Auto loans: a deadline looms
The Obama Administration is beginning to leak to the press their impending decision on loans to U.S. auto manufacturers. I am writing in parallel to explain how you might think about such a Presidential decision. There’s an obvious caveat that every President and each Administration are different, but I hope my explanation will at least give you a feel for how you could think about such a challenging policy decision.
I will begin today with some background, and a presentation of four basic options and their costs and benefits. I will follow up later by describing two different approaches to the issue, and then I will ask for your recommendation. We’re going to pretend you are an advisor to the President. You can pick Cabinet (Treasury, Commerce, Budget, Energy, Labor, Transportation, EPA) or a senior White House staffer.
U.S. auto manufacturers face a set of long-term challenges. Let’s divide them up into factors affecting their future revenues, their future costs, and their balance sheets.
(Note: “Detroit 3” = General Motors, Ford, and Chrysler)
Revenues
- The economic slowdown means fewer vehicles are being purchased from all auto manufacturers, foreign and domestic.
- Even apart from the economic slowdown, U.S. auto manufacturers have been losing market share over time.
- This is in part because they made a bet on light trucks versus smaller cars. This product mix doesn’t work when gas prices are high. Think of the proliferation of SUV’s in the past 10 years. (Note that this was in part the fault of U.S. government policies. SUV’s are technically light trucks, and so they qualify for lower fuel economy requirements.)
Costs & productivity
- The Detroit 3’s ongoing labor costs are higher than those of foreign-based firms. This is still true when you compare an American worker in a GM plant in Michigan, for instance, with an American worker in a Nissan plant in Mississippi.
- Productivity is lower in U.S. plants of U.S. firms than it is in U.S. plants of foreign-based firms. Some of this is because of the UAW contract that mandates certain inefficiencies. Some of it is poor management.
- The Detroit 3 have huge dealer networks that are costly to the manufacturers. These dealer franchises are often protected by state laws that make it hard for the manufacturers to make these networks smaller and more efficient.
- Auto manufacturers face a burdensome and unpredictable legislative and regulatory environment.
Balance sheets
- The Detroit 3 have enormous legacy costs from their retirees. Past UAW contracts provided generous benefits that continue to burden these firms. This drains profits (when they earn them) away from productivity-enhancing investments.
I have found that different people emphasize the above points differently. The manufacturers tend to stress the economic slowdown point. The Wall Street Journal editorial page likes to focus on the costs of CAFE and government regulation. Conservatives in Congress and on the outside tend to emphasize the legacy retiree costs, and the ongoing labor costs.
The Detroit 3 must overcome these challenges to survive and be profitable in the long run. GM and Chrysler, however, face a much more immediate problem. They are out of cash, and no private lender will loan them funds. They pay their suppliers on a monthly schedule, due in the first few days of a month. GM and Chrysler were going to be unable to pay their suppliers in full in early January of this year. If you cannot pay your suppliers and if they will not extend you credit, then you cannot get the parts you need to make cars and trucks, and you shut down. Ford seems to be in better shape, at least in terms of short-term cash flow.
In late December, after more than a month of wrangling with the Congress, President Bush authorized $24.9 B of three month loans to be made to GM, Chrysler, and their financing companies in late December, using funds from the $700 B pot at Treasury known as the TARP: Troubled Assets Relief Program. (If you want to dive in deep, you can find the gory details of the loans to GM, Chrysler, GMAC, and Chrysler Financial on the Treasury website.)
A March 31 deadline looms for GM and Chrysler. The Obama Administration faces its own March 31 deadline, which it can unilaterally extend to no later than April 30. So sometime within the next five weeks (at most), the President must make a decision about the fate of General Motors and Chrysler. It is, however, quite possible that GM and/or Chrysler will need funds before the end of April, which would force the President’s hand earlier.
According to the terms of the loan (bottom of page 6 for the GM term sheet),
On or before March 31, 2009, the Company shall submit to the President’s designee a written certification and report …
If the President’s Designee has not issued the Plan Completion Certification by March 31, 2009 or such later date (not to exceed 30 days after March 31, 2009) as the President’s designee may specify, the maturity of the Loan shall be automatically accelerated …
The President has four basic options:
- Extend the term of the current loan and loan additional taxpayer funds, using more TARP money.
