Kidnapping Chrysler

In this brief interval before the new housing plan is announced, I’ll try to sneak in a comment on the auto bailout, and the plans submitted by GM and Chrysler yesterday. This may be an obvious question that many people have thought about, and got some discussion in December, but: Why does Cerberus (the private equity firm that owns Chrysler) need money from the government?

Let’s take this step by step. Assume GM has a viable restructing plan, but it needs $30 billion to execute the plan, after which it will be a viable standalone business. Even on that assumption, given market conditions, they would be unlikely to be able to sell $30 billion in newly-issued stock or raise $30 billion through bonds or loans, because of information asymmetry: put simply, no one would believe them. Therefore, they can only get the money from the government, because the government is the one institution that will provide a below-market loan because of the public interest (saving the auto industry and either hundreds of thousands or millions of jobs, depending on whom you believe).

Now, with Chrysler, which is asking for $5.3 billion in new loans (on top of the $4.3 billion already committed, and in addition to another $6.0 billion from the Department of Energy’s alternative energy funding program – see page 16), there is a difference: The people writing the plan and the people who could provide the money are the same people, since Chrysler is majority-owned by Cerberus, so there is no information asymmetry. Let’s provide a comparison. If Chrysler were a Silicon Valley, venture capital-funded startup that needed cash, and had a viable plan, the VCs would simply invest more money, effectively diluting themselves (and the founders). If the Cerberus overlords really believe the plan that their underlings mailed in yesterday, why not put in the money themselves? And even if they don’t want to put in additional equity like a VC would, why not loan the money to Chrysler and keep the interest payments themselves instead of sending them to Washington – and avoid the oversight that comes with government money? (In the proposal, Cerberus does offer to exchange their $2 billion loan to Chrysler for equity; but this just shows that they don’t expect to get the full $2 billion back. More tellingly, they are not offering to send good money after bad; they are not even offering to contribute some new cash, leveraged with a loan, which is the classical private equity model.)

Cerberus’s stated reason in December for not putting in more money was that this would violate their fiduciary duty to their limited partners. This looks to me like an admission that putting more money into Chrysler is a bad investment, but if someone knows more about this argument, let me know.

There are two other plausible reasons why Cerberus would prefer to go to the government. The first is if they can get cheaper capital (a lower-interest loan) from the government than from their limited partners or from the capital markets. But then the question becomes why the government should be in the business of giving cheap capital to a private equity firm that has other sources of capital.

The other possibility is that Cerberus/Chrysler doesn’t actually believe the plan, and that’s why Cerberus doesn’t want to put in the money. The plan is a Hail Mary strategy that might work, but the chances of it working aren’t good enough to put in their own money; but if they can get free money from the government (free in the sense that if Chrysler collapses, Cerberus won’t have to repay the government), they might as well give it a shot. This is the implication of page 13 of the Chrysler proposal:

If Chrysler is unable to restructure its liabilities and if further government funding is not forthcoming, the “Orderly Wind Down” alternative would be pursued, however it may have severe social and economic consequences for both Chrysler and the broader U.S. economy

This sounds like an admission that they are willing to attempt the plan with government money, but not their own money.

However, we can’t reliably infer what Cerberus really believes from their behavior, because even if they were willing to put in their own money, they wouldn’t say so until after the government turned them down. You’ve probably heard this bank bailout analogy: The banker walks into the Oval Office, puts a gun to his head, and threatens to blow his brains out unless he gets a bailout; the government bails him out because they don’t want to have to clean the carpet. The difference here is that no one cares about Cerberus (the three-headed dog that guards the entrance to the underworld), so instead he dragged a hostage named Chrysler into the Oval Office and put the gun to her head. In the end, this feels like a kidnapping, where Cerberus is betting that the Obama Administration won’t be willing to take any risks with the hostage’s life.

(Of course, American oligarchs don’t use guns; they use lobbying. Which is why John Snow is still chairman of Cerberus despite overseeing this catastrophic bet on the auto industry.)

44 responses to “Kidnapping Chrysler

  1. I wonder what Republicans will say about this. Afterall, if they stick to their supposedly free market principles, a holding company that won’t save one of its investements is just making a sound business decision based on market action and valuation.

