Private equity firms believed that, unlike the managerial bureaucrats that ran most public companies, they could fix anything. So Chrysler looked intriguing to the firm that had emerged from obscurity a year earlier to buy GMAC: Cerberus Partners LLP. It was named for the three-headed dog of Greek mythology that guarded the gate to the underworld. That was appropriate, because Chrysler would become Cerberus’s deal from hell.
Cerberus’s founder, forty-eight-year-old Stephen Feinberg, drove a Dodge Ram pickup truck and liked to hunt, with guns. Cerberus was headquartered on Park Avenue, but the upscale address didn’t prevent Feinberg from decorating his office with the mounted head of an elk that he had shot himself, and a scale model of a Harley-Davidson motorcycle, just like the real one he had at home. Meetings there rarely began before eleven A.M. because Feinberg worked late and didn’t want to get up early.
He saw Chrysler as a chance to combine patriotism (saving an iconic American company) with profits, though not necessarily in that order. He figured there had to be synergies between GMAC (now controlled by Cerberus) and Chrysler’s own lending arm, Chrysler Financial. In fact, if Chrysler’s auto operations could just get to break-even, Cerberus still could make tons of money on automotive financing. Besides, Feinberg knew that Zetsche had come to view Chrysler as a millstone that would drown him, and possibly even Daimler itself, unless he got rid of it somehow. Feinberg loved dealing with desperate sellers. And on May 14, after weeks of negotiations, he and Zetsche reached a deal.
Nine years after paying $36 billion to buy Chrysler, the Germans sold 80.1 percent of the company (enough to get Chrysler off their books under the accounting rules) for only $7.4 billion, or 20 percent of what they had paid. But that wasn’t all. Virtually all of the $7.4 billion would be paid not to Daimler but to the new holding company created to own Chrysler, which meant that Cerberus would be paying itself.
The deal was lubricated by some of America’s biggest banks—JPMorgan Chase, Citibank, and others—who bought $10 billion of Chrysler debt that was secured by the car company’s assets. The banks planned to resell the debt to investors and pocket a profit for their trouble. Cerberus’s one concession was agreeing to retain Chrysler’s $18 billion of unfunded retiree healthcare liabilities, which the Germans wanted to get off their balance sheet. Under almost any scenario, however, Cerberus figured it wouldn’t get stuck holding the bag for that money. Zetsche had gone way beyond discounting the price of cars; he had discounted the price of an entire car company.
It was a humiliating retreat for Daimler and, by all appearances, a sweet deal for the banks and for Feinberg. With control of GMAC and now Chrysler, the once-obscure private equity firm had emerged in little over a year to become one of the dominant forces in the American automobile industry. Cerberus celebrated the deal with a party for Chrysler employees. Acrobats rappelled from the roof of the headquarters in Auburn Hills, and daytime fireworks streaked across the sky.
“People say, ‘How can you turn this around and [others] can’t?’” remarked John Snow, the former U.S. Treasury secretary who had become Cerberus’s chairman and public spokesman. The answer, he said, was patience, the inherent advantage of private equity ownership. “It might take a couple of years to really show the results. And public companies don’t have two or three years.” There was plenty of hubris on Wall Street as well as in Detroit.
Not that Cerberus was willing to wait years, or even weeks, to make money from its new prize. On August 3, 2007, the same day Cerberus completed the transaction, a company called Auburn Hills Owner LLC bought Chrysler’s headquarters—the nation’s second-largest office building, behind only the Pentagon—for the bargain price of $325 million. Auburn Hills Owner then mortgaged the property and leased it back to Chrysler, which would use its cash flow to pay the rent.
The lease terms, which weren’t public, were easy to negotiate because Auburn Hills Owner, like Chrysler, was a subsidiary of Cerberus. So Cerberus could collect rent money on Chrysler real estate while waiting to make money on Chrysler’s cars. It was all perfectly legal and clever—rather too clever, in fact, for an ailing car company that needed to devote its cash flow to filling its anemic pipeline of new products. But financial finagling is what private equity firms did. Why wait for automotive engineering when financial engineering was faster?