- Same as option (1), but only if a firm files for bankruptcy. This is called debtor-in-possession (DIP) financing. If a firm does not file for bankruptcy, allow the December loans to be called, in which case the firm will go bankrupt anyway.
- Allow the loan to be called and provide no additional funds.
- Punt to Congress. Refuse to spend additional TARP money, and tell Congress that if they want the companies to survive, they should appropriate new funds.
In part two I’ll discuss the pros and cons of each option.
Parts three and four will compare the Bush and Obama approaches to this problem. Part five will ask you to make a recommendation to the President.
Bonuses and the peril of Congressional hindsight
Which matters more to you?
- Anger at failed AIG executives who are receiving bonuses while their employer is being bailed out by the taxpayer.
- Fear of what this or a future Congress might do once they cross the line and start breaking contracts retroactively for people who are politically unpopular.
There are few more unsympathetic figures than a failed AIG official receiving a large bonus. You couldn’t design a more politically unpopular situation if you tried. Yet I am more afraid of what Congress will do, now and in the future, if it crosses the line into forcing retroactive changes to contracts between private parties. I know of no way that Congress can change the law to address their political problem that does not also do tremendous policy damage. I think they’re fundamentally irreconcilable goals, and policymakers have to choose.
As a policy matter, this is a no-brainer for me. Hindsight is not an appropriate basis for evaluating a contract, and Congress should not change the rules of the game retroactively. When two parties reach an agreement, they are bound by honor and the law to fulfill that agreement, no matter how unpleasant it may later seem, and no matter how conditions or circumstances change.
The House lost track of time. The AIG bonus payments were determined pre-bailout, and are being evaluated by elected officials post-bailout, when circumstances differ. If allowed to grow, this hindsight is perilous for all participants in our economy. Who knows if you will be Congress’ next target for retroactive legislation?
Our economy relies on millions of voluntary contracts made every day. We can borrow, lend, make future commitments, and buy and sell risk because we know that a deal is a deal. The government has an obligation to enforce those contracts without prejudice, not to apply their own judgment to those contracts after conditions have changed. Government’s job is to set the rules by which the rest of us operate, not to change the rules mid-stream so that their favored party can win. Full stop. Our system of contracts must protect everyone, including politically unpopular greedy failures.
The House’s behavior makes the U.S. a less attractive place to invest. In passing a bill to retroactively tax bonuses and even cash compensation for employees in firms receiving taxpayer funds, the House behaved like the Venezulean or Russian government. Replicating that bad behavior would sacrifice one of America’s core economic advantages: a stable and predictable system that respects the sanctity of contracts. A deal is a deal, especially when it later looks like a bad deal to one party. Congress needs to respect and enforce that, even when it’s politically unpopular. This is a pillar of our economic system that must not be damaged. Domestic and foreign investors have historically incorporated an extremely low political risk premium to investing in the United States. This kind of behavior increases that risk premium, making investment in America more costly and hurting American workers in the long run.
I believe that government should not set rules for compensation. That’s for you and your employer to work out. Compensation incentives, whether they’re commissions, bonuses, or merit pay, modify workers’ behavior. They reward and incent hard work, innovation, and greater productivity. Employers use them because they are effective at making their workers and firms more successful. They should be legally free to do so however they see fit to make their firms successful.
Finally, the House-passed bill fails to recognize that there are good, hard-working, and successful employees in failing and struggling firms. The management of these firms needs to be able to reward success on the individual level, even as the firm struggles to break even. I am not arguing that they should be prospectively rewarding employees who have failed in the past, but instead that they should have the right to offer incentive pay going forward to those who help the firm recover and succeed. The House bill paints all employees at firms receiving taxpayer aid with the same broad brush, inappropriately grouping them with the subset that caused the firm’s problems.
The House’s policy failure was broadly bipartisan. 243 of 249 voting House Democrats (98%) voted aye, while 85 of 172 House Republicans (49%) voted aye. I offer my compliments to the 6 House Democrats and 87 House Republicans who took the political risk and voted no.
