Expert answer:Ballout Case Study

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the_gm_bailout.docx

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By mid-December 2008, GM, the world’s second largest auto manufacturer, was losing
$2 billion a month. Rick Wagoner, CEO since 2000, knew that GM did not have enough
money to survive much longer. The year 2008, GM’s 100th anniversary, was turning out
to be its worse ever.1 Wagoner already knew GM would end the year with losses of about
$31 billion. But that was an improve- ment from 2007 when the company lost $38.7
billion, the fourth-biggest corporate loss in history. Those losses, and losses of $1 billion
in 2006 and $10 billion in 2005, meant that the company Wagoner led lost an astonishing
$80 bil- lion in four years.
Wagoner was a dedicated, affable, and likable man. In high school, he had excelled in all
sports but his height of six feet four made him a star in basketball and upon graduation,
he was secretly hoping to be a professional basketball player. But as a freshman
basketball player at Duke University, it became clear to Wagoner that he did not have the
talent and drive to be a professional athlete. Instead, he majored in economics and also
began dating Kathleen Kaylor whom he eventually married. After grad- uating from
Duke University and getting an MBA from Harvard University, Wagoner went to work
for GM. He rapidly worked his way up through the company’s ranks and in 2000, he was
named CEO, the youngest person to ever hold that position in the company’s history.
Wagoner blamed GM’s misfortune on a number of factors. One of the most significant
factors, he felt, was the “Great Recession” of 2008 that had hurt the sales of all the auto
companies, particularly when the troubled banks stopped lending money so customers
could no longer get car loans. Unfortunately, GM did not anticipate the “credit crunch,”
and by 2006, it had sold off a controlling interest in GMAC, the previously whollyowned finance company that had provided cheap loans to its car buyers. After GM sold
51 percent of GMAC to Cerberus for $7.4 billion, Cerberus refused to let GMAC
continue providing the same easy credit to GM’s customers, which turned out to be a
significant blow to GM’s sales.
Yet another problem was GM’s labor costs. In 2008, GM was paying an average of about
$70 per hour for labor. That $70 included $30 that the worker actually received in wages,
and $40 that went to fund other labor costs including the worker’s benefits and pension,
plus the cost of providing health care and pensions to about 432,000 GM retirees.
Because GM had been operating for 100 years, the number of its retirees was much larger
than those of new car companies. Toyota, for example, was pay- ing about $53 per hour
for labor in its U.S. manufacturing plants, of which $30 went to the worker as wages, and
$23 went to pay for the worker’s benefits and pension, but very little for retirees since the
number was relatively low. In some of its plants, a Toyota spokesman said, it was paying
as little as $48 per hour for labor.
But perhaps the major cause of GM’s difficulties was its self-inflicted dependence on
large SUVs (sport utility vehicles). Japanese car makers could make small and mid- sized
cars for less than it cost GM to make comparable cars. To compete, GM had to lower its
prices until the profit margins on its small and mid-sized cars were van- ishingly thin. But
during the 1980s, when gas was cheap, GM discovered that large SUVs were big hits
with male customers and with couples with growing families. More- over, unlike its
smaller car models, profit margins on its large SUVs were hefty, as much as $10,000 to
$15,000 per vehicle. As its SUV sales boomed during the 1990s, GM expanded its line
and eagerly converted many of its plants over to the production of the lucrative big
vehicles. By 2003, the bulk of its profits were coming from SUV sales. But when the
price of gasoline gradually crept up- ward, the costs of owning an SUV also increased
causing the SUV market to slow and then to decline. In 2004, unsold SUVs started piling
up at car dealerships. When Hurricane Katrina made gasoline prices soar in 2005, sales of
SUVs eventually collapsed. Thus, GM ended 2005 with a loss of $10.4 billion. Things
improved some- what in 2006, but then losses climbed to record levels: $38.7 billion in
2007, and $30.9 billion in 2008. Unfortu- nately, by now GM’s plants, strategic plans,
research and development programs, and its mindset, were all locked into the production
of SUVs, and it would take years to change them.
Because of its reliance on SUVs, GM had put off in- vesting in the small fuel-efficient
cars a gas-conscious pub- lic had turned to in 2005. In the 1990s, GM had developed the
technology for an all-electric car, the EV1. The EV1 was, in fact, the first mass-produced
modern electric car made by a major car company. By 1999, GM had spent $500 million
producing the EV1 and $400 million mar- keting it, yet had leased only 800 vehicles.
