As policymakers consider the terms and conditions of the next bailout of the Big Three under the so-called TARP II plan, it is worth pausing to consider lessons learned from the Chrysler bailout of 1979. For, although it had its detractors, the government's $1.2 billion assistance to Chrysler 30 years ago met some very important criteria for success that the $25 billion bailout Congress has already given the automakers does not.
The best definition of success of any bailout must avoid any biases of hindsight and satisfy broadly held views of limits on government activity. A successful bailout is one (1) where the market cannot act because of a clear market failure and (2) the government acts in ways that mimic the way private parties would have acted. Under this definition, were the auto bailouts then and now a success?
In both cases, there is a reasonable argument that there was a market failure. Thirty years ago, Chrysler was a viable company, shifting production to smaller, more fuel-efficient vehicles, but had tapped out all private lending sources. Today, a firm would use chapter 11 to reorganize, but that was not an option. The bankruptcy code was rewritten in 1978, right before the bailout, and no large firm had successfully reorganized under it at that time. Moreover, reorganizations of that era were very long, creating special problems since warranties and continuity of service are important for car buyers. A long bankruptcy is also much more costly when interest rates are 20 percent (then) compared with nearly zero (now).
Chapter 11 works great today, so if there is a credible claim that any of the Big Three are still viable companies, banks should be willing to loan them money. Firms could then force a renegotiation of existing liabilities and emerge within months as reorganized entities. But the freezing of credit markets as a result of the bursting of the housing bubble means companies with strong balance sheets are having a difficult time raising money, let alone ones headed down the drain. Since the government has a monopoly on printing money and is a lender of last resort, acting as a lender when others would, but cannot, satisfies the first criterion of success.
The problem with today’s bailout is with the second criterion. The first Chrysler bailout got it right. The $1.2 billion loan for Chrysler approved by Congress in December 1979 enumerated $2 billion in specific concessions that had to be made before any federal monies would be forthcoming. Banks, state and local governments, dealers, and labor unions had to meet concession levels set by Congress. This process was not easy. Arms were twisted, arguments were made, and deals were struck, but monies were not released for over seven months. This bailout design, which mimics the way private parties act in chapter 11 today, created strong incentives for Chrysler to get its house in order. This is a lesson parents trying to get their children to eat broccoli know well: dessert comes only after sacrifice.
Sadly, we forgot this lesson. The already approved bailout – the “Auto Industry Financing and Restructuring Act” – gives automakers $25 billion to do with what they want. The loan does empower a new “auto czar” to oversee the development of a plan “to rationalize costs, capitalization, and capacity with respect to the manufacturing workforce, suppliers, and dealerships of the eligible automobile manufacturer” and to call the loans (that is, force the firms into bankruptcy) if they do not comply. But it is much easier to withhold money than to claw back monies already spent. And, given the inevitable political pressures against pushing any automaker into liquidation, the Big Three have the upper hand in any deals. No private lender would agree to act as the government has here – lending without first winning concessions – and this means the bailout so far is a failure.
Let this be a lesson to the new administration and Congress when new monies to help the auto industry are deployed. Broccoli first.