The mob mentality appears to be subsiding. The House acted with passion and reckless abandon, using the tax code as a punitive political weapon against an unpopular foe. It appears the Senate may kill the bill through inaction. The Senate is good at that.
I fear, however, that further riotous behavior is just around the corner. There are other struggling financial firms and auto manufacturers receiving large taxpayer subsidies. It won’t be long before a demagogue finds another politically noxious example. The Congressional mob will then return, angrier than ever, and they will again try to act. I fear what Congress might do in such a scenario. I hope the Obama Administration is preparing for this scenario, substantively and legislatively.
I would also hope that managers would understand that employment contracts that reward failure, or appear to do so, cause tremendous political pain to elected officials. The AIG bonuses are one example. The CEO who “resigns” and garners a news story that he is “leaving with $___ million in deferred compensation and other benefits” puts those Members of Congress who embrace free market economics in an untenable position. Even if those benefits were legitimately earned long ago, the optics of receiving them after the failure are just horrible.
If the only possible cure to the frustrating situation of failed AIG executives receiving bonuses is for Congress in effect to rewrite past contracts, then the cure is worse than the disease.
President Obama meets with the CEOs of several major banking firms Friday. I was responsible for setting up many similar meetings with President Bush, and I’m certain that the White House staff have carefully planned the President’s public message coming out of that meeting.
If you had to write three talking sentences for the President to say to the TV cameras after meeting with the Banking CEOs Friday, what would they be?
Alternately, if you were one of those CEOs, what 3-4 sentences would you like to say to the President about this issue? Remember, you’re talking to the President of the United States, so please keep it professional and respectful.
I’ll post the 2-3 best answers I get to each question, including those from a different perspective than mine.
A reporter’s budget mistake at the press conference
At Tuesday evening’s press conference, Jake Tapper, Senior White House Correspondent at ABC News, asked the President:
Q: Thank you, Mr. President. Right now on Capitol Hill Senate Democrats are writing a budget and, according to press accounts and their own statements, they’re not including the middle-class tax cut that you include in the stimulus; they’re talking about phasing that out. They’re not including the cap and trade that you have in your budget, and they’re not including other measures. I know when you outlined your four priorities over the weekend, a number of these things were not in there. Will you sign a budget if it does not contain a middle-class tax cut, does not contain cap and trade?
This question makes no sense.
Senate Budget Committee Chairman Kent Conrad (D-ND) is doing what every budget committee chairman does at this time of year: he is drafting the Senate budget resolution, and he is getting his committee to “mark it up” — amend and vote on it. His House counterpart, Chairman John Spratt (D-SC), is doing the same in the House.
A budget resolution is a concurrent resolution. When it has passed the House and Senate in identical form, it takes effect and binds House and Senate action throughout the year.
A concurrent resolution never goes to the President for a signature or veto. It is a tool the Congress uses to manage itself. Yes, the concurrent resolution sometimes uses the substance of the President’s budget proposal as a starting point, and so Mr. Tapper’s substantive point that Senate Democrats appear to be ignoring some of the President’s top priorities is an important one.
But asking the President whether he would “sign a budget” has no meaning. The President never faces that choice. Later in the year, he may face various bills that do or don’t contain his spending and tax priorities, but those aren’t “a budget,” and they’re not what House and Senate Democrats are working on now.
Mr. Tapper pressed his question in a follow-up:
Q: So is that a “yes,” sir? You’re willing to sign a budget that doesn’t have those two provisions?
Everyone makes mistakes, but he had all day to prepare this question. To his credit, the President did not make the same mistake as Mr. Tapper.
The White House press corps holds the President to an extremely high standard, and hammers him if he misspeaks. I hope that similarly rigorous treatment, applied to the press corps, can elevate our public policy debate.
Parsing the President: no “climate change”?
I watched the President’s Tuesday evening press conference twice, and have been studying the transcript as well. I believe the best way to understand a policymaker is simple: read, watch, or listen to the words that he or she says. Getting a policymaker’s views through a news filter distorts and loses content. In this blog, I hope I can show you where to look for the best primary sources, and only then give you my analysis.
