The Obama Administration's Auto Bailout FailureOct 18, 2012
By Andrew Grossman
With the industry-heavy Midwestern states up for grabs in the coming election, the Obama Administration has been touting its bailout of General Motors and Chrysler in support of exaggerated claims of upwards of 1.5 million auto industry jobs saved. This is the height of audacity. The auto bailout transferred over $25 billion in taxpayer dollars to the United Autoworkers labor union, in pay and benefits, while actually hindering the kind of “fresh start” that is necessary for the industry’s future success and that normal bankruptcy procedures, without political meddling, provide. By any measure, the auto bailout was a failure and waste of taxpayer dollars compared to what would have happened absent government intervention: an orderly Chapter 11 restructuring that allowed the automakers to shed their liabilities, restructure their operations, and get back to business stronger than before. And far from saving additional jobs, it put the jobs at GM and Chrysler into long-term peril, by allowing the companies to continue many of the compensation and management errors which significantly contributed to those automakers’ prior poor economic health and have continued to lead to unimpressive performance since the bailouts.
When a public policy produces worse results than doing nothing, it properly should be described as a failure. The Obama Administration auto bailout is such a failure.
A Political Intervention
There is no question that the U.S. auto industry was in turmoil when the Obama Administration entered office. Already weakened by years of bad business decisions, the Big Three were hit hard by high fuel prices and the economic slowdown in 2007-08. Though sales dipped across the industry, buyers’ interest in the Big Three’s fleets plummeted. For the first time in history, Detroit's share of the U.S. market slipped below 50 percent in 2008, and both Chrysler and GM faced dwindling cash reserves. (Ford, by contrast, had already begun a major turnaround several years prior, borrowing the necessary billions before lending markets seized up in 2008.) Even after “bridge loans” by the Bush Administration, Chrysler and GM were racing fast toward insolvency, and had engaged attorneys to prepare bankruptcy filings.
Bankruptcy is not, of course, the end of the road for promising businesses that have hit hard times, but a chance at a new beginning. Chapter 11 affords those businesses a fresh start and a chance to reorganize to take better advantage of their assets and capabilities.
Bankruptcy is not, of course, the end of the road for promising businesses that have hit hard times, but a chance at a new beginning. Chapter 11 affords those businesses a fresh start and a chance to reorganize to take better advantage of their assets and capabilities. It provides unique flexibility to unlock the fundamentally sound productive capacity of a faltering business by freeing it of obstacles to success, such as unviable contracts, unsustainable debt loads, and poor management. It is a sound choice for businesses, such as Chrysler and GM in 2009, that need to adjust quickly to new economic realities but are, at their cores, sound, productive, and potentially profitable.
Although agreeing that Chapter 11 was the right choice for the ailing automakers, the Obama Administration decided that it would insert itself into the reorganization process, directing all major decisions and injecting $80 billion in taxpayer funds from the Troubled Asset Relief Program (which Congress had limited to stabilizing the banking sector) into the companies. Under the Administration’s plan, the automakers filed for bankruptcy and then sold their assets to new entities, bearing the old firms’ names, that the government had created and capitalized. Debts and some bad assets were left with the “old” businesses, to be worked out in the bankruptcy process, with most creditors receiving pennies on the dollar for their claims.
The result was a reorganization that superficially resembled bankruptcy but was driven as much by politics as by economic realities. The Obama Administration’s “Auto Task Force” decided which nameplates to shutter, which dealerships to cut loose, and how the automakers should invest in product going forward. Evidence suggests that many of these decisions had a political basis—for example, GM’s ongoing billion-dollar investment in the self-immolating electric plug-in Volt, a white-elephant project that is unlikely ever to turn a profit. Although Chrysler and GM are back on their feet, there is no reason to believe that they are in a stronger position as a reult of the Administration's intervention, which actually shifted the focus of reorganization away from considerations of competitiveness and profitability.
To begin with, the claim that the auto bailout saved 1.5 million jobs is demonstrably false. It is predicated on the assumption that an orderly bankruptcy would have resulted in not only closing GM and Chrysler, but also solvent domestic companies like Ford, foreign transplants like Toyota and Honda, as well as part suppliers and supporting companies for the car industry. Even assuming that its bailouts did preserve jobs, the Administration surely cannot take credit for the jobs produced by bailout recipients’ competitors.
But even as to Chrysler and GM, the Administration’s jobs claims are extremely dubious. The assumption that, absent intervention, Chrysler and GM would have collapsed, and their workforces been dismissed, is actually contrary to the purposes and provisions of Chapter 11, which seeks to preserve and maximize a business’s value. As explained further below, Chapter 11 provides a variety of protections for a business to continue in operation while in bankruptcy. Most important of these is the “automatic stay,” which permits a business to hold creditors at bay as it restructures its operations. No one—not the automakers’ managements, not their creditors, and not their workers—had any reason to see either company cease operations and its asset value plummet. For that reason, both companies would have continued operations while in bankruptcy (or undergone a “quick dip” pre-packaged bankruptcy), preserving jobs in their long-term economic interests.
Sacrificing the Rule of Law in the Name of Political Favoritism
Perhaps even worse, the Obama Administration’s heavy-handed treatment of Chrysler’s and GM’s creditors violated fundamental rule-of-law principles. The rule of law means that all parties are treated equally, with their preexisting obligations honored, and that the government does not intervene when things go wrong to favor politically-connected parties over regular investors. It is, of course, the bedrock of a sound economy, ensuring that contracts are honored, debts repaid, and disputes are resolved by impartial judges applying neutral rule of decision. Without a strong rule of law, the cost of doing business rises, as parties that cannot rely on the law are forced to take expensive measures to protect their interests, and economic growth slows, as capital is misallocated according to political interests.
