Keith Hennessey, the last head of the National Economic Council before Larry Summers, has a blog post out (hat tip Alex Tabarrok) reviewing yesterday’s announcement by the Obama administration on their proposed new CAFE (Corporate Average Fuel Economy) standards. It links to a very informative report that I’m still digesting. (I was planning a post on the economics of CAFE for today, but now I need to read part of that report.)
Update: I found a mistake in the way Hennessey used a table and I posted about it here. Hennessey graciously acknowledged the mistake, fixed it on his post, and left a comment here. So I decided to delete my criticism. I really should have sent him an email first, and I feel bad about that.
By James Kwak
I was talking to an old friend last night about the Chrysler bankruptcy and, in particular, whether Chrysler (and Treasury, and the UAW) will be able to get around the order of priority of creditors in bankruptcy – which ordinarily would favor the senior secured lenders who are trying to block the proposed plan. I thought I would do a little research, but then (again via Calculated Risk) I found Steve Jakubowski’s analysis of precisely this issue, which apparently everyone on the Internet has already been linking to. It’s actually Part 3 of a series; you may want to start with Part 1.
My summary, for those who don’t like reading citations from court opinions: The issue with the “restructuring initiative” agreed-upon by Chrysler, the government, Fiat, and the UAW, is that it only pays the senior secured creditors $2 billion in cash for $6.9 billion in secured debt; since secured creditors’ claims should come first, they argue they would get more from a liquidation. In particular, the VEBA created to fund retiree benefits is owed $8.5 billion; it is getting $4.6 billion debt and 55% of the equity in New Chrysler.
This post was written by my friend Ilya Podolyako, an occasional contributor here and a third-year student (though not for much longer!) at the Yale Law School.
In the last couple of days, a few disparate news pieces attracted my interest. First, as I mentioned in my last post on industrial policy, an accelerating, worldwide decrease in consumer disposable incomes is beginning to percolate through the manufacturing sector. As a result, Caterpillar, DuPont, and United Technologies posted double-digit declines in sales. Second, reports surfaced that Fiat, Obama’s designated buyer for Chrysler LLC, was looking instead to purchase GM’s Opel division. Third, Sen. Diane Feinstein (D-CA) introduced a “cash-for-clunkers” bill that would provide a credit of up to $4500 toward the price of a fuel-efficient car for individuals or government-owned fleet operators who turn in a low-mpg “clunker.”
What do all these data points have to do with each other? In my mind, they highlight the need for a structured approach to the U.S. industrial sector. The current policies are completely random and occasionally conflicting, which is not surprising, considering that they are coming from different branches of government who seem reluctant to talk to each other. For example, the purpose of the Feinstein bill seems to be to support the auto industry by lowering the effective price of a new car while also boosting aggregate fuel efficiency. Presumably, these measures would help the ailing American automakers transition from making money on SUVs to making money on hybrids. Yet in this context, a government-financed sale of Chrysler to Fiat doesn’t make very much sense. If we are concerned about rescuing the American auto industry from the bottom up, why are we selling bits and pieces of this industry to foreign companies? Imagine if GM, Chrysler, and Ford did not exist – in this world, the government could surely find a better way of spending money to combat climate change than paying Toyota and Honda to chop 20% off the sale price of a new car. Just because other countries do it, doesn’t mean we should too.
My Yale Law School colleague Ilya Podolyako comments on the Obama administration’s plan for the auto industry and the tension between public goals – preserving jobs, increasing fuel efficiency, etc. – and private goals – profitability.
By now, the dust seems to have settled around Obama’s rescue plan for two-thirds of the long-ago “Big 3” (in 2007, Chrysler ranked 12th in the world in total auto sales; GM has ranked 2nd; Ford, which is not receiving government assistance, was 4th). The policy itself seems prudent enough. The President’s Task Force on the Auto Industry recognized that due to its small scale, reliance on light trucks, and objectively low product quality, Chrysler is not viable as a stand-alone company. On the other hand, General Motors has large economies of scale and makes certain well-received products (the report mentions the Chevy Malibu and Cadillac CTS by name, though one could add the Cavalier, Corvette, and Escalade to those lists), but faces exorbitant legacy costs for its nearly one million retirees and low margins on its fuel-efficient vehicles. Given this fact pattern, the plan does as good of a job as anyone could in offering a helping hand to iconic American manufacturers while preserving some incentives for efficient private-sector operation.
