Automotive industry crisis of the 2000s

A major downturn in the US automotive industry from 2008 to 2010, resulting from a global financial crisis, high fuel costs, and poor vehicle sales, and ultimately forcing Chrysler and General Motors to file for bankruptcy despite receiving government support

The automotive crisis demonstrated the central role of the industry in the US economy, but also revealed that US automakers had been slow to respond to changes in economic conditions and consumer demand. After receiving approximately $80 billion in emergency government loans, US automakers would recover from the crisis in part by streamlining their brands, offering purchase incentives, and developing smaller, more fuel-efficient vehicles.

Decline in Sales and Lending

Automotive sales by US automakers held relatively steady throughout the early part of the 2000s, growing between 2 and 4 percent per year. However, the distribution of sales was shifting steadily from the Big Three US companies (Chrysler, Ford, and General Motors) to foreign automakers, particularly Asian companies such as Honda and Toyota, which were offering better product lines of fuel-efficient vehicles than their US competitors. Beginning in 2001, rising gas prices began to negatively affect consumer demand for larger vehicles, which represented the bulk of US automakers’ product lines. Heightened competition from affordable and reliable foreign brands put pressure on US automakers, but a relatively healthy economy enabled total vehicle sales to continue increasing. In 2006, the Japanese automaker Toyota surpassed Chrysler and Ford in US sales, heightening the competition between US and foreign automakers. Two years later, Toyota surpassed General Motors (GM) as the world’s largest automaker, a distinction GM had held since 1931.

Before the United States entered into a recession in 2007, the Big Three were already in a difficult situation. All three companies lost money in 2006: Chrysler, $1.5 billion; GM, $2 billion; and Ford, $12.7 billion. (In part because of this major loss in 2006, Ford may have been better prepared to weather the crisis of 2008: It had applied for and received a $23.5 billion line of credit in 2006, even offering up its famed blue oval logo as collateral.)

In 2008, a spike in fuel prices and an economic recession combined to devastate the US automotive industry. The economic collapse, sparked by interrelated housing and financial factors, made financial institutions reluctant to extend credit, complicating the ability of many consumers to receive auto loans. Additionally, many automobile purchases had typically been financed by home equity lines of credit—lines of credit offered based on home values—a practice that became less viable as home values decreased.

These factors combined to reduce US auto sales from 17 million in 2006 to 10.6 million in 2009, a decrease of nearly 40 percent. The rapid decline in sales hit Chrysler and GM particularly hard, in part because of their labor structure and product mix and because they did not have adequate cash reserves to respond effectively to the crisis.

Other Factors

In addition to declining auto sales, several other economic factors influenced the progression of the automotive crisis, including higher unemployment, reduced access to credit, reduced consumer spending, and higher fuel costs. All of these factors negatively affected consumer ability and willingness to purchase and maintain automobiles.

Chrysler and GM were especially affected by rising fuel costs and the resulting decline in truck and sport utility vehicle (SUV) sales. Since the late 1990s, these companies had made more than half of their profits from trucks and SUVs, particularly because these larger vehicles typically offered more profit per vehicle than smaller cars. As a result, the companies had continued to invest in the design and production of these large, fuel-inefficient vehicles throughout the 2000s.

With the dual economic and energy crises of the late 2000s, and gas prices exceeding four dollars per gallon across the United States in July 2008, Chrysler and GM were caught without a sufficient line of fuel-efficient passenger vehicle models to attract buyers, as well as a surplus of fuel-inefficient vehicles for which there was little demand. As a result, dealerships were forced to sell many vehicles at a loss. Truck sales dropped 17 percent from 2007 to 2009, while large SUV sales declined 29 percent. In contrast, Toyota capitalized on its Prius hybrid, which featured both electric and gasoline-powered engines and sold one million vehicles by May 2008.

The struggles of GM and Chrysler may also have been related to their multiple vehicle brands: more than eight for GM and four for Chrysler. Developing and marketing separate brands was not only expensive, but also may have caused internal sales cannibalization as consumers switched from one GM or Chrysler brand to another.

In response to the crisis, GM sold its Saab brand and phased out Saturn, Hummer, and Pontiac, leaving the company to work with its Chevrolet, Cadillac, Buick, and GMC brands. Chrysler did not shut down brands entirely, but heavily retooled most of its vehicle lines and eliminated some models. Ford also made multiple brands but sold its luxury brands—Aston Martin in March 2007, Jaguar Land Rover in June 2008, and Volvo in August 2010—to concentrate on Lincoln and Mercury.

Labor costs were also perceived as a problem for the automakers. In contrast to foreign countries, where automobiles could be produced with much cheaper labor, companies building cars in the United States typically pay higher wages for similar work, in part because of the negotiating power of unions such as the United Auto Workers (UAW). Automakers were also paying wages to some autoworkers whose plants were closed or who were otherwise out of work, as well as the health insurance premiums and pensions of many retired workers.