In administering the automaker reorganizations, the Obama Administration was anything but neutral and fair. It discriminated among similarly situated creditors, providing labor unions with generous payouts, while forcing other unsecured creditors, including workers’ retirement funds and large numbers of small investors who had put their money in automaker bonds, to accept far less than the face value of their loans and perhaps far less than they would have received in a regular bankruptcy. And it applied unprecedented legal and political pressure on secured creditors—that is, those whose loans were actually collateralized by the automakers’ property—to accept massive cuts, so that the reorganization could go forward on the terms favored by the Administration.
By violating the rights of individuals who had lent money to the automakers, the Administration sent the message that, when the political stakes are high, the federal government will run roughshod over investors’ rights and take actions more at home in a banana republic than the United States. The predictable results are higher costs to businesses seeking investment and, should another economic crisis occur, flight of capital from industries that the government may consider worthy of its intervention, adding to the brittleness of the economy.
A Labor Union Handout
Looking closely at the numbers demonstrates the extent to which, in financial terms, the Obama Administration’s auto bailout really was a transfer of funds from taxpayers to the United Auto Workers labor union. As James Sherk and Todd Zywicki explain in a recent Heritage Foundation report, because bankruptcy law requires equal treatment for similarly situated creditors, it is possible to calculate precisely how sweet a deal the UAW received in the Chrysler and GM bankruptcies. By comparing the treatment of the union’s trust funds, which were unsecured creditors, to the treatment of other unsecured creditors, they calculate that the UAW received $26.5 billion more than they would have received under the normal application of bankruptcy law, in which similarly-situated creditors are treated equally. That figure actually exceeds taxpayers’ expected losses for the auto bailouts, which the Treasury estimates will amount to $23 billion.
Sherk and Zywicki’s conclusion is stark: “Taxpayers would not have lost money on the auto bailout had the UAW not received this special treatment.”
The labor union’s special treatment actually goes beyond this billion-dollar handout, to the above-market pay and benefits that many union members continue to enjoy. In Chapter 11, everything is on the table to make a reorganization successful, and that includes collective bargaining agreements. But rather than push UAW members to accept prevailing market wages and benefits, the Obama Administration’s Auto Task Force was content to accept concessions regarding future hires, while only trimming at the margins for existing workers. The result is that GM still pays above-market compensation, averaging $56 per hour. The UAW itself has told its members that the current contract preserves the pre-bankruptcy status quo: “For our active members these tentative changes mean no loss in your base hourly pay, no reduction in your healthcare, and no reduction in pensions.” This uncompetitive compensation structure, combined with still-rigid work rules mandated by the collective bargaining agreement, leaves GM in particular at a competitive disadvantage to its rivals, threatening its future success.
A Better Solution: The Chapter 11 Alternative
The auto bailout was not inevitable, and it was certainly not necessary to rescue the automotive industry. Typical bankruptcy, without government intervention, would have immediately given Chrysler and GM breathing room to put reorganization plans in place and then implement them. It would have empowered them to trim nameplates and their dealer networks, with a focus on the economics. It would have allowed them to renegotiate their labor agreements, with bankruptcy court oversight, so as to increase flexibility and align compensation with prevailing rates. And it would have allowed them to restructure their debts in a manner that was fair to all parties, without favoritism.
The only unknown and the point that the Obama Administration cites as justifying its intervention is whether the automakers could have obtained financing to complete their reorganizations at a time when the answer to this question.
But even if financing had proven unavailable, that does not justify the Administration’s actions. Rather than orchestrate a politically-directed takeover of Chrysler and GM, the federal government could simply have offered limited guarantees to private lenders providing “debtor-in-possession” financing for the reorganization process. This would have limited taxpayer exposure to loss and, more importantly, allowed the bankruptcy process to go forward in an orderly and fair fashion, without injecting politics into decisions that should be based on the business’s best interests. The result would have been a resurgent industry, likely on sounder financial and competitive footing than it is today.
There is no evidence that the Obama Administration’s auto bailout somehow “rescued” the auto industry and the many jobs that it provides. Instead, the evidence shows that the Obama Administration injected politics into the reorganization process, actually hindering the industry’s recovery. The chief beneficiary of this intervention was the United Auto Workers labor union, which received undue billion-dollar payouts that exceed taxpayers’ bailout losses and avoided concessions that would have improved the automakers’ current competitive positions. Because the normal bankruptcy process would likely have had superior results, the Obama Administration auto bailout must be judged a failure.
1. See Editorial, NATIONAL REVIEW ONLINE (Sept. 10, 2012), http://www.nationalreview.com/articles/316379/democrats-gm-fiction-editors
2. James Sherk and Todd Zywicki, Auto Bailout or UAW Bailout? Taxpayer Losses Came from Subsidizing Union Compensation, HERITAGE FOUNDATION BACKGROUNDER No. 2700 (June 13, 2012), available at http://www.heritage.org/research/ reports/2012/06/auto-bailout-or-uaw-bailout-taxpayer-losses-came-from-subsidizing-union-compensation
3. Letter from UAW General Motors National Negotiating Committee to UAW Members at GM (May 2009), available at http://online.wsj.com/public/resources/documents/gmuaw.pdf