales had declined by 53% in December, which accompanied the decline of the firm's U.S. sales by 30% the previous year (par, 4). The decline in Chrysler's sales in the United States by 30% in 2007 was the most among the main automotive companies in the country. This decline was partly contributed by the decline in industry deliveries by at least 27% in every month of the final quarter of 2008 because of the credit crunch. According to analysis by an economic forecasting company, Chrysler's decline in sales by 53% in December 2008 could have only reduced by 30% if the company had more money to lend.

At the time General Motors was requesting for bailout from the government, it had warned that it would fall below the minimum cash it needs for continual operations (Isidore, par, 28). Unlike Chrysler, General Motors was experiencing major financial challenges to an extent that it was nearly running out of operational cash. The company was basically looking for money to finance operating losses brought by the very low level of production in North America.

Purpose of Loan:

The other major difference in the automotive bailout of General Motors and Chrysler is the purpose of the requested loan. As previously mentioned, General Motors basically requested for the loan in order to fund the operating losses it was experiencing due to the prevailing industry conditions and the extremely low levels of North American production. On the contrary, Chrysler requested for a working capital bridge loan to help boost its sales and rescue the company from near collapse. Moreover, Chrysler's loan was structured differently than many other loans since Chrysler Financial created a separate entity to receive the loan and make new auto loans instead of investing the money directly.

Requirements for the Bailout:

The government's involvement in bailing out General Motors and Chrysler was mainly geared towards preventing disorderly bankruptcy in the automotive industry. Generally, the government has the responsibility to protect the wider stability and health of the economy. Therefore, the government's intervention in these firms was a necessary measure for preventing the collapse of auto industry and the potential devastating impacts on the economy and workers. However, as part of providing loans to General Motors and Chrysler, the government established some requirements for these firms. These requirements included transforming bad management practices and long-term restructuring. Chrysler and General Motors were also required to limit the compensation of their executives, remove perks like corporate jets, and issue warrants to the government. Moreover, the companies were required to lessen their debt load by two-thirds through a debt for equity exchange with present bondholders. These companies met most of these requirements and the established targets that enabled them to receive the loans.