Convinced that the car would never match the profitability of its SUVs, the company
stopped making the cars and in 2002, it re- possessed all the EV1s it had leased and
phased out the project. At the same time, both Toyota and Honda were introducing their
small hybrid electric-gas engine cars into the United States. The hybrids turned out to be
a com- mercial success and, more importantly, production of the cars allowed both
Toyota and Honda to gain almost a de- cade of experience in hybrid technology, while
GM con- tinued focusing on its gas-guzzling SUVs. In a June 2006 interview published
in Motor Trend, Rick Wagoner con- fessed that his worst decision during his tenure at
GM was “axing the EV1 electric-car program and not putting the right resources into
hybrids.”
All of these problems had culminated in the $80 bil- lion loss that placed GM in the
difficult situation Wagoner knew he had to deal with in the closing weeks of 2008. With
many analysts predicting that GM would go bank- rupt, banks—which themselves were
barely surviving the worse financial crisis in decades—refused to loan the com- pany
more money. At the rate it was running through its cash reserves, Wagoner knew the risk
of bankruptcy was growing daily. Given the company’s dire straits, he de- cided that only
a government bailout could save it.
Government bailouts were not popular. In Septem- ber, 2008, the George W. Bush
administration asked the U.S. Congress to pass legislation creating a $700 billion fund
called the Troubled Asset Relief Program (TARP). A reluctant U.S. Congress approved
the TARP bill which authorized the U.S. Treasury Department to use the funds “to
purchase . . . troubled assets from any financial institu- tion.” The “troubled assets” were
millions of mortgage loans that banks had extended to home buyers who were now
unable to make their monthly mortgage payments, and whose homes were worth less than
their mortgages because home prices had collapsed in early 2007. Since the homes were
worth less than their mortgage loans, the mortgages could not be repaid in full when
delinquent homeowners sold their homes or when banks confiscated them. Suffering
huge losses, many U.S. banks were on the verge of failing as were European banks that
earlier had taken over thousands of the now “troubled” U.S mort- gages. Many
economists predicted that these widespread bank failures would turn the deepening
recession into a global depression worse than the worldwide Great De- pression of the
1930s.
In spite of the looming financial crisis, many had opposed the plan to bail out the banks.
A hundred lead- ing economists signed a letter to the U.S. Congress that said lack of
“fairness” was a “fatal pitfall” of the plan because it was “a subsidy to investors at
taxpayers’ ex- pense. Investors who took risks to earn profits must also bear the losses.”2
Calling the bank bailouts “socialism for the rich,” the Nobel prize-winning economist
Joseph Stiglitz wrote “this new form of ersatz capitalism, in which losses are socialized
and profits privatized, is doomed to failure. Incentives are distorted [and] there is no
market discipline.”3
Nevertheless, if U.S. banks were able to get bailout money from Washington, perhaps
GM could do the same. So Rick Wagoner and two GM board members flew to
Washington on October 13, 2008 to meet with officials of President George W. Bush’s
administration. During the meeting, Wagoner summarized the precarious position of the
company and asked for a loan from the TARP fund. Bush’s people balked at the request,
saying the legislation explicitly said TARP funds were for financial institutions so they
could not be used to provide loans to car manu- facturers. Turned down by the
administration, a desper- ate Wagoner turned to the U.S. Congress. On November 18 and
19, he and the CEOs of Chrysler and Ford—the two other U.S. auto companies were also
going through difficult times—came before Congressional committees and asked for
legislation authorizing government funds to aid the auto industry. Committee members,
however, be- came angry, particularly when the auto executives admit- ted they had not
prepared plans detailing how they would use the funds nor what changes they intended to
make to ensure they could return to profitability. In the end, the three CEOs were told to
come back in December with detailed financial plans for their companies. In early December, the CEOs dutifully returned to the U.S. Congress with plans in hand and
repeated their requests for finan- cial assistance. A few days later, both the U.S. House
and the Senate proposed legislation to aid the auto companies. Unfortunately, while the
House approved the auto aid bill on December 10, the Senate voted it down. Without the
support of both the House and the Senate, the proposed legislation was dead.