The Tuesday evening press conference should keep me busy for at least a week, so I will break it up into small bites. I was stunned by the President’s language when asked about his cap-and-trade proposal. The premise of the reporter’s question was that the cap-and-trade proposal is running into resistance from Congressional Democrats. Here’s what the President said in response:
When it comes to cap and trade, the broader principle is that we’ve got to move to a new energy era, and that means moving away from polluting energy sources towards cleaner energy sources. That is a potential engine for economic growth. I think cap and trade is the best way, from my perspective, to achieve some of those gains because what it does is it starts pricing the pollution that’s being sent into the atmosphere.
The way it’s structured has to take into account regional differences; it has to protect consumers from huge spikes in electricity prices. So there are a lot of technical issues that are going to have to be sorted through. Our point in the budget is let’s get started now, we can’t wait. And my expectation is that the energy committees or other relevant committees in both the House and the Senate are going to be moving forward a strong energy package. It will be authorized, we’ll get it done and I will sign it.
I rewound this to make certain I hadn’t misheard him. He never said the words “climate change,” “global warming,” “greenhouse gases,” “carbon,” “carbon dioxide,” or “C-O-2.” His answer was entirely about clean energy and clean energy technology. He expects that the committees will move forward a strong energy package, not a strong climate change package, and not (necessarily) a cap-and-trade bill. This persisted throughout the press conference.
I tried to figure out if this is intentional, so I looked at the President’s recent weekly address, in which he used similar language:
First, it must reduce our dependence on dangerous foreign oil and finally put this nation on a path to a clean, renewable energy future. There is no longer a doubt that the jobs and industries of tomorrow will involve harnessing renewable sources of energy. The only question is whether America will lead that future. I believe we can and we will, and that’s why we’ve proposed a budget that makes clean energy the profitable kind of energy, while investing in technologies like wind power and solar power; advanced biofuels, clean coal, and fuel-efficient cars and trucks that can be built right here in America.
Again, it’s all about clean renewable energy and spending money on technology, with no mention of climate change or global warming. I am not suggesting any change in the President’s substantive view on climate change, nor that he has given up on it as a legislative matter. He is, however, framing this as a clean energy and technology issue, rather than as a climate change / global warming issue. If I’m missing some other venue in which he has recently advocated vigorously for climate change legislation and framed it as such, please point it out to me in the comments.
This does not seem to be an oversight. It appears strategic. At a minimum, it would allow him to later declare victory if the Congress does not pass a cap-and-trade bill, but instead just increases clean energy research funding in appropriations bills.
I should mention three side notes about his second quote:
- Clean coal is not renewable energy.
- He included clean coal in the list. This is somewhat surprising, and I’m glad that he included it.
- He left nuclear power off the list. This is not surprising, and I’m disappointed that he excluded it. Nuclear power is clean, reliable, safe, and it emits no greenhouse gases.
Is $700 billion enough? Part 2: the Obama warning
In part one of this series, I explained why I think the Obama Administration will soon run out of TARP money and need to ask Congress for more.
Several weeks ago the Obama team began to lay the groundwork for such a request. Here are four signs.
- In his February 24th Address to the Nation, the President said:
Third, we will act with the full force of the federal government to ensure that the major banks that Americans depend on have enough confidence and enough money to lend even in more difficult times. … Still, this plan will require significant resources from the federal government and yes, probably more than we’ve already set aside.
- The President’s budget submission includes a $250 B “placeholder for potential additional financial stabilization effort.” See Table S-6, page 125, the Treasury section in the President’s budget submission. Importantly, the budget puts this $250 B placeholder in federal Fiscal Year 2009, which ends September 30 of this year. So they have a placeholder in the President’s budget for another $250 B request some time in the next six months.
- In his written testimony before the Senate Budget Committee on March 12th, Secretary Geithner wrote:
It acknowledges that, as expensive as it already has been, our effort to stabilize the financial system might cost more. It establishes a placeholder to help ensure we can cover any additional financial stability costs.
