How the Feds will Govern GM and Chrysler

The two automakers get a stay of execution, but the future remains bleak.

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The federal government has rescued banks, insured a huge insurance company, and stepped up as a lender of last resort. Now, with its bailout of the auto industry, it's the functional equivalent of a bankruptcy judge, too.

By agreeing to loan General Motors and Chrysler a combined $17.4 billion, the government keeps the two companies on life support during the worst car-industry downturn in decades. But the deal also gives the two companies a tight, three-month window to prove how they'll get competitive, become profitable, and pay back taxpayer largesse.

[See the cars that drove Detroit's customers away.]

That's the kind of process a bankruptcy judge would oversee—with a great deal of power to force change—if the companies were to declare Chapter 11. Instead, it will be the government that decides if GM and Chrysler are making adequate progress. If they're not, the deal calls for the firms to repay the government loans, which would leave little choice but bankruptcy, and probably liquidation. Here are the questions government overseers will be asking:

Should current management stay? Key members of Congress, like Senate Banking Committee Chairman Chris Dodd, have insisted that any automaker getting a bailout needs a regime change. But GM's board still insists CEO Rick Wagoner is the right guy for the job, and Vice Chairman Bob Lutz told the New York Times recently that firing Wagoner would be "the equivalent of the Incan or Mayan days, when everybody would go to the top of the volcano and throw a virgin in."

Likely way forward: Wagoner has made a few missteps, but he's also driven a lot of reforms at GM since he took over as CEO in 2000. It would be politically expedient to demand his scalp, but keeping him is a defensible move. If Wagoner stays but doesn't produce results, he could always be fired as a condition of GM receiving further loans. Chrysler CEO Bob Nardelli is relatively new to his job, still able to claim he's an outsider who didn't cause Chrysler's problems.

[Read a defense of Rick Wagoner.]

Can Chrysler stand on its own? Chrysler is the most threatened U.S. automaker. Sales are off 28 percent this year, the worst performance of any big car company, with a staggering 48 percent plunge in November. Chrysler has fallen from the third-biggest U.S. carmaker to the fifth, behind its two domestic rivals, Toyota, and Honda. Its corporate parent, the private-equity firm Cerberus Capital Management, has been trying to force a merger with GM or unload Chrysler to somebody else. And Chrysler is already showing signs of folding up the tent: Its portfolio of future products is painfully thin. The company recently killed a hybrid version of its Durango SUV, just weeks after introducing it. And plans for building a small car with the Chinese carmaker Chery—announced with much hoopla last year—are suddenly off.

Likely way forward: Will the government really commit money to a company whose heart isn't in it? The initial loan helps keep Chrysler going, but a better long-term strategy might be finding a manageable way to dissolve Chrysler—by folding it into GM or another company. That would go a long way toward solving one of the car industry's biggest underlying problems: There are too many carmakers building too many cars.

[See one exit strategy for Chrysler.]

What should the unions give up? In recent years, the United Auto Workers have agreed to part with many of the job protections and other benefits they've gained over decades. But it's not enough. Detroit's labor costs are still 30 to 40 percent higher than at nonunion auto plants, and the timetable for reducing those costs over the next few years is simply too slow. The UAW has agreed to suspend—but not kill—a "JOBS bank" program that provides workers nearly their full pay if they get laid off. And healthcare and pension benefits are still more generous than what many U.S. employers offer. The UAW has signaled that it will make further concessions if the car companies are at the brink. But it also asked for a GM board seat, which would give the unions more leverage, not less.

Likely way forward: Taxpayer involvement probably means much deeper cuts in union benefits. There's no way the government can defend a bailout of union workers who get better layoff pay or healthcare benefits than many tax-paying Americans, especially in a devastating recession. But the unions are battling for their very existence at this point, and will fight hard.

[See why many Americans are shunning GM.]

How big should the domestic automakers be? They're going to lose market share and shrink no matter what. The question is how fast. And the answer probably needs to be: faster than anybody thought possible. All three Detroit automakers have redundant brands—such as Chevrolet, Pontiac, and Saturn at GM, or Ford and Mercury at Ford—and sell nearly identical models under a confusing array of badges. Shuttering a brand—and its dealers—costs a lot of money, one reason the automakers have resisted doing it. But there may be no choice now. Dealers will sue if they suddenly have no product to sell, but that would probably happen in bankruptcy, and there may never be a better time to address this problem.

Likely way forward: After years of defending its eight overlapping brands, GM has finally said it will consider shrinking or killing some of them. If GM does, Ford will probably follow suit. GM execs routinely point out that it cost abut $1 billion to shutter Oldsmobile in the 1990s, a figure they apply to the cost of killing any other brands. Bailout funds could help cover the expense.

[See an analysis of the automaker's bailout plans.]

What kinds of cars should they build? There's been a lot of talk in Washington about forcing the automakers to build smaller, greener, cars, but the fact is, they already have convincing plans to do that. GM and Ford both have a number of hybrids on the way, along with small cars that should be more appealing than the bland rental-fleet specials they've been turning out for the past two decades. And Ford and GM have made quality improvements on their own (Chrysler less so).

The real issue over the next few years will be building the right number of cars, instead of way too many cars that need to be heavily discounted to sell, and having a broad lineup of good vehicles, not just good SUVs and pickups. Toyota succeeds because it has strong vehicles in nearly every category, so if consumer tastes change rapidly, odds are Toyota is prepared.

Likely way forward: Detroit's cars aren't really the problem. Better to focus on overcapacity, inflexible labor, excess dealerships, and overall bloat. If Detroit can force down labor costs and actually make a profit on small cars—which they haven't been able to do—that alone would be incentive to focus more on high-mileage vehicles.

[See 10 cars that could salvage Detroit.]

Should GM or Chrysler declare bankruptcy? This is the biggest question of all, and short-term loans don't eliminate the possibility. The administration hopes to use the threat of bankruptcy at the end of the three-month window to wring painful change out of GM and Chrysler.

Likely way forward: The threat of bankruptcy gives the Detroit CEOs more negotiating leverage with unions and dealers than they've ever had. But it's still possible that executives, unions, dealers, or a combination of all three could be obstinate enough to block the automakers' resuscitation. If that happens, then there will be little doubt that they all deserve bankruptcy.

[See how bankruptcy might benefit GM.]