The Auto Bailout - Venture Capitalism in Action?

Mitt Romney's position on the auto industry bailout has been anything but consistent, but his latest spin is to try to compare the process of the bailout to the actions of a venture capitalist. Paul Krugman points out that Romney is now trying to claim a form of "credit for the very policy he trashed when it hung in the balance",

So what the story of Romney and the auto bailout actually shows is something we already knew from health care: he’s a smart guy who is also a moral coward. His original proposal for the auto industry, like his health reform, bore considerable resemblance to what Obama actually did. But when the deed took place, Romney — rather than having the courage to say that the president was actually doing something reasonable — joined the rest of his party in whining and denouncing the plan.

But there's something else we need to recall: at the time of the bailout, Chrysler was not a publicly traded company. It had been acquired and mismanaged by a private equity firm.

I don't want to overstate Obama's role in the bailout, as I don't think President Bush would have done things much differently, but here's the thing: President Obama pushed Chrysler through a managed bankruptcy after the private equity process failed. You can't say "It's the same thing a private equity firm would have done" because we know what the private equity firm actually did before the government had to take over and clean up its mess.

Update:

Why Shouldn't The Government Be The Senior Creditor

I'm sorry. Although I support the creation of a new bankruptcy chapter for companies deemed "too big to fail", and I support proposals to keep "too big to fail" from being an excuse in the future to bail out companies that should go through bankruptcy or otherwise be allowed to fail, I find myself completely unable to get worked up about the idea that certain Chrysler and GM creditors are getting a raw deal in bankruptcy.

The concept seems to be this: Even though the auto companies survive solely on government bailout funds, and can make their way through bankruptcy only with the government guaranteeing their debt and warranties and providing additional cash support, and even though the creditors objecting to the proposed distribution would be receiving far less but for the government bail-out, and even though to give them more increases the government's future exposure through the Pension Benefit Guarantee Corp., it's hideously unfair that the government is using its position to bring about a settlement that doesn't provide a greater transfer of taxpayer money to cover the private losses of GM and Chrysler investors.

Why are these people so willing, eager, to regard taxpayer dollars as meaningless. No, that's not quite right. As a justification for a wealth transfer from the taxpayers to investors who made a poor investment. What if we had a perfectly reasonable law that, when a major business falters and is deemed "too big to fail", but cannot obtain the private capital it needs to maintain its operations, in the event of bankruptcy any loans or other aid it receives from the government to get it through the crisis must be paid back to the penny before any other creditor may receive a distribution? How would that be unfair? Yet in the context of GM and Chrysler, the deal being offered to creditors is far more generous.

With all due respect to those who pretend that nobody can bid against Fiat for Chrysler because nobody has had time to figure out what Chrysler is really worth, how hard is it to beat a bid of $0? What reason is there to believe that Obama would be anything but pleased with a higher bid, a bidding war, or a bid from a domestic company? Seriously, Chrysler was privately held by Cerberus Capital Management, a company that deems itself a turnaround specialist, and I don't think they would have hesitated to provide a detailed prospectus to anyone who was willing to outbid Fiat. I also don't accept that Fiat is the only company that noticed Chrysler was for sale, and spent a bit of time kicking the tires and looking under the hood.

I expect that the legal challenges to the proposed resolution of Chrysler's bankruptcy will fail. I agree that what we're doing here (and, outside of the bankruptcy process, with major financial institutions) is far from ideal. I am anything but thrilled with the prepackaged bankruptcies we're looking at, and would very much have preferred to keep GM's ownership in private hands. But this notion that keeps rearing its head, that it's unfair not to give investors, financial industry employees, and others a windfall at taxpayer expense - where their investments would be worthless or they would be out on the street without government intervention - just doesn't move me.