I should note here that the existence of the $250 billion placeholder for financial stability in the President’s Budget does not represent a specific request. Rather, as events warrant, the President will work with Congress to determine the appropriate size and shape of such efforts, and as more information becomes available the Administration will estimate potential cost.
- Budget Director Peter Orszag has similar language, both in his written testimony, and on his blog. Here’s a quote from page two of his written testimony:
Because of problems in financial markets, the costs of stabilization may amount to $650 billion or more – including the placeholder should additional efforts prove necessary to address the crisis we have inherited.
And here’s his blog:
Requiring $650 billion or more to stabilize financial markets (including placeholder):
- $171 billion for stock purchases in Fannie Mae and Freddie Mac
- $247 billion in federal costs for TARP
- $250 billion placeholder in case additional actions are necessary
These are not small signals. This is a coordinated, Administration-wide message: “Hey, Congress, we may need to ask you for more TARP funds. Assume $250 B for now, and we’ll come back to you with a real number when we know it.” If they do make this request, it will dominate the legislative agenda.
Congress: you have been warned. Are you listening?
In part three of this series (coming soon), I will provide my views and recommendations.
Welcome!
Welcome to my new blog. If you would like to learn more about American economic policy, I would be honored to be your guide. I will do my best to explain the options faced by senior American economic policymakers, and to analyze the choices they make.
I anticipate defining “economic policy” broadly as we did at the White House, to include not just the macroeconomy, but also financial market issues, tax policy, energy and climate change, health care, trade and international finance, Social Security and Medicare reform, housing, transportation, pensions, technology and telecommunications, and agriculture policy.
I’m kicking this off with a surge of initial posts on a range of topics, featured in the photo gallery to your right. Click on any photo to go directly to that post. Some are easy, others are a bit more challenging (TARP Math).
This is a successor to my White House Economics mailing list that I had while serving as an advisor to President George W. Bush. You can get updates either through a mailing list or an RSS feed, both of which you can find in the sidebar to the right. If you were a subscriber to White House Economics, please re-subscribe, as this is technically a new list.
I should caution you: the posts here are longer than on other blogs. Economic policymaking can be complex, and is not easily summarized in an 150-word post. I hope you will find that it’s worth your effort.
Please leave comments, and please forgive (and tell me about) any technical glitches. I’m new to blogging.
Thank you for visiting. I hope you will bookmark this site, subscribe to the mailing list or feed, and tell your friends!
Is $700 billion enough?
I think President Obama will soon need to ask Congress for more TARP funding, and that such a request will displace his legislative agenda for a while. Let’s do the math.
When President Obama took office, $387 B of the $700 B of available TARP funds had already been publicly committed. Here’s the breakdown.
| Public commitment | |
| Banks — Capital purchase program | $250 |
| AIG | $40 |
| Citigroup | $25 |
| Bank of Amrerica | $27.5 |
| Autos | |
| ….GM | $13.4 |
| ….Chrysler | $4 |
| Auto finance | |
| ….GMAC(including $1B from UST –> GM –> GMAC) | $6 |
| ….Chrysler Financial | $1.5 |
| Term Asset-backed Lending Facility (TALF)for new securities for consumer credit | $20 |
| Total | $387.4 |
This meant that the Obama team had $313 B left to commit before reaching the $700 B limit.
Since January 20th, President Obama has made the following new commitments:
$50 B from TARP into housing subsidies — Note that this is just the TARP commitment. There’s other spending on housing, but it’s not from TARP.
$30 B more from TARP for AIG
$5 B from TARP for auto parts suppliers
$15 B from TARP to buy securities derived from small business loans guaranteed by the Small Business Administration
$80 B to further expand the TALF to consumer credit and mortgages
$75 B — $100 B for the new “Public Private Investment Plan” announced Monday, to purchase toxic loans and mortgage-backed securities from banks. They call these “legacy loans” and “legacy securities.”
That’s a total of $255 B — $280 B in new commitments.
Add that range to the $387 B we had committed, and you come up with a range of $642 B — $667 B already committed.
That leaves them $33 B — $58 B before they hit $700 B.
Uh-oh.
