Autopilot bailout

Despite their successes, some vital lessons went unlearned in the auto bailouts.

(Photo: Tannen Maury/Corbis)

Standing in the Etobicoke Casting Plant on May 30, Sergio Marchionne knew things could have turned out worse. But for massive government intervention, this small facility in western Toronto might have ended up yet another empty industrial graveyard, with only puddles of invading rainwater marking where machinery once stood. Instead, red lights whirled behind him, and steam periodically burst forth from equipment. The plant, which had been up for auction three years earlier, still builds aluminum die-cast components for use in Chrysler vehicles, and is actually in the midst of a modest expansion. Clad largely in blue or grey overalls, many of its 280 workers turned out to hear Marchionne, who heads both Chrysler and its new owner, Italian automaker Fiat, announce that the company had repaid its outstanding loans to the U.S., Canada and Ontario. “They gave us a second chance,” he said, “something that happens rarely in life.”

With the bailout era now entering the rear-view mirror, we can see that two years of intense government intervention helped the auto sector recover more rapidly than many expected. Jobs have been preserved, and at less cost than feared. However, there will always be critics who will argue it was the wrong thing to do, whatever the cost. More ominously, government’s failure to learn important lessons means it might well happen again.

The so-called Detroit Three (including Ford, which did not require bailout loans) nearly wound up on history’s scrap heap. In decline for decades, their “legacy costs” associated with providing retirement and health benefits to aging workforces left them unable to compete with foreign competitors. Their production lines mostly churned out trucks and SUVs. And they’d racked up huge debts. Abysmal management meant these long-recognized weaknesses went largely unaddressed, and during the financial crisis of 2008, they became terminal. Demand for new autos plummeted as consumers lost jobs and auto loans dried up. Those buyers still wandering the lots suddenly took interest in the very fuel-efficient models the Detroit Three couldn’t provide. Apparently invoking the logic that misery loves company, GM and Chrysler briefly attempted to put aside their century-long blood feud to merge. Then they went bust.

North America’s auto sector is highly integrated, with multiple assemblers relying on the same suppliers. Politicians worried that losing just one of the Detroit Three might cast their already precarious suppliers into bankruptcy, causing cascade failures across the industry. In short, GM and Chrysler were too big to fail. So the U.S., Canada and Ontario co-ordinated massive, complex aid that enabled the two companies to execute orderly restructurings. It operated largely on the theory that Ontario, home to about one-fifth of North America’s total auto production, should ante up 20% of whatever America provided. Canada and Ontario teamed up to provide a combined total of $13.7 billion. Governments also guaranteed vehicle warranties and insured parts suppliers’ receivables, and shored up GM’s and Chrysler’s financing companies. They provided further cash infusions in exchange for equity. They provided non-refundable grants for product development, particularly of fuel-efficient vehicles. All this helped each of the Detroit Three to negotiate huge concessions from suppliers and employees, creating further cost savings. “You can easily build a case that you’re over [US]$200 billion in improvements in balance sheet and/or cost savings across three companies,” says Dennis DesRosiers, a veteran industry consultant.

Needless to say, these moves were widely unpopular, with many pundits predicting the efforts would fail spectacularly. Jeff Rubin, then chief economist of CIBC, said in late 2008 that even very large bailouts “will not be enough to save the domestic carmakers.” (Rubin predicted North American auto sales would remain at depressed levels—10 million units a year—for the long haul.) Confounding critics, GM and Chrysler successfully exited from restructuring proceedings as stronger companies. Michael Burt, associate director of industrial economic trends at the Conference Board of Canada, notes that just prior to the recession the industry sold 17.5 million units a year yet barely broke even. Today, sales range between 14.5 and 15 million, yet the industry earns a small profit. “GM in particular and Chrysler to a lesser extent bounced back more quickly from the brink than I would have thought,” he says. At Chrysler’s celebration in Etobicoke, Federal Finance Minister Jim Flaherty proclaimed the bailouts a success. “It’s estimated that about 52,000 Canadian jobs were protected,” he claimed. “It was the right decision.” DesRosiers agrees GM and Chrysler achieved much, but says the real question is whether the improvements are worth US$200 billion. “You can look at it and say, ‘That’s all we got?’” he quips.

