Auto Bailouts Changing Lanes

December 12, 2008

(bettertrades) - The real question taxpayers should be asking themselves is not if the U.S. government should bailout the automakers but how it will be done. It's no secret that GM and Chrysler will most likely be back for additional financing early next year, begging the question: How can the U.S. taxpayer keep the auto industry afloat long enough for the big three to change gears? On December 8th, General Motors (GM) and Ford (F) stock jumped on news Congress hashed out details of a bailout for the auto industry. Specifics of the $15 billion bridge loan include an ownership stake by the government (Warrants equal to 20% of the loan), a promise by GM to invest $2.9 bill in alternative fuel projects, aggressive pursuit of plant consolidation, and the potential sale or closing of multiple operations including Saab, Hummer, and Pontiac. The bridge financing is for a 7-year term at a 5% interest rate over the first five years, and 9% for the remaining years.

Additionally, the automakers must drop lawsuits against states that enforce lower emission standards than those imposed at the national level. During Q&A sessions before Congress, big three CEO's Wagoner, Mulally, and Nardelli pitched their plans for survival on the going assumption that motor vehicle sales will not drop below the current breakpoint. Considering the current state of rising unemployment and downwardly revised GDP forecasts, a reasonable assumption would be for big ticket items such as motor vehicle sales to continue to plummet. If this is indeed the case, can the U.S. taxpayer prop up the auto industry for an indefinite period of time?

Clearly, the UAW is the elephant in the room. Legacy costs for auto unions make up a principal obstacle to structural change in the industry's business model. Pension funds are in fairly good condition, but younger retirees may be forced to accept reduced benefits pending the rescue package. The UAW currently has $1.25 billion in assets and collects roughly $169 million in Union dues. Benefit concessions from the UAW will likely cost an equity stake and a seat on the board for the unions.

Why exactly are the U.S. taxpayers footing GM and Chrysler's bill when Ford is demonstrating how efficient and responsible management should adjust to changing market conditions? The world's fourth largest automaker is on pace to be profitable next year following a restructuring plan begun in 2005. Ford has been giving up market share over the past several years, highlighted by losing its status as the number 2 auto producer in the U.S. to Toyota last year. The kicker is that Ford doesn't need or want bailout money, but General Motors and Chrysler are in such bad shape that an industry-wide plan is being forced down their throats. Yet systemic risk to the industry remains and most analysts agree that if one of the automakers goes down, ripple waves will spread throughout the economy. If bottom lines don't improve, TARP funds are exhausted, and the Fed's balance sheet gets bloated beyond capacity, where can the auto makers turn to next?