Lose a Billion, Get a Check

New Deals: The Chrysler Revival and the American System, by Robert Reich and John D. Donahue, New York: Times Books, 360 pp., $17.95

Perhaps the cleanest way to slice America's socioeconomic philosophers into rival factions is to ruthlessly pursue the question: "Are you now or have you ever been in favor of the Chrysler bailout?" No issue seems clearer to Americans. Type A: "Well of course you can't just let a giant employer die—thousands of workers and dozens of communities would suffer vast, needless pain. And they did pay the loan back with interest, proving that they were worthy claimants for public help." Type B: "What's so special about Chrysler? You don't see the local TV repair shop getting federally guaranteed loans. And it's not as if Chrysler doesn't have better access to private credit markets. If no one wants to risk his own money on Iacocca, why should the taxpayer assume his risk?"

Hence, when New Deals: The Chrysler Revival and the American System floated into my mailbox, I was less than impish in my enthusiasm. The book is coauthored by Robert Reich, a lawyer at Harvard's Kennedy School of Government, with economic consultant John D. Donahue. This is the Reich of 1983 bestseller fame, whose Next American Frontier raised the flag for centralized economic planning under the guise of "a national industrial policy." Since Reich is a reliable champion of the view that government attorneys know more economics than markets do, I expected this new book to be a brief for the bailout that Chrysler Chairman Lee Iacocca might plug into his next autobiography (or possibly use as a narration to his exhibit when he goes on display at the Smithsonian).

But Reich and Donahue are no Iacocca-puffs. The tale they relate is not a useless exercise in subsidy pleading. The Chrysler bailout, and its paradox-strewn aftermath, turn out to be a strangely fascinating episode in US economic history.

The tale basically began in mid-1979, when Chrysler Chairman John Riccardo trooped to Washington, D.C., as most all patriotic American businessmen are wont to do, and asked the Treasury Department for a favor. Not a great big front-page, socialistic handout, but a quiet, itty-bitty rule change allowing vast money-losing firms to get their tax write-offs in cash up front, rather than waiting to write them off against future income in better times. Alas, the heartless Treasury Secretary, G. William Miller, told them: "No, forget it, no way, absolutely not, get it out of your head. If you're going to get anything, it's going to be loan guarantees…,and even if it passes it's going to be so awful tough you'll wish you'd never brought the whole thing up, and I hate you guys and wish you'd go away." So Riccardo bopped back to Motown and began working on federal loan guarantees.

In the meantime, Chrysler, which had developed a widespread reputation for engineering excellence, was acquiring an even better one for losing big bucks. In keeping with Jimmy Carter's theme of "national malaise," Chrysler, Inc., went into the red $205 million in 1978 and $1.1 billion in 1979—setting the all-time major-league record for an American corporation.

But just before Christmas of 1979, Congress dropped the Chrysler Loan Guarantee Act in Lee Iacocca's stocking. (Iacocca had moved up from president to chairman to displace Riccardo, who was axed in a high-profile beheading to convey the notion that Chrysler's old managerial incompetence was being ruthlessly purged.)

The Loan Guarantee Act was staunchly opposed by liberals and conservatives—and so it passed. Walter Wriston, Chairman of Citicorp, denounced any bailout by noting: "There is no avoiding the fact that it is an attempt by the government to move economic resources to where they would not otherwise go. Such distortions inevitably lead to less, not more, productivity." Ralph Nader condemned Chrysler's inept management as the guilty party, while Sen. Lowell Weicker (R–Conn.) questioned the intervention's distributional effects: "How do you think they feel in the Naugatuck Valley of Connecticut, where literally hundreds of small businesses have gone under over the years?… They didn't have the army of high-priced lawyers and executives pleading their case in the halls of Congress. So now they are out of business."

The loan guarantee became federal policy—but the objections counted. Thanks to the ill-feelings of such Carter appointees as Paul Volcker, G. William Miller, Alfred Kahn, and the annoying Sen. William Proxmire (D–Wisc.), the guarantees came with a catch: private concessions. Before the feds were to sign off on incremental loan guarantees (up to a $1.5-billion max), Chrysler's workers, managers, suppliers, creditors, and local governments had to put up a little blood money of their own. In tense, round-the-clock negotiations, bankers, lawyers, and bureaucrats worked through three rounds of concessions among these constituencies: workers giving up cost-of-living and other wage hikes in exchange for stock sharing; banks restructuring debt and forgiving some loans altogether; local governments waiving tax payments.

The plan worked, in the following sense: in guaranteeing Chrysler paper, it allowed the firm to raise $500 million, $300 million, and $400 million in rapid-fire debt offerings in 1980–81—paying just about three-quarters of a point above Treasury-bill rates. By 1982, the automaker was virtually back to break even (minus $70 million in operating profits for the year) and by 1984 was scoring record profits (a projected $2.3 million).

