Chapter 4
Industrial-Era Bailouts (1971-1995)
When things are going well, the companies stress the idea of free enterprise, with no need for government regulation. But when things aren’t going well, they suddenly become a close partner with the government and want it to bail them out. All they have to do is threaten to collapse and the government pours in more money.
—A. Ernest Fitzgerald, civilian cost analyst and
Management Systems Deputy to the Air Force
Assistant Secretary for Financial Management
The previous era of government interventions focused broadly on emergency economic and prewar relief: Housing, jobs, finance, industrial production, and wartime preparation all received enormous aid.
The era that followed took a new and different path: bailouts of individual companies. This represented an enormous break from past philosophies, government activities, and use of taxpayer proceeds.
The year 1971 was a sea change in the history of American bailouts. That was the year when, for the very first time, the United States bailed out an industrial firm whose own financial mismanagement had driven it to the brink of extinction. The company was Lockheed Aircraft Corporation, and the bailout was in the form of loan guarantees worth $250 million.
Prior to the Lockheed rescue, the United States had never acted in loco parentis for any single firm. Previous rescue operations were intended to help the nation work through difficult times. During the Great Depression, one in four workers was unemployed, and the nation’s economy was contracting 15 percent per year. The fear of further economic damage and civil unrest essentially forced the government’s hand. During the period prior to U.S. entry into World War II, the government gave aid to steel, munitions, and rubber companies. As much as any governmental interventions, before or since, it is difficult to call these actions bailouts—they were acts of national self-preservation aimed at entire wartime industries, not individual private enterprises.
Lockheed was an unprecedented and, to many people, alarming new development. Never before had the government effected a rescue operation of a single company.
The firm had been having financial troubles for several years, posting losses in 1969 ($19.5 million) and 1970 ($86.3 million). Management had repeatedly made significant miscalculations on major projects: The company had won a $1.9 billion defense contract for the C-5A military transport plane in 1965, underbidding Boeing by $300 million.1 Lockheed’s optimistic projections led to enormous cost overruns. Separately, the firm’s attempt at building passenger aircraft—the L-1011 TriStar—was also problematic. On top of these, Lockheed also had cost overruns on three other large military projects.
All in all, the firm was in dire financial straits due to its own actions and mismanagement.2
Despite its bumbling missteps, Lockheed hadn’t become the nation’s largest defense contractor because its management was foolish. They may have been marginally competent when it came to managing large military projects, but their true genius lay in the procurement process. By 1971, they had learned to quite skillfully navigate the vast bureaucracy of the U.S. military. And since the majority of Lockheed’s revenues were already coming from the taxpayers, it did not require a big stretch to identify the federal government as the most likely potential rescuer of the company’s precarious financial condition.
Facing continual cost overruns with four major U.S. military projects, as well as delays in the development of the TriStar, Lockheed saw no alternative. The firm formally petitioned the government for assistance on March 2, 1970, via a letter from Chairman Daniel Haughton to Deputy Defense Secretary David Packard. The company asked for a whopping $600 million in government assistance. That would be the 2007 equivalent of $3.2 billion.
The emergency loan package for Lockheed Aircraft was highly contested in Congress. The term corporate welfare was coined by Wisconsin Senator William Proxmire (D) to describe the proposed bailout. The House just barely voted in favor of the Emergency Loan Guarantee Act of 1971, 192 to 189. The bill almost didn’t make it through the Senate; Vice President Spiro Agnew cast the deciding vote, winning passage 49 to 48.
SOURCE: © 2008, R. J. Matson, St. Louis Post Dispatch, politicalcartoons.com. Reprinted by permission.
Something else happened in 1971 that many believe was a critical catalyst to the United States becoming Bailout Nation: Richard Nixon took America off the gold standard.
As World War II came to its bloody conclusion, the Bretton Woods agreement had established the dollar as the world’s reserve currency and set a fixed rate for the dollar’s value versus an ounce of gold (3.5 ounces per $1,000). On August 15, 1971, just a few weeks after Congress approved the Lockheed bailout, Nixon broke that dollar-gold relationship.