  2. At some point in time, people are going to demand proof that the world will really end if they let these big companies fail (banks or auto companies).

    At that time, the government will be in a position to refuse these bailouts. For now, I think Chrysler will get the money despite the fact that all your arguments are perfectly valid (and well known?)

  3. Ransom Notes? Hostages? Kidnapping?

    This is getting more Hollywood Thriller by the day.

    Time to call <>!

  4. I wonder what Republicans will say about this.

    Well, I can tell you what this conservative has to say about the company that produces America’s last great and iconic vehicle, the Jeep Wrangler:

    Let ‘em go under.

    Most rank-and-file conservatives have been saying that with regards to the banks as well, which is why the house rejected TARP I initially. I’d rather see bad companies fail, restrictions on starting new companies relaxed (look how difficult it was for Tesla to get started, and they still can’t sell a car anyone other than a handful of VC’s up on Sandhill can buy) and social services provided to those dislocated by the failing companies. That way we let the market do its job and don’t end up with zombie companies, but we also don’t have people starving in the streets.

    Even nasty conservatives don’t like seeing people starving in the streets.

    Cheers,
    Carson

  5. It feels like every interest group in the country is rushing to extract what they can from the federal government while there is still something there to extract.

  6. It may be of some interest that Cerberus is “double-dipping,” in that it also is substantially invested in GMAC.

  7. On the issue of why doesn’t Cerberus just put in their own money, one thing you don’t mention anywhere is that the needs are likely far more than the money they have available. Especially when you account for the fiduciary/fund structure issues which you mention in passing. Most private equity firms have extremely strong provisions (potentially even contractual) against investments in the same company being made from different funds they manage. The reasons for this are sound, and involve questions of self dealing, fraud prevention, and shareholder protections. Beyond that, within any given fund there is a limit as to how much capital any one investment is allowed to account for, again stemming from the fiduciary duties owed to shareholders.

    I don’t want to come off as a Cerberus defender – they made an investment that was stupid, and clearly should (and likely will) lose all of it. It doesn’t, however, strike me as reasonable to say to an investment manager, “hey, you lost a bunch of your investors’ money on this company already, how about losing some more for kicks.” The auto companies are almost text book examples of what a bankruptcy restructuring is designed to address – firms that would have ongoing economic value, but have made commitments to various parties (debt investors, unions, etc.) that will be impossible to meet. Bankruptcy court is where these guys belong, with the government likely having to provide DIP financing.

  8. One could plausibly argue that with 22% market share GM is “too big to fail” – Chrysler definitely is not. If further investments in it are not good for Cerberus’s health, it cannot be so for the US tax payer. It needs to liquidate.

  9. Why would you invest more money in a losing business if the government is likely to give you money if you ask? It is their responsibility to their partners to do what they can, and that includes getting free money. Also as you mentioned maybe they are done doubling down into this pig. Either way if the government will put the money in then the partners don’t have to.

    Happy Trading,
    Dave

  10. @Carson:
    “Even nasty conservatives don’t like seeing people starving in the streets.”

    I would agree with your theory of letting them fail and helping out those displaced except the conservatives in this country only follow the let them fail part of that plan. The recent past fully illustrates that conservatives only care about those that have money and can take care of themselves. I’m sure everyone, liberals and conservatives, would be much more willing to let Chrysler fail if we had a reasonable estimation that that people displaced by such a failure would be taken care of. However, when conservative economic policy is to take money from those that need it most and give it to companies like Cerberus, there’s no way we can just “let them fail.”
    Ironic that the conservative policies of the past are contributing to the huge government expenditures of the present isn’t it?

  11. I disagree that Cerberus didn’t know what it was doing or where it was getting. Surely, the idea of government bailing/helping/giving low interest rate loans, was included in the buy out of the company.

    Besides, don’t we all already know what private equity companies do? Buy public, dress it up and sell it back to public, getting good return on whatever leverage and other loopholes that are possible to find.

    What we need in this country is not BIG and AMERICAN but incentives for true businessmen to utilize their talents, hard work and abilities instead of utilizing previously mentioned qualities to (game) the system.