My problem with the restructuring proposal comes not from any one of its details, nor even its general spirit. At this point, I feel fairly neutral about heavy-handed government involvement in US industrial policy. Admittedly, I am from Michigan and really like cars (despite consistent problems, I keep driving Fords, though I am not sure why), so I have some emotional connection to the industry to balance against the gross, obvious inefficiency of pouring money into enterprises that, by their own admission, will at best break even by 2014. I also do believe that a GM bankruptcy would lead to the net loss of a significant number of jobs that would permanently cripple Michigan’s already desperate economy.
Back in the early days of the Clinton administration, James Carville was credited with saying something like this:
I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 basball hitter. But now I would like to come back as the bond market. You can intimidate everybody.
The story back then was that bond investors, by buying or selling Treasury bonds, could lower or raise the government’s cost of borrowing and interest rates across the economy, depending on how they felt about government policy.
Today bond investors have discovered a much more direct lever over government policy. I’ve already written about the importance of bondholders in dealing with the financial sector. This week we are seeing their power over the auto industry.
Robert Siegel gave GM a priceless gift today: a feature segment on All Things Considered, with a bunch of softball questions and a paean to the Chevy Malibu (which was, to give credit where credit is due, the 2008 North American Car of the Year, which includes foreign imports). Then Bob Lutz, GM’s vice chairman, fumbled the gift and dropped it on the floor, where it smashed into a thousand pieces. When asked what it was like to operate using money borrowed from the federal government, he said:
I’ve never quite been in this situation before of getting a massive pay cut, no bonus, no longer allowed to stay in decent hotels, no corporate airplane. I have to stand in line at the Northwest counter. I’ve never quite experienced this before. I’ll let you know a year from now what it’s like.
At my old company, it was a point of pride to search on price-comparison sites for the cheapest hotels you could find. (I know the argument that it saves money for expensive execs to fly corporate jets rather than flying commercial, because at their hourly rates it’s not worth the time spent waiting in line. I think those arguments are bunk, because they assume that the ten minutes you spend waiting in line are ten minutes of work you will not do that day, while my experience is that in high-level positions the amount of work you do is a function of the amount of work you have to do, not the amount of time you have.)
It may be true, as Bob Lutz claims, that GM makes good cars again. (I happen to own and drive a GM car that I am very satisfied with, but it’s a Chevy Prizm, which may not count.) But GM’s brand reputation today is that it is out of touch, and stories like this don’t help.
I’m a little late to the GMAC bailout story, but after reading all the newspapers and blogs I usually read, there are still some things I don’t understand. I’m particularly confused about the announcement that GMAC will start lending to anyone with a credit score above 620, down from their previous minimum of 700. (The median credit score in the U.S. is 723.)
1. What is the relationship between GM and GMAC? I know that Cerberus owns 51% of GMAC and GM owns the other 49%. I also know that, in order to become a bank holding company, both were forced to reduce their ownership stakes. In any case, GMAC is an independent company that should not be run for the benefit of GM. Its obvious that GM benefits if GMAC reduces its lending standards. But how does GMAC benefit?
2. If a loan to someone with a credit score of 621 was a bad idea on Monday, why was it a good idea on Tuesday? The only theory I can think of under which this makes sense is that GMAC thinks that loans to people with credit scores of 621 are profitable, but they couldn’t get the capital cheaply enough until they got their government bailout money.
3. Who is going to pay the bill when these loans go bad? It looks to me like GMAC is making a big gamble by trying to pump up its lending volume with higher-risk borrowers, right in the middle of the worst recession since . . . 1981? the 1930s? (In any case, it won’t be able to get anything like the lending volume it used to have, simply because fewer people are buying cars.) Isn’t this a situation where a company is choosing a high-risk strategy because its only option is to watch its revenues shrink away to nothing because the demand for credit has plummeted? But if that’s the case, how smart is it to go chasing after high-risk borrowers because the low-risk ones are suddenly saving their money? And now that GMAC has gotten the Henry Paulson seal of approval (remember, TARP money was not supposed to go to unhealthy “banks”), I think there’s a fair chance they are counting on Treasury to bail them out of their next round of bad loans.
Of course, it could be said in GMAC’s defense that they are just doing what Congress wants them to do: take TARP money and use it to make loans more available to consumers. But this goes back to the fundamental schizophrenia of TARP: it was conceived to keep banks from failing, but most people think its purpose should be to increase credit. And in this case I suspect GMAC’s taxpayer money is being used to sell GM cars that people wouldn’t buy otherwise, and when it runs out GMAC will be back for more.