Submitted by Edward Harrison of the site Credit Writedowns
I like the fact that President Obama has drawn a line in the sand and signaled that no more funds will be given to U.S. automakers without their presenting a viable long-term plan for restructuring. Ultimately, the automakers cannot survive merely as a result of government largesse, but through the discipline of a competitive auto market.
In my view, the American automakers are viable companies which can produce cars that sell well. It is their poor operating cost structure and disastrous balance sheets which make them bankrupt organizations. This should mean they are prefect candidates for restructuring.
Nevertheless, other aspects of Obama’s treatment of the automakers are troubling. The dichotomy between how the big three automakers are being treated and how the big banks are being treated plus the sacking of a CEO at a critical juncture leave a lot of questions.
First, as to what Obama has done.
- The Obama Administration used the threat of withholding bailout funds from General Motors to induce that firm’s CEO Rick Wagoner to resign and its board to seek replacement members.
- GM has received 60 days to come up with a viable restructuring plan or they will face Chapter 11 bankruptcy. Chrysler gets 30 days to forge a deal with Fiat or they too face the same fate. The Obama Administration has indicated that it will help the companies with liquidity during this time, but will not give them any ‘bailout’ funds.
- Any bankruptcy will be heavily ‘directed’ by the Obama Administration to mitigate any fallout in terms of jobs, suppliers, regional economies or the broader American economy.
- Meanwhile, the Administration has indicated that it would guarantee any vehicle warranties offered by either firm on existing and newly purchased vehicles if either firm were to go into bankruptcy.
- The Administration has also made green car production, federal car purchases, an tax breaks for buyers a large part of helping increase demand for domestic vehicles. Very smart. The green emphasis is something the Germans have also done.
In short, the Administration is credibly threatening to withhold support for GM and Chrysler unless those organizations can create a restructuring plan that Obama’s people consider viable, the penalty for failure being bankruptcy.
This approach has several benefits. Here are a few:
- Taxpayers will not need to commit more money without the certainty that this money will be used effectively.
- The carrot and stick approach forces the unions, management and bondholders to the table because their best alternative to a negotiated agreement (BATNA) is clearly inferior in each case. Bankruptcy would mean significant losses for each constituency. That is the stick side of things. Simultaneously, if they do reach agreement, their concessions will be met with additional capital from the government. This is the carrot.
- Even if the parties cannot agree, the Administration can make sure that bankruptcy will not mean Armageddon for workers and local communities by taking a direct role in the proceedings. Moreover, by withholding funds until bankruptcy, the government will be senior to all other creditors including bondholders.
All in all, this seems like a difficult choice, but the right one.
But, is this not what should be happening with the big banks? Why the differential treatment here? Here’s my take. I see two reasons.
First, the Obama Administration suffers from cognitive regulatory capture. Former denizens of Wall Street are so ensconced in the Administration that they cannot but see events from a ‘Wall Street perspective.’ In effect, they operate like a horse with blinders. Their view takes as axiomatic the importance and needed continued existence of the big banks that they dismiss alternative workout solutions out of hand.
Second, the Obama Administration is well aware of rising populist sentiment. They understand that bailing out the big three automakers would weaken them politically as this would be seen as another outrageous subsidy to big business. However, Obama errs politically because the juxtaposition between his treatment of the big three and his treatment of the banks is obvious to everyone. the big three are seen as representing ordinary blue collar Americans. While the big banks are seen as Gordon Gekko-like rapers and pillagers of the robber baron class. This alone increases populist outrage at the administration. Effectively, Obama’s unwillingness to deal with the banks in the same fashion earlier has put him in a lose-lose situation.
Then there is the dismissal of the GM CEO and re-composition of its board of directors. While the need for someone to take ‘responsibility’ for failure has been obvious, the timing is questionable. GM is about to go through the most crucial phase of its existence. To subject the organization to the type of turmoil that a change in leadership entails at such a juncture is a catastrophic misstep.
Finally, the uncertainty surrounding the Big Three has led to a major selloff globally. In my view, this eliminates all of the positive momentum we saw earlier this month and after the Geithner bank plan was announced. Tactically, this announcement, then, has been another major misstep.
My conclusion, therefore, is that the Obama Administration has developed a fairly good plan here. It looks to force necessary concessions from all interested parties without bankruptcy. It is also still viable in bankruptcy. However, tactically, I see the plan as having misfired for the reasons enumerated above. And, this is unfortunate because this auto plan may end up weakening the Administration rather than pushing it forward.