Chrysler's loans were paid back with interest and even provided the government a risk premium when some stock warrants, thrown in to shut up Senator Proxmire and the curmudgeon element in Congress, paid off over $300 million to the federal Treasury in 1983 (but not without Chrysler's whining for the government to forget all about the warrants). But Reich and Donahue do not jump to the conclusion that all's well that bails out well. The premise, that paying back loans means the guarantees were wise, is bogus. Give me the right to borrow at Treasury-bill rates (or a blip above), and I'll be happy to invest in a well-diversified portfolio of higher-risk securities, predictably pay back my loans, and make a fat surplus—and I'm an economist (think what an astrologer or game show host could do if similarly staked!)

"We got lucky this time," write Reich and Donahue. "People can also win at Russian Roulette—for a while.…If we as taxpayers make a habit of standing behind private firms' debt, we will lose a large fraction of our bets. Insurance companies bear risks for a fee; if they charge too little, over time they go broke. Risk is cost."

But to the extent that this single shot did not backfire, it was, ironically, not because of the best intentions of the loan's supporters—but because of the obnoxious carping of Chrysler's doubters. Economist Alfred Kahn, for instance (he of airline deregulation fame), entered into congressional testimony the blunt fact that the requested loan guarantees of $1.5 billion (of which only $1.2 billion was actually tapped) had to be put in perspective: Chrysler workers were to receive $1.3 billion in raises over just the ensuing three-year contract period. (The observation earned Kahn the following endorsement from United Auto Workers (UAW) President Douglas Fraser: "He's a dangerous man when he's on the loose and ought to be locked up for a couple of weeks.")

Using government-made-me-do-it as alibi, Chrysler did get the UAW to give up automatic cost-of-living adjustments and retreat from the cherished workers' cartel that fixed wages among the Detroit Big Three. Again, with Volcker, Miller, Proxmire, and the Wall Street Journal breathing down their necks, Chrysler liquidated—spinning off their profitable tank division and European and other overseas operations and massively breaking up the monolithic corporation. By the time the Chrysler "miracle" was over, the New Chrysler Corporation bore small resemblance to the old, relying on outside suppliers for 70 percent of its parts requirements.

Most fundamentally, Chrysler had recovered only by laying off nearly half of its hourly workers and permanently reducing its full-time work force by a fat one-third. Eighteen Chrysler factories had shut their doors—economic collapse for the 18 communities that heard those doors slam. Or so we were told back in 1979, when Iacocca hit the D.C. pavement toting cue cards boasting of the "two-million Americans who would be severely impacted by the failure of this company."

When the dust had settled, Chrysler still stood, but many an illusion was gone. "It was just a professional reorganization outside of government," surmised G. William Miller. Certainly he is correct, and there can be little doubt that a Chapter 11 proceeding under the federal bankruptcy code (where output keeps churning as the judge passes out claim checks to creditors) would have largely achieved quite a similar outcome. With two exceptions: the wage deal and the stock price.

The senior workers coughed up about $10,000 per worker during the dark days of 1979–82 but finished at wage parity with Ford and General Motors, hauling in $27 an hour in wages and fringes in 1984. This is 70 percent above the average for all US manufacturing, and a cold slap at many late workers of the old Chrysler: "Labor…never offered larger wage and benefit concessions…in exchange for more job security. Harrowing job risk for some workers was chosen over greater wage risk for all."

On the other side, stockholders would clearly have been the first to take a dive in any official bankruptcy hearing, but that's what equity owners are there for. Socializing their losses makes no sense unless we socialize—well, you know. And the authors do perceive that "it was not blue-collar workers but stockholders, managers, lenders, consultants, lawyers, and lobbyists—all relatively wealthy—that benefitted most from the bail-out."

In the end, the ironies of the Chrysler episode begin to bump into each other. In fact, we still have little reliable evidence that Chrysler should have survived: its stunning 1984 performance was largely the result of—close your eyes, Nancy—Reagan administration subsidies. The first gimme was "safe-harbor leasing," which gave Chrysler the opportunity to sell its plants and equipment to other companies that would in turn lease them back to Chrysler. The scheme provided needed cash for Chrysler and enabled the buyers to take tax depreciation write-offs from which Chrysler could not benefit because it had no profits.

But this was really only peanuts for Chrysler—$100 million annually—and quickly reversed. The real plum was Japanese import restrictions. Driving down Japan's market share from 24 percent to a flat cap of 1.68 million cars (about 19 percent) drove up car prices by several hundred dollars per unit. There you are, Lee—now go talk about success through free enterprise on the Merv Griffin Show.

Reich and Donahue conclude that the Chrysler bailout probably raised more policy options than it made standard. In this intriguing monologue on the real-life evolution of a public policy, we see the surprising result that a questionable but explicit subsidy—the bailout—was undoubtedly less costly than a quieter and indirect—but massive—award in the form of import restrictions. The final message is unmistakable: the so-called Reagan Revolution has managed to bring the federal government's "industrial policy" back down under the table, right where it belongs.

Contributing Editor Thomas Hazlett is an economist at the University of California, Davis, and a senior editor of the Manhattan Report.