TARP Assistance for Chrysler: Restructuring and Repayment Issues
Released: 2012-09-07T00:00:00

Introduction

In 2008 and 2009, collapsing world credit markets and a slowing global economy combined to create the weakest market in decades for production and sale of motor vehicles in the United States and other industrial countries. The declines in production and sales were serious business challenges for all automakers, and rippled through the large and interconnected motor vehicle industry supply chain, touching suppliers, auto dealers, and the communities where auto-making is a major industry.

Old Chrysler and Old GM were in especially precarious positions. As the supply of credit tightened, they lost the ability to finance their operations through private capital markets and sought federal financial assistance in 2008.

During the recession, both of these U.S. automakers and two auto financing companies, Chrysler Financial and GMAC, received federal financial assistance from the Bush and Obama Administrations. Alone among the world's major automakers, Old Chrysler and Old GM filed for bankruptcy and, with oversight from the Obama Administration as well as the bankruptcy court, restructured their operations in an attempt to become more competitive companies. Both bankruptcies took place in the summer of 2009. Reasoning that Chrysler was not financially strong enough to be an independent company, the Obama Administration reached an agreement with Fiat to take over the management of New Chrysler in a bankruptcy reorganization; Fiat also received a 20% equity ownership stake in the new company.

The U.S. government's assistance to Chrysler ultimately resulted in New Chrysler owing the government several billions of dollars in loans and the government having an initial 9.9% ownership stake in New Chrysler. In May 2011, the loans directly owed by New Chrysler were repaid; in July 2011, Fiat purchased the U.S. government's remaining interests in the company, thereby ending direct government involvement with New Chrysler. The TARP assistance for Chrysler, however, was not fully recouped due to losses in the bankruptcy process and because the ultimate value of the government's ownership stake in Chrysler was less than the amount of outstanding TARP assistance.

This report describes the progress that New Chrysler has made since it was created from the sale of the Old Chrysler assets in July 2009 and the path of the divestment of the federal government's stake in Chrysler.

Government Assistance to the U.S. Motor Vehicle Industry

The initial U.S. government loans to assist the U.S. motor vehicle and motor vehicle financing industry were made by the Bush Administration in December 2008 and January 2009. At that time, $24.8 billion in assistance was provided to the four companies, the first of what would eventually total nearly $80 billion in assistance through the Troubled Asset Relief Program (TARP). TARP was authorized by the Emergency Economic Stabilization Act (EESA), enacted in the fall of 2008 to address the ongoing financial crisis. This statute specifically authorized the Secretary of the Treasury to purchase troubled assets from "financial firms," the definition of which did not mention manufacturing companies. According to the U.S. Treasury Department,

The overriding objective of EESA was to restore liquidity and stability to the financial system of the United States in a manner which maximizes overall returns to the taxpayers. Consistent with the statutory requirement, Treasury's four portfolio management guiding principles for the TARP are: (i) protect taxpayer investments and maximize overall investment returns within competing constraints; (ii) promote stability for and prevent disruption of financial markets and the economy; (iii) bolster market confidence to increase private capital investment; and (iv) dispose of investments as soon as practicable, in a timely and orderly manner that minimizes financial market and economic impact.

The authorities within TARP were very broad, and when Congress did not pass specific auto industry loan legislation, the Bush Administration turned to TARP for funding, arguing that to not provide any assistance to Old Chrysler (and Old GM) would make the recession much worse.

The Obama Administration took office and built on this precedent. In 2009, both Chrysler and GM received additional TARP loans, which kept them functioning as they went through a major restructuring prompted by the Obama Administration's Auto Task Force. GMAC/Ally Financial received additional capital infusions, enabling the company to survive both the economic downturn in the auto market as well as large losses on the company's mortgage operations. Chrysler Financial, in contrast, required no additional aid and relatively quickly repaid the TARP loan it received. The assistance for the auto industry was not without controversy, and questions were raised about the legal basis for the assistance and the manner in which it was carried out.

Table 1 summarizes the TARP assistance given to the U.S. motor vehicle and motor vehicle financing industry.

Chrysler: Two-Time Recipient of Federal Aid

Since 1980, when it first received federal assistance, Chrysler has had four different ownership structures, as shown in the Appendix . During this time, its share of the U.S. passenger car market fell by half while its share of the light truck market has generally grown ( Table 2 ).

In the late 1970s, Old Chrysler was losing market share as successive oil price shocks raised the price of gasoline and many Americans began deserting large American cars for small, more fuel-efficient German and Japanese imports. More stringent federal safety, fuel efficiency, and pollution standards required a level of capital investment that Old Chrysler did not possess. As the smallest of the Detroit 3, and without stronger financial resources, Old Chrysler faced possible bankruptcy. In December 1979, to avoid the loss of a large American manufacturer, Congress approved a $1.5 billion federal loan guarantee proposed by the Carter Administration. The loan was repaid and the warrants received by the federal government as part of the assistance were sold at auction for $311 million.