  12. so the 73rd Treasury Secretary is aksing the actual one for funds ?

  13. I think there is one more possible reason: the restructuring is contingent on renegotiation of Chrysler’s debt and labor obligations. If the creditors or union believe Cerberus won’t reinvest, and the gov’t is the financier of last resort, then they may be more likely to make concessions. If Cerberus is willing to reinvest, it says the firm has some economic value under current circumstances, and the creditors/union won’t want to give up their share of said value. If the creditors/union truly believed it was “restructure or you’ll get nothing” they’d do so – they don’t believe it when Cerberus says it (and rightfully so, PE guys lie like rugs) but they may believe it when Treasury does.

  14. I’m thinking about wall-papering my house with $50s. How long do you think it’ll be before they’ve printed enough of them to make this cheaper than using regular paper?

  15. Check out who owns Cerberus, and then you will have the answer.

  16. I respect your outlining the two possibilities, but to me, it seems obvious that they don’t believe Chrysler is a good investment.

    A private equity firm has many options for its capital. I cannot believe that they believe Chrysler (with bad products, labor problems, and legacy health care/pension costs) is the most attractive use of their money. In order for them to put more into Chrysler, they would need to say “There are no other opportunities that we believe will produce a higher return on our capital than Chrysler.” If that is true, we really are in trouble.

    Also, my understanding is that they got saddled with Chrysler by accident, they really wanted to acquire Chrysler’s finance arm (which also was unwise in retrospect, but better than the car company itself).

  17. Last time I checked the stockholders were John Snow ex Treasury and Dan Quale

  18. Among the smartest infrastructure investments that can be made is to rebuild the manufacturing infrastructure so that much more of our consumption is derived from the well paid labor of US workers, workers who consume US Services and who pay US and state taxes on their incomes.

    I can’t imagine a worse strategy that to accelerate the movement of auto production to overseas competitors which will only push the US further into balance of payments deficits that clearly are unsustainable.

    It simply is essential that we have a strong vital US automotive industry. Far more important in the long run than spending money to repave existing roads etc the focus of most of the so-called infrastructure spending in the stimulus plan.

    We should be working on ways to increase the domestic content of the entire auto industry including parts suppliers as one way to sustain good well paying manufacturing jobs in the US.

    The biggest concern in the GM plan as I see it is further plant closings and further job cutting rather than somehow working to preserve those plants and those jobs.

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  20. Wow! John Snow is the head of Cerebus. That’s all I need to know.

  21. Pingback: Why Are We Helping Cerberus Save Chrysler? | But Then What

  22. Steve,

    Well, the comments of James’ blog aren’t much of a place for the discussion required (and this is veering hugely off topic) so I’ll keep this brief: conservatism is far more diverse than you give it credit for. The austrians (see Mish) have been consistently right on this crisis, even calling the commodities crash that almost no one else saw coming (Krugman was dead wrong on oil, for example.) Communitarians have been railing against both big govt. and big business for years. The rank and file Republicans are far more populist (and skeptical of big business) than you are giving them credit for: after all, they were the reason the house rejected on TARP I. Also keep in mind that a rejection of a centralized state providing assistance to the poor is not a rejection of providing assistance to the poor: rather is is an objection to the centralized state.

    Both sides of the isle are deeply involved in this crisis: Citi was run by Rubin and a slew of ex-cliontonites, Rahm is an ex-Freddie board member, Frank’s lover is (or was) a Fannie exec, Goldman was Obama’s second largest campaign contributor, etc, etc. Thus, in my opinion, thinking in terms of “liberal” vs. “conservative” isn’t very useful in the current environment. It’s more useful to think in terms of the DC/New York consensus vs. The Rest.

    In any event, enough thread hijacking. I’m happy to continue the discussion over email if you like.

    Cheers,
    Carson

  23. I read recently that these Auto companies are overstocking the dealers with cars to ease the companies inventory levels. Perhaps you or someone with more knowledge on the subject could go into further detail of this problem and possible results/solutions. Maybe, you could also discuss the residual value losses these companies are now facing and possible solutions. I really enjoy this site. This site offers some great insight, and hope the site continues to grow.

