Auto Industry: A Framework for Considering Federal Financial Assistance
Published: 2008-12-04T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The current economic downturn has brought significant financial stress to the auto manufacturing industry. Recent deteriorating financial, real estate, and labor markets have reduced consumer confidence and available credit, and automobile purchases have declined. While auto manufacturers broadly have experienced declining sales in 2008 as the economy has worsened, sales of the "Big 3" (General Motors, Chrysler, and Ford) have also declined relative to those of some other auto manufacturers in recent years because higher gasoline prices have particularly hurt sales of sport utility vehicles. In addition to causing potential job losses at auto manufacturers, failure of the domestic auto industry would likely adversely affect other sectors. Officials from the Big 3 have requested, and Congress is considering, immediate federal financial assistance. This testimony discusses principles that can serve as a framework for considering the desirability, nature, scope, and conditions of federal financial assistance. Should Congress decide to provide financial assistance, we also discuss how these principles could be applied in these circumstances. The testimony is based on GAO's extensive body of work on previous federal rescue efforts that dates back to the 1970s.
section_title: What GAO Found
paragraphs: From our previous work on federal financial assistance to large firms and municipalities, we have identified three fundamental principles that can serve as a framework for considering future assistance. These principles are (1) identifying and defining the problem, (2) determining the national interests and setting clear goals and objectives that address the problem, and (3) protecting the government's interests. First, problems confronting the industry must be clearly defined--separating out those that require an immediate response from those structural challenges that will take more time to resolve. Second, Congress should determine whether the national interest will be best served through a legislative solution, or whether market forces and established legal procedures, such as bankruptcy, should be allowed to take their course. Should Congress decide that federal financial assistance is warranted, it is important that Congress establish clear objectives and goals for this assistance. Third, given the significant financial risk the federal government may assume, the structure Congress sets up to administer any assistance should provide for appropriate mechanisms, such as concessions by all parties, controls over management, compensation for risk, and a strong independent board, to protect taxpayers from excessive or unnecessary risks. These principles could help the Congress in deciding whether to offer financial assistance to the domestic auto manufacturers. If Congress determines that a legislative solution is in the national interest, a two-pronged approach could be appropriate in these circumstances. Specifically, Congress could 1) authorize immediate, but temporary, financial assistance to the auto manufacturing industry and 2) concurrently establish a board to approve, disburse, and oversee the use of these initial funds and provide any additional federal funds and continued oversight. This board could also oversee any structural reforms of the companies. Among other responsibilities, Congress could give the board authority to establish and implement eligibility criteria for potential borrowers and to implement procedures and controls in order to protect the government's interests.

section_title: Letter
paragraphs: We appreciate the opportunity to testify on possible federal assistance to  the domestic auto industry. The current economic downturn has added to  the significant financial stress facing that industry. Deteriorating financial,  real estate, and labor markets have reduced consumer confidence and  available credit, and automobile purchases have declined. After reaching a  recent high of about 1.8 million in July 2005, the number of vehicles sold in  the United States dropped to about 800,000 in October 2008,  approximately a 54 percent decline. While most auto manufacturers have  experienced declining sales in 2008, recent economic conditions have  particularly hurt sales of the “Big 3” domestic auto manufacturers (General  Motors, Ford, and Chrysler), in part because these companies have  historically derived most of their sales from vehicles such as sport utility  vehicles, which are less fuel efficient, but more profitable than small cars.  Higher gasoline prices over the past several years, which rose to over $4  per gallon in the summer of 2008 before falling steeply this fall, have  contributed to a sharp decline in consumer demand for these vehicles. The  tightening of the credit markets has also affected the Big 3 and their  suppliers, which together employ about 730,000 people. In addition to  potential job losses at auto manufacturers, the collapse or partial collapse  of the domestic auto industry would adversely affect auto dealers,  suppliers, and other sectors.
Officials from the Big 3 have requested immediate federal financial  assistance, reporting that their companies are experiencing significant  financial stress. Less than two days ago, the Big 3 submitted business  plans to Congress that describe their requests for federal assistance and  restructuring plans. Congress has asked us to review these plans. In  deciding whether to provide financial assistance, Congress must consider  and balance the perceived need for expedience with the need to put a  structure in place to ensure that the interests of taxpayers are safeguarded  and the specific problems that have put the industry in its current financial  crisis are addressed.
