TARP funding for the American automotive industry during the financial crisis

TARP and American Auto Companies

Of the $1.1 trillion in authorized bailout funds for financial firms and banks ($700 billion Troubled Asset Relief Program (TARP) and $400 billion for Fannie and Freddie) over $450 billion is still uncommitted and unused (This doesn't count the $68 billion that was repaid by bailed out banks the week of June 15th) (Source). This paper discusses why these funds should also be used to help the beleaguered automotive industry. Although the intent of TARP was restricted to financial institutions, the President has the right to exercise executive power to use the funds for other purposes during times of crisis. Certainly, the potential devastating impacts of an automotive industry meltdown warrants such action despite concerns over interrupting free market dynamics. Throughout history, the government has assisted industries and companies in the national interest of this country. In fact, prior intervention in the automotive industry was successful. With a continuation of its policies to temporarily provide taxpayer money to rescue ailing firms, especially in a very fragile economy, the government is making an investment that in the long run that will be profitable, thus beneficial to everyone involved.

The Legal and Political Debate

In October 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 which created TARP. This program authorizes the Department of the Treasury to purchase or insure up to $700 billion of troubled assets. The term "troubled asset" is defined as ("The Troubled Asset Relief Program: Report on Transactions through December 31, 2008," 2009):

"(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and (B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress."

Opponents of using TARP funds to bail out the auto industry believe this move is unconstitutional. In supporting their argument, they point to Article 1, Section 9 of the Constitution, which states that, "No money shall be drawn from the treasury, but in consequence of appropriations made by law." (cited in Meyers, 2009). They continue on in their debate to emphasize the lack of such appropriations by the Emergency Economic Stabilization Act of 2008. Indeed, this Act limits the recipients of TARP funds to financial institutions which are clearly defined according to the following criteria (cited in Grossman and Gattuso, 2008):

"The term 'financial institution' means any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the United States or any State, territory, or possession of the United States, the District of Columbia, Commonwealth of Puerto Rico, Commonwealth of Northern Mariana Islands, Guam, American Samoa, or the United States Virgin Islands, and having significant operations in the United States, but excluding any central bank of, or institution owned by, a foreign government."

Add to the debate the fact that Congress failed to pass a bailout bill of its own for automakers, and those against using TARP for the auto bailout state that they have more than made their case that the actions by both Presidents Bush and Obama are illegal.

However, precedents relying upon constitutional authority and congressional delegations made at various times over the past 200 years have granted the President of the United States the right to exercise executive authority when the nation is threatened by crisis, exigency, or emergency circumstances (Relyea, 2001). An emergency requires immediate action, but is, as well, unanticipated and, therefore, cannot always be "dealt with according to rule" (Relyea, 2001). Thus, on December 19, 2008, President Bush legally used his executive authority when he declared that TARP funds be spent on the auto bailout in order to avert financial crisis (Liu, 2009). At that time, Chrysler and General Motors would have been insolvent in January 2009 (Kiley, 2008). While Ford had enough cash to last until 2010, bankruptcy filings by Chrysler and General Motors would have also dragged down Ford and hundreds of auto suppliers because of the interdependencies of the industry (Kiley, 2008).

Adding to the political turmoil, the government soon revealed that the 17.4 billion in low-interest loans that Bush had just approved for General Motors and Chrysler would not be enough to avoid bankruptcies. Under the Obama Administration, both companies have recently headed to bankruptcy court. Chrysler's bankruptcy filing involves the assistance of another $8 billion in taxpayer money and a restructuring that would consist of ten percent ownership by United States. And Canadian governments, 35% ownership by Fiat and 55% ownership by the United Autoworkers ("Obama Backs Chrysler Bankruptcy," 2009). General Motors, on the other hand, would require even more government assistance with United States financial aid for the company expanding to nearly $50 billion (Miller, 2009). This investment would be in exchange for a United States government stake in the company of 60%. Also, under the bankruptcy plan, Canada agreed to provide $9.5 billion in funding and would get a 12% stake. The United Auto Workers union would have 17.5% share of General Motors, and bondholders would get a ten percent stake (Miller, 2009). The magnitude of the bankruptcy is tremendous; General Motors' bankruptcy will be the fourth largest in the history of the United States and the largest ever by an industrial company (Miller, 2009).

