Moody’s Chief Economist Says US Automakers Would Likely Need Up to $125B; Recommends the Requested Government Aid Now
In testimony before the US Senate Committee on Banking, Housing and Urban Affairs on 4 December, Mark Zandi, Chief Economist and co-Founder of Moody’s Economy.com, said that under the most likely outlook for the economy and auto industry, the Detroit 3 will need between $75-$125 billion to avoid bankruptcy at some point in the next two years.
The three recently presented restructuring plans by the three automakers totaled up to a possible $34 billion (GM, $12 billion in loans and $6 billion in a line of credit; Ford, $9 billion in a line of credit; Chrysler, $7 billion in loans). Despite the potential quadrupling of that amount, Zandi said that the Federal government should provide the financial help that the automakers need.
Zandi made two other primary points in his testimony. First, while the restructuring plans could result in a viable long-term domestic auto industry, there is a “considerable risk” that those plans will not be executed effectively by all three. Second, he recommended that Congress provide the $34 billion in aid in two tranches in exchange for warrants and restrictions on executive compensation and dividend payments. The first payout should be sufficient to forestall the automakers’ imminent disorderly bankruptcy. The second payout should be made only if the restructuring plans are proceeding successfully.
If the restructuring plans are unsuccessful, he said, then the government should provide no more loans, but work to ensure that there is an orderly bankruptcy process by providing financing in bankruptcy and guaranteeing warranties on new vehicles sold.
Even in an orderly bankruptcy, there still would be substantial layoffs. The companies would come out of bankruptcy much smaller, reflecting the much smaller new-car market and their loss of market share. But if this rationalization is done in an orderly way, the job losses should be thousands of jobs per month and not hundreds of thousands. While painful, this is manageable.
The danger of filing for bankruptcy now, Zandi said, is that a Chapter 11 restructuring would likely turn rapidly into a Chapter 7 liquidation, with factories and other operations shut down and assets sold to pay creditors.
Given the collapse in the financial system and resulting credit crunch, debtor in possession, or DIP, financing would be all but impossible to get. Bankrupt firms need DIP financing to operate their businesses—to pay suppliers, finance inventories and meet payroll—while they restructure...in the current credit crunch nothing will persuade creditors to take the risk.
Zandi assessed GM as being in much worse shape than Chrysler, which is in much worse shape than Ford. Although Ford has more financial latitude, it too would be at significant risk of bankruptcy if GM or Chrysler failed given the disruption to their supply base, dealers and creditors, Zandi said. The collapse of the Detroit 3 would put some 2.5 million jobs at risk, he said.
The auto industry has among the largest economic multipliers of any industry. For every one lost job in auto assembly, another nine jobs are lost in other supplying industries. Industries that would face considerable negative repercussions include auto suppliers, auto dealers, steel and metal suppliers, plastic and rubber companies, healthcare providers, and trucking and freight operators.
The hit to already record low consumer and business confidence would be devastating. The economic fallout on the already very hard-hit industrial Midwest would be disastrous. The Michigan and Ohio economies have been in recession more or less since the beginning of this decade, and the collapse of the Big Three would completely undermine their economies well into the next decade.
Other state economies that would be significantly hurt include Indiana, Illinois and Wisconsin. Exacerbating the economic fallout in the industrial Midwest is that unemployed workers would find it difficult to move to perhaps Kentucky, Tennessee or Alabama to work for the stronger transplants. Their home values have fallen so sharply that many are now underwater—they owe more on their homes than they are worth. To move would require that they put more into their home or to default on their existing mortgages
Zandi based his $75-$125 billion cost estimate in part on the expectation that light vehicle sales will average close to 11 million units in 2009, 13.5 million units in 2010, and less than 15 million units in 2011. Vehicle sales in the US have averaged almost 17 million units annually from 1999 to 2006.
Also weighing on vehicle sales is the large amount of pent-up vehicle demand. Given broad demographic, wealth and income trends, underlying new vehicle sales are at best 16 million units annually. The automakers were able to maintain sales of closer to 17 million units during the first half of this decade only by providing increasingly large discounts and easier financing terms...Total pent-up vehicle demand is estimated to be over 10 million units; at the current sales pace, the entire auto industry would have to shut down production for nearly a year to work it all off.