In my statement today, I will discuss principles that could serve as a  framework for considering the desirability, nature, scope, and conditions  of possible federal financial assistance and, should Congress decide to  provide financial assistance, how these principles could be applied in  these circumstances. My remarks are based on our extensive body of work  on previous federal financial assistance efforts that dates back to the  1970s, including those efforts directed to individual large corporations,  such as the Chrysler Corporation and Lockheed Aircraft Corporation, as  well as municipalities and commercial aviation.
subsections: section_title: Principles for Large- Scale Federal Financial Assistance Efforts Could Guide Congressional Consideration of Auto Manufacturers’ Requests
paragraphs: We have identified three fundamental principles that can serve as a  framework for considering large-scale federal assistance efforts. These  principles are (1) identifying and defining the problem, (2) determining the  national interests and setting clear goals and objectives that address the  problem, and (3) protecting the government’s interests.
Identify and define the problem: The government should clearly  identify and define the specific problems confronting the industry— separating out those that require an immediate response from those  structural challenges that will take more time to resolve. According to the  auto manufacturers, the most immediate threat to the industry comes from  inadequate cash reserves and negative projected cash flows combined  with a tightening or denial of credit by commercial lending institutions.  General Motors and Ford have not been profitable since at least 2006, and  sales have decreased substantially for the Big 3 in 2008. In this regard,  deteriorating financial and real estate markets, weakening labor markets,  and high fuel prices have contributed to reductions in consumers’ demand  for new vehicles, particularly less fuel-efficient vehicles. In addition,  tightening consumer credit has made it difficult for some consumers to  obtain auto loans. The industry, however, also faces structural challenges  that will need to be dealt with, including higher labor and pension costs  than competitors, dealership relationships and structure, and fleet  characteristics—especially in the area of fuel efficiency.
Determine national interests and set clear goals and objectives  that address the problem: After defining the problem, Congress must  determine whether a legislative solution best serves the national interest.  If Congress determines that the benefits of federal intervention exceed  those of bankruptcy reorganization for one or more of the domestic  manufacturers, Congress could draft legislation to guide the availability  and use of federal assistance. It is important that the legislation include a  clear and concise statement of the objectives and goals of the assistance  program. A statement of the objectives and goals of the program would  help Congress and program administrators determine which financial  tools are needed and most appropriate for the industry and for company- specific circumstances; provide criteria for program decisions; and serve  as a basis for monitoring progress. Finally, although Congress may decide  that there is a compelling national interest in providing financial  assistance to help ensure the long-term viability of the Big 3, companies  receiving assistance should not remain under federal protection  indefinitely. Identifying the conditions that will signal an end to that  protection would serve as congressional guidance on when the industry  should emerge from the assistance program.
Protecting the government’s interest: Because these assistance  programs pose significant financial risk to the federal government,  appropriate mechanisms should be included to protect taxpayers from  excessive or unnecessary risks. Mechanisms, structures, and protections  should be implemented to ensure prudent use of taxpayer resources and  manage the government’s risk consistent with a good faith attempt to  achieve the congressional goals and objectives of any federal financial  assistance program. This can be achieved through the following four  actions—all of which have been used in the past.  1.  Concessions from others: Congress should require concessions from  others with a stake in the outcome—including management, labor,  suppliers, dealers, and creditors. The concessions are not meant to  extract penalties for past actions, but to ensure cooperation and  flexibility in securing a successful future outcome. 2.  Controls over management: The government must have the authority  to approve an aid recipient’s financial and operating plans and new  major contracts. The authority is meant to ensure a restructuring plan  with realistic objectives and to hold management accountable for  achieving results. 3.  Collateral: To the extent feasible, the government should require that  the recipient provide adequate collateral, and that the government be  in a first lien position.  4.  Compensation for risk: The government should receive compensation  through fees and/or equity participation in return for providing federal  aid. The government’s participation in any upside gains is particularly  important if the program succeeds in restoring the recipient’s financial  operational health.
section_title: Using the Principles As a Framework for Considering Financial Assistance for the Auto Manufacturing Industry
paragraphs: Congress could apply these principles if it decides to offer financial  assistance to the domestic auto manufacturers. If Congress determines  that the systemic, economic consequences of risking the immediate failure  of any or all of these companies are too great, a two-pronged approach in  applying the principles could be appropriate. Specifically, Congress could  1) authorize immediate, but temporary, financial assistance to the auto  manufacturing industry and 2) concurrently establish a board to approve,  disburse, and oversee the use of these initial funds and provide any  additional federal funds and continued oversight. This board could also  oversee any structural reforms of the companies. Among other  responsibilities, Congress could give the board authority to establish and  implement eligibility criteria for potential borrowers and to implement  procedures and controls in order to protect the government’s interests.
