The 2008 U.S. Auto Industry Bailout: GM and Chrysler

Introduction to the 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 sought federal assistance because their potential collapse could result in approximately 3 million layoffs within a year — a outcome that could plunge the American economy further into recession. The three major firms were General Motors, Ford, and Chrysler. The bailout of General Motors and Chrysler was intended to provide operating cash for both companies and to make auto loans available to car buyers.

However, many people in the United States opposed the automotive bailout, arguing that these American automakers had brought near-bankruptcy upon themselves. Critics contended that the automakers had failed to retool for an energy-efficient era, which eroded their competitiveness in the global market.

In addition to assistance extended to Ford Motor Company, the bailouts of General Motors and Chrysler totaled approximately $34 billion in government loans. Both companies promised to accelerate development of energy-efficient vehicles and to consolidate operations. As part of the agreements, General Motors promised to streamline the number of brands it manufactured. These firms also secured agreements from the UAW union to delay contributions to a health trust fund for retirees and to reduce payments made to laid-off workers (Amadeo, par. 5).

Specifics of the GM and Chrysler Bailouts

General Motors obtained $6 billion through GMAC, which became a bank holding company. The company requested $18 billion in total loans, of which $4 billion was required immediately 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 and preferred stock, and to repay the government loan by 2012, when it expected to break even. The company also agreed that union health-care benefits would be paid to retirees beginning in 2010. The deal further included promises to sell certain divisions — such as Saturn, Hummer, and Saab — reduce the number of models manufactured to 40, and cut employment to 45,000 by 2012.

Chrysler's bailout, by contrast, involved a $1.5 billion loan under the Emergency Economic Stabilization Act (EESA) made to Chrysler Financial, a new financing entity established for this purpose. This loan carried an interest rate of more than one percentage point above the London Interbank Offered Rate (LIBOR). Chrysler Financial promised to repay the government $75 million in notes and to reduce executive bonuses by 40%, which would in turn enable car buyers to obtain 0% financing on select models for up to five years.

While Chrysler initially requested a $7 billion bridge loan, it ultimately received $4 billion. Additionally, Chrysler requested $6 billion from the Department of Energy to retool for more energy-efficient vehicles. Cerberus, Chrysler's owner, also promised to convert the firm's debt to equity. Chrysler further proposed that the three major automotive companies partner with the federal government in a joint venture aimed at developing alternative-energy vehicles. In its loan request, Chrysler committed to introducing an electric vehicle by 2010, with production rising to 500,000 units annually by 2013.

Although General Motors and Chrysler both requested government loans during the same period to avoid bankruptcy, there were notable differences in the circumstances surrounding each bailout.

According to Levin and Christie, Chrysler's sales had declined by 53% in December 2008, following a 30% decline in U.S. sales the previous year (par. 4). The 30% drop in Chrysler's domestic sales in 2007 was the steepest among the major automotive companies in the country. This decline was partly attributable to a contraction in industry-wide deliveries of at least 27% in each month of the final quarter of 2008, driven by the credit crunch. Economic analysis suggested that Chrysler's December 2008 sales decline could have been limited to 30% had the company had more capital to lend to customers.

Differences in Financial Position

At the time General Motors was requesting its bailout, the company had warned that it was in danger of falling below the minimum cash reserves needed for continued operations (Isidore, par. 28). Unlike Chrysler, General Motors was experiencing such severe financial pressure that it was nearly running out of operational cash entirely. The company was essentially seeking funds to finance operating losses caused by severely reduced production levels in North America.

The other major difference in the automotive bailouts of General Motors and Chrysler was the purpose for which each loan was requested. As previously noted, General Motors primarily sought the loan to cover operating losses resulting from prevailing industry conditions and the extremely low levels of North American production. Chrysler, on the other hand, requested a working capital bridge loan to help boost sales and rescue the company from near collapse. Moreover, Chrysler's loan was structured differently from most other federal loans, since Chrysler Financial created a separate entity to receive the funds and issue new auto loans, rather than investing the money directly into the parent company.

The government's involvement in bailing out General Motors and Chrysler was primarily aimed at preventing a disorderly bankruptcy in the automotive industry. Generally, the government has a responsibility to protect the broader stability and health of the economy. The federal intervention was therefore considered a necessary step to prevent the collapse of the auto industry and the potentially devastating consequences for workers and the wider economy. As conditions of the loans, the government required both firms to overhaul poor management practices and commit to long-term restructuring plans. Chrysler and General Motors were also required to limit executive compensation, eliminate perks such as corporate jets, and issue warrants to the government. Furthermore, the companies were required to reduce their debt loads by two-thirds through a debt-for-equity exchange with existing bondholders. Both companies met most of these requirements and the established benchmarks that enabled them to receive the loans.

Conclusion

Levin, Doron, and Rebecca Christie. "Chrysler Financial Gets $1.5 Billion to Aid Car Sales (Update4)." Bloomberg. Bloomberg L.P., 16 Jan. 2009. Web. 29 Nov. 2012.