After it received the federal loan guarantee, Old Chrysler revamped its operations and developed several new vehicle lines, including the minivan. Old Chrysler's fortunes changed in the 1990s as the economy expanded and as the auto industry was becoming more globalized and integrated. In 1998, Old Chrysler and Daimler announced a merger of their operations, an event that was heralded by some as emblematic of the global restructuring of the auto industry. Others questioned whether the different German and American corporate cultures could be effectively meshed.

Although Daimler improved efficiencies and quality, invested $10 billion in new facilities, and helped Chrysler develop 34 new models, the so-called "marriage of equals" did not work out. As time went on it became apparent that it had de facto become a takeover of Old Chrysler by Daimler with an unclear vision and pathway to integration of the German and American companies. The Chairman of the Board of DaimlerChrysler said in a 2007 speech that the companies would split because (1) synergies between the two companies were limited and (2) price pressures on Old Chrysler in the U.S. market were adversely affecting Daimler's overall profitability and share prices. Others said Daimler lost interest because of growing losses at Old Chrysler and its rising health care costs. While Daimler had paid $37 billion for Old Chrysler in 1998, it sold 80% of it for $7.4 billion in 2007 to Cerberus Capital Management, a private equity investment company.

Old Chrysler was not the only auto industry investment by Cerberus. In addition to the manufacturing operations, it also bought Chrysler Financial, the automaker's financing arm, and 51% of GMAC, Old GM's financing arm. Cerberus management had an optimistic outlook, with the Cerberus Chairman, John Snow, observing that such private equity investments had a unique role in strengthening U.S. manufacturing:

Fundamentally, we view Cerberus's role as helping Chrysler achieve its full potential. Private ownership offers many advantages in that regard. As a private company, Chrysler will be able to implement a plan to build longer-term value, to make strategic investments and to focus all of its energies on improving the company's performance—all without fear of short term negative market reaction from quarterly public company reports and the pressures to meet analyst targets.

Had the U.S. economy not suffered a financial crisis and recession—with auto sales starting to fall in 2007 and accelerating their decline into 2009—Cerberus might have strengthened Old Chrysler as it planned. Despite its ownership by a private equity company, Old Chrysler was in precarious financial straights similar to Old GM. In testimony in the Senate, Old Chrysler Chairman and CEO Robert Nardelli explained the reasons the company sought federal aid in December 2008:

We are here because of the financial crisis that started in 2007 and accelerated at the end of the second quarter of 2008. As consumer confidence fell and credit markets remained frozen, the lowest U.S. auto sales in more than 20 years put tremendous pressure on our cash position. U.S. industry sales fell from 17 million a year in 2007, to a monthly annualized rate of 10.5 million last month—a 6.5 million unit decline. What does that mean for Chrysler? At 10 percent market share, it translates to a loss of 650,000 vehicles, or roughly $16 billion in lost revenue opportunity. With such a huge hit to our sales and revenue base, Chrysler requires the loan to continue the restructuring and fund our product renaissance.

Chrysler's Restructuring Through Bankruptcy

When it made the initial TARP loans to Chrysler, the Bush Administration required Old Chrysler to submit a viability plan in February 2009 as a precondition for further federal assistance. Old Chrysler's viability plan forecast restructuring the company through plant closings, labor concessions, operational changes, dealership closings and other measures. President Obama rejected this viability plan at the end of March 2009, saying it did not go far enough, giving the company one month (until May 1) to devise a more thorough restructuring plan and obtain the support of major stakeholders, including labor unions, dealers, creditors, suppliers, and bondholders.

During April 2009, Old Chrysler worked with its stakeholders to devise a restructuring plan that would meet the requirements of the Auto Task Force and avert bankruptcy. While the company reached tentative agreements with most stakeholders, a group of creditors would not agree to the proposal. Some larger banks, such as JP Morgan, agreed to write down their debt by more than two-thirds; however, a few mutual funds and hedge funds holding about 30% of the debt balked. Old Chrysler could only avoid bankruptcy if all of its creditors approved the settlement, so the disagreement prompted a filing in bankruptcy court on April 30. Old Chrysler became the first major U.S. auto company to seek bankruptcy protection since Studebaker in 1933.

Old Chrysler reached agreement with most of its stakeholders prior to filing for bankruptcy, thereby helping to speed the bankruptcy court decisions, which were completed in just 42 days. Many of the liabilities of Old Chrysler were initially subsumed by a special entity known as Old Carco, and they remain in bankruptcy. Most of Old Chrysler's assets were sold during the court proceedings to New Chrysler, now officially known as Chrysler Group LLC. The government provided New Chrysler with a final TARP installment to assist in the transformation to a new, smaller automaker.

Post-Bankruptcy Chrysler

New Chrysler began operations on June 1, 2009. Old Chrysler's departing Chairman and CEO Robert Nardelli summarized the gains that came from the bankruptcy proceedings:

Through the hard work and foresight of many Chrysler stakeholders, Chrysler Group will soon begin operations with significant strategic advantages, such as a wage and benefit structure for active and retired employees that is competitive with those of transplant manufacturers; a reduction of debt and interest expense; the disposition of idle assets; a rationalized and more efficient dealer network; and sound agreements with our suppliers. While this has been an extremely difficult chapter in Chrysler's history for all involved, the new Company and its customers, employees and suppliers can now begin on a fresh page.

