Sunday, May 3, 2009

Chrysler Bankruptcy -- Fixing The Auto Industry Revisited

In my first real blog entry, I identified what will have to be agreed before US car companies become sustainable businesses. Debtholders will have to sacrifice (in Wall Steet lingo, take a haircut). But the structural problems associated with retiree health and pension benefits and worker health and pension benefits need to be addreessed before these companies can be competitive. It appears that, rather than address the hard choices, the Obama administration in its plan for Chrysler has creatively kicked the can down the road. At some point, they are going to have to pick up the can and deal with it.

The Obama plan requires a haircut from debtholders and current workers, who have apparently agreed to get pay and benefits comparable to workers at Toyota’s workers US plants, although analysts say that the union preserved high wages and rich benefits for its employees. The UAW has also agreed to concessions that undoubtedly should have come well before the last moments before bankruptcy. According to the Wall Street Journal, "Among the cost-cutting measures that the UAW leaders have accepted are a suspension of cost-of-living-adjustments and new limits on overtime pay. Workers will only be paid for overtime after they have worked at least 40 hours in a week. Chrysler workers will also lose their Easter Monday holiday in 2010 and 2011, according to the union summary."

The Obama plan differs from what I presented in my earlier blog entry because it does not yet get to the inevitable changes involving the treatment of health care for retirees and of pensions. Chrysler transferred obligations for retiree health obligations to a trust run by the UAW but still owed roughly $10 billion to that trust. In lieu of that obligation, the trust will receive a $4.6 billion note and 55% of the stock in the new Chrysler, which it will have to use to pay for retiree health benefits. While this could be overturned by the bankruptcy judge, my impression is that this step just postpones the day of reckoning on health care costs. Similarly, the administration’s plan does not transfer pensions over to the Pension Benefit Guarantee Corporation (PBGC). As a result, the company will still be burdened by some structurally high costs that its non-American competitors do not have to pay. To become competitive, these costs too will ultimately have to be transferred and the question is whether to do it now or in a subsequent bankruptcy.

One interesting aside: People don't fully understand the incentives this plan has for the UAW workers at Chrysler. To the extent that Chrysler does not become profitable, its shares will be worth fairly little and the trust will not have the wherewithal to pay for retiree health care. If workers obstruct improvements in productivity, their actions will drive down the value of the stock, which will reduce what is available for retiree benefits. Analysts have noted that this will place discipline on the UAW to behave in a constructive manner. But the pain that nonconstructive UAW behavior creates will be born not by the workers but by retired workers. In my experience as an investment banker for labor unions, I never saw the chief political constituencies in a union sacrifice their wages and work rules for the benefit of other union members.

At the core, this is a political deal. In comparison to traditional bankruptcies, the Obama administration advantaged obligations to workers for health care, retiree health care, and pensions relative to senior creditors. As the only party willing to inject new cash, it can call the shots and offer whatever deal it wants to the creditors as a take-it-or-leave-it offer. It did and some of the creditors left it, so the company was forced filed for bankruptcy. The main problem is that this political deal doesn’t yet eliminate the structural burden placed on the company by its retiree health and pension costs. The Obamanauts have kicked the can down the road, but someone will have to pick it up at a later date when they or their successors will have to take actions that are painful to the unions if they intend to actually fix the problem.

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