As for the banks that helped to finance the deal, unlike Cerberus, they really would have to be patient. Contrary to their plans, they couldn’t find buyers for the $10 billion of Chrysler debt they had agreed to accept, so they were stuck with holding it for a while. The loans would come back to bite the banks in a way they couldn’t imagine.
Despite the celebrations at Chrysler’s headquarters, workers at the factory in Belvidere watched the company’s sale to the moguls on Wall Street with worry. The workers were delighted to see Daimler go. While they didn’t know much about Cerberus, they did know, as Gene Young put it, that private equity firms “break companies up into little pieces and sell them off.” Young and his co-workers described the sale to Cerberus with a special acronym: BOHICA. It was pronounced bo-hee-cuh, and it stood for “Bend Over, Here It Comes Again.” Belvidere workers had been nervous under the Germans; now they were frightened, but also frozen in their tracks.
Belvidere’s workers were making such good money that few started looking for another job, BOHICA or not. In 2007, the year Cerberus bought Chrysler, Young would make $72,000, his best year so far. (He didn’t know it would be his best year ever.)
He was forty years old and had worked at Chrysler eight years, living a Ping-Pong work life as he bounced back and forth between the assembly line and the Jobs Bank. During his Jobs Bank stints he volunteered for community service projects, including painting his church. Other times he hung out at the union hall, helping his fellow “bankers” repair their computers, until an inverse layoff or an increase in production would bring him back to work.
The Jobs Bank was just part of the UAW’s elaborate safety net that included “thirty and out” retirement, guaranteed pensions, nearly free healthcare, and more. The system fostered a “So what?” attitude that was reinforced by management’s professed dedication to quality, which seemed to disappear every time production fell behind schedule.
Sometimes when workers pointed out defects, they were ordered to ignore them, because “it’s just a Mexico car”—that is, bound for the Mexican market. Once when Young suggested a more efficient method for installing windshield wipers—the sort of suggestion the Japanese welcomed in their factories—he was rudely rebuffed by his supervisor. After that he pretty much kept his mouth shut.
This workplace culture was part and parcel of what Cerberus was getting when it bought Chrysler, but the Wall Street guys didn’t have a clue. Their analysts and bankers pored over every number in Chrysler’s financial reports, but none of the braniacs on the due-diligence team bothered to head to downtown Belvidere for coffee with Young to talk about BOHICA, inverse layoffs, and other realities of life in the trenches. The guys from Cerberus were flying at thirty thousand feet, and Belvidere was in the fly-over zone.
Nor did anyone talk to Gene Benner in South Paris, Maine. By 2007 his sales volume had plunged to just half of what it had been two years earlier, and his initial belief that the problem was just a cyclical slump was fading fast. By focusing on trucks and SUVs, Chrysler had left him without an attractive lineup of smaller cars at a time when demand for those vehicles was increasing. The Chrysler 300C’s initial success had been a flash in the pan. And those people who still wanted an SUV could choose from among an increasing array of Japanese vehicles, such as the redesigned Toyota 4Runner or, for hard-core off-roaders, the Nissan X-Terra.
The initial promise of DaimlerChrysler had long since faded. But car dealers are, by nature, optimists. Benner was hoping that the new owner for Chrysler would mean better days ahead because private equity firms, he figured, were sort of like car dealers—people who put their own money on the line. Surely, he figu
red, the Cerberus people understood the need to invest in better products. “Any new owner will be better than Daimler,” Benner would say. “Right?”
In July 2007, while Cerberus was working to finalize the Chrysler deal, Ford announced second-quarter earnings of $750 million, its first quarterly profit in two years. A few days later General Motors weighed in with earnings of $891 million for the second quarter. Cost cutting seemed to be working at both companies, and normally the return to modest profitability would have been good news. But the summer of 2007 wasn’t normal in Detroit. Good news, in this case, was really bad news.