    Thanks,
    Mike

  24. The fallacy of placing government money, in the form of bailouts, into Chrysler is that ultimately there are few who can afford to purchase a new car. What good is it to prop up the top if the bottom crumbles.

  25. One of my biggest disappointments in the last six months is reading articles or listening to speakers expound upon topics of which they don’t have the basic facts. Unfortunately, it is easy for the popular press (and it appears this forum) to jump up and down and demand the “populist” approach (ie salary caps, get cerberus to pay etc). Some facts:

    1). What is a private equity firm? I private equity firm is basically a vehicle for their LPs to invest in private companies. Who are LPs– guess what they are you and me. Generally LPs are state pension funds, university endowments, company pension funds, some banks, some insurance companies. Now how do they invest? Through contracts. The LP agreement has very specific clauses that box the GP (general partner) into what they can invest in and how much can they invest. Guess what? cerberus doesn’t have any more money to invest because of these restrictions into Chrysler. BUT, let’s now take the discussion one step further!

    2). Cerberus is an investor in chrysler (common stock, some preferred I’m sure, maybe debt). So again, pierce that veil and its really pension funds etc who are investors in Cerberus (common, preferreds, debt etc). Guess who are the largest investors in US PUBLIC equities??? The same people! Guess what, the same people are public and private common equity holders..just through different vehicles! So guess what again, the argument that they have the money is specious, because the public shareholders also “have the money”.

    3) Last point on cerberus. Why would a rational investor not invest money in competiton against the gov’t? If GM gets the money, Chrysler has to get the money from the gov’t too, or it will go bankrupt because GM now has the govt as its largest stakeholder (if it isn’t already) and now has more resources than private cerberus could ever imagine putting in.

    I’m not an apologist for cerberus but let’s look at the base cause and not just say the evil pe firm should fix the problem. Frankly, I think the only solution is to jam these 2 together and let’s the go bankrupt, wiping out common, cramming down the bonds and fixing the uaw contracts. Guess what? Yes that will hurt everyone involved, but everyone involved made a bad decision to get involved in this industry and should lose money, just like people who invested in pets.com made a bad decision.

    Typed on my mobile, so sorry for any typos.

  26. Managing Director PC

    As a fiduciary I tend to agree with Rob. There are clearly better investments for Cerebus to make than to sink more money into Chrysler and Cerebus management’s primary duty is to their investors.

    Since I have been on auto company investor calls and followed the industry for nearly 3 decades I’d also point out that as the bailout issue began to simmer the Cerberus website was changed so that one could not look up the management team. This is a major red flag as far as I am concerned.

    Finally, before Cerberus bought Chrysler, Tracinda was also doing their due diligence. Tracinda has in its employ the brilliant Jerry York who was the former CFO of Chrsyler and is largely responsible for putting in place financial controls which saved IBM. Jerry passed on the Chrysler deal — which shows you the quality of the Cerberus management team…

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  28. Let’s stop kidding! Almost everyone knows Chrysler is not a viable company and gov’t will still put more money in it. Publicly everyone including Cerberus, Congress and White House will say that it is viable and privately everyone will concede that it is not.

    The taxpayers will effectively lose the money. It will be used to build more lousy money losing vehicles for few more years. If the rest of the economy gets better by then, Chrysler will eventually be liquidated or parts of it sold cheaply.

    Following the liquidation, the taxpayers will guarantee pension for the generations of workers at Chrysler through the Pension Guarantee corporation and also pay for their healthcare.

  29. The big Detroit firms are horrible corporate citizens, they were in trouble long before this whole financial mess started. Let them restructure – declare bankruptcy , they’ve been saying : “I outta cash again” for a long time now. There is a need for introspection within the auto industry, let them innovate or die.

  30. James, another good article. Thanks.

  31. Pingback: Some follow-up to my last post. « The Kibitzer

  32. Pingback: A Good Question About Chrysler | The Blog of Record

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  34. We must also consider how a further bailout will be interpreted by the rest of the world. Protectionism?

    If so, are we setting a path to a divided world?

  35. Well that explains the situation very neatly.

    Cerebus has something to win or lose with both Chrysler and GMC. I suppose that is why they flew (hmm drove) to Washington to plead for funds together. I’m sure John Snow knew the White House was not going to let them fall.