There’s some uncertainty around the $80 B figure to further expand TALF, because the Administration has been ambiguous about how big the new TALF would be in total. I’ll bet they’re scrambling this week trying to figure out what they actually meant.
They can create some wiggle room for themselves if they say that the $15 B for small businesses and the $5 B for auto parts suppliers are a subset of the $100 B (in total) for “consumer credit.” This uncertainty and ambiguity should not obscure the critical point: they’re almost out of money.
They have $33 B — $58 B before they hit the $700 B barrier. Let’s assume they do some hand-waving: “What we meant was …,” and redefine some of those previous commitments as overlapping and therefore non-additive. It appears to me that their best case scenario is they could have $100 B of room. My best guess is that they have less than $40 B of room.
Let’s look at what other needs they will face:
- The banking regulators are doing rigorous stress tests on the 19 biggest banks. Some of those banks are going to need more capital.
- The auto loans we (the Bush Administration) issued expire March 31st. If they continue those loans, then that $25 B remains committed. It looks like they will extend the loans, using at least a few billion more from the TARP. Let’s be optimistic and call it $5 B — $10 B. (If they instead provide debtor-in-possession financing, their initial outlay is probably more like $20 B.) I’ve written a separate series of posts on the Administration’s auto loan options.
- They need “dry powder” for unexpected bad scenarios, which seem to crop up every few weeks. You always have to worry about AIG needing more money, and unpleasant surprises could come from any direction.
- I assumed only $75 B for the direct costs of the Geithner plan. If they want to go to the top end of their range, that’s another $25 B.
- The ambiguity on the size of the TALF is an additional $50 B — $100 B question for TARP.
- I think the Geithner plan risks being too small to have the desired effect. Much of the informed commentary seems to agree with this judgment. If it is successful, they will want and need to put more funds into it. (I think this is their strategy.)
I would bet heavily against them being able to stay within the $700 B this year. It’s easy to imagine them approaching the limit within a few months. The auto deadline looms, and there will be pressures when the stress tests complete.
Recommendations
- The Obama Administration should produce an accounting of TARP commitments similar to what I’ve done above. It doesn’t have to be complex — a two-column table will do nicely.
- This accounting should show how the various consumer credit and TALF commitments overlap, if at all. It should also provide clarity to the markets about the sizes of various components of the TALF.
- The Administration should explain how much room they have left within the $700 B provided by Congress, what possible demands they anticipate, and what their game plan is for allocating the remaining resources. Secretary Geithner should be given tremendous flexibility to change this game plan as circumstances warrant, but should provide initial clarity.
- Congress should take the Obama Administration’s previous warnings seriously, and incorporate the possibility of a new TARP request into next week’s budget discussions. It makes no sense to build a budget and ignore that $250 B elephant over there in the corner.
I think the President will need more TARP funds soon. If he does, he’s going to have to go to Congress to get them. If this happens, it will overwhelm his legislative agenda.
In part two of this series I’ll show you that the Obama Administration has warned the Congress that this may be coming.
In part three (coming soon), I’ll give my views and recommendations.
The transition, my new role, and the mailing list archive
Q: This blog launched in late March of 2009, and yet there are more than 40 posts dated in 2007 and 2008. Why?
A: While working for President Bush, I had a mailing list titled White House Economics, which I used to explain the President’s economic policies. This blog and the associated mailing list are successors to White House Economics.
I have taken about 40 of the notes I sent to the White House Economics list and turned them into archival blog posts. I cleaned up a few grammar and presentation mistakes, and changed the formats of the graphs to be consistent with this blog’s format. If you care to browse through these archival posts, you’ll see that I use “we” a lot. I wrote these notes (now displayed as blog posts) in my role as a White House advisor to President George W. Bush. I wrote these notes to help explain his policies, and use “we” to refer to the Bush Administration. These notes are therefore describing official Administration policy.
There is thus a difference between posts on this site that are dated before January 20th, 2009, and posts dated after that transition date. Those dated during the Bush Administration are my writing as an Administration official. Those dated after January 20th, 2009 are my writing as a private citizen. They do not represent the views of President Bush or his Administration.
