The Automaker bailout

Republican Politics, American Style
Published on February 26th in Metro Éireann By Charles Laffiteau
Today I want to discuss the additional government loans being proposed for GM and Chrysler and expand on my comments in last week’s column about my belief that the US and other governments’ must take ownership of their banks “bad assets”, in order to get them off their books so that banks can start raising and lending new capital again.
I recognize that taking these kinds of radical actions sounds to many observers like I am proposing that taxpayers should get stuck with the bill for the mistakes of these US automakers and the lending excesses of financial executives around the globe. Indeed, in a worse case scenario, taxpayers may end up footing a large part of the bill. But history tells me that if the automaker loans and the disposal of toxic bank assets are handled in a judicious manner, then there is a very good chance that taxpayers won’t be stuck with much if any of a tab, and might even profit from these so-called “government bailouts”.
As regards the loans for Chrysler and GM, the very same issues; that such help rewards failure and could cost taxpayers a lot of money, were debated 30 years ago prior to the US Congress approving the first such government loan for Chrysler. The US was also in the midst of a severe economic downturn and the bankruptcy, of what was then America’s 10th largest manufacturer was considered unthinkable to many US citizens. In fact, in most respects, the current situation involving GM, and to a lesser extent, Chrysler, mirrors that which existed in 1979. So what was the end result of that government loan?
First Chrysler proceeded to develop and produce its first front wheel drive small cars, which in turn helped Chrysler double its automobile line-up’s corporate average miles-per-gallon of petrol. Then Chrysler paid off the US taxpayer guaranteed loans in 1983, resulting in a net profit for US taxpayers of over $350 million. Excuse me, but I happen to think a $350 million profit on a 4 year, $1.5 billion loan sounds pretty good.
Having said this, while I am supportive of giving GM more government loans, I’m not so sure US taxpayers should also do so in the case of Chrysler. That is because unlike GM, Chrysler is no longer a publicly held stock company like it was back in 1979. Cerebus Capital Management LP, a huge private equity fund owned by a large group of well heeled private investors, bought Chrysler from DaimlerChrysler 18 months ago. It actually acquired Chrysler’s automaking operations free of debt, so it could get its hands on Chrysler’s lucrative auto finance subsidiary, Chrysler Financial Corporation.
Cerebus wanted to combine Chrysler’s much smaller finance operation, with the GM finance subsidiary, General Motors Acceptance Corporation, that Cerebus had bought a controlling stake of 51% in from GM a year earlier. Of course back in 2006 and 2007 when Cerebus made these acquisitions, the US and world economies were growing quickly and money to finance risky acquisitions was easy to get. But Cerebus Chairman and CEO John Snow, President Bush’s former Treasury Secretary, and Cerebus Capital’s wealthy private investors also knew there were risks associated with such acquisitions. As such, I don’t think it’s fair to provide more government loans to help Cerebus unless Cerebus Capital’s investors decide to invest more of their own money in Chrysler as well.
The US government also has some even more recent experience dealing with the toxic assets of America’s financial institutions. The Resolution Trust Corporation (RTC) was a US Government-owned asset management company created by Congress in 1989 to deal with the savings and loan crisis of the 1980s. It was charged with liquidating the assets of savings and loan associations (S&Ls) declared insolvent by the Office of Thrift Supervision, mainly real estate and mortgage loans. The RTC also took over the deposit insurance duties of the Federal Home Loan Bank Board. So what kind of job did it do?
Congress initially gave the RTC $50 billion to clean up the S&L mess, but the RTC wound up needing three additional infusions of taxpayer funds over six years because the situation proved to be much worse than Congress originally thought. In the end, according to one study, taxpayers took a $124 billion loss on the RTC’s total assets of $394 billion. That means taxpayers lost 31 cents on each dollar of assets handled by the RTC, an institution that was simply disposing of the property of failed institutions.
So using this recent US government toxic asset disposal history as a guide, if the US government has to end up taking over a total of $3 trillion in toxic bank assets, then a more realistic worst case scenario is that the ultimate cost to tax payers will be at most $1 trillion or about $150 billion a year over the next 6 years. I also think the same calculus could be applied to toxic bank assets in Ireland, the UK and the rest of the world. But just as there was a silver lining to those US government loans to Chrysler back in 1980, I also think it’s possible that taxpayers in the US and other nations could actually end up seeing a profit from a judicious acquisition and subsequent disposal of these “toxic assets”.
While government officials will have to spend a lot of money to show the market that they won't let their banks fail, taxpayers won't have to end up on the hook for the entire amount of money that's being injected into these banks. Governments could get warrants when they acquire toxic assets that would convert to bank stock when the government sells them, and hire private equity managers to oversee the assets to ensure that they’re sold only when the time is right.
I think these kinds of arrangements will allow governments to extract some gains for taxpayers once the recession ends so that taxpayers can actually profit from the financial bailout.