We live in a post-bailout world.
It wasn’t always this way. Before the 1970s, America was not a bailout nation. For the first 200 years or so of our history, this country did not believe in bailing out specific companies. That changed in 1971, when defense contractor Lockheed received a $250 million rescue during the Vietnam war.
Once the ice was broken, more specific company bailouts soon followed: $676.3 million for Penn Central (1974), $1.5 billion dollar rescue of Chrysler (1980), $1.8 billion for Continental Illinois Bank (1984), and the then giant $178.6 billion S&L crisis (1990s). The long list of companies that were bailed out during the 2008-09 Financial Crisis — between direct loans and bailouts of companies — totaled somewhere between 3 and 5 trillion dollars.
These rescues interfere with the marketplace, pick winners and losers, misallocate capital, and confer advantages on those with political connections. Least well understood, these bailouts create unintended consequences.
Those unintended consequences are the subject of today’s counter-factual: What if Chrysler was not bailed out in 1980? How might the world be different today?
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The 1960s and 70s were unkind to American automakers. The post war boom was fading. Japanese manufacturers such as Toyota, Honda, and Datsun were producing small, efficient cars. They were front-wheel drive, fun cars that handled well in the rain and snow. Japanese cars were well made and reliable. Meanwhile, the big “two and a half”1 as GM, Ford and Chrysler were known, were still making giant, inefficient vehicles – ugly, unreliable behemoths. Like their cars, the U.S. automakers were also big and inefficient, with too many layers of management between the factory floor and the executive suite.
Then came the 1973 oil embargo. Gas prices skyrocketed, pushing more of the public towards cheaper, more efficient Japanese brands. Chrysler, the perennial U.S. sales laggard, was hardest hit. The company began to hemorrhage cash: It lost $52 million in 1974, $259.5 million in 1975, $204.6 million in 1978. When a new oil embargo sent gasoline prices up again in 1979, Chrysler was looking at its first billion-dollar annual loss – and likely bankruptcy.
A rescue plan for Chrysler was engineered in 1980. It included 1.5 billion-dollar in loan guarantees, and required an additional 2 billion dollars in concessions from “owners, stockholders, administrators, employees, dealers, suppliers, foreign and domestic financial institutions, and by State and local governments.”
But it wasn’t a bankruptcy reorganization – the company had the same management team, union contracts, pension liabilities, and health care obligations as it did as before.
Worse still, all of the underlying forces which drove Chrysler towards bankruptcy were still in effect, impacting all three US automakers. The bailout treated the symptoms, but not the cause. Even with the rescue, the United Auto Workers saw union membership fall, from 1.5 million members in 1979 to less than a third of that 25 years later. The market share of domestic automakers in the U.S. still fell post-bailout: In 1968, 4 out 5 cars sold in America were domestic brands. By 2008, U.S. car sales accounted for less than half of the American market.
What if, instead of the bailout, the government allowed Chrysler Corp. to file bankruptcy?
We are constrained only by our imaginations in contemplating what might have happened next. The fallout of Chrysler going belly up would have opened an even greater market opportunity for the Japanese brands. In the place of ugly Aries K cars and Chrysler LeBarons, there would have been more Honda Preludes and Toyota Corollas sold. The adoption of smaller, more fuel-efficient cars would have been accelerated better average fuel standards. CAFE targets would have been met, and the air quality in the United States would have markedly improved.
Beyond increasing Japanese market share in America, the collapse of Chrysler would have scared the hell out of senior management at General Motors, Ford and even the United Auto Workers union. Picture the panic sets in behind the doors at all three executive suites. They recognize the same bad cost structure that crushed Chrysler still exists: Expensive hourly wage contracts, pricey pension fund obligations, rising health care costs. The difference between executive bonuses and chapter 11 bankruptcy was a mere few thousand car sales per year. That cost structure was an accident waiting to happen.
The loss of 123,000 jobs at Chrysler similarly terrifies the UAW. Not just the loss of dues, although that would be crippling. Beyond lost jobs, the bankruptcy filing also discharges the health care benefits. And that generous but underfunded pension plan? It yields less than ~40 cents on the dollar for the former Chrysler employees.
The remaining two automakers study what had made the Japanese automakers so successful. They recognize the need for better manufacturing efficiency and improved quality. But they understand a cooperative and flexible workforce is required, with employees as partners, not adversaries. With GM, Ford and UAW terrified, a new deal is negotiated: The Union reduces pension and health-care guarantees in exchange for employee stock options. Instead of seeing their market share slide, GM and Ford stabilize. Their balance sheets improve on the backs of a better cost structure and much better cars.
In this alternative future, a bailed-out Chrysler does not go on to invent the Minivan and the Sports Utility Vehicle (SUV). Nor does a post-bailout corporate management wage an extensive political war against those CAFE standards. In this post Chrysler world, American cars are more reliable, with improved gas mileage.
What Congress accomplished with the 1980 bailout of Chrysler was to postpone the inevitable. Decades later, GM and Ford began to make more efficient cars; and improve their manufacturing processes. But they never could shake that terrible cost structure. In 2008, a $60 billion-dollar bankruptcy reorganization took place for GM and Chrysler.
The world might be very different place today if Chrysler did not receive life-saving loan guarantees from the federal government.
Even worse, that giant rescue set a precedent, and made each subsequent bailout a little easier to push through. After all we successfully rescued, Chrysler? What’s the worst that could happen if we bailout another company?
The short answer: Long Term Capital Management.
Coming Friday: Unintended Consequences, Part II: Long Term Capital Management
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1. It was Barron’s who described the Detroit automakers as “the big two and a half.”
