Automaker Bailout Loan: Secured Or Not?

December 19, 2008 by TFB

News came that the federal government is going to give a $17.4 billion loan to GM and Chrysler. It's still not clear what the government receives as security for such loans. The Associated Press article on Yahoo! said,

"Under terms of the loan, GM and Chrysler must provide the government with stock warrants giving it the option to buy GM and Chrysler stock at a specific price."

If that's the only thing the government gets, it doesn't mean much because if the companies go into bankruptcy, the value of their stocks becomes zero. The warrants also become worthless. The government just becomes an unsecured creditor. Some reports said the government's loans have priority over other creditors, but law professor Adam Levitin already analyzed it and said it's not possible under existing laws. Go figure.

[Update] The Treasury released the terms of the loans. Interest rate is 3-month LIBOR (currently ~2%) + 3%. It's secured by all assets not already pledged to somebody else (not much) plus a secondary lien on assets already pledged to somebody else. It's like giving someone a home equity loan when they have an upside-down mortgage. There is a special provision in case of bankruptcy which seems to make the government's claim ahead of others' claims. For more information see Professor Adam Levitin's analysis of the loan terms.

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Comments

6 Comments on Automaker Bailout Loan: Secured Or Not?

  1. Ted on December 19, 2008 | permalink
    2.  

    What world is Adam Levitin living in where he believes the Federal Government will be stopped from doing what it pleases, contrary to law or not?

  2. simplesimon on December 19, 2008 | permalink
    3.  

    What happened to "no bailout until changes to union contracts"?

  3. Pelon on December 20, 2008 | permalink
    4.  

    I have mixed feelings about this and other bailouts. On the one hand, I'm a firm believer in the necessity for the creative destruction that has allowed our economy to rapidly develop. Bad companies must be allowed to fail so that their resources can be applied to more efficient uses. On the other hand, I have a lot of concern for the people affected by that destruction. I would be willing to sacrifice a little of our long term prosperity to avoid a huge fall in current employment. I'm not willing, however, to mire the country in a decades long stagnation. You can argue that the attempt to preserve jobs and industries is the reason Japan has had such problems.

    The question I have is are we simply providing a helping hand to an auto industry that has a viable future, or are we investing in the equivalent of a state sponsored buggywhip industry that will never be able to stand on its own?

  4. TFB on December 20, 2008 | permalink
    5.  

    Pelon – There are strong restructuring requirements in the current auto bailout loans. I hope they enforce them and not let them be simply an empty threat. If they truly follow-through, I think we will still have a viable auto industry. I'm not against the auto bailout. I think this just gives them some time to organize a prepackaged bankruptcy. Financial problems can be solved by throwing money at them or wiping out some debt in bankruptcy. The competitive operations issues are much harder to solve.

  5. Bill M. on December 21, 2008 | permalink
    6.  

    Unfortunately there is so much fear in people's minds that there is nothing that can really be done by other Government that has an approval rating in the low 20s. Until we replace the well-connected politicians that are in the beltway, we will just be delaying the worst to come and make it even worst because the debt load just continues to grow. Lets every one slow down including the government, take a deep breath, repeat step 1 & 2 at least 3 times before anything is signed.

  6. Pelon on December 21, 2008 | permalink
    7.  

    I think the best hope for the auto companies is if the government guarantees a large portion of their retiree costs. That seems to be a major reason they weren't profitable before the sales slowdown. Their direct labor costs in both dollars per vehicle and dollars per hour aren't much different than the Japanese manufacturers. The legacy costs, though, are much more. To be competitive, they need to dump those costs on someone else. They were in the process of trying to do just that by transferring those obligations to the union when the market slowdown occurred. Now, they have no hope of raising the cash necessary to fund the transfer. The Treasury loan terms attempt to address that problem by requiring that the union accept a large transfer of company stock in lieu of cash, but I'm not sure the union will agree to that unless the government guarantees any shortfalls.

    In hindsight, it's easy to blame the car companies for allowing themselves to get stuck with such high legacy costs, but who knew that health care costs and life expectancy would increase so much? That's something to keep in mind for people planning for a retirement 20 to 40 years from now. What will our life expectancy be at that time? My retirement plan is setup to last until I'm 105. Currently, few people live that long, but what if that changes? How many of us will come up short?

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