Political opponents of General Motors' partial nationalization are clearly unhappy with the notion of the government running a company using taxpayer dollars. These critics doubt that the government will be able to meet its objective to sell off shares of General Motors in six to 18 months time and, therefore, question if taxpayers will ever get their investment back. Opponents' concerns range from legal challenges to the uncertainty of when consumer demand for new cars, particularly those from a poorly perceived General Motors, will rebound (Helliker, King and Stoll, 2009). Opponents of nationalization also worry that liquidation of unwanted plants could take years and that Congress will interfere in the company's daily operations and business plans (Helliker, King and Stoll, 2009).

Despite these political criticisms, Obama aptly defends his nationalization plan by referring to it as temporary and stating that, "We are acting as reluctant shareholders because that is the only way to help GM succeed." (Thomas, Kuhnhenn, Espo and Johnson, 2009) According to these authors, due to the dire financial consequences, Obama did not believe in letting General Motors fail outright and he also did not think that giving it more bailout loans would work. Instead, Obama wants General Motors to start over with a clean slate, operating from the strongest parts of its business with one-third few workers, 40% less dealerships and nine less plants. In addition, General Motors' new deal with the United Auto Workers, will deliver considerable cash savings, and will place the company's labor costs on a more level playing field with competitors such as Toyota and Honda Motor (Helliker, King and Stoll, 2009). For example, General Motors has cut hourly costs, such as overtime provisions, supplemental unemployment and entry-level pay rates, by more than $1.5 billion a year.

Further, throughout history, the government has nationalized industries due to economic necessity. It has taken shares in railways, steel mills, coal mines and foreclosed homes as well as taken over failed savings and loans in the 1980s (Thomas, Kuhnhenn, Espo and Johnson, 2009). In the current economic crisis, the government has also taken stakes in banks and insurer American International Group as well as taking control of mortgagers Fannie Mae and Freddie Mac (Thomas, Kuhnhenn, Espo and Johnson, 2009), leading one to question why the vital automotive industry should be excluded from government control in times of economic distress.

In response to criticisms that government doesn't know how to run a business, Obama counters that, "GM will be run by a private board of directors and management team…They -- and not the government -- will call the shots and make the decisions about how to turn this company around. The federal government will refrain from exercising its rights as a shareholder in all but the most fundamental corporate decisions." (Thomas, Kuhnhenn, Espo and Johnson, 2009)

From an industry perspective, a bankruptcy without government assistance would have crippled Chrysler and General Motors. The automotive industry relies on brand power which is built over years, but can be lost in a blink of an eye. In order for revised versions of the companies to be sustainable and make sales, they have to demonstrate to vehicle buyers and owners that they can to meet their current, past and future obligations.

Summary

The President of the United States must be able to lead the country through an emergency or crisis and is granted executive powers to do so. A collapse of the Big Three automotive companies would have crippled the economy of the United States. With two bankrupt and the other surely to follow, the President made a wise decision to rescue Chrysler and General Motors by using TARP funds originally intended for financial institutions. Opponents of the auto makers' bailout are justly concerned that the Big Three are struggling in large part due to their inability to compete against foreign competitors. No wonder they feel like the government is throwing money into a rat hole. However, the bailout is coming with massive requirements to restructure that should spark greater innovation and cut costs so that they are in line with lower-cost producers. While temporarily distorting free marketing dynamics, this is a frequent practice of countries throughout the world. The goal should be to promote free trade, but not at the expense of losing an entire industry that is so vital to United States economic interest. Therefore, Bush and then Obama have both made the best decision to bailout automotive companies given the circumstances they faced, certain failure with dire consequences.