Lemon Aid

Debunking the case for the Chrysler bailout

"Three years ago, the Chrysler Corporation was on the threshold of bankruptcy—but in the nick of time it was saved by loan guarantees provided by the federal government. Because of those loan guarantees, which didn't cost us taxpayers a penny, Chrysler started on the road to solvency and is now beginning to show a profit. There is an important lesson to be learned from this happy experience: Adam Smith's ideas of laissez-faire capitalism don't fit modern industrial societies. American corporate success in the years ahead will depend on an intimate relationship between business and government, of which federal loan guarantees such as the Chrysler bailout will be only one manifestation."

This is the sort of argument one hears 'round and about the land these days. But this conventional wisdom rests on a bedrock of myths and half-truths about the Chrysler bailout. These myths have clouded important issues involved in the larger question of government loan guarantees for failing corporations. A look at some common Chrysler myths and the facts they have obscured reveals Chrysler's true financial condition and the real impact of those controversial loan guarantees.

MYTH NO. 1:

Government loan guarantees prevented the Chrysler Corporation from going bankrupt.

The Chrysler Corporation has already gone bankrupt. Or, to be precise, in the past three years it has renegotiated its debts and restructured its organization in a way that greatly resembles a company that has gone through bankruptcy.

The Chrysler Corporation Loan Guarantee Act of 1979 included a clause that required Chrysler's creditors at the time to make certain "concessions" to Chrysler. With that clause to exploit and with Treasury Department officials, including then-Secretary William Miller, pressuring its creditors, Chrysler was able to pay off more than $600 million in debts for 30 cents on the dollar. In addition, it converted nearly $700 million in debts into preferred stock—stock that is relatively worthless in the financial markets, because the shares presently earn no dividends and are unredeemable for several years.

But Chrysler's creditors aren't the only ones who have been hurt by the company's quasi-bankruptcy. Despite the fact that the loan guarantees were supposed to protect jobs at Chrysler, the company has cut its white-collar work force by 20,000 and laid off 42,600 of its hourly workers since the loan guarantee was signed into law. In the opinion of many observers, including Senator William Proxmire (D–Wis.), the number of employees laid off at Chrysler in this period is at least as large—and may even be larger—than the number of jobs that would have been lost had Chrysler actually been forced into bankruptcy.

In reality, the primary difference between the actual bankruptcy that Chrysler faced in 1979 and the quasi-bankruptcy that Chrysler has gone through over the past three years is that under this quasi-bankruptcy, the federal government has accepted responsibility for guaranteeing over $1 billion in Chrysler loans. But if Chrysler's creditors and employees have already suffered through the debt renegotiations and layoffs that typify reorganization under the bankruptcy laws, who is benefiting from those loan guarantees? Mainly Chrysler's stockholders, whose investment decisions are being paid for by the taxpayers.

MYTH NO. 2:

Federal loan guarantees are justified because Chrysler's financial problems were brought on by the federal government.

Although federal safety regulations have certainly contributed to the financial decline of the automobile industry, Chrysler's management played a decisive role in putting it on the road to bankruptcy. The company's problems began shortly after World War II, when it decided to stick with prewar manufacturing and styling methods instead of retooling to meet the expectations of postwar automobile buyers. While Ford and General Motors developed a sleek and streamlined automobile design that sold well, Chrysler's crusty top management forced the company to stick with the shoebox-style designs of the 1930s.

By the time this shoebox mentality had disappeared in the 1950s, Chrysler had slipped to third place among the nation's automobile manufacturers. Chrysler's panicky new management emphasized sales and production over engineering, and the firm's cars became little more than delayed copies of Ford and General Motors products. "Chrysler was always into a fad, but always into it at the tail end, after it had crested," says Maryann Keller, automobile industry analyst for Paine Webber.

Even Chrysler's own president Lee Iacocca doesn't accuse the federal government of total responsibility for Chrysler's plight. "I don't blame regulations for all of Chrysler's problems," Iacocca testified before a congressional committee. "I think that half of all Chrysler's problems were tough management mistakes." Regulations may have played a part in forcing Chrysler over the edge, but the stage had been set for Chrysler's problems long before seat belts and bumper standards were even a gleam in Ralph Nader's eye.

