The Real Story Behind the U.S. Auto Bailouts

NEW YORK (TheStreet) -- Detroit's relationship with local boy Mitt Romney is ... complicated.

The son of a former Michigan governor and automobile industrialist finds himself in a critical battle to gain trust among American blue-collar voters that perceive him as a wealthy, private-equity businessman who was open to letting an icon of American manufacturing take an unprecedented fall.

Mitt Romney must cure his auto-sector headache

"Regardless of what Mitt Romney may try and say, if we took his route the industry would have most likely been liquidated resulting in economic devastation across the Midwest," an Obama campaign official said on background.

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The auto issue is a delicate middle ground for two campaigns that have struggled to convince middle-class voters that its candidate can save them from lethargic economic conditions.

On the left, the middle class sees president who has overseen a period of high unemployment, moderately slow GDP growth and a host of other tepid economic indicators. On the right, they have a former governor who earned success by cutting jobs and gutting companies in order to turn things around.

To make things worse for Romney, critics blasted the former Massachusetts governor this week after he took credit for the industry's comeback.

Romney's justification has some truth, but the infamous headline attached to his 2008 New York Times op-ed, "Let Detroit Go Bankrupt," is the sound bite that's stuck.

So while Obama claims victory for reviving the American automotive industry and Romney defends his bankruptcy argument, we're here to cut through the vagaries and explain what Romney suggested versus what Obama did.

DIP Financing, Say What?

Forget the first sentence of Romney's op-ed and jump towards the end.

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This was less about "If General Motors, Ford, and Chrysler get the bailout ... you can kiss the American automotive industry goodbye," and more about "The federal government should provide guarantees for post-bankruptcy financing."

He was referring to debtor-in-possession financing , which usually involves a private lender putting up the cash to restructure a company during Chapter 11 bankruptcy proceedings.

Lenders typically rush in for DIP financing in bankruptcies because there is a high interest rate and they're one of the first creditors to be paid back by the restructured company.

Romney's suggestion was for the government to provide guarantees to any lender that chose to provide debtor-in-possession financing to the automotive giants.

Why the guarantee?

It was November 2008, the stock market had crashed after Lehman Brothers' collapse and the country was losing heaps of jobs per month. Credit had dried up, and banks were in survival mode.

"Romney argued for private equity only, but in the depth of the recession in 2009 there wasn't any - a fact Mitt Romney knew well," the Obama campaign official said.

True, Romney must have understood this, but this is likely why he argued for private lenders backed with a federal guarantee.

The government can guarantee loans, but the problem is that if a bank doesn't have the money to lend from the start, then there's nothing to guarantee.

Appointed "car czar" Steven Rattner, who the administration tapped to lead the team that eventually devised the bailout plan for the American automotive giants, wrote in an op-ed that there wasn't any liquidity.

"I know this because the administration's auto task force, for which I was the lead adviser, spoke diligently to all conceivable providers of funds, and not one had the slightest interest in financing those companies on any terms," wrote in The New York Times in February.

Kirk Ludtke, a GM equity analyst at CRT Capital Group, said the DIP financing needed to bailout and restructure GM and Chrysler was too much for a private lender to handle.

"It was just too much money. I don't know that you could raise that much money -- if GM filed today, I'm not sure you could raise the kind of money that they needed," Ludtke said.

The government injected some $50 billion into GM and $12 billion into Chrysler in order to keep critical operations running as the companies went through bankruptcy and restructuring. That's $62 billion combined to save two automotive giants.

For some perspective, data provided by Dealogic showed all lenders had provided a combined $13.63 billion on 47 DIP deals in 2008, which was up from $10.58 billion on 16 deals in 2007. All DIP loans of 2007 and 2008 accounted for just 39% of what a lender would ultimately have needed to finance the GM and Chrysler restructurings.

For Romney in November 2008 to suggest government guarantees for any lender willing to put up the money for DIP financing of GM and Chrysler now appears wildly impossible. In 2009, syndicated DIP loans to U.S. borrowers hit $20.82 billion -- still just 28.9% of what GM and Chrysler required.

What Did Romney Really Say?

Father George Romney in 1954 became chief executive of the former American Motors Corp. and successfully revamped the brand, but Mitt disgruntled much of the automotive industry in 2008 when he suggested to let the major players (including eventual American Motors' acquirer Chrysler) go into bankruptcy.

The election 2012 uproar, though, could be attributed to a misunderstanding of bankruptcy.

"Bankruptcy doesn't mean liquidation. Bankruptcy can mean that the company comes out the other end, and that's exactly what happened with GM," said Brent Horton, a law professor at Fordham University who wrote in 2010 about the GM bailout .

Horton said that as a company as big as GM moved through bankruptcy that it needed money to continue operations and pay employees, warranties, suppliers and any other contracts that it owed money on.

Debtor-in-possession financing means that the debtor -- GM and Chrysler in the case of the auto bailouts -- still possesses and runs the company as it moves through the restructuring process.

Romney in his op-ed was not calling for liquidation, he was referring to DIP financing, said a Romney campaign official who spoke on background.

The U.S. Treasury and Fiat jointly padded Chrysler's bankruptcy while the Treasury took a 60.8% common equity stake in GM. The equity stake would eventually allow GM to pay back its "loan" by buying back stock from the Treasury. The majority position also gave the U.S. government to call the shots.