The federal government has a range of tools it could use to provide such  bridge assistance, including loans and loan guarantees. Historically, the  federal government has used loans and loan guarantees in its financial  assistance to specific companies. In providing such credit assistance, the  government has assumed that the federal role is to help the industry  overcome a cyclical or event-specific crisis by gaining access to cash in the  short term that it otherwise cannot obtain through the markets. Credit  assistance assumes that the aided companies will eventually return to  financial health and have the capacity to pay back the loans. The  government has offered such assistance in return for companies providing  various forms of collateral and/or equity to protect taxpayer interests, as  well as for various concessions by interested parties to share the risk and  promote shared responsibility. For example, any federal assistance to an  auto manufacturer might seek to ensure that all parties, including labor  and management, share responsibility for bringing the company back to  profitability, and that no party makes excessive concessions relative to the  other parties. Finally, accountability should be built in so that Congress  and the public can have confidence that the assistance was prudent and  consistent with the identified objectives. For example, as a condition for  receiving federal assistance, the auto manufacturers should be required to  provide program administrators and appropriate oversight bodies with  access to their financial records and submit detailed operating and  financial plans indicating how the funds and other sources of financing  will be used to successfully return the companies to profitability. Such  information would allow program administrators to oversee the use of  funds and to hold the companies accountable for results.
Congress should concurrently establish a board to approve, disburse, and  oversee the use of these initial funds and provide any additional federal  funds and continued oversight. This board could also oversee any  structural reforms of the companies. The federal government has  established boards to implement past financial assistance efforts,  including when providing assistance to Lockheed in 1971 and Chrysler in  1980. More recently, in the aftermath of the 2001 terrorist attacks on the  United States, Congress created the Air Transportation Stabilization Board  (ATSB) to provide loan guarantees to the airline industry. The voting  members of ATSB included a member of the Board of Governors of the  Federal Reserve System and representatives from the Departments of the  Treasury and Transportation. While the exact membership of a board to  provide financial assistance to the Big 3 auto manufacturers could differ,  past federal financial assistance efforts suggest that it would be prudent to  include representatives from agencies knowledgeable about the auto  manufacturing industry as well as from those agencies skilled in financial  and economic analysis and assistance. In creating such a board, it will be  crucial for Congress to ensure that the board, similar to boards created to  implement past federal financial assistance efforts, has access to all  financial or operational records for any recipients of federal assistance so  that informed judgments and reviews can occur. It would also be  important to ensure that the board has the authority and resources to hire  or contract for necessary legal, financial, and other expertise. For  example, ATSB hired an executive director, financial analyst, and legal  counsel to help the board carry out its duties.
Beyond access to records and expertise, however, to succeed in achieving  the goal of a restructured industry, the board is likely to need the authority  to implement procedures and controls to protect the government’s  interests. This would include bringing the parties with a stake in a  successful outcome to the table. Our review of past large-scale financial  assistance efforts leads us to conclude that all of these parties must make  concessions—not as penalties for past actions but rather to ensure  cooperation in securing a successful future. The board would also need  authority to approve the borrower’s operating and financial plans and  major new contracts to ensure the plans are realistic and to assess  management’s efforts in achieving results. In addition, the federal  government should be the first creditor to be repaid in the event of a  bankruptcy or when the company returns to profitability. In 1980, when  providing assistance to Chrysler, Congress mandated that Chrysler meet  additional policy-oriented requirements such as achieving certain energy  efficiency goals and placed limits on executive compensation. More  recently, as a condition of receiving federal assistance in the wake of the  September 11 terrorist attacks, the Air Transportation Safety and System  Stabilization Act required that airlines limit executive compensation.
In addition, the board, consistent with congressional direction, could  require that manufacturers, with the cooperation of labor unions, take  steps to help control costs. Such steps could include reducing excess  capacity by closing or downsizing manufacturing facilities, reducing work- rule restrictions that limit flexibility in terms of which workers can do  what types of jobs, and ending contracts with dealerships that require the  manufacturer to pay a large buyout to a dealer if a product line is  eliminated. Some of these steps should be specifically addressed in the  legislation. It will be important to keep in mind, however, that the affected  parties will cooperate only if the assistance program offers a better  alternative than bankruptcy. The government should not expect creditors,  for example, to make concessions that will cost them more than they  would expect to lose in a bankruptcy proceeding. Finally, Congress  should provide the board with enough flexibility to balance requirements  in each recipient’s business plan to achieve and maintain profitability.
