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December 3, 2008
The three domestically owned U.S. manufacturers of cars and light trucks are requesting federal financial assistance in the form of "bridge loans" to assure their ability to continue in business. The companies, General Motors (GM), Ford and Chrysler (collectively known as the "Detroit 3"), have directly appealed to Congress for aid in a series of hearings that began in November 2008. The companies have been affected by a long-term decline in U.S. market share, the impact of a general decline in U.S. motor vehicle sales in 2008 that has impacted all producers, and the effects of a severe constriction of credit, resulting from problems in U.S. and global financial markets. The rise in gasoline prices to more than $4.00 a gallon in July 2008 caused a significant fall in vehicle use and miles driven, and a structural shift in motor vehicle consumption patterns. The subsequent decline in gas prices in Fall 2008 has not led to increased consumer spending on autos and light trucks, in spite of numerous incentives by American and foreign-owned motor vehicle companies.
A bill to provide up to $25 billion in direct loans to the companies was introduced on November 17, 2008, by Senate Majority Leader Harry Reid (S. 3688). This bill would make these loans available from $700 billion already set aside by Congress in the Troubled Asset Relief Program (TARP) established under the Emergency Economic Stabilization Act of 2008 (EESA, P.L. 110-343). Earlier, Secretary of the Treasury Henry Paulson rejected requests to use his existing authority to designate TARP funds for this purpose. The Bush Administration instead proposed that bridge loans to the auto industry could be taken from the direct loan program for advanced technology vehicle production set up under Section 136 of the Energy Independence and Security Act (EISA, P.L. 110-140). This bill had become law in December 2007, and had been funded under P.L. 110-329, legislation that included continuing appropriations for FY2009.
A number of other draft bills have been discussed in both houses, but none has been introduced. Senator Reid and House Speaker Nancy Pelosi have said that funding for bridge loans to the industry will be considered at a session of Congress to be convened in early December 2008, after the Detroit 3 present detailed plans to Congress as to how they would use the funds to assure their long-term financial viability.
This report reviews the U.S. automotive industry at present, aspects of the industry's financial situation, and relief options. It includes an analysis of the current situation in the U.S. automotive market, including efforts to address problems of long-term competitiveness and the impact of the industry on the broader U.S. economy. It focuses on financial issues, including credit questions, and legal and financial aspects of government-offered loans or loan guarantees. This further includes consideration of legacy issues, specifically pension and health care responsibilities of the Detroit 3. It also reviews potential solutions to the financial crisis, including options of government receivership and participation management, and various forms of bankruptcy. Finally, the report reviews stipulations that Congress might impose on auto manufacturers as conditions of providing assistance.
Contents Introduction Are The Detroit 3 Facing an Economic Collapse? Organization of This Report Impact on the National Economy Financial Issues in the Auto Industry Credit Conditions Direct Bridge Loan Provisions The Domestic Motor Vehicle Market Loss of Detroit 3 Market Share Labor Negotiations in 2007 to Address Competitive Issues The Energy Independence and Security Act of 2007 (EISA) Legislative Efforts to Assist Automakers Employment in the Automotive Sector Financial Solutions: Bridge Loan or Bankruptcy? Bankruptcy Chapter 7 Chapter 11 Assistance from the Federal Government Government-Sponsored Reorganization Pension and Health Care Issues Pensions and Pension Insurance The Pension Benefit Guaranty Corporation Funded Status of Auto Manufacturers Pension Plans Health Care Issues Stipulations and Conditions on Loans Executive Pay and Compensation Fuel Economy and Advanced Vehicle Technologies Other Conditions in Oversight of Company Management
U.S. Motor Vehicle Industry: Federal Financial Assistance and Restructuring
Are The Detroit 3 Facing an Economic Collapse?
Motor vehicle sales continued to decline in late 2008, despite falling gasoline prices. Consumers were apparently deterred by poor economic prospects, plus the impact of reduced credit availability. The Detroit News observed that GM and Chrysler U.S. sales in November 2008 each fell by more than 40% compared to year-earlier results. Ford and the three leading Japanese companies (Toyota, Honda, and Nissan) did little better, with sales of each falling more than 30%. The poor results occurred despite the predictions of "Many analysts [who] had expected better November sales because of aggressive [automakers' sales] incentives and the thought that the plunge in gas prices may have put a floor under sales." (2)
In the unfavorable economic circumstances of late 2008, all manufacturers and sellers of motor vehicles (passenger cars and light trucks) faced difficult times in the United States. For the first ten months of the year, sales were down by two million vehicles versus the same period one year earlier--a 15% decline. Moreover, the decline accelerated during the latter part of the year. Sales were about one-third lower in October 2008 compared to the same month in 2007. Virtually every manufacturer reported declines for the year.