It’s difficult to show any direct causation from Nixon’s act to the massive bailouts of modern times. But what is uncontested is that the U.S. federal debt and money supply exploded in the years subsequent to 1971, while the dollar steadily declined in value:• In 1971 the total U.S. federal debt stood at $436 billion. Today, that number exceeds $10 trillion.
• From about $800 billion in 1971, the total broad-based money supply (M3) increased to a staggering $10.2 trillion at the end of Alan Greenspan’s tenure as Federal Reserve chairman in 2006.
• After the first quarter of 2006, the Fed stopped reporting M3 money supply, a story for another book entirely.3
As long as foreigners were willing to buy U.S. Treasury securities, it became easier as the years went by for politicians and policymakers to approve bailouts that were largely financed by debt. Nearly 40 years later, Americans have become shockingly comfortable with Congress raising the U.S. debt ceiling in order to pay for various and sundry expenditures, including by $1.5 trillion in the summer of 2008 alone for the Housing Bill and Paulson’s TARP plan.
The dollar was literally losing its value, but that was almost an afterthought.
It took a while for politicians and policymakers to grasp the significance of just how much you can buy on credit when corporate welfare was in its infancy in 1971. But Lockheed was the proverbial Pandora’s box that unleashed a generation of evils on American capitalism.
Even as they tackled Lockheed’s rescue, members of Congress were already contemplating an even bigger bailout: Penn Central Railroad. Faced with mounting losses and unable (or unwilling) to pay its creditors, Penn Central declared bankruptcy in 1970. “In his petition to the court, Chairman Paul Gorman said that the line was ‘virtually without cash, unable to meet its debts, [and] has no means of borrowing.’ ”4
At the time, Penn Central was the nation’s largest railroad, and the Nixon administration proposed allowing the Defense Department to underwrite $200 million in loans to the struggling firm. But Congress balked. “The potential for political mischief really scared people,” one observer told Time magazine in a statement that sounded serious at the time but now seems quaint. Time reported:
In an effort to revive the failing intercity passenger rail service, Congress enacted the Rail Passenger Service Act (RPSA) in 1971. The RPSA authorized the creation of the National Railroad Passenger Corporation, a federally funded corporation better known as Amtrak [and what a winner that turned out to be].
When it became apparent that it was not possible to reorganize a viable rail system solely through the Bankruptcy Case, Congress, drawing upon its bankruptcy power and the eminent domain authority available to it under the Commerce Clause, enacted the Regional Rail Reorganization Act of 1973 (the Rail Act) to ensure the existence of a viable rail system in the Northeast.5
In the end, Congress provided $125 million in loan guarantees to Penn Central’s creditors and spent $7 billion in direct federal operating subsidies for Conrail, which Congress created in 1976 from the carcass of Penn Central and five other struggling East Coast rail lines.
If Lockheed was the government’s first sip of bailout elixir, Penn Central was a big gulp that opened the floodgates for t
he bailout binge that was about to come.
In 1971, corporate welfare was just a baby. By 1980, it was a baby no more.
There is a strong case that such help rewards failure and penalizes
success, puts a dull edge on competition, is unfair to an ailing
company’s competitors and their shareholders, and inexorably leads the
Government deeper into private business. Why should a huge company
be bailed out, say critics, while thousands of smaller firms suffer
bankruptcy every year? Where should the Government draw the line?
GM Chairman Thomas A. Murphy has attacked federal help for
Chrysler as “a basic challenge to the philosophy of America.”
—Time, 19796
Throughout the 1970s, American automakers were being challenged as never before. The luxo-barges they were building had become stale and tired looking; they did not lend themselves easily to higher fuel efficiency changes or attractive redesigns. Creating a manufacturing system that produced mechanically reliable vehicles seemed to be beyond their ken. The companies themselves had become bloated bureaucracies with far too many layers of management to be able make significant changes.
Besides, change was not their forte.
Then came the oil embargo of 1973. Skyrocketing energy inflation was the new reality. As gasoline prices soared, