How often have you asked yourself the question, “What if I had done it differently?” Many people have speculated about the fate of the domestic auto industry had Washington not poured more than $80 billion in taxpayer money into the breach of impending bankruptcy at General Motors and Chrysler (even more when you factor in auto suppliers).
Apologists for the bailout assert that were it not for the federal government’s emergency intervention, America would have lost one of its premier industries, along with a critical mass of skilled labor, physical plants, technology, and suppliers. Michigan, by default — with 20 percent of its $340 billion economy tied directly and indirectly to automotive-related manufacturing, along with sales and service activities — would have experienced a $60 billion to $70 billion annual economic hit for several years.
Critics of the bailout, on the other hand, point to Ford Motor Co. — which reported a record $20.3 billion in profits for 2011 — as proof positive why direct government intervention was not needed as a turnaround agent. After all, Ford rejected taxpayer funding and, rather than going bankrupt, adapted swiftly and durably to reality, thereby overcoming an existential economic threat.
Undoubtedly, elements of truth support both views, but reality is what it is. Though the economic impact of alternative courses of action in GM’s situation are speculative, the “What if?” question regarding the taxpayer bailout is valuable, and deserves the most objective response.
Whether analyzing the actual Washington-structured bankruptcy or the speculative, but unused, Chapter 11 court-sequenced bank-
ruptcy-protection route, the purely economic impact of GM’s bankruptcy hinged largely on issues related to unprecedented illiquidity affecting U.S. financial markets at the time.
The government-engineered bail-out portends another looming crisis: the Obama administration’s aggressive curb on auto tailpipe emissions. By 2025, cars and light trucks must meet an average 54.5 miles per gallon, which represents a 40 percent reduction in fuel consumption compared with today’s vehicle lineup.
The new Corporate Average Fuel Economy (CAFE) standards could severely crimp the domestic industry’s fortunes, given consumers would be reluctant to pay as much as $6,000 more for a car or light truck. Arguably, the nation needs a comprehensive energy strategy rather than pigeonholing the domestic auto industry — a fact that has eluded Washington for decades.
The similarities between the recent bankruptcy proceedings and the lead-up to the 2025 fuel economy regulations are telling. Another crisis is possible, given the right set of circumstances. Indeed, even a mere four years later, it is difficult to fully comprehend the sense of panic and the degree of market disorientation that existed during 2008 and 2009.
While few found comfort watching politicians who can’t balance the nation’s budget grill the CEOs of the Big Three automakers in the fall of 2008 — many of the OEMs’ problems were self-inflicted, although CAFE standards set by the political regime in the 1970s were as much to blame — we now know the short-term outcome of the GM and Chrysler bankruptcies.
So what are the expected longer-term economic effects of these restructuring alternatives and outcomes, coupled with the 2025 fuel economy regulations, for the state of Michigan?
Past is Prologue
Comparing the former GM with the automaker that emerged after a formal bankruptcy filing in July 2009 is beneficial. The automaker shed major production brands: Pontiac, Saturn, Hummer, Goodwrench, and Saab. Its domestic employment rolls fell by more than 22,000 (GM now employs 76,000 at domestic facilities). The number of GM dealerships shrank by nearly 1,000, costing another 50,000-70,000 jobs. The company also shuttered 13 U.S. plants.
From these out-of-the-gate downsizings, it stands to reason that if GM had not received the cash liquidity injections necessary to continue operating during the bankruptcy proceedings (assuming private lending sources remained frozen and unavailable), GM would have been liquidated, never to re-emerge as a going concern to serve and service automotive products in the marketplace.
Moreover, in the absence of taxpayer-supplied cash to GM, those who support the government-led bailout suggest the likelihood of a severe cascade. Supporters assert that GM’s liquidation would have sunk hundreds of suppliers (small and large), as the automaker’s purchasing requirements spanned such an immense and dependable cross-section of clients among scores of industries throughout Michigan and the rest of the country.
The reasoning is rational: Already mired in a steep recession, many of GM’s suppliers, no longer hopeful of receiving on-time payments for deliveries, would have declared insolvency — causing Ford, Chrysler, and possibly other Michigan-headquartered automakers and suppliers to topple.
Rather than pursuing a government-led bankruptcy, critics of Washington’s intervention maintain that normal bankruptcy procedures under Chapter 11 would have afforded court protection (against creditors) sufficient to enable GM to sell, mothball, or streamline enough of its plants, equipment, name brands, patents, and other assets to cover its operations for long enough to transcend the desperate period of low demand for its products and services.
This view contends that GM would not have faced liquidation because, although the automaker was undeniably frozen out of external financing, the public’s demand for motor vehicles (and GM’s technology for competing for that sales revenue) remained intact, just as it did in the wake of the 9/11 terrorist attacks.
Moreover, this line of reasoning suggests that normal Chapter 11 would have provided GM with more flexibility in dealing with labor contracts, thereby avoiding an expropriation of much bondholder wealth, unrecoverable billions in taxpayer funds, and the transfer of stock ownership from individuals and their pension funds to Canadian and U.S. UAW pensions, health care benefits, and other bargaining causes, as well as GM ownership.
So, the essential disputation for this line of argument pivots around the wisdom of setting legal precedents for government intervention prior to formal bankruptcy, particularly in dealing with troubled firms in the private sector. These critics also challenge the federal government’s provision of large sums of cash (called “debtor in possession” funds) to pay GM’s suppliers and distributors during the hiatus between the recession’s bottom and a revival in overall demand for motor vehicles.
In normal times, in a competitive market system, the purely economic case for bankruptcy is straightforward and compelling. Why? Because during normal times, economic solutions and financial options based on hundreds of actual examples of companies facing bankruptcy and progressing through court claims and protections has worked quite well. Within the past generation alone, Chapter 11 filings and workouts have improved the long-run effectiveness of many major industries: Telecommunications, energy, entertainment, education, finance, steel, aerospace, health care, and the legal industry, to name a few.
There are common threads in bankruptcy filings. Struggling firms confront both short- and long-term challenges. In the short term, transitioning from financial chaos and decay to stability and profitability typically presents a period of employment upheaval, personnel displacement, and serious emotional disorientation. The longer-term adjustments embody equally significant — but somewhat more positive — dynamics, particularly in instances of survival and successful emergence from bankruptcy.
Some companies enter Chapter 11 protection and return to market operations considerably strengthened. Some die and are liquidated. In liquidation, any remaining land, physical assets, or intellectual property is sold or auctioned off. In nearly all cases of liquidation (firms unable to emerge from bankruptcy), the common denominator is the disappearance of market demand for a particular product(s). Computers have pretty much replaced typewriters, just as cell phones now threaten land-line phone installations. Firms facing liquidation under these circumstances have been overtaken by what is known as “economic failure.”
But economic failure was not the threat confronting GM. The automaker’s problem was “financial distress.” After all, the auto and truck marketplace, while in a deep recession for a full year, was still trending upward, and even more so in the thriving markets of Asia and the Middle East.
Consequently, where existing managements prove flexible enough to adapt to competitive challenges or hire more qualified leadership in quick order, chances are the firm will avoid liquidation — assuming it can access financial capital, either from internally generated profits and cash flow or, temporarily, from external sources such as bank loans and capital markets. GM’s confrontation with bankruptcy reflected the sudden deprivation of access to financial capital, mostly from external sources. As a consequence, the federal government stepped in rather promptly to provide tens of billions of dollars in “debtor in possession” financing.
Another example of Chapter 11 filings that underscores the fundamental distinction between the economic failure form of terminal bankruptcy versus survivable (financial distress) bankruptcy is the airline industry. The advent of federal deregulation in the late 1970s and the startup of well-planned, very tightly cost-controlled discount airlines (e.g., Southwest) were factors that pushed several larger, poorly managed competitors over the cliff. These were instances of “financial distress,” not “economic failure.”
In other words, the threats facing traditional airlines did not constitute evidence of “economic failure,” because more travelers were flying more often and to more destinations. Economically speaking, the volumes, preferences, and income demand for air travel among airline passengers was continuing to expand on a grand scale.
To be sure, tourism and leisure time grew at a robust pace in the final 25 years of the 20th century. Consequently, the true threat to many traditional airlines seemed to be “financial distress” more akin to that faced by Detroit’s automakers. For decades, Detroit’s automakers struggled to meet rising customer expectations of quality, convenience, and cost. Unfortunately, the efforts fell short of the remediation necessary to stanch steep earnings losses, and thus retain the liquidity required for operations and future innovation.
Economics of Liquidation
One often-overlooked economic facet of bankruptcy is the “signal effect.” As the term suggests, a bankruptcy announcement signals all marketplace participants to view the mistakes and opportunities created by a stumbling firm. As with air travel or the computer market, as long as total demand for that industry’s products or services expands in the subsequent recovery, surviving firms have a chance to bid for the most productive plants, equipment, and labor (current or laid-off workers and management) from the contracting or liquidating firm. Occasionally, a bankruptcy crisis incites vigorous pricing wars and/or merger and acquisition activity. This sounds predatory and vulturous in a Darwinian way, but it results in an industry that builds a healthy learning curve and remains fleet-footed at better serving customers.
By way of example, recall the sad shape of U.S. steel firms from 1974-87. Nearly one of every four U.S. steel companies went bankrupt, and the remaining mills accounted for a mere 11 percent of global output. More than 1.5 million steelworkers lost their jobs in less than a quarter of a century, yet bankruptcy and downsizing (including four of five steelmakers in Detroit) translated into a resurgent American steel industry by 2000, thanks to the emergence of leaner, more competitive “mini-mills” and other profit-making adaptations made in the private sector.
In the case of Detroit’s automakers, automobile manufacturers accrued phenomenal losses. In the two years preceding June 2009’s bankruptcy, GM bled $70 billion in losses and was burdened with debt that had grown to 24 times its market capitalization. How ironic for a firm in an industry that had contributed more than $60 trillion (current dollar estimate) in GDP over the previous 100 years. Were GM and Chrysler truly without recourse to restructure themselves?
The fundamental “What if?” question here is whether a traditionally structured bankruptcy would have been less costly than Washington’s taxpayer-sponsored bailout, which carries an ultimate price tag somewhere between $83 billion and $95 billion.
Defenders of Washington’s bailout claim that by mid-2009 there was insufficient liquidity in the economic system for buying cars, as well as a virtual seizure affecting lending facilities. They suggest that a normal bankruptcy wouldn’t have worked. Economic data amply supports both points — although, ironically, June 2009 marks the official start of the current cyclical upswing, according to the National Bureau of Economic Research.
Looking ahead, there are positive fundamentals in the car and truck markets if Detroit is nimble enough to exploit the potential. Vehicle sales are rising. Profits are up. Financing rates are more affordable. Best of all, pent-up demand to replace aging vehicles should underpin steady sales growth for many years.
For all the optimism regarding Detroit’s renewed prospects and the market’s ability to teach lessons and re-establish strength on the ashes of failure, it’s clear that Detroit and Michigan would have struggled mightily to overcome the loss of GM, Chrysler, and key suppliers. Many more automotive facilities would have closed. While other automakers may have stepped in to purchase some assets, the state’s labor and financial climate would have loomed as clouds of caution over any new investment.
Such a scenario would have impacted hundreds of related businesses and tens of thousands of jobs. Michigan’s unemployment rate would more than likely be in double-digits, real estate markets would probably have collapsed further, public services would have been vastly overhauled and curtailed, and the city of Detroit most likely would have entered bankruptcy (it is now under a Michigan-directed consent agreement). Undoubtedly, Washington’s bailout provided Michigan and Detroit with a huge short-term window of opportunity for financial restructuring and economic revival.
The long-term view remains unclear. For all the hope surrounding Detroit’s renewed prospects, that other storm — more stringent CAFE standards in 2025 — is closing in on Detroit’s Big Three and their rivals.
The Obama administration’s more lethal strain of Corporate Average Fuel Economy standards and regulations means that we may be doomed to repeat history. After all, the CAFE rules from the 1970s greatly contributed to the eventual bankruptcies of GM and Chrysler. If the new regulations are not revised — the industry can revisit and potentially limit the mandate prior to 2025 — it will likely bankrupt OEMs and suppliers alike; technology is expensive and requires firms to generate great and continuous profits internally without subsidies and without living off higher burdens placed on sorely beleaguered American taxpayers.
Detroit and Michigan have historically epitomized the virtues of Yankee ingenuity, solving the most formidable technical and financial challenges of the marketplace. We should place greater confidence in our private sector’s initiatives and flexibility, while contracting economic burdens imposed on them by inexperienced regulators and politicians. db