Kidnapping Chrysler

In this brief interval before the new housing plan is announced, I’ll try to sneak in a comment on the auto bailout, and the plans submitted by GM and Chrysler yesterday. This may be an obvious question that many people have thought about, and got some discussion in December, but: Why does Cerberus (the private equity firm that owns Chrysler) need money from the government?Let’s take this step by step. Assume GM has a viable restructing plan, but it needs $30 billion to execute the plan, after which it will be a viable standalone business. Even on that assumption, given market conditions, they would be unlikely to be able to sell $30 billion in newly-issued stock or raise $30 billion through bonds or loans, because of information asymmetry: put simply, no one would believe them. Therefore, they can only get the money from the government, because the government is the one institution that will provide a below-market loan because of the public interest (saving the auto industry and either hundreds of thousands or millions of jobs, depending on whom you believe).

Now, with Chrysler, which is asking for $5.3 billion in new loans (on top of the $4.3 billion already committed, and in addition to another $6.0 billion from the Department of Energy’s alternative energy funding program – see page 16), there is a difference: The people writing the plan and the people who could provide the money are the same people, since Chrysler is majority-owned by Cerberus, so there is no information asymmetry. Let’s provide a comparison. If Chrysler were a Silicon Valley, venture capital-funded startup that needed cash, and had a viable plan, the VCs would simply invest more money, effectively diluting themselves (and the founders). If the Cerberus overlords really believe the plan that their underlings mailed in yesterday, why not put in the money themselves? And even if they don’t want to put in additional equity like a VC would, why not loan the money to Chrysler and keep the interest payments themselves instead of sending them to Washington – and avoid the oversight that comes with government money? (In the proposal, Cerberus does offer to exchange their $2 billion loan to Chrysler for equity; but this just shows that they don’t expect to get the full $2 billion back. More tellingly, they are not offering to send good money after bad; they are not even offering to contribute some new cash, leveraged with a loan, which is the classical private equity model.)

Cerberus’s stated reason in December for not putting in more money was that this would violate their fiduciary duty to their limited partners. This looks to me like an admission that putting more money into Chrysler is a bad investment, but if someone knows more about this argument, let me know.

There are two other plausible reasons why Cerberus would prefer to go to the government. The first is if they can get cheaper capital (a lower-interest loan) from the government than from their limited partners or from the capital markets. But then the question becomes why the government should be in the business of giving cheap capital to a private equity firm that has other sources of capital.

The other possibility is that Cerberus/Chrysler doesn’t actually believe the plan, and that’s why Cerberus doesn’t want to put in the money. The plan is a Hail Mary strategy that might work, but the chances of it working aren’t good enough to put in their own money; but if they can get free money from the government (free in the sense that if Chrysler collapses, Cerberus won’t have to repay the government), they might as well give it a shot. This is the implication of page 13 of the Chrysler proposal:

If Chrysler is unable to restructure its liabilities and if further government funding is not forthcoming, the “Orderly Wind Down” alternative would be pursued, however it may have severe social and economic consequences for both Chrysler and the broader U.S. economy

This sounds like an admission that they are willing to attempt the plan with government money, but not their own money.

However, we can’t reliably infer what Cerberus really believes from their behavior, because even if they were willing to put in their own money, they wouldn’t say so until after the government turned them down. You’ve probably heard this bank bailout analogy: The banker walks into the Oval Office, puts a gun to his head, and threatens to blow his brains out unless he gets a bailout; the government bails him out because they don’t want to have to clean the carpet. The difference here is that no one cares about Cerberus (the three-headed dog that guards the entrance to the underworld), so instead he dragged a hostage named Chrysler into the Oval Office and put the gun to her head. In the end, this feels like a kidnapping, where Cerberus is betting that the Obama Administration won’t be willing to take any risks with the hostage’s life.

(Of course, American oligarchs don’t use guns; they use lobbying. Which is why John Snow is still chairman of Cerberus despite overseeing this catastrophic bet on the auto industry.)

Originally published at the Baseline Scenario and reproduced here with the author’s permission.

3 Responses to "Kidnapping Chrysler"

  1. Anonymous   February 18, 2009 at 1:09 pm

    If the government is paying people to dig holes and fill holes, etc., to avoid job losses, why not do it via Chrysler. And so we have Congress in the role of the investment committee asking for revised workout plans and projections. Here’s the thing. In the end, businesses fail because they don’t make it on the sales line. Without sufficient unit volumes sold at a decent price, there is no way to make enough gross margin to justify restructuring the balance sheet. GM and Chrysler got themselves into trouble because of falling sales. So, in addition to the bailout, which seems inevitable, the government needs to agree to buy a lot of cars if it really intends to save these companies. The government’s purchasing power could be a way to get some US built state of the art green vehicles on the road at last.

  2. Anonymous   February 18, 2009 at 2:18 pm

    I’d been wondering the same thing. Though Cerberus’s involvement does help explain why Chrysler is so anxious to avoid Chapter 11!

  3.   February 18, 2009 at 4:23 pm

    Three points:1)It does also depend on how much capital Cerberus has available or can obtain itself at reasonable cost to survive the current big dip in orders. It’s reasonable for them to avoid putting all their eggs in one fragile basket.2) De-stocking may be running its course. But the phase of postponing new auto purchases whilst adjusting to a less frequent replacement cycle could take 12 months. During that time orders could well run at 40% + below norm. But, once the new equilibrium is reached, orders will bounce up, though not to the old levels. It could be wise for government to prop up the finances of producers of durable goods during the adjustment phase. However, longer term investment should be private.3) There are externalities to a Chrysler collapse, so not surprising if Cerberus tries to get government to pay to avoid these.