Romney wanted private lenders, not the government, to provide the DIP financing. The Bush administration originally considered this action , but didn't carry it out. Even though DIP financing of the $62 billion amount needed to restructure GM and Chrysler was likely impossible, RBC Capital Markets auto equity analyst Joseph Spak offered another grim reality of the presumptive nominee's then-suggestion.

"Historically, when you see private equity come in and take control of the situation, there's massive cost cutting and changes -- and not to say there wasn't restructuring under the government -- but there likely would have been a larger ripple effect through the entire automotive supply chain," Spak said.

That automotive supply chain, according to Rattner, could have lost an estimated 300,000 jobs if the government had simply shut down the entire Chrysler operation.

Romney first suggested in his 2008 op-ed that the Big Three ( Ford ( F) was still part of the discussion at this point) negotiate new labor agreements to match pay and benefits of workers who worked for foreign car company plants in the American Sun Belt (non-union workers). He additionally wrote that retirement benefits should be reduced. Romney estimated that the "extra burden" that American automobile companies shoulder means it costs them some $2,000 more than foreign competitors to make a car.

Rattner wrote in his 2009 retrospective that senior Obama official Ron Bloom successfully negotiated UAW concessions on fringe benefits and company obligations with Chrysler.

"We believed that Chrysler's labor costs would finally be competitive with the transplants," Rattner wrote at the time.

The government scaled back labor costs, which provided the groundwork for an eventual comeback. Romney, though in vague terms, did make this suggestion.

Opponents have said that the UAW received preferred treatment against other unsecured creditors, but Stephen J. Lubben, a law professor at Seton Hall University, clarified the situation.

Lubben argued that if the government -- then a major stakeholder in the automotive companies -- simply allowed liquidation, it would have faced possible greater costs: unemployment payments, unpaid environmental cleanup costs and other analogous expenses.

"Indeed, unlike a private lender who can largely ignore these costs since they will be absorbed by the government, the government as lender has a better set of incentives in this instance," Lubben wrote.

Romney then wrote that management must be pushed out the door: "Second, management as is must go."

Rattner wrote a nearly identical statement in his 2009 retrospective on the events: "Management has got to go."

That's what happened.

Rattner booted GM Chief Executive Rick Wagoner and replaced him with GM lifer Fritz Henderson . When Fiat swooped in to help save Chrysler, Fiat CEO Sergio Marchionne took the helm. Marchionne fit the profile of another Romney suggestion: a new face from an unrelated industry.

Marchionne had started in the 1980s as an accountant and tax specialist who didn't enter the auto industry until the 2000s.

Romney suggested that the Big Three make investments for the future, and one of those investments was fuel-saving designs.

Rattner wrote that the White House negotiated fuel-efficiency standards directly with the auto makers, but Romney simply wanted the federal government to invest in basic research on new energy sources and fuel-economy technology -- not to dictate the terms of fuel-efficiency. (This is a side-product argument from the two sides about how much control the Obama administration had during the restructurings.)

Finally, Romney said "don't fire the best dealers," which Rattner and the Obama administration found to be a difficult task. But ultimately, the government let GM and Chrysler choose which dealers to shutter -- a choice Romney likely had in mind.

"Every congressional district had dealers, many of whom were leading figures in their communities. We were inundated with an avalanche of calls, letters, and demands," Rattner wrote. "We patiently worked through each grievance and explained hundreds of times that the companies -- not the government -- made the decisions about which dealers to close."

Did Obama Make a Good Investment, Or Select the Only Option?

General Motors recently beat first-quarter estimates and raised its 2012 sales outlook showing signs of shrugging off troubles in Europe, which have seemingly been offset by promising sales in China.

Shares of the company, though, have dipped 37.2% since going public again in late 2010, and because the Treasury still holds an equity stake in GM, they've lost money on the investment.

The Treasury exited its Chrysler stake in July 2011 reportedly at a $1.3 billion loss .

Though the American automotive industry has enjoyed some recent strength driven by truck sales, accelerated depreciation on new equipment is scheduled to expire at the end of 2012 . This is a big tax incentive for small businesses, which are the likely purchasers of a huge chunk of those vehicles.

But would the end of accelerated depreciation specifically hurt auto manufacturers?

"It's distinctly possible," said Doug Roberts, chief investment strategist of "Heavy trucks -- most of them are used for small businesses, so at some point it's like you have to get a new truck and you may have postponed it during all this time, and then all of a sudden if you can do an accelerated depreciation on new equipment, you think, 'OK, now it's a good time to buy a new truck.'"

Roberts pointed to the Cash For Clunkers program, which he said had a solid spurt before it finally began to fade out.

Traders and analysts aren't certain what the end of accelerated depreciation means for the auto industry, and it's tough to say with all of Europe's uncertainty which direction American car sales will trend in the future. Possibly China.

"China's a strong market for them, it comes down to the contribution that China is going to make to the income statement," said Alex Potter, senior equity analyst at Piper Jaffray. "It is still dwarfed in comparison to the U.S. and right now you're probably looking at maybe 15% to 20% of the parts and labor coming out of China."

Potter warns that China, though a bright spot for GM and others, likely would not be able to carry the load if matters worsened in the United States and Europe.

"If people get nervous about the U.S. and if the concern on Europe doesn't go away, then those two things will trump any amount of strength in China just because of how significant the impact could potentially be on the income statement," said Potter.

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The UAW, Obama campaign and Romney campaign declined to officially comment for this story. The Republican National Committee did not return three calls for comment requests.

-- Written by Joe Deaux in New York.

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