President Bush discusses his Administration’s plan to assist automakers
President Bush spoke at 9:01 AM this morning in the Roosevelt Room, announcing his plan to aid two U.S. auto manufacturers. Here are his remarks.
THE PRESIDENT: Good morning. For years, America’s automakers have faced serious challenges — burdensome costs, a shrinking share of the market, and declining profits. In recent months, the global financial crisis has made these challenges even more severe. Now some U.S. auto executives say that their companies are nearing collapse — and that the only way they can buy time to restructure is with help from the federal government.
This is a difficult situation that involves fundamental questions about the proper role of government. On the one hand, government has a responsibility not to undermine the private enterprise system. On the other hand, government has a responsibility to safeguard the broader health and stability of our economy.
Addressing the challenges in the auto industry requires us to balance these two responsibilities. If we were to allow the free market to take its course now, it would almost certainly lead to disorderly bankruptcy and liquidation for the automakers. Under ordinary economic circumstances, I would say this is the price that failed companies must pay — and I would not favor intervening to prevent the automakers from going out of business.
But these are not ordinary circumstances. In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action. The question is how we can best give it a chance to succeed. Some argue the wisest path is to allow the auto companies to reorganize through Chapter 11 provisions of our bankruptcy laws — and provide federal loans to keep them operating while they try to restructure under the supervision of a bankruptcy court. But given the current state of the auto industry and the economy, Chapter 11 is unlikely to work for American automakers at this time.
American consumers understand why: If you hear that a car company is suddenly going into bankruptcy, you worry that parts and servicing will not be available, and you question the value of your warranty. And with consumers hesitant to buy new cars from struggling automakers, it would be more difficult for auto companies to recover.
Additionally, the financial crisis brought the auto companies to the brink of bankruptcy much faster than they could have anticipated — and they have not made the legal and financial preparations necessary to carry out an orderly bankruptcy proceeding that could lead to a successful restructuring.
The convergence of these factors means there’s too great a risk that bankruptcy now would lead to a disorderly liquidation of American auto companies. My economic advisors believe that such a collapse would deal an unacceptably painful blow to hardworking Americans far beyond the auto industry. It would worsen a weak job market and exacerbate the financial crisis. It could send our suffering economy into a deeper and longer recession. And it would leave the next President to confront the demise of a major American industry in his first days of office.
A more responsible option is to give the auto companies an incentive to restructure outside of bankruptcy — and a brief window in which to do it. And that is why my administration worked with Congress on a bill to provide automakers with loans to stave off bankruptcy while they develop plans for viability. This legislation earned bipartisan support from majorities in both houses of Congress.
Unfortunately, despite extensive debate and agreement that we should prevent disorderly bankruptcies in the American auto industry, Congress was unable to get a bill to my desk before adjourning this year.
This means the only way to avoid a collapse of the U.S. auto industry is for the executive branch to step in. The American people want the auto companies to succeed, and so do I. So today, I’m announcing that the federal government will grant loans to auto companies under conditions similar to those Congress considered last week.
These loans will provide help in two ways. First, they will give automakers three months to put in place plans to restructure into viable companies — which we believe they are capable of doing. Second, if restructuring cannot be accomplished outside of bankruptcy, the loans will provide time for companies to make the legal and financial preparations necessary for an orderly Chapter 11 process that offers a better prospect of long-term success — and gives consumers confidence that they can continue to buy American cars.
Because Congress failed to make funds available for these loans, the plan I’m announcing today will be drawn from the financial rescue package Congress approved earlier this fall. The terms of the loans will require auto companies to demonstrate how they would become viable. They must pay back all their loans to the government, and show that their firms can earn a profit and achieve a positive net worth. This restructuring will require meaningful concessions from all involved in the auto industry — management, labor unions, creditors, bondholders, dealers, and suppliers.
In particular, automakers must meet conditions that experts agree are necessary for long-term viability — including putting their retirement plans on a sustainable footing, persuading bondholders to convert their debt into capital the companies need to address immediate financial shortfalls, and making their compensation competitive with foreign automakers who have major operations in the United States. If a company fails to come up with a viable plan by March 31st, it will be required to repay its federal loans.