The better argument is that we should have let Ford and GM enter bankruptcy last fall, without federal support, and let the market deal with it. It's highly questionable whether, three or five years down the road, this will look like the best use of the taxpayer money we're pouring in, with the short-term goal of saving jobs and perhaps allowing viable companies to emerge from the ashes of their former selves. Will it still look like it was a good idea to keep the companies going, in order to prevent huge numbers of their employees from becoming jobless in the middle of a difficult recession? It's hard to know - there is a serious price to worsening or perpetuating the recession. But while I hope I'm wrong, I don't think it is ever going to look good in terms of "dollars spent per job saved".

Who Wants to Dance With Chrysler?

I'll give Jerry Flint credit for sounding the alarm bell on GM and Chyrsler, but I think he's off-base in suggesting that, to stay out of bankruptcy, Chrysler has any realistic alternative other than merging with Fiat.

This deal makes no sense to me. It would take two to three years for Chrysler and Fiat ( FIA - news - people ) to figure out how to make this work. In that time, Chrysler could design and build its own new cars as long as the government is providing the money. So why does it need Fiat?

* * *

Chrysler's pickup, the Ram, is well thought of, as are are its minivans and Jeep. The big trouble is its cars; they don't sell, and the lineup is weak. But with government money, Chrysler could rehire engineers and design new ones.

A better possibility could be some kind of affiliation with someone other than Fiat, someone that builds cars here now. The perfect partner would be Nissan, because as Chrysler could use its cars, rebadged as Chryslers and Dodges, Nissan could use Chrysler's pickups and minivans, rebadged as Nissans.

But, as Flint notes, Nissan doesn't want to dance. It might be convinced to buy GM's truck division, possibly also its minivans, but that would make Chyrsler even less viable as a going concern.

Flint and others seem taken aback by how little Fiat has to bring to the table to get a significant stake in Chyrsler, replace its CEO, and redefine its management structure. Not only does Fiat pay no cash, it won't assume responsibility for any of Chrysler's debts. And it wants more labor concessions. The fact that Fiat's considered a possible suiter tells you a lot about Chyrsler's condition. The fact that it's the only suitor, perhaps, tells you even more.

Flint believes Chyrsler could presently hire engineers, have them design a next generation drivetrain, retool its plants, and have the new vehicles in production within two or three years? For real? Even assuming that the government hands it the billions necessary to stay in business while that happens, I think it's more realistic to expect it to take two or three years for the next generation of cars to be designed, and another two or three years for factory retooling. Even before you look at Chrysler's hit-or-miss track record, and its overall inability to design cars that people want to buy, you should have a sense that it's not going to happen.

Fiat appears to be willing to take on Chrysler as a gamble to get its cars back into the U.S. market, both as FIats and perhaps also rebranded as Chryslers. It may see value in some of Chrysler's brands, and its truck and minivan business. But despite Flint's concern about how long it might take for Fiat to get its cars into production while meeting U.S. safety and emissions standards, that can be done in half the time (perhaps less than half the time) that it would take for Chrysler to develop and produce next-generation vehicles. And assuming the synergy goes better than with Daimler-Chrysler, Chrysler vehicles may be able to integrate some of Fiat's technologies within the relative short-term.

Cerberus appears to be doing the absolute minimum that it can get away with doing, while continuing to pretend that Chrysler is a viable going concern. Waiting to see if another dance partner comes along, or hoping that the government will carry Chrysler indefinitely in the hope that Cerberus and Nardelli will suddenly become competent, caring custodians of Chyrsler¹ is neither wise nor realistic. Each day the hole gets deeper, and it's only a matter of time before even Fiat walks away from the dance floor.
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1. Alliteration worthy of Safire?

Just Checking

Is there anybody who still believes this crap:

Cerberus specializes in providing both financial resources and operational expertise to help transform undervalued companies into industry leaders for long-term success and value creation.

Because, well....

Sure, I admit, that sounds better than saying, "We're a bunch of politically connected hacks with access to lots of money who take over distressed companies through highly leveraged acquisitions, and try to flip them or carve them into pieces for quick profit, and demand multi-billion dollar government bailouts when we screw up."