Within an overall down market, the U.S.-owned automakers have fared the worst. The major Detroit-based auto manufacturers were formerly known as the "Big 3." They are not any more, because by 2007, one Japanese company, Toyota, outsold two of the Detroit companies, Ford and Chrysler, in the United States, their own home market. In addition, Honda in 2008 roughly equaled Chrysler in domestic U.S. motor vehicle sales. Through October 2008, the Detroit 3, consisting of General Motors (GM), Ford Motor Company, and Chrysler LLC (owned by Cerberus Capital Management LP), had seen their annual rate of sales fall by more than 21% in total, and by more than 20% in each case. The Japanese, Korean, and European producers, all recorded declines in the single-digit ranges, except for Toyota, the largest company, whose sales were down by 11.5%. (3)
This has not been merely a loss of some companies' competitive position to others, a normal shift in the marketplace. The Detroit 3 are facing a myriad of peculiarly disadvantageous conditions in addition to the worsening economy. The credit crunch that has dampened general consumer demand for new vehicles has moreover impacted the ability of their "captive" credit companies to make loans to either consumers or dealers for their inventories. The Detroit 3 have much higher legacy costs than foreign automakers, and may in some cases be more adversely affected by stricter federal corporate average fuel economy (CAFE) standards. (4)
The cyclical decline in the market has combined with a sudden change in consumer preferences from trucks back to cars, to both sales decline and accelerated losses of market shares for the former "Big 3." This has put their entire business model, which includes a collective bargaining relationship between management and labor, at risk. Because the foreign-owned companies in general are non-union operations in the United States, Congress is facing the possibility that the unionized, domestically owned motor vehicle industry could, by its own testimony, go out of the business. On November 17, 2008, legislation was introduced in the Senate (S. 3688) that would have implemented a loan program to prevent one or more of the Detroit 3 from entering into bankruptcy, but a decision on any specific actions was deferred.
Organization of This Report
This report focuses on the current situation faced by the Detroit 3, key aspects of their current crisis, including the consequences of a failure of one or more companies, and some aspects of legislative actions that have been considered to bridge their financial conditions to a more stable situation. The subjects covered are:
* The impact of the automotive industry on the broader U.S. economy and of potential failure of the Detroit 3 companies;
* Financial issues, including the present conditions affecting credit for automotive consumers and dealers, and legal and financial aspects of government-offered loans or loan guarantees to the industry;
* The current situation in the U.S. automotive market, including efforts in 2007 by the Detroit 3 and the United Auto Workers union (UAW) to address problems of long-term competitiveness;
* Potential solutions to the financial crisis, including options of government receivership and participation management, and various forms of bankruptcy;
* Legacy issues, specifically pension and health care responsibilities of the Detroit 3;
* Stipulations that Congress might impose on auto manufacturers as conditions of providing assistance.
Impact on the National Economy (5)
The question of rescuing one or more of the Detroit 3 automakers comes up at a time of considerable weakness in the overall economy. In the third quarter of 2008, real gross domestic product (GDP) fell by 0.3%. Most economists are not very sanguine about short run prospects either. The November 2008 Blue Chip Economic Indicators consensus forecast was for real GDP to decline by 0.4% for all of 2009 and for the unemployment rate to reach 8.5% by the end of next year. (6) The prospect of a failure of any of the big three U.S. automakers could only cast more gloom on that outlook.
In the third quarter of 2008, the total value of motor vehicle output was $331.3 billion out of a total gross domestic product (GDP) of $14,429.2 billion. (7) Motor vehicle production thus represents 2.3% of total output. The total number of workers employed in the manufacture of U.S. autos in 2007, measured on an annual basis and somewhat different from the numbers generated in the table above, was 859,000. Of those, 186,000 worked in light vehicle assembly, and 673,000 were employed in the manufacture of parts. (8) Economists generally assess that economic growth of at least 2% is required to accommodate a growing labor force and keep the rate of unemployment from rising. A loss of anything approaching 2% of output would very likely lead to significant increases in the unemployment rate in the short run.
The Center for Automotive Research (CAR), an organization supported in part by industry contributions, did an economic simulation of a failure of domestic automakers based on two separate sets of assumptions. (9) In the first case it was assumed that the problems of the Detroit 3 automakers led to a permanent 100% decline in the production of domestic automakers in the first year (2009). It was also assumed that the effect of that shock would result in a such a large drop in the demand for parts that suppliers would be forced to either liquidate or restructure. It was assumed that the disruption to the parts suppliers would cause domestic production of foreign-owned auto manufacturers to also drop to zero in the first year.
In this scenario, the total number of jobs lost in the United States in the first year was estimated to be 2.95 million. That figure includes jobs lost at auto manufacturers, parts suppliers, as well as in the rest of the economy because of the drop in consumer spending resulting from the direct job losses. In the second year (2010), production at the foreign-owned firms begins to pick up and employment recovers somewhat with the number of jobs lost falling to 2.46 million.