    But what about the fallout if we don’t help. They really have us over a barrel. Sorta like the ransom hold the banks are using. What a da** shame.

  36. Post (GRD) great republican depression, the remaining working population of America will drive Buick LeSabres and Cavalier-like cars made in China. These cars are a current-day reality on the streets of China, and await export to the U.S. on the docks of Shanghai as we speak! The elitist uber-rich shareholders of GM had GM-America teach GM-China how to build these cars using 85 cent and hour, Chinese peasant women, the supply of which is unending and self-regenerating in China. The Uber rich chose these women over the North American car builders for quite apparent economic reasons! The current “bail-out bullshit” is a smoke-screen devised by the Uber-rich bastards, to foist liability for the large number of unemployed they intend to create, from the private sector, over to the public sector to relieve themselves of any undue expenses, before they collapse expensive North American operations in favor of highly profitable Chinese and Asian operations. Remember, they now own both, are dumping the American white elephant, and the workers, and the old factories, liabilities, environmental cleanups, and all, for existing, expandable, more profitable, modern, Asian production centers, so that they can be truly competitive with Honda, Hyundai and the like! It is a good, sound business strategy for the uber-rich shareholders, and by selling American stock and buying Asian stock, they slide away to new fields of immense profits, liability free as they collapse American corporations, and Yankee doodle gets it up the brown spot, hard and firm, once again, and is left, smarting and holding the bag (ouch!). Any truly innovative and advanced ideas will be incorporated into the new Chinese built, highly “profitable for shareholders” cars. The “Volt” is a 1969 chevelle body, complete with sheet metal and hydraulic support, engine removed, battery pack added, a nightmare of 1930’s greasepit engineering – no servo’s, no drive by wire, no plastics, no carbon fiber, no magnesium parts, no aluminum, no advanced polymer composites – Hell, even Hyundai is trying to make better, lighter bodies from recycled soda bottles, and Henry Ford did a number with Soy-plastics way back when! There is no way in Hell, that a major corporation in the country that put a man on the moon can be so backwards, unless they have other motivations, they just are not that stupid!

  37. One phrase: milk the cow.

  38. Pingback: Does Cerberus Believe in Chrysler? - Wheels Blog - NYTimes.com

  39. Really, an excellent piece.

    I found it by reading the NYTimes article that references your site and this article. I’m happy I followed the link back to your site.

    As we noted on our site that covers the auto industry, the difference in detail and intended sacrifice between Chrysler’s plan and GM’s plan was glaring.

    Perhaps Fiat Group should find another partnner…

    B Moore – autosavant.com

  40. Why doesn’t Cerberus put more money into Chrysler Auto? I would rather ask the question as “Would Cerberus put more money into Chrysler Finance” because as I argue that is the real reason they bought Chrysler.

    First, one needs to understand the Chrysler holding company structure which is comprised of a holding company owned by Cerberus and Daimler that in turn owns Chrysler Auto, Chrysler Finance, and Auburn Hills headquarters real estate. Chrysler Auto is a standalone entity financed with non-recourse bank loans [$7 bil (orig $10 bil) 1st mortgage + $2 bil 2nd mortgage (Daimler $1.5 bil/ Cerberus $500 mil] and $5.4 bil equity from Cerberus. Chrysler Financial, the primary funding source for Chrysler dealers and car buyers, is financed separately with an est. $36 bil in non-recourse debt [$6 bil 1st mtg bank loan, est. $30 bil in asset backed securitizations, and $1 bil equity from Cerberus. Auburn Hills is financed separately from Auto and Finance and has an est. $225 mil 1st mtg. The RE was appraised at a value of $800 mil back in spring, 07. Thus Chrysler Auto remaining viable was critical to Auburn Hills’ value.

    Cerberus hoped they were getting Chrysler Auto-Finance cheap by only paying $7.2 bil for a company that Daimler paid $38 bil for in 1998. However, it was more likely they were more intent on buying Chrysler Finance and if they could turn around C-Auto that would enable C-Finco to become profitable. If that worked the real value would come from the finance company and less so the auto company. When buyers look at buying finance companies they tend to value them based on a multiple of book value.  I believe that $6.45 bil (net for $950 paid to Daimler and $300 in cash already on the balance sheet) is close to the book value of C-Finco implying that Cerberus only paid 1.3x book value (see note 1 below).