The same month that they posted their second-quarter profits, GM and Ford, as well as Chrysler, began negotiations for a new national contract with the UAW. The talks offered a potential safe harbor for the corporate rowboats careening downriver: the chance to jettison some of the healthcare costs for UAW retirees, similar to the reductions the companies had imposed on retired managers. But the chances for convincing the union to go beyond the modest concessions of 2005 hinged on the companies’ ability to prove that they were in dire straits. The second-quarter profits were, well, not helpful, especially because GM couldn’t resist citing them as further evidence of its turnaround. Then again, other facts painted a darker picture.
GM’s unfunded healthcare liabilities had swollen to $51 billion. The 450,000 U.S. hourly workers the company had in 1985 had shrunk to under 74,000. Yet GM continued to provide generous healthcare benefits for 340,000 UAW retirees and their spouses. It was now a ratio of nearly five retirees for every active worker—an increase from the three-to-one ratio of a few years earlier, because the company continued to shrink. GM’s numbers were unsustainable, like a preview of might happen to the U.S. Social Security system thirty years in the future. Except this was now—and GM, unlike the federal government, couldn’t print money to pay its retirees.
The burden added more than $1,600 to the cost of every car and truck that General Motors made. In contrast, Toyota spent less than $200 per vehicle for retiree healthcare because it didn’t have many U.S. retirees, and the ones it had paid co-pays and deductibles for doctor visits, just like most other Americans. Thirty years earlier, ironically, Detroit had demanded the Japanese build factories in America to “level the playing field.” Now there were more than two dozen U.S. transplants, and Detroit and the UAW were fingering them for giving the Japanese an unfair advantage.
At Chrysler and Ford, the retiree-cost numbers were a little better than at GM, but not much. After decades of delaying the pain of a solution, the system had reached the breaking point. All three companies wanted to toss their retiree healthcare baggage overboard by creating a VEBA (vee-buh). The name was being heard so often in Detroit that one might have thought the Ford VEBA was a new car.
Instead it was a Voluntary Employee Beneficiary Association (though it wasn’t exactly voluntary), a trust fund to be financed with company payments capped at a fixed amount, but controlled by the UAW and union-appointed trustees. The trust would dispense healthcare benefits however the trustees decided—setting deductibles, co-payments, and benefit levels—at whatever the fund could afford. A VEBA’s benefit to the car companies was obvious: The funding cap would get them off the hook for unlimited, and constantly rising, healthcare expenses.
There actually was an upside for the UAW too. Without a VEBA trust, healthcare benefits for union members could be wiped out if the car companies ever did file for bankruptcy. By mid-2007 that possibility was quietly beginning to enter the UAW’s calculations. Just to be sure, the union again hired some number-crunching Wall Street bankers, who confirmed that it damned well should be considered a possibility.
Whatever the logic, however, a VEBA wouldn’t be an easy sell to the union’s rank and file. When the 2007 contract discussions began, union activists started handing out leaflets saying VEBA stood for Vandalizing Employee Benefits Again. It was better than BOHICA, but not much.
The man in the middle was Gettelfinger, a tough negotiator who wasn’t about to sleep with the enemy—or even with the enemy’s pillow. In mid-September, when the national contract negotiations with GM turned into an around-the-clock marathon, Gettelfinger took to sleeping on the floor in a company conference room. But the man who had banned company-union golf outings archly refused the pillow offered by GM negotiators, opting instead to use a plastic bag filled with shredded documents from the talks. A man with such a stiff backbone, and neck, wasn’t about to go down easily. The pillow was a symbolic act of defiance that presaged a bigger one just ahead.
At eleven A.M. on Monday, September 24, just as a new national contract with a VEBA appeared imminent, Gettelfinger ordered GM workers to walk out of their factories and take to the picket lines. It was the first national contract strike against General Motors in thirty-seven years. “We’ve done a lot of things to help that company,” Gettelfinger told a crowded, hastily called news conference. “But look, there comes a time when you have to draw a line in the sand.”
The GM negotiators were stunned, and the news media entered hyperventilation mode. National Public Radio described the move as the union’s “bold gamble that it could get a stronger contract by shutting down an already weakened company.” In truth, the strike wasn’t a line in the sand or a bold gamble or any other such cliché. Instead it was calculated political theater, intended to last just long enough to let UAW members blow off steam and convince the rank and file that their leader had fought the good fight. Just two days later, exactly as planned, Gettelfinger ended the strike and declared a historic victory for the UAW. He was right about the historic part, but not about the victory. The new contract marked the end of seventy years of steady, virtually uninterrupted UAW gains.
For the first time ever the union accepted a two-tier wage system, with lower pay for new hires at Detroit Three factories. It also agreed to a VEBA, completely absolving the car companies of their responsibility for retiree healthcare, which instead would fall to the trust fund. GM agreed to cover its $51 billion of unfunded retiree health liabilities with a payment of $35 billion in cash to the trust—about seventy cents on the dollar, a pattern that Ford and Chrysler would follow.
The money would be paid in installments over three years, although there was one big catch. The companies wouldn’t realize any cost savings on retiree healthcare until 2010, so reaping the fruits of their historic breakthrough would require some delayed gratification. GM’s shareholders, at least, didn’t seem to mind. On October 12 the company’s stock hit $42.50 a share, its highest price in three years. One retired GM executive who had been ready to cash in his stock options decided to wait, because his contacts on Wall Street advised him the company’s stock was sure to go higher. It would be like waiting for Godot.
Just three weeks later GM’s third-quarter financial results unveiled some ugly surprises. ResCap, the mortgage-lending arm of GMAC, had racked up $1.8 billion of losses on “subprime” loans to deadbeat borrowers. At least the good news there, relatively speaking, was that Cerberus was stuck with 51 percent of the losses.
The real stunner was GM’s decision to write off $38.6 billion in tax credits it had accumulated over the prior three years—more than eclipsing the company’s $34 billion in earnings between 1996 and 2004. The “reversal of tax-loss carry-forward” was an accounting charge that, GM quickly explained, didn’t impair the company’s actual cash condition. Which was true, but quite beside the point.
The accumulated tax credits could have been used to reduce taxes on the company’s future profits, but there was a time limit on their use. By writing off the credits, GM was conceding that it didn’t expect to make any profits in the next few years. It was a shocking admission for a company that had been proclaiming its turnaround and had just cut a deal to shed $51 billion of healthcare obligations to retired hourly workers. On top of the accounting charge GM lost another $400 million in the quarter from its operations.
Now the stock went into reverse. Over the next few week
s GM shares plunged nearly 40 percent to close, on November 20, at $27—lower than when Wagoner had launched his first restructuring effort three years earlier. Despite all the plant closings, layoffs, contract concessions, and cost cuts since then, the company’s profitability picture really hadn’t changed. General Motors was rowing hard but going nowhere, and the boat was slipping farther downstream.
Nonetheless, in January 2008 Wagoner’s annual presentation to Wall Street analysts was an upbeat update on the state of GM, with nearly fifty PowerPoint slides covering everything from the “Revitalized Sales and Marketing Strategy” to GM’s “Multi-Pronged Leadership Strategy” on fuel-efficient cars. Revitalized. Multi-pronged. No buzzword was left behind. The presentation was titled: “From Turnaround to Transformation.” The message might have been disingenuous, but it wasn’t duplicitous. Wagoner believed it so much that he delivered the same message a month later in Naples, Florida, to his old friends and former colleagues in the GM Executive Retirees Club, a group whose existence bespoke the continuing cozy insularity of GM’s corporate culture. The old-boy attendees applauded appreciatively.
But four months later the company posted a first-quarter loss of $3.25 billion, which would have been shocking except that bad news from GM was losing its shock value. General Motors was heading for a transformation, all right, but not the kind Wagoner had in mind.
While Detroit’s new labor deal was coming together, Cerberus was staffing Chrysler with an automotive all-star team, including some high-profile American executives it had lured from Toyota. The real headliner, though, was the selection of Bob Nardelli, no stranger to headlines, as Chrysler’s CEO.
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