Wagoner was stunned and despaired for the future of the company he had served for over
thirty years. But his despair turned to elation when he got a telephone call from the Bush
administration. The administra- tion had decided the U.S. Treasury could, after all, use
the TARP funds to provide loans to GM as well as to Chrysler. (Ford had decided it could
survive without gov- ernment money.) On December 19, 2008, President Bush
announced that the U.S. Treasury would provide GM with a $13.4 billion loan from the
TARP fund, while Chrysler would get a $4 billion loan. In announcing the assistance to
the auto companies, the Bush administration said “the direct costs of American
automakers failing and laying off their workers . . . would result in a more than one per-
cent reduction in real GDP growth and about 1.1 million workers losing their jobs.”4 To
get the money, Wagoner had to agree that by February 17, 2009, GM would hand over a
detailed plan specifying how it would achieve “financial viability” and the plan had to be
acceptable to U.S. Treasury officials. With his back to the wall, Wag- oner agreed to the
terms and on December 31, 2008, GM got a first installment of $4 billion from its allotted
loan amount; it received another $5.4 billion on January 16, 2009, and a final installment
of $4 billion on Febru- ary 17, 2009.
Many objected that bailouts violated the free market philosophy embraced by many
Americans and replaced it with a kind of socialism. Republican Senator Bob Corker said
the GM bailout “should send a chill through all Americans who believe in free
enterprise.”5 Several Re- publican members of Congress submitted a resolution on the
bailouts that said they were “moving our free-market based economy another dangerous
step closer toward socialism.”6
By February 17, 2009, newly-elected President Barack Obama had taken office so his
administration would end up finishing the auto bail-out that the previ- ous administration
had set in motion. As part of the “viability plan,” that he had agreed to submit by
February 17, Wagoner was to renegotiate GM’s union contracts to make its labor costs
competitive with foreign car makers in the U.S., reduce the number and models of cars it
made, shrink its unsecured debt of $27.5 billion down to $9.2 billion by getting creditors
to cancel part of their debt in exchange for GM stock, and invest in fuel-efficient hybrid
and electric vehicles.7
Wagoner had quickly entered negotiations with the United Auto Workers (UAW), GM’s
major union, and with creditors. But GM’s creditors had stubbornly refused to reduce
their debt by the amount the govern- ment wanted. In the end, GM did not reach the debt
re- duction targets the U.S. Treasury wanted it to reach by February 17. Nevertheless, in
the final “plan for viabil- ity” it submitted to the U.S. Treasury on February 17, GM said
it would cut 37,000 blue-collar jobs and 10,000 white-collar jobs, close 14 plants over
three years, elimi- nate four of its eight car brands, cut manager salaries by 10 per cent
and all other salaries by 3 to 7 percent, and shift the costs of retiree health insurance to an
indepen- dent trust funded in part with GM stock and in part with debt. However, the plan
added, GM would need an ad- ditional $22.5 billion from the government to continue
operating to 2011.8
The Auto Task Force Obama had put together to re- view GM’s proposed plan was not
happy with it. Steven Ratner, who headed up the task force said:
It was clear to us from the “viability plans” that the companies had submitted on Feb. 17
that GM and Chrysler were in a state of denial. Both companies needed gigantic
reductions in their costs and liabilities. They had way too many plants and workers for
expected car volumes. And their labor costs were out of line with those of their most
direct competitors . . . I was shocked by the stunningly poor management that we found,
particularly at GM, where we encoun- tered, among other things, perhaps the weakest
finance operation any of us had ever seen in a major company.9
“Team Auto,” as the Obama task force called itself, spent over a month studying the plan
and concluded that GM’s optimistic assumptions that its market share would grow in the
future, its costs would decline, and in a few years it would have positive cash flows, were
out of touch with reality. On March 30, 2009, the Obama administration told the
company that its plan was not ac- ceptable and did “not warrant the substantial additional
investments . . . requested.” Nevertheless, GM was given 60 days, until June 1, to try to
extract deeper conces- sions from its creditors and was also given another loan of $6.36
billion to carry it through the next two months. Although GM continued trying to work
with its credi- tors, the Obama task force soon realized that the only way GM would force
its creditors to forgive GM’s debt was by filing for bankruptcy.10 This would give a
federal judge the authority to cancel as much debt as was needed for the company to
become a viable business again. On March 31, the U.S. Treasury informed the company’s
board of directors that if it filed for bankruptcy, the gov- ernment would provide the
funding it would need to emerge as a viable company.