The automakers and unions must understand what is at stake, and make hard decisions necessary to reform, These conditions send a clear message to everyone involved in the future of American automakers: The time to make the hard decisions to become viable is now — or the only option will be bankruptcy.
The actions I’m announcing today represent a step that we wish were not necessary. But given the situation, it is the most effective and responsible way to address this challenge facing our nation. By giving the auto companies a chance to restructure, we will shield the American people from a harsh economic blow at a vulnerable time. And we will give American workers an opportunity to show the world once again they can meet challenges with ingenuity and determination, and bounce back from tough times, and emerge stronger than before.
Thank you.
What was accomplished at the G-20 Summit?
Here is the “Leaders Declaration” for the Summit on Financial Markets and the World Economy (aka the G-20 Summit) hosted by President Bush last Friday and Saturday in Washington, DC.
This is the second of a two-part note. Here’s the first part.
A fair amount of the press coverage followed a ready-made storyline: “Lame duck President / not much accomplished.” This storyline is incorrect. Let’s look at some important wins in the actual text of the declaration.
- Formerly Communist China and Russia (along with all the other participating nations) agreed to the following text:
12. We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems. These principles are essential to economic growth and prosperity and have lifted millions out of poverty, and have significantly raised the global standard of living. Recognizing the necessity to improve financial sector regulation, we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.
- All 20 nations agreed to reject protectionism, to refrain from raising new trade barriers for a year, and to continue working toward a global free trade “Doha” agreement:
13. We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports. Further, we shall strive to reach agreement this year on modalities that leads to a successful conclusion to the WTO�s Doha Development Agenda with an ambitious and balanced outcome. We instruct our Trade Ministers to achieve this objective and stand ready to assist directly, as necessary.
- All 20 nations agreed on the “root causes of the crisis.” It’s not as clear as the President’s explanation, but it’s quite close, especially given that this is the result of a 20-nation negotiation.
3. During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.
4. Major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. These developments, together, contributed to excesses and ultimately resulted in severe market disruption.
- All 20 nations agreed on five key principles:
- strengthening transparency and accountability;
- enhancing sound regulation;
- promoting integrity in financial markets;
- reinforcing international cooperation; and
- reforming international financial institutions.
- The document never talks about a “single global regulator” or anything approaching that. Instead, it emphasizes coordination and cooperation among national regulators.
Regulation is first and foremost the responsibility of national regulators who constitute the first line of defense against market instability. However, our financial markets are global in scope, therefore, intensified international cooperation among regulators and strengthening of international standards, where necessary, and their consistent implementation is necessary to protect against adverse cross-border, regional and global developments affecting international financial stability.
- The document emphasizes strengthening transparency and accountability, thus allowing well-informed market forces to provide market discipline:
We will strengthen financial market transparency, including by enhancing required disclosure on complex financial products and ensuring complete and accurate disclosure by firms of their financial conditions.
- While agreeing on the need for financial sector reform, the leaders sounded a cautionary note against over-regulation warning that it would “hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.” This is similar to what the President said last Thursday.
- The leaders committed to continue to work to alleviate poverty and address the needs of the most vulnerable.
- The leaders agreed to meet again by April 30th of next year “to review the implementation of the principles and decisions agreed today.”
- You’ll note that pages 6-10 of the declaration are an “action plan” of 47 specific to-dos. The list addresses:
- accounting standards;
- addressing the valuation of complex illiquid securities, especially during times of market stress;
- requiring financial institutions to disclose more information about their risks and losses on an ongoing basis;
- looking for opportunities to better coordinate among national financial regulators;
- improving bankruptcy laws to allow for an orderly wind-down of “large complex cross-border financial institutions;”
- reforming the regulation of credit rating agencies;
- strengthening capital standards “in amounts necessary to sustain confidence;”
- actions to reduce risk in the markets for credit default swaps;
- enhancing regulatory guidance “to strengthen banks’ risk management practices;” and
- steps toward reforming international financial institutions like the International Monetary Fund and the World Bank.
Skim the document and judge for yourself. We think this summit was a big success, both in the good things that were agreed to, and the bad things that were not.