    Furthermore, I believe they were hoping to merge C-Finco with GMAC .   By coincidence they only paid 1x BV for GMAC (see note 2 below).  It is highly likely that they were going to merge GMAC and C-Finance (it was discussed as potential strategy for increasing value of GMAC in GMAC investor meetings). Merging 2 finance co’s can save significant costs ($millions) by reducing redundancies and benefiting from scale economies (think 2 banks merging). This new much larger auto lender could be sold to a large bank, at 2-4x book value.

    It should be noted that in the Restructuring Plan filed, there was an industry consolidation section. It was done by JPMorgan per acknowledgment on slides. JPM has banked the C deal from the start, having been a primary M&A banker and lender to Cerberus. JPM is also the owner of Bear Stearns who was another big proponent of deal. This section highlights how consolidation of GMAC-CFC would be positive, positive for Cerberus as still 100% owner of CFC and 33% owner of GMAC. Bailouts of both these co’s are still benefiting Cerberus who has not put one new dollar into these co’s since the bailout began.

    Notes:
    1. C-Finco book value was derived from: typical finance companies such as GMAC or FMCC are structured with assets equal to 8-10x equity or in C-Finco’s case about $40 bil.
    In this case, it looks like Cerberus paid only 1/4th of book value but if you assume they valued C-Auto at close to zero given the huge OPEB liability for healthcare, then the total value spent on C-Finco was $6.45 bil or 1.4x book value (assuming 8x equity ratio).

    2. Cerberus and GM paid $14.5 bil for GMAC.  Cerberus paid $7 bil to GMAC and GM retained a 49% interest valued similarly even though no cash left GM.  GMAC’s mortgage business, Rescap, had a $7 bil BV and GMAC’s auto loan business had a $7.5 bil BV. Of course if your book value is overstated due to pending problems with your assets (i.e. loan charge-offs) that means you might have overpaid. That is exactly what happened with GMAC.  

    Cerberus investment structure:
    The argument that they put more money in is valid, but most likely would require either additional money from Other Investors or special permission for its own fund investors. Nardelli and others reasoning is flawed.
    Cerberus Institutional Partners IV fund (CIP4), closed in ’07 equal to approx. $7 bil. This fund invested approximately $1-1.5 bil in both GMAC and Chrysler. Some of the investors in this fund are institutional investors such as Penn state teachers pension, Idaho state pension, Indiana state pension, NY common fund, Univ of Calif endowment, Univ of TX endowment, and Allstate insurance.
    Est. $5.5-6 bil from other primarily distressed fund investors such as Franklin Templeton (one of their mutual funds), Avenue Capital, and others. These same funds invested a similar amount in GMAC.
    Cerberus has approx. $27-30 bil assets under management. Thus they have invested approximately 7-8% of total assets or 30% of CIP4.

  41. Simple fact is Chrysler belongs to a private firm that isnt even US owned. They should put their own money up. Let it fall and the Taxpayers can buy it for pennies if they let it fail. Dont spend money on trying to keep a company that is no longer owned by the US.

  42. Gmoney,
    Just wondering how did you come up with C or Cerberus not U.S. owned?
    Daimler owns 20% and Cerberus is private equity partnership controlled by Feinberg, a U.S. citizen. Fund investors in Cerberus managed funds come from everywhere.

  43. Leonard Edwards

    Thank You. Oustanding

  44. Greg Rushing

    Polly, you nailed it. Ofcourse, bankruptcy is out of the question. Under a chapter 7 or ch 11 filing, the labor unions would lose their current contracts. Prez Obama still owes the UAW a big favor in return for all the money they contributed to him in 2008. So he won’t let GM or Chrysler get out of their labor contracts that easily. Therefore, until the Chinese finally wise-up and refuse to buy any more US T-bills, the US taxpayer will continue subsidizing a bunch of over-paid, lazy, and obsolete bums in Detroit. I have no sympathy for you people. If you wanted to earn six figures, then you should have gone to med school.