MYTH NO. 3:

The loan guarantees won't cost anything unless Chrysler goes bankrupt.

Under the provisions of the Loan Guarantee Act, Chrysler is supposed to compensate the federal government for the risk that the government has taken in making the guarantees. The House Committee on Banking, Finance, and Urban Affairs defined this risk as "the difference between the rate that the guaranteed loans carry and the rate Chrysler would be required to pay if the loans were obtained without the federal guarantees."

Just how large is the difference between the two rates? In early 1980 Chrysler was able to issue government-guaranteed bonds at an interest rate of only 10.35 percent, while Ford Motor Company was forced to pay about 14.50 percent for its unguaranteed bonds. If Chrysler did not have the loan guarantees, it would almost certainly have to pay a higher interest rate on its bonds than the more secure Ford Motor Company. Therefore, Chrysler should be paying the federal government a guarantee fee of at least four percent, right?

Even if it should be, it isn't. Instead, Chrysler pays only one percent, or about $12 million a year. Chrysler has attempted to make up the difference by granting the federal government the right to buy 14.4 million shares of its common stock at $13 a share. The government can exercise this right at any time until the end of 1990.

But consider this: If we assume that Chrysler will gradually pay off all of its guaranteed loans between 1983 and 1990, and if we accept the conservative figure of four percent as an adequate risk premium, and if we assume that Chrysler will continue to pay a guarantee fee of one percent a year (although Chrysler has had the audacity to petition the government to lower that rate to one-half percent and may ultimately get the reduction), and if we use a 10 percent discount rate in our calculations, then in order for the federal government to receive full compensation for its risk, the price of Chrysler's stock would have to rise to at least $42 a share by 1990. In January, Chrysler stock was selling for $17.13, and in 1982 it dipped as low as $3.50.

So, if Chrysler goes bankrupt, we lose; we're forced to come up with $1.2 billion to cover Chrysler's loans. On the other hand, if Chrysler doesn't officially go bankrupt, we "win"—but we may never be fully compensated for the $200 million in interest subsidies that Chrysler will enjoy during the 1980s. Either way, we almost certainly pay a price.

MYTH NO. 4:

Chrysler's top management has been forced to take dramatic cuts in salary until all of Chrysler's financial problems have been solved.

In 1979 when Chrysler was petitioning the federal government for the financial assistance it wanted, the company announced the implementation of a Salary Reduction Program. Executive salaries were cut by two to ten percent, and Lee Iacocca's base salary was reduced to one dollar a year (although it was made clear that, under the program, Iacocca would collect the balance of a recruitment bonus due to him in 1980). If Chrysler's financial performance was adequate after two years, the executives would be eligible to receive retroactive salary payments to make up for these reductions.

In 1981, despite the fact that Chrysler lost nearly $500 million in that year, the Salary Reduction Program was ended and executive salaries were restored to their 1979 level. Not only that, but the company made retroactive payments to its executives for about two-thirds of the pay lost while the program was in effect—on the rationale that its stock price in 1981 was about two-thirds of its 1979 price. Iacocca himself received over $360,000 in salary, supplemental payments, and director's fees in 1981—including "amounts paid in accordance with the Salary Reduction Program," according to documents filed with the Securities and Exchange Commission. There is nothing inherently wrong with this level of payment; in fact, the well-known Iacocca could probably be making much more money with a healthier corporation somewhere. Still, it's worth noting that the days of the much-ballyhooed Salary Reduction Program at Chrysler are over.

MYTH NO. 5:

Chrysler is on the road to financial recovery.

Chrysler's supporters were elated when the company reported a net profit of over $260 million for the first three quarters of 1982—its largest profit since the loan guarantees were granted. Many people have called this a "comeback" for the company, but rumors of Chrysler's resurrection may be premature.

It is important to recognize that most of Chrysler's profit for the first nine months of 1982 came from two unusual sources: the sale of its profitable Chrysler Defense subsidiary, and the carrying forward of massive tax losses from previous years. If these two extraordinary items are removed from the income statement, Chrysler is left with a profit of only $4 million from its continuing operations (although an unsold Chrysler Defense probably could have generated another $50 million in earnings for the corporation).