The largest equity owner in New Chrysler in 2009 was the United Auto Workers' health care retirement trust, known as a VEBA (Voluntary Employee Beneficiary Association). The union's VEBA trust was accorded a large piece of Chrysler because Old Chrysler's retiree healthcare liability of $8 billion could not be met with a cash contribution and was instead converted into an equity stake. New Chrysler's other major stakeholder was Fiat, which became a partner to manage New Chrysler, help it finance its operations, and develop a new stream of competitive vehicles, including small, fuel-efficient passenger cars, such as those Fiat builds in Europe. As part of this agreement, Fiat was given a 20% equity stake without making a direct financial contribution. These ownership stakes and others are shown in Figure 1 .

The bankruptcy court decision outlined steps that Fiat could take to raise its equity stake in New Chrysler by meeting three performance benchmarks, including production at a U.S. plant of both a new fuel efficient engine and a new vehicle with fuel efficiency of at least 40 miles per gallon.

Fiat took additional steps in 2011 to buy additional equity in New Chrysler. In April 2011, it exercised an option to purchase an additional 16% stake for $1.3 billion. In June 2011, it announced that it would pay the U.S. Treasury $500 million to buy back the government's 6% equity interest. This transaction was completed on July 21, 2011. When combined with the performance benchmark events described above and the sale of the Canadian equity interest, these cumulative steps have given Fiat a 58.5% equity stake in New Chrysler, with the remaining equity held by the UAW VEBA.

Fiat's share could rise to more than 70% if it exercises the rights it holds to purchase some of the UAW VEBA Trust stake. Fiat purchased these rights from the U.S. Treasury for $60 million. A chronology of Chrysler's ownership since bankruptcy is shown in the Appendix .

Assessing the Cost of TARP Assistance for Chrysler

The federal government provided $10.9 billion in financial support for Chrysler in 2008 and 2009, as detailed in Table 3 .

TARP assistance for Chrysler, like most of the TARP assistance, was initially provided through financial instruments that were expected to be repaid or repurchased by the recipients. In the bankruptcy process, however, some of the loans to Old Chrysler remained with the bankrupt company and the loan to New Chrysler included common equity in the new company in return. Common equity is not expected to be repaid by the company, but represents an ownership stake in the company. Similar conversions of TARP assistance into common equity were also undertaken for a small number of other TARP recipients, including GM, GMAC/Ally Financial, AIG, and Citigroup.

In general, government holding of common equity means that whether the government recoups its assistance depends on the price it receives when the government sells this equity. If the government's common equity stake ends up being sold for less than the amount of the government's assistance, the company involved has no legal responsibility to compensate the government for the difference. If the value of the government's equity stake is sufficiently high, however, the government may end up making a greater gain on the assistance than if the company directly repaid the assistance. As specified by the TARP statute, any proceeds from equity sales "shall be paid into the general fund of the Treasury for reduction of the public debt."

In the case of New Chrysler, the agreement for sale to Fiat of the U.S. government's remaining interests in the company resulted in a $560 million payment to the Treasury, compared to $1.8 billion in TARP assistance outstanding. Even including other gains, such as $1.1 billion in interest payments received, the government recouped less money from the TARP assistance for Chrysler than the loans given to Chrysler. Exactly how large a loss might be attributed to the Chrysler assistance, however, depends on what accounting method is used.

One straightforward way to calculate gains or losses for TARP assistance is to simply compare the amount of assistance provided by the government to the funds returned to the government in nominal amounts. In the case of Chrysler, TARP provided $10.9 billion in loans to support the company. In return for this $10.9 billion, the government is received a total of approximately $9.6 billion:

$5.5 billion in loan repayments; $1.9 billion in recoupment from the bankruptcy process of Old Chrysler; $1.66 billion in interest and other fees; and $560 million paid by Fiat for the U.S. government's New Chrysler common equity and rights.

Compared to the original $10.9 billion TARP loans, this method arrives at an approximate $1.3 billion gap between the funds loaned and the funds recouped. This $1.3 billion figure, however, does not fully include a number of other cost factors that one might include, such as the cost to the government to borrow the funds which it then provided to Chrysler, a premium to compensate the government for the riskiness of the loans, and the cost to the government in managing the assistance given.

The budgetary scores produced by the Congressional Budget Office (CBO) and the Office of Management of Budget (OMB) take many of these additional factors into account. The TARP statute required that TARP assistance be scored for government budget purposes in a similar manner to loans and loan guarantees under the Federal Credit Reform Act. Specifically, the expected present value of actions under TARP is to be estimated using market, risk-adjusted interest rates and reflected on the federal budget at that time. The estimates produced according to these formulas, however, have only been reported in aggregate figures. For example, CBO estimated in March 2012 that the budget cost of the assistance for the entire auto industry would be $19 billion, and the Treasury in coordination with OMB estimated lifetime cost as of May 31, 2012, to be $25 billion. Neither of these, however, reports separately the individual gains or losses on Chrysler, GM, and GMAC/Ally Financial.

Appendix. Chrysler Ownership Structure