More on Not Bailing Out Cerberus

James Kwak helps explain why we shoudn't bail out Cerberus in the name of "saving" Chrysler:

There are two other plausible reasons why Cerberus would prefer to go to the government. The first is if they can get cheaper capital (a lower-interest loan) from the government than from their limited partners or from the capital markets. But then the question becomes why the government should be in the business of giving cheap capital to a private equity firm that has other sources of capital.

The other possibility is that Cerberus/Chrysler doesn't actually believe the plan, and that's why Cerberus doesn't want to put in the money. The plan is a Hail Mary strategy that might work, but the chances of it working aren't good enough to put in their own money; but if they can get free money from the government (free in the sense that if Chrysler collapses, Cerberus won't have to repay the government), they might as well give it a shot.

You already know that I'm a believer in the second scenario. I don't see why Cerberus can't be required to guarantee loans to Chrysler with its remaining portfolio. If that's something they would purport to "violate their fiduciary duty to their limited partners", well, too bad, so sad, get the loan somewhere else.

A GM Bankruptcy?

I say, go for it! If in fact it's a viable plan, it seems like a much better option than limping along, surviving only with infusions of taxpayer money.

The viability of a GM bankruptcy might also give Congress the backbone to give Cerberus the overdue instruction that it needs to live up to its claims of being a turnaround specialist, and require it to pay for its own mistakes.

But It's Even Worse, Isn't It?

If you wait long enough, somebody's probably going to articulate what you are thinking, and probably say it better. Case in point: I haven't had much time to type out my thoughts on the nation's fear of "nationalization", but Robert Reich does a pretty good job of describing something that's been bothering me:

The federal government -- that is, you and I and every other taxpayer -- has taken ownership of giant home mortgagors Fannie and Freddie, which are by now basket cases. We've also put hundreds of millions into Wall Street banks, which are still flowing red ink and seem everyday to be in worse shape. We've bailed out the giant insurer AIG, which is failing. We've given GM and Chrysler the first installments of what are likely to turn into big bailouts. It's hard to find anyone who will place a big bet on the future of these two.

In terms of the companies lining up for bailouts,

If anyone has a good argument for why the shareholders of these losers should not be cleaned out first, and their creditors and executives and directors second -- before taxpayers get stuck with the astonishingly-large bill -- I would like to hear it.

I completely agree. But there's something Reich doesn't mention that concerns me: Our current bailouts aren't working. That is, it may cost us more to continue bailing out loser companies while declining to nationalize them than it would if we nationalized them, ate their bad debt and, as quickly as possible, restored them to private ownership. (Part of the reason, of course, is the appalling greed of incompetent managers.)

I can also tell you this, not far off from one of Reich's points - Chrysler is a black hole. If it weren't, Cerberus would be bailing it out itself. They shouldn't be invited back for more "loans" or bailout funds, save perhaps a bridge loan to help them seal a takeover deal with a viable company.
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Addendum: "Moral haz... whuttard?" David Ignatius flat-out calls for subsidy:

How will the managers of the Bad Bank coax the gremlins out of hiding? With money, of course -- buying up an estimated $1 trillion to $2 trillion in toxic paper. Will the government overpay? Of course it will, especially at first, as it discovers fair prices for securitized debt for which there isn't now a functioning market.

Anybody even casually conversant with this crisis knows that the government will overpay because to do otherwise won't help the banks. We can buy them for the pretend value the banks presently use, knowing we're paying probably two, three, four times their actual value, removing a huge liability from the banks' shoulders, then hope that with actual assets back in their coffers banks will return to "business as usual". Or we can try to come up with something approximating market value, force banks to report multi-billion dollar losses on those assets, and... then most of them have to admit insolvency.

At least people seem to be through arguing that if the taxpayer ends up owning these toxic assets, there's a chance of "turning a profit". Does Larry Kudlow blush when he reads crap like this, or does he shrug, smile at the corporate interests he serves and say, "It was worth a shot."

Well, There You Go....