By this time, Rick Wagoner’s fate had been sealed. In mid-March, Steven Ratner asked
Wagoner about his plans and he replied, “I’m not planning to stay until I’m 65 but I think
I’ve got at least a few years left in me…, but I told the [Bush] administration that if my
leaving would be helpful to saving General Motors, I’m prepared to do it.”11 On Friday,
March 27, Wagoner attended a meeting with the Auto Task Force to discuss GM’s
restructuring plans. Before the meeting Steven Ratner pulled him aside and said, “In our
last meeting you very graciously offered to step aside if it would be helpful.
Unfortunately our con- clusion is that it would be best if you did that.” Wagoner agreed
to step down, and on March 30 he submitted his resignation from GM.
On June 1, 2009, GM entered bankruptcy. The U.S. Treasury created a new company
named “General Mo- tors Company,” and the now bankrupt “Old GM” sold its most
profitable brands and most efficient manufac- turing facilities to the new “General
Motors Company” who used $30 billion of the government’s money to buy them. The
creditors of “Old GM” received a 10 percent share of the new company plus proceeds
from the sale of the assets of “Old GM.” A 17 percent share of the “New GM” was put
into a trust to pay for union retiree health care benefits; the union trust also received a
$2.5 billion note from “New GM” and $6.5 billion of its preferred stock. The government
of Canada, which had contributed $10 billion to bail out several GM plants in Ottawa and
Ontario, got 12 percent of the new company. The remain- ing 61 percent share of the
company became the property of the U.S. government in return for a total of $50 billion it
pumped into GM. The U.S. government also retained the right to elect 10 of the 12
members of the board of directors of the “New GM”; it was now the major owner of a car
company.12
GM was not the only firm that became a (partially) state-owned company during the
financial crisis. On Feb- ruary 27, 2009, it was announced that in exchange for $25
billion the U.S. Treasury was taking 36 percent ownership of Citigroup, Inc., a large
banking company driven to the brink of failure by the financial crisis. On September 16,
2008, American International Group, an insurance com- pany also brought to its knees by
the financial crisis, an- nounced that the government, through its Federal Reserve Bank,
was taking ownership of 80 percent of the company in exchange for $85 billion.
Many observers claimed that government owner- ship of companies is the kind of
government ownership of the “means of production” that Marx and other social- ists
advocate. For example, Robert Higgs, editor of The Independent Review, wrote that “the
government is resort- ing to outright socialism by taking ownership positions in rescued
firms.”13 And the Mackinac Center, a conser- vative research institute focused on
promoting “the free market,” published an article by Michael Winther that stated:
There are only two economic systems in the world . . . These two economic systems are
gen- erally described as “the free market” and “social- ism.” . . . Socialism is
characterized and defined by either of two qualities: Government owner- ship or control
of capital, or forced pooling and redistribution of wealth. . . . [T]he current bail- out could
be described as “super-socialism” be- cause it involves every possible component of
socialism: the forced redistribution of wealth, increased government control of capital,
and even the extreme of socialism, which is govern- ment ownership of capital. Our
federal govern- ment is not content to just regulate the markets (capital), but is also taking
the next step of pur- chasing ownership interest in previously private companies.14
Questions
1. How would Locke, Smith, and Marx evaluate the vari- ous events in this case?
2. Explain the ideologies implied by the statements of: the letter to the U.S. Congress
signed by 100 leading economists, Joseph Stiglitz, Bob Corker, the Repub- lican
resolution on the bailouts, Robert Higgs, and Michael Winther.
3. In your view should the GM bailout have been done? Explain why or why not. Was the
bailout ethical in terms of utilitarianism, justice, rights, and caring?
4. In your judgment, was it good or bad for the govern- ment to take ownership of 61
percent of GM? Ex- plain why or why not in terms of the theories of Lock, Smith,
and Marx.
Notes
1. TomKrisherandKimberlyS.Johnson,“GMPosts$9.6Billion Loss,” Associated Press, February 26,
2009; accessed May 30, 2010 at http://www.thestar.com/Business/article/593350.
2. Justin Wolfers, “Economists on the Bailout,” The New York Times, September 23, 2008.
3. Joseph Stiglitz, “America’s Socialism for the Rich,” The Guardian, June 12, 2009.
4. Congress …
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