1. Economic Team: Auto Industry Discussion Document
November 12, 2008
Economic Team: Auto Industry Discussion Document
Approved capabilities list
Automotive
Aviation, Aerospace & Defense
Communications, Media & Technology
Consulting Actuaries
Delta Organization & Leadership
Energy & Utilities
Corporate Risk
Financial Services
Industrial Products & Services
Health & Life Sciences
Retail & Consumer Products
Surface Transportation

2. Overview
The Problem: Auto industry faces severe short- and long-term challenges
Severe Short-Term Liquidity Crisis: dramatic drop in sales compared to relatively fixed costs, while credit contraction prevents access to other funding. As a result, GM could be below necessary cash for operations by the end of this year; Ford could be in the same state by mid 2009.
Longer-Term Challenges: Excess capacity, significant non-operating costs (health care & pensions), impaired ability to adapt to market trends (too many name plates), playing catch up on technology adoption, structural problems in supply chain (auto parts companies already in bankruptcy, estimated to be 2x the market optimal number of auto dealers).
Proposed Objectives of Government Response:
Prevent an uncontrolled slide into bankruptcy that produces potentially massive disruption to economy and jobs
Provide short- and long-term support within a framework that requires automakers to become viable independent economic entities that do not rely on government assistance and that contribute to reducing our vehicle fleet’s dependence on oil

3. Campaign Position
Accelerate the availability of $25 billion in approved Federal loan guarantees
Supported an additional $25 billion of loan guarantees to ensure the auto industry’s success
Sought the Federal Reserve and Treasury to explore all of the other options at their disposal, including authority under TARP to support liquidity for the automobile industry to help it weather the financial crisis, and
Pledged that all options will be on the table to help our nation’s auto industry succeed. 2

4. Immediate Liquidity Crisis
Liquidity crisis driven primarily by a sharp drop in demand and the inability to quickly restructure in a high fixed cost business
U.S. auto sales have fallen from 16 million in 2007 to a projected 13.2 million in 2008 (12.0 million projected in 2009 – many view this as optimistic); GM Q3 sales were lowest on a population adjusted basis since WWII; Big three auto makers and dealers are carrying 50-60% more inventory than necessary
The imbalance between capacity and demand has caused both Ford & GM to run at negative operating margins, which are projected to be about -6% for Q408
Further exacerbated by high commodity prices and mix shift as consumers move away from profitable SUVs and trucks
At projected rates, GM could run out of cash as early as December, while Ford could run out by the middle of 2009
GM burned $6.9B in cash from operating activities in Q3, leaving it with $16.2B on hand. GM requires $11-$13B in cash on hand to fund operations. Even with active efforts to cut cash burn in second half of Q4, GM may fall below its minimum before year’s end.
Ford has somewhat more cushion: burned $7.7B in Q3, leaving it with $22.1B in cash on hand, while requiring ~$9B to fund operations. But could run down in first half of 2009.
Credit contraction has made borrowing difficult for all firms, while long-term concerns about strength of U.S. auto-industry have made borrowing on the financial markets essentially impossible
GM debt is trading at half its price from just 2-months ago, and GM has conceded that “we do not currently have other traditional sources of liquidity available to fund these obligations”

5. Longer-Term Concerns
Excess Capacity: Medium-term demand will be lower than recent past
For the industry to break even, US auto-demand needs to be ~15.5M cars per year. Almost all analysts predict that 2009 will fall well short of that mark by several million
Mismatch between demand trends and production:
Consumer demand has shifted towards smaller more fuel efficient cars, while Big Three production capacity and profit centers are skewed towards trucks and SUVs
U.S. firms have not been able to adjust to market developments as nimbly as competitors. GM in particular carries excess costs in overhead and distribution due to eight separate name plates
Health Care Costs: Solution available, but require massive payments
Big Three automakers have agreed to have payments made into the Voluntary Employee Beneficiary Association (VEBA) and thereby reduce their long-term health care obligations, but GM alone is scheduled to make $3-4B in contributions in 2009 and $13B in 2010.
Capital structure:
Big three all carry unsustainable levels of debt
[Details to come]
Labor Costs:
[To come]
Pension Obligations:
Decline in financial markets have likely created large unfunded obligations
Lagging on advanced technologies:
Despite closing the quality gap, U.S. automakers continue to lag in the development and commercialization of hybrid and other fuel efficient and alternative fuel technologies
Lower investment during current downturn has potential to cement that disadvantage

6. Broad Policy Objectives
Prevent free fall of automakers into bankruptcy, which would have serious spillover effects in the economy
Surveys suggest that 90% of consumers should shun an auto maker in bankruptcy given concerns about servicing and resale value
Center For Automotive research projects that a 50% contraction in production could cause an immediate loss of 2.5 MM jobs, and a $125 bn decline in personal income.
Signficant spillover effects for government (estimated $50bb loss of revenue for federal and state governments, huge new liability for PBGC)
Create conditions on government aid that precipitate the structural changes necessary for long-term economic viability and independence with the goal of promoting energy efficiency – government support is a short-term necessity, not a long-term solution.
Avoid creating competitive disadvantage between automakers by virtue of government assistance (e.g., don’t pick winners and losers)

7. Selected Transition Policy Options
Two goals:
Encourage immediate assistance
Encourage the precedent of conditionality
Section 136 unlikely to be sufficient
Congress unlikely to provide additional authority during lame duck
Unclear exact source of additional funding, but precedents suggest ability to find sources in an emergency (e.g., Mexico crisis in 1995)
Considerations on pushing Bush Administration to adopt meaningful conditionality on any short- or medium-term assistance provided
Pro: Better policy; reduces moral hazard; protects taxpayers; reduces risk of backlash for Obama Administration if precedent is established by this Administration
Con: Not clear that conditionality on short-term assistance is feasible in current environment and given timetable. GM in particular has little capacity to meet conditions in the short-term (e.g. Section 136 retooling assistance has a financial viability test that none of the auto-makers could currently meet)
Also could be seen as advocating job cuts if done explicitly

8. Longer Term Options
Uncontrolled bankruptcy: very unappealing given impact on ongoing business, suppliers, etc. Government assistance very likely to be needed, but would be “investing” into a very unstable situation
Pre-packaged bankruptcy: key tenants are agreed to beforehand and actual bankruptcy period is days; government could provide financing needed to help companies emerge on a restructured basis (government becomes debtor in possession (“DIP”) lender)
Pro: Opportunity to reduce wide variety of liabilities including excessive debt; planned nature and shorter restructuring period would somewhat reduce stigma and negative economic spillover
Con: “Pre-packaged” bankruptcies often take time to prepare; negotiations involve considerable uncertainty and without deadlines may not produce necessary reforms
Chrysler-style restructuring: set out independent structure in legislation to oversee restructuring in exchange for assistance
Pro: Avoid stigma of bankruptcy, legislated response, full set of options available
Con: Timing (Chrysler took a year to plan), less control over process