There also remains an issue of fairness. Toyota, Honda and other foreign competitors mounted no public protest against the bailouts. Nevertheless, free-market proponents argue these and other manufacturers should have been granted the opportunity to buy up GM’s and Chrysler’s assets, or to ramp up their own production. “BMW, Volkswagen, Mazda, because they did not go under, they deserve the reward of triumphing over competitors,” argues Derek Fildebrandt, national research director for the Canadian Taypayers Federation. “And they were denied that by the bailouts.” That said, fears that GM’s and Chrysler’s survival would simply push other competitors into bankruptcy have proven unfounded. Indeed, Ford managed to grow its market share significantly. Although a full reckoning is still not possible, the costs are becoming clearer. Chrysler received $2.9 billion in loans from Ottawa and Ontario, of which $1.7 billion has been repaid. (Ottawa will likely never see the remaining $1.2 billion, which was disbursed pre-bankruptcy.) As for GM, it received about $10.8 billion. Much of that was later converted into equity, but at a huge loss: $6.6 billion of it was written off. (The company repaid its outstanding $1.5 billion in April 2010.) So if one accepts Flaherty’s estimate on jobs protected, the probable loan losses alone amount to $130,000 per job.

The Canadian government still owns shares that fluctuate in value. Today, Ottawa owns 1.6% of Chrysler and 9% of GM. Few expect those stakes to suddenly skyrocket: of late, GM’s shares have been trading below $33, their price at the company’s initial public offering last November. Flaherty indicated he’s open to selling, but would seek an acceptable price on behalf of taxpayers. “But let’s be clear: At the end of the day, there’s not going to be full recovery of the taxpayers’ investments,” he said.


More worrisome is Ottawa’s apparent lack of introspection. Bailouts of any kind introduce moral hazard—which arises when an individual or organization does not bear the full consequences of its actions. Academics warn that by intervening to support failing firms, governments fundamentally and permanently alter the marketplace; firms may now be willing to take risks they otherwise wouldn’t, knowing a safety net probably exists. “It sends a message that taxpayers are essentially an insurance company, except you don’t have to pay premiums every month,” argues Fildebrandt. “The moral hazard that was created out of it will probably last forever.”

Partly in response to moral hazard stemming from bank bailouts, governments around the world are pondering new regulations for the banking sector. Yet having executed the largest bailout in our nation’s history, the federal government has said little about what it might do the next time a “too big to fail” automaker hits the skids. Asked what changes the department made to avert such situations in the future, an Industry Canada spokesperson could identify none. “We will do what is in the best interest of the Canadian economy,” he responded simply, “but we will do so in a way that is always very cautious with the hard-earned money of Canadian taxpayers.”

The lack of progress addressing this issue leaves some observers uneasy. “We have to figure out ahead of time how to deal with potential failures of those companies so we’re not making policies on the fly,” warns Burt. “That’s one lesson we haven’t learned.” The Congressional Budget Office recently made essentially the same point about the U.S. government’s response to the auto bailouts.

The prime justification of Canada’s bailouts was preserving Ontario’s share of the auto sector. In exchange for government aid, GM promised Canada at least 16% of its North American production until 2016, while Chrysler vowed to maintain 20% here until 2014. (Additionally, GM agreed it would invest $2 billion in its Canadian operations, and $1 billion in research and development.) That much has been achieved: although total continental volume is down, Ontario’s cut is the highest it’s ever been. “Ford is closing its Crown Victoria plant in St. Thomas,” notes Burt, “but we haven’t seen any additional closures by GM or Chrysler at their facilities. As long as the existing facilities stay in place, that share should be sustained.” Keeping those facilities will never be a sure thing, though. DesRosiers explains that auto plants survive or die based on whether they can secure mandates to build new products. These mandates on average run eight years, accompanied by billions of dollars in investment. Winning them invariably requires generous government incentives, with jurisdictions in the U.S. and Mexico competing vigorously. Whereas in the past, Canada’s tactics included eliminating duties, today the game requires direct cash outlays. “The levers that government has, and the appetite to actually get involved in these companies in a significant way, is relatively low,” DesRosiers says. He believes Ford’s Oakville plant mandate has two more years to run, and is next up for renegotiation. Virtually all other Ontario plants will be in play during the second half of this decade. Marchionne’s displays of gratitude notwithstanding, automakers will continue exploiting political arbitrage when deciding where to produce cars. As long as cars are built in Ontario, the era of government involvement in the auto sector will persist.