The second CAR analysis assumes that although in the first year (2009) domestic production of the Detroit 3 automakers drops to zero, auto production recovers to 50% of its former output in the second year and continues at that level. In this scenario, the estimated U.S. job loss in the first year is 2.46 million, falling to 1.50 million in the second year.
A general criticism of this analysis is that it assumes that the suppliers and all other automakers, aside from the the initially failed company or companies, would see their output drop to zero, and that they would be merely passive observers of an industry collapse. (10) There are many examples in recent years of bankrupt or financially distressed suppliers being supported by their OEM customers, or by other suppliers that acquire parts of the business to gain new contracts or to be able to continue servicing their own contracts from a failed subassembly producer. Different examples include Collins & Aikman, Plastech, and ten Visteon plants, whose ownership reverted to Ford as the Automotive Holdings Group. While CAR posits, for the sake of analysis, that, in the first year, no auto manufacturing in the United States could survive a major Detroit 3 bankruptcy, in actuality, such an extreme outcome is unlikely. Immediate and radical restructurings among suppliers are a more likely outcome, and other brands would continue to produce.
In addition, the CAR totals on job losses include losses at dealers, repair shops, retails parts stores, and other auto-related occupations, most of which would survive a Detroit 3 OEM bankruptcy, at least in the short term. (11) Sales in late 2008 continued at annualized monthly rates of about 10 million vehicles, indicating considerable continuing demand, much of which could be supplied from discounted inventory in cases where new vehicle supply was interrupted. And even if all new car production in the United States fell to zero in the next year, some of the money that would have been spent on new cars would instead be spent on repairs and maintenance, so income and employment in those firms would be likely to rise.
Moreover, the CAR analysis is only partial, with respect to the redistribution of consumer spending and the national economy. Some of the money that otherwise would have been spent on cars produced in the United States might instead be spent on cars manufactured abroad. An increase in car imports would have several effects. It would increase the supply of dollars in foreign exchange markets, tending to reduce the price of the dollar in terms of foreign currencies. A fall in the value of the dollar in foreign exchange markets would have the effect of reducing the price of goods and services produced in the United States to foreigners. That would tend to stimulate exports more generally, offsetting to some extent the loss of domestic car sales.
Separately from the CAR simulations, the chief economist of the economic consultancy firm Global Insight, Nariman Behravesh, has estimated what the effects of a GM liquidation would be. He assumed that associated supplier shutdowns, combined with that of GM, would push the national unemployment rate up by a point from a projected 2009 level of 8.5% to 9.5%. "... [S]pending for existing programs, such as unemployment insurance, and new measures that would be needed to revive economic growth ... would cost the government $200 billion should [GM] be forced to liquidate," Behravesh said in an interview. Expenditures would be especially focused on Michigan, Ohio, and Indiana, he added. (12)
To the extent that consumers are forced to delay new car purchases, some of that money might be saved until more new cars became available. Any increase in saving would tend to lower interest rates, below what they would otherwise be, reducing the cost of other credit-financed purchases. Spending for household furnishings such as appliances or furnishings might benefit. If the money that might otherwise have gone to a new car purchase is not saved it could result in increased output and employment in other firms. Some of the estimated direct effects of the loss in employment in auto-related firms might thus be mitigated by gains in other sectors, but in the short run any of these offsetting gains would likely be considerably less than the immediate effect of auto-related job losses.
Any loss of output due to the difficulties with U.S. automakers will likely be felt nationwide, but because of the geographic concentration of those firms it will be much greater in some regions than in others. According to Klier and Rubenstein, Michigan accounts for one-quarter of all auto parts. (13) They also point out that there is a corridor between the Great Lakes and the Gulf of Mexico that has become known as "auto alley." In 2008, 43 of 50 auto assembly plants are located in auto alley. Those geographic areas where automakers are concentrated would experience the greatest economic difficulties resulting from any loss of U.S. auto output.
It is important to keep in mind that all of the changes discussed in this section are measured relative to what would happen in the absence of a disruption of Detroit 3 auto production. While it would certainly be noticeable in auto alley, there may well be significant areas of the country where the effects would be negligible and would not be readily apparent from one quarter to the next.
In the long run the U.S. economy tends toward full employment. Slack labor markets tend to slow wage growth and eventually lead to an increase in the demand for labor. But if the demand for autos is increasingly met by foreign made cars, or by increasing capacity in existing plants in other locations, then autoworkers who have lost their jobs may face either relocating or retraining.
Financial Issues in the Auto Industry
Credit Conditions (14)
Credit is the lifeblood of the U.S. auto industry. Credit conditions govern the industry's ability to invest, the ability of its dealers to finance their inventory ("floorplan"), and the ability of dealers, in turn, to sell to individual consumers. The systemic crisis in the …