The board could be the logical entity to establish and implement clearly  defined eligibility criteria for potential borrowers, consistent with  statutory direction provided by Congress, and establish other safeguards  to help protect the government’s interests and limit the government’s  exposure to loss. The safeguards could vary, depending on the nature of  the financial assistance tools used. Examples of safeguards over loans and  loan guarantees that have been used in the past include the following:    Potential borrowers have been required to demonstrate that they meet  specific eligibility criteria, consistent with congressional direction as to  the problems to be addressed and the objectives and goals of the  assistance.
Potential borrowers have been required to demonstrate that their  prospective earning power, together with the character and value of any  security pledged, provided reasonable assurance of repayment of the loan  in accordance with its terms.
Potential borrowers have been required to clearly indicate the planned use  of the loans so that the board could make appropriate decisions about the  borrower’s financial plan and terms and conditions, as well as collateral.
The government has charged fees to help offset the risks it assumed in  providing such assistance.
For loan guarantees, the level of guarantee has been limited to a given  percentage of the total amount of the loan outstanding.
To further enhance accountability and promote transparency, the board  should monitor the status of federal assistance on a regular basis and  require regular reporting from companies receiving assistance. This  reporting should, at a minimum, include information on cash flow,  financial position, and results of independent audits. In addition, the board  should be required to provide periodic reports to Congress. This reporting  should include status reports on the amount and types of assistance  provided to the auto manufacturing industry, periodic assessments of the  effectiveness of the assistance, and status of any repayments of loans that  the federal government has provided to the industry.
In addition to providing oversight and accountability of the federal funds,  the board could be charged with overseeing efforts of the assisted  companies to implement required changes and reform. The board would  likely need to consider industry-specific issues in implementing financial  assistance and industry reform. Employee compensation would be one of  those issues, and a very complex one. Benefits for auto industry workers  represent a significant long-term financial commitment of the companies  seeking assistance, much of it to retirees and their families. Although  success in a company’s future will depend in part on sacrifice from all  stakeholders, most of the changes in this area will necessarily take effect  over the long term. The complexities of these arrangements and their  interface with active workers and with existing government programs will  make implementing federal assistance particularly challenging. For  example, the board would need to consider the impact that a possible  bankruptcy filing by an auto manufacturer would have on the Pension  Benefit Guaranty Corporation, the federal agency that insures private  employers’ defined benefit pensions, and whose cumulative balance is  already negative.
section_title: Concluding Observations
paragraphs: In conclusion, Congress is faced with a complex and consequential  decision regarding the auto manufacturers’ request for financial  assistance. The collapse or partial collapse of the domestic auto  manufacturing industry would have a significant ripple effect throughout  other sectors of the economy and serve as a drag on an already weakened  economy. However, providing federal financial assistance to the auto  manufacturing industry raises concerns about protecting the government’s  interests and the precedent such assistance could set for other industries  seeking relief from the current economic downturn.
My remarks today have focused on principles Congress may wish to  consider as it contemplates possible financial assistance for the auto  manufacturing industry. These principles are drawn directly from GAO’s  support of congressional efforts over several decades to assist segments of  industries, firms, the savings and loan industry, and municipalities.  Although the principles do not provide operational rules outlining exactly  what should be done, they do provide a framework for considering federal  financial assistance. By defining the problem, determining whether a  legislative solution to that problem best serves the national interest, and— assuming that such a solution is appropriate—establishing an appropriate  governance structure, Congress might better assure itself and the  American people that the federal assistance will achieve its intended  purpose.
Thank you Mr. Chairman, Ranking Member Shelby, and members of the  committee for having me here today. We at GAO, of course, stand ready to  assist you and your colleagues as you tackle these important challenges.
section_title: Contacts
paragraphs: For further information on this testimony, please contact Katherine A.  Siggerud on (202) 512-2834 (auto industry issues), J. Christopher Mihm on  (202) 512-3236 (GAO’s principles), and Gary L. Kepplinger on (202) 512- 5400 (legal issues).
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