Rumor has it, Cerberus sees Chrysler as being worth more as a write-off than as an investment:

Meanwhile, Chrysler is understood to have retained a law firm that specialises in bankruptcy proceedings to begin a liquidation process if Congress does not agree to lend the money it needs to survive.

Cerberus doesn't need government money to keep Chrysler afloat. It needs government money to avoid taking a loss on what turned out to be a bad investment.

I reiterate:

I would offer Chrysler loans on one of two conditions:

1. Cerberus first sells Chrysler to a publicly traded firm, divesting itself of any and all interest in Chrysler (and yes, this still works as a subsidy to Cerberus, as it will increase the selling price); or

2. Cerberus guarantees the money Chrysler borrows, putting up its portfolio of investments as security.

If they are asking that this money be loaned to Chrysler Holdings LLC, with no recourse against Cerberus itself, I would tell them to kiss off.

That, of course, is exactly what they're asking.

Bailing Out Chrysler

When Cerberus Capital Management, LP, comes to Washington D.C. to ask taxpayers to bail out its failed investment, I can't help but think, "No!"

My objection doesn't arise from a lack of concern for the workers. I know some Chrysler workers who are likely to be laid off whether or not there is a bailout. Hate unions if you will, but auto industry job losses will cause extreme hardship for a lot of good people.

But here's the wrinkle. Unlike GM and Ford, Chrysler is not a public company. It's in the portfolio of a wealthy private equity firm:

Cerberus Capital Management, L.P. is one of the world's leading private investment firms. Cerberus specializes in providing both financial resources and operational expertise to help transform undervalued companies into industry leaders for long-term success and value creation....

Cerberus holds controlling or significant minority interests in companies around the world. In aggregate, these companies currently generate over $100 billion in annual revenues.

That's right - a company that is supposedly a leader in providing financial resources and operating expertise to failing companies wants U.S. taxpayers to paper over its losses.

As a private company, Chrysler doesn't have to publish financial statements and it doesn't appear that Cerberus is going to open its books. We're told that CEO Bob Nardelli gets a salary of only $1, with no benefits, but he receives other income that's not disclosed - what is it, and why is it a secret? Given his glorious golden parachute from Home Depot, he doesn't actually need to be paid, but let's not pretend he's actually earning a mere dollar. Chrysler has told Congress that it expects an operating profit of $2.6 billion in 2010, with slightly lower profits in 2011 and 2001. If that's what they truly believe, why isn't Cerberus happily financing its own bail-out? Why is it suggesting that absent an infusion of taxpayer money, Chrysler is likely to enter bankruptcy?

If Chrysler is going to fail without additional working capital, it's not because Cerberus can't afford to pay. If it wished, it could sell part or all of one or more of its other holdings or borrow money against those holdings to keep Chrysler running. If it won't, it's safe to conclude that it doesn't think Chrysler is a safe or worthy investment. And if that's what it thinks, why should taxpayers subsidize their billionaire's version of "flip this house"?

Further, there's cause to question whether Chrysler can survive as an independent company. If it cannot, why should taxpayers bear part or all of the loss Cerberus faces as it carves up the company and sells off its viable parts? From what I can see of its present cost-cutting measures, it is not planning to remain independent - given the manner in which it has reduced its professional workforce, it's not even clear that it still has the capacity to develop a new generation of vehicles. At the same time, the announced round of job cuts will save a suitor a lot of trouble, as there will be a much lower level of redundancy if Chrysler is acquired by another auto company.

I would offer Chrysler loans on one of two conditions:

1. Cerberus first sells Chrysler to a publicly traded firm, divesting itself of any and all interest in Chrysler (and yes, this still works as a subsidy to Cerberus, as it will increase the selling price); or
2. Cerberus guarantees the money Chrysler borrows, putting up its portfolio of investments as security.

If they are asking that this money be loaned to Chrysler Holdings LLC, with no recourse against Cerberus itself, I would tell them to kiss off.