Government Involvement

The large and sudden drop in auto sales put Chrysler and GM in a difficult situation regarding how to continue operations in a resource-intensive industry. Due to the credit freeze, Chrysler and GM were unable to borrow the cash they needed to maintain operations through the crisis. The situation was so dire that in the fall of 2008, the two competitors even considered merging. Instead, in a congressional hearing before the House Financial Services Committee on November 19, 2008, the companies requested $25 billion in government-subsidized loans out of the $700 billion approved by Congress in October for the Troubled Asset Relief Program (TARP). GMAC Financial Services, the financing arm of General Motors, also applied for assistance. Congressional leaders doubted the companies’ ability to use funds effectively and requested detailed recovery plans.

There was widespread popular opposition to any form of “bailout” for the auto industry. Many voiced the idea that the bailout was unnecessarily propping up a dead or dying industry. Government support was perceived as working to discourage innovation and competition, as well as to “reward” the automakers’ poor financial and product planning. Public opinion of the automakers was already negative when media reports revealed that the Big Three auto executives had all traveled to the congressional loan meetings in private luxury jets. When the automakers returned to DC to submit their recovery plans, the company CEOs all arrived in American-made hybrid vehicles.

The automakers submitted their plans by December 2, 2008, along with a $15 billion short-term loan proposal on December 9, 2008. This proposal was rejected by the Senate on December 11, but President George W. Bush approved a $17.4 billion loan ($9.4 billion for GM and $4 billion for Chrysler, with $4 billion in conditional funds) on December 19. On the same day, Fitch Ratings downgraded Chrysler and GM to a “C” default rating, emphasizing the dire financial situation of the companies. GMAC received $5 billion in aid on December 29, 2008.

Despite negative public opinion of the bailout, jobs were the major motivator for the government to support the automotive industry. Government analysis uncovered three million jobs linked to the Big Three in some way. The anticipated loss of these jobs, combined with an anticipated increase in the number of vehicles imported (which alone was expected to take $25 billion out of the US economy) and a 7.3 percent unemployment rate in December 2008 played a large part in the government’s decision to fund Chrysler and GM.

Initial Outcomes

The money loaned to the companies was only a short-term solution, however, and in exchange for the bailout, GM and Chrysler were required to submit long-term restructuring plans by March 2009. Just weeks after President Barack Obama took office, on February 15, 2009, he announced the creation of the Presidential Task Force on the Auto Industry, which would assume responsibility for reviewing the viability plans submitted by Chrysler and GM. That same month, GM and Chrysler requested an additional $14 billion, saying that their loaned funds would run out by the end of March. In March, the US Treasury and the presidential task force determined that the automakers’ proposed plans were insufficient to achieve long-term viability and required the companies to restructure more thoroughly, with conditions such as limitations on CEO pay and UAW benefits, in order to continue to receive government assistance.

In January 2009, Italian automaker Fiat had proposed a deal in which it would take a 35 percent stake in Chrysler to help the company develop fuel-efficient vehicles and share resources with the European company, which was interested in moving back into the US market. When the task force rejected Chrysler’s restructuring plan in March, it determined that Chrysler was no longer viable as a stand-alone company, giving the automaker thirty days to solidify its partnership with Fiat or risk being denied additional government funding.

In April, Chrysler and Fiat completed their partnership. However, despite Fiat’s involvement and major concessions made by the company and the UAW, a small number of Chrysler’s creditors refused to accept the terms of the restructuring plans. On April 30, 2009, Chrysler filed for Chapter 11 bankruptcy—the first major automaker to do so since Studebaker in 1933. In response, the government announced a plan that allowed UAW, Fiat, and the US and Canadian governments to take stakes in the company, and committed $8 billion in additional government support. In May, a bankruptcy court approved the sale of Chrysler’s assets to “new Chrysler,” formally known as Chrysler Group LLC, thus overturning the objections of a small group of Chrysler’s creditors. On June 10, 2009, forty-two days after filing for bankruptcy protection, Chrysler emerged from bankruptcy.

As part of its restructuring, Chrysler announced plans to close 25 percent of its US dealerships in May 2009. GM followed with similar news, closing a total of 1,100 GM dealerships representing 18 percent of its total outlets but just 7 percent of sales. General Motors Corporation filed for bankruptcy on June 1, 2009, reporting more than $91 billion in assets and $172 billion in debt—the fourth largest bankruptcy in US history.

General Motors Corporation became Motors Liquidation Company, the organization that would handle bankruptcy restructuring. Core GM assets were repurchased by General Motors Company (the “new GM”). The US Treasury offered an additional $30 billion in government funds to facilitate the company’s restructuring; the governments of Canada and Ontario contributed an additional $9.5 billion in assistance. GM emerged from bankruptcy proceedings after forty days, on July 10. Having contributed nearly $50 billion to the company, the US government now owned a 61 percent stake in GM, with a UAW health benefits fund, the Canadian governments, and bondholders taking up the remaining stakes.

Cash for Clunkers

To help encourage the purchase and use of fuel-efficient vehicles, the US government initiated the Car Allowance Rebate System (CARS), nicknamed “Cash for Clunkers,” in the summer of 2009. The program allowed consumers to trade in vehicles no more than twenty-five years old with an average fuel economy rating of less than 18 miles per gallon (mpg) for new vehicles with an economy of at least 22 mpg. Consumers then received a purchase credit of anywhere from $3,500 to $4,500 to use toward new, more fuel-efficient vehicles.

The program required the scrapping of the old vehicles through engine disablement to prevent resale. The program officially launched on July 1, 2009, and claims were first processed on July 24. The initial $1 billion in funds allocated was used by July 30, 2009, prompting Congress to approve an additional $2 billion in funds. The program ended August 24, 2009.

CARS was viewed as successful in motivating many visits to car dealerships and stimulating the US economy. About twenty-three thousand dealerships participated and thousands of cars were sold as many consumers downsized from SUVs or trucks to passenger vehicles. The Department of Transportation reported that the average trade-in vehicle’s fuel efficiency was 15.8 mpg, while the new vehicles purchased as part of the program averaged 24.9 mpg. Additionally, trucks represented 84 percent of the trade-in vehicles, while 59 percent of the newly purchased vehicles were passenger cars, confirming the consumer trend toward smaller vehicles.

Although sales increased for the Big Three during the promotion, the top ten cars (and all trucks, vans, or jeep vehicles) traded in were all Big Three vehicles. Worse yet, eight of the top ten new cars that replaced them were Asian brands (Honda, Hyundai, Nissan, and Toyota), with only the Ford Focus and Ford Escape cracking into the top ten new vehicles. These top ten lists starkly showed the emphasis on large vehicles that had been so pervasive—and problematic—for the Big Three. The final tally for the program saw 690,114 cars traded in for $2.88 billion in rebates.

Impact

After emerging from bankruptcy, both Chrysler and GM quickly moved to retool their product lines. All three major US automakers placed a new emphasis on fuel-efficient vehicles after the crisis. Chrysler launched several significantly redesigned vehicles in 2009, including the highly successful redesign of the Jeep Grand Cherokee, which offers a significantly better fuel economy than previous models. Chrysler also introduced a number of compact cars, such as the Fiat 500, to the US market. GM continued developing the Chevrolet Volt hybrid vehicle, which went on sale in 2010.

Although the auto industry did not fully recover by the end of 2009, Chrysler and GM both returned to profitability within two years of filing for bankruptcy protection. In addition, both fully repaid their government loans several years ahead of schedule. However, the majority of the US government’s investment in GM was in stock holdings; for the government to break even on that bailout, GM’s share price would have to exceed $51 a share. Also, the several billion dollars the US government invested into the “old” GM and Chrysler is unlikely to ever be repaid. The bailout represented unprecedented government intervention into the private market, and the crisis showed that even large companies must respond to, not dictate, changes in economic markets and consumer demand.

Bibliography

Hoffman, Bryce G. American Icon: Alan Modally and the Fight to Save Ford Motor Company. New York: Crown Business, 2012. Print. An overview of the crisis based on close interaction with Ford CEO Alan Mulally, who brought the company through that problematic period.

Lutz, Bob. Car Guys vs. Bean Counters: The Battle for the Soul of American Business. New York: Portfolio Hardcover, 2011. Print. Describes the automotive crisis in the context of larger trends in corporate America. Written by a former General Motors CEO.

Roth, Gregory, and Seth Feaster. “Milestones in the Carmakers’ Crisis.” New York Times. New York Times, 16 Feb. 2009. Web. 15 Oct. 2012. An interactive month-by-month timeline of the automotive industry crisis, including short overviews, related photographs, and links to in-depth news articles.

US Dept. of the Treasury. “Auto Industry.” Treasury.gov. US Dept. of the Treasury, 22 Aug. 2012. Web. 15 Oct. 2012. An overview of US government assistance to the automotive industry. Also features a graph showing the spike in vehicles sold during Cash for Clunkers program.

Vlasic, Bill. Once Upon a Car: The Fall and Resurrection of America’s Big Three Automakers—GM, Ford, and Chrysler. New York: Morrow, 2011. Print. Provides a comprehensive take on the automotive crisis.