Chrysler managed to earn this modest profit despite the fact that it sold fewer cars than in the same period of 1981, when it lost money. The secret to Chrysler's newly-found profitability has been cost cutting. But is it the kind of cost cutting that provides a solid foundation for long-term profitability?

• Decreases in research and development spending. Chrysler boosted R&D spending from $161 million in 1972 to $358 million in 1979 (equal to $206.6 million in 1972 dollars). But between 1979 and 1981, R&D spending was cut back to $250 million (equal to only $116.1 million in 1972 dollars). R&D, of course, includes product planning and design for Chrysler's future models.

• Decreases in capital investment. Industry analysts are concerned that Chrysler is sacrificing long-term capital investment in the interest of short-term profits. "We still have long-term concerns about the company and the fact that during this period of trial and tribulation, they have not spent much money for product, plant, and equipment," says Harvey Heinbach, automobile industry analyst for Merrill Lynch. "This year, Chrysler will have invested $500 million in capital spending, compared to General Motors' $8 billion." These figures mean that Chrysler will devote only about 5 percent of its gross income to capital spending, while General Motors will spend nearly 13 percent of its gross income.

• Deferrals of pension costs. In January 1982, Chrysler reached an agreement with the United Auto Workers to defer $220 million in pension fund contributions. If we assume that Chrysler has been able to invest this money at 15 percent interest, then this deferral will have contributed more than $30 million to its 1982 year-end revenues. The UAW, which conducted a 104-day strike of Chrysler in 1950 over the issue of independent pension funding, is not likely to allow these deferrals to continue indefinitely.

• Decreases in labor costs. In January 1981, Chrysler negotiated special concessions from the UAW that saved the company more than $600 million in 1981 and 1982. After a threatened strike in the United States and an actual strike of Chrysler's Canadian workers in late 1982, Chrysler was forced to give back many of those concessions. More "give-backs" are expected when the current agreement expires in January 1984, and wage parity with General Motors and Ford workers is an avowed long-term goal of the auto workers' union and its members.

Not all of Chrysler's cost cutting has occurred in these four areas, of course. But these examples illustrate that Chrysler's current profitability—as well as its prospects for future profitability—depend to a large extent on a set of unique and inherently temporary circumstances.

MYTH NO. 6:

Even if we don't like the loan guarantees, there isn't much we can do about it now.

True, there are currently $1.2 billion in outstanding loan guarantees that we can't do much about. There is, however, an additional $300 million in potential guarantees that should be watched closely.

The Chrysler Corporation Loan Guarantee Board, which consists of the secretary of the Treasury, the chairman of the Federal Reserve Board, and the comptroller general, has the authority to provide the additional guarantees. This authority expires at the end of 1983. Although Chrysler has said that it has no intention of drawing upon those remaining guarantees, it's entirely possible that as 1983 draws to a close, Chrysler's executives will have a completely natural reaction: "Aw, what the hell, let's grab it." Fortunately, the board has a number of tools at its disposal, including audits by the General Accounting Office, to prevent such a reaction from exposing another $300 million in taxpayers' money to needless financial risk.

Will Chrysler ever default on its guaranteed loans? No one can be sure. The best that can happen is that Chrysler will survive and the shrinking automobile market will be shared by four ailing auto makers, instead of the two or three relatively healthy car manufacturers that probably would have emerged had Chrysler been allowed to go into bankruptcy in the late 1970s. The worst that can happen is that Chrysler will formally default, and we'll all be stuck with a bill for $1.2 billion—and nothing to show for it. The fate of the Chrysler Corporation and a big chunk of taxpayers' money is at the mercy of several imponderables: Will the economy improve? Will the market for new automobiles improve? Will Chrysler's sales improve with it? Will Chrysler ever be able to pay off its guaranteed loans? Those are all mysteries right now, but one thing is clear: each of us is now an involuntary and undercompensated partner in a company whose future is still very much in doubt. And this is supposed to teach us that Adam Smith is passé?

James Hickel is a Washington-based legislative and regulatory policy consultant.