This week the CEO’s of the Big Three (GM, Ford and Chrysler) begged Congress for money, as they flew into Washington on their private jets. Congress has correctly denied funding and now the Big Three are left on their own. However, Congress should help out U.S. auto manufacturers, but not by providing them money outright. Congress should promote Chapter 11 bankruptcy by the automakers, encourage them to revamp their business models and provide adequate funding and programs for any employees adversely affected by the bankruptcy.
How exactly did the U.S. auto industry end up in this mess? There are several explanations and, in turn, quite enough blame to go around. The big pickup trucks, Hummers and Escalades, that have been rolling off the assembly lines of U.S. auto plants are no longer profitable. During the years of cheap gasoline Americans could not buy enough of these cars. However, as gas prices have risen, credit has tightened and consumer spending has declined, these large gas guzzlers are no longer selling. Meanwhile, competitors such as Toyota and Honda have been producing smaller cars with better mileage and have now found themselves atop the U.S. auto industry market. Those who have been charged the task of operating GM, Ford and Chrysler have failed their shareholders.[img_assist|nid=33853|title=American auto brands’ share of the domestic market continues to slip, although Japanese, Korean and German brands gain shares.|desc=|link=node|align=left|width=|height=0]
The executives and management of U.S. auto companies have refused to change their business models and are now burning through cash reserves at the expense of shareholders. Also at fault is the United Auto Workers union (UAW), which has pushed for better contract terms that ironically may contribute to the failure of U.S. automakers. The 2007 contract between GM and UAW makes labor costs for GM about 17 percent higher than those of competitor Toyota. Furthermore, GM is charged with paying pensions and healthcare benefits to over 432,000 GM retirees, in addition to fringe benefits it must pay current employees. Some problems with the benefits GM must pay are a product of the U.S. healthcare system and tax laws on fringe benefits, but certainly some blame lies with the UAW, which of course is vehemently pushing for congressional aid.
Chapter 11 bankruptcy for U.S. automakers (especially GM) is not only the best, but the most viable option at this point. It is not a liquidation of the company, but rather, forces the company to restructure its finances as well as propose a plan to restructure not only its debt but also its business model. Chapter 11 bankruptcy also helps rework union contracts within the company and charges the position of trustee (in addition to a U.S. trustee with oversight powers) over the company’s operations. There is also a period of automatic stay during which creditors may not pursue their claims against the debtor. In essence, the company is offered a new lease on life, provided it is able to successfully improve its operations and financing.
Those who oppose bankruptcy for these companies have some valid claims, including unemployment of current workers, funding for pension plans and other benefits and a loss of revenue. The first two claims are valid and this is where the government needs to step in. The federal government should assist those who lose benefits or work as a result of bankruptcy proceedings. Money should be provided to the Pension Benefit Guaranty Corporation. Undoubtedly, foreign-owned auto manufacturers who are successful will employ former Big Three employees, but the government should provide a safety net for former employees in terms of job training and job placement. As far as health benefits are concerned, the government will need to work with insurers to maintain some of the GM employee benefits, but this might also be the impetus needed for healthcare reform and movement away from the employer-based system. Government involvement in this fashion is appropriate and can have far reaching effects, beyond those that a bailout can.
Any successful Chapter 11 bankruptcy proceeding relies on the fact that the given company is able to reorganize itself in order to improve profitability. Part of this hinges on the hope that, in this instance, consumers will still have enough faith in our automakers to purchase U.S. cars. Some argue that consumers will shy away from U.S. cars because there is no guarantee that a bankrupt company will be able to provide maintenance and service and make good on its warranties. It is important to remember, though, that Chapter 11 bankruptcy is not liquidation. U.S. consumers purchase goods and services from bankrupt companies every day (when was the last time you flew on a U.S. airline?). It is true that warranties may run a course of several years whereas a plane ticket may only be held for a few weeks. As far as the long term contracts for car warranties, however, Chapter 11 bankruptcy allows for Debtor In Possession (DIP) financing, by which the bankrupt company can receive financing which is senior to any other claims. As proposed by some, the U.S. government may even be able to provide DIP financing to U.S. automakers and calm fears about default on warranties.[img_assist|nid=33854|title=The amount of cash on hand and the third quarter burn rate of the Big Three point to a cash crunch in the near future.|desc=|link=node|align=left|width=|height=0]
Nothing is for sure and nobody has a crystal ball as far as what plan is best for the U.S. auto industry. Based on all of the facts and circumstances, however, the most appropriate measures would include Chapter 11 bankruptcy, a revamping of the business model and those who run the business, as well as prudent government support. The fact of the matter is that neither GM, Ford nor Chrysler are too big to fail. An outright capital injection will do nothing to provide the companies with incentives to restructure and improve. Unfortunately, bankruptcy is really the last best hope to save our auto industry.