Big three bailout, auto industry bailout
David Zalubowski/AP

Too Big to Fail: How Would an Automaker Collapse Affect the Economy?

November 28, 2008 09:59 AM
by Josh Katz
Time is running out for a bailout. If GM, Chrysler or Ford shut down, what would that mean for workers and the economy?

Bailing Out the Big Three

Congress has not budged and the auto companies might have to wait until the new presidential administration for an emergency bailout, although all of the Big Three might not survive that long.

"The sad reality is that no one has come up with a plan that can pass the House and the Senate and get signed by President Bush," Senate Majority Leader Harry Reid (D-Nev.) said, according to the Los Angeles Times.   

In the third week of November, the three auto CEOs laid out their cases for a $25-billion bailout. GM requested $10 to $12 billion, Ford sought $7 to $8 billion, and Chrysler asked for $7 billion. But by the end of the week, congressional leaders announced that they weren’t persuaded, and told the automakers to submit more detailed plans by Dec. 2 that would explain how they plan to use the money to assure their long-term success. If the plans seem viable, Congress could reconvene for a special session the following week. Otherwise, the automakers will have to wait until President-elect Barack Obama takes office on Jan. 20.

The CEOs didn’t help their case by flying to Washington on separate private jets. "What happened here in Washington this week has not been good for the auto industry," Reid said, adding that "these guys flying in their big corporate jets doesn't send a good message to people in Searchlight, Nev., or Las Vegas, or Reno, or any other place in this country."

Some Democrats said it was necessary to give the automakers some of the funds from the $700 billion financial bailout. Allocating $25 billion for the automakers would only account for 4 percent of the bailout, they contended. Reid cautioned that a “potential meltdown” could occur if the 355,000 autoworkers and 4.5 million employees of related industries lost their jobs. He also pointed out another 1 million people, consisting of retirees and their family members, could be robbed of their retirement and medical plans, according to U.S. News & World report.

White House press secretary Dana Perino warned Congress not to “raid” the Treasury" of funds needed to stabilize our financial system," The Washington Post reported. According to Perino, it would be more prudent to revise the already developed $25 billion loan program meant to assist the auto industry with fuel-efficient vehicle production.

Sen. Jon Kyl (R-Ariz.), the minority whip, also condemned the idea of handing the auto industry more loans because he feels the long-term future of the industry is in jeopardy regardless of how much money is put into it. "There's no reason to throw money at a problem which is not going to get solved," Kyl said, according to the Post.

Although the Big Three may not get the loans they desire, they have demonstrated that the economy would suffer in their absence. For example, the Ann Arbor-based Center for Automotive Research indicates that “that 1 in every 10 jobs is directly or indirectly affected by the automobile industry and the failure of the three Detroit automakers could result in the loss of 3 million jobs in the first year,” according to the Detroit Free Press.

The National Association of Manufacturers and the U.S. Chamber of Commerce have also lobbied in favor of federal assistance for the auto industry. The Detroit Free Press writes: “The clear message being: If the economy's not in a recession now (and it may well be), wait until one of the major automakers fails.”

Rick Wagoner, the CEO of GM, rejected the idea of declaring bankruptcy because of the “far-reaching negative effect it would have on the company, workers, dealers and suppliers,” the Associated Press reports.

Out of the Big Three, Ford is unquestionably in the best condition. According to Time magazine, the CEOs of GM and Chrysler made it clear that without the loans, they’re not going to survive until 2010, sparing bankruptcy.

Opinion & Analysis: What will happen if the auto companies fail?

If the major car companies were to fail, car and truck prices could increase, fewer vehicles will be available and used car owners will struggle to find replacement parts, some experts say. "Vehicles could cost anywhere from 5% to 15% more, maybe even more than that," said Michael Robinet, vice president of global vehicle forecasts for auto consultant CSM Worldwide. Automakers might also be forced to drop many of their buyer incentives, such as cash-back or low financing rates,” according to CNN Money.

If GM were to fall, companies that supply GM with parts and materials will take a huge hit. "The first thing they'll stop making is [replacement] parts," Kimberly Rodriguez, co-leader of global automotive services for accounting firm Grant Thornton, said. "That's the least profitable business they do. If the production suppliers aren't functioning, the 150 million used vehicles out there are going to have trouble."

Even though Ford isn’t experiencing a “cash crisis,” a GM or Chrysler bankruptcy could take a substantial toll on Ford because suppliers would suffer. Asian markets, which are “financially healthy,” would also experience production difficulties, CNN Money reports.

If GM goes bankrupt, a prominent economist indicates that unemployment could rise to 9.5 percent in the U.S., in comparison to last year’s 6.5 percent, sending the country into a “severe recession,” according to Eoin O’Carroll of The Christian Science Monitor. GM employees aren’t limited to the U.S., and the workers would lose their jobs from “Ecuador to Poland to Kenya to Uzbekistan.” But O’Carroll suggests that “Japanese, Korean, and German automakers could step in and make up for the lost jobs.”

Wilbur Ross, who earned billions on investing in troubled steel and textile companies, and is called the “King of Bankruptcy,” also said it would be disastrous for the economy if one of the Big Three filed for Chapter 11. He claimed that if one of the companies went into bankruptcy, the other two and their suppliers would fall as well, because of tightened credit lines from the economic crisis.    

Hedge-fund manager William Ackman and former CEO of General Electric Co. Jack Welch disagree with Ross, claiming bankruptcy could benefit the companies by forcing them to restructure.

Similarly, Ted Reed of wonders why the automakers think they are entitled to government loans when some airlines accepted bankruptcy and it actually helped them survive. “After all, while ‘bankruptcy is not an option’ has become a mantra for automakers, the legacy airlines expect to post profits in 2009, largely because recent bankruptcies prepared them to deal with the troubled economy,” Reed writes.

Even though GM CEO Rick Wagoner said that "80% of consumers would not consider buying a car from a company in bankruptcy,” Reed contends that Delta used bankruptcy to its advantage by merging with Northwest and “took the opportunity to remake itself.”

A blog entry from the investment site Motley Fool argues that, out of the three companies, Chrysler should not be bailed out. The writer claims that the federal government has given Chrysler money before, and it failed. Furthermore, out of the three companies, Chrysler is privately owned and the U.S. should “Let big, private money succeed or fail of its own merits.” Finally, it might be beneficial to let Chrysler die, the writer notes, because there is an “overcapacity” of producers in the industry right now. “Rather than having congress give away money for all Big Three to limp through this recession, why not just solve the underlying condition by drastically slashing one of the three,” the writer asks.

“Ford could actually prosper” when all is said and done, according to Bill Saporito of Time magazine. Ford still posts a profit, thanks partly to the fact that it doesn’t have a bank bogged down by subprime mortgages, like GM’s GMAC. Ford also maintains credit lines of $10.1 billion. The company is investing more and more in smaller, fuel-efficient cars, and Ford CEO Alan Mulally said, "By the end of 2010, two-thirds of our spending here will be on cars and crossovers—up from one-half today."

Saporito admits that Ford would hurt in the short term if some suppliers fail as a result of a GM or Chrysler collapse, because they often use the same suppliers. “But longer term, customers might flock to a U.S. company that isn't in bankruptcy and thus stands 100% behind its products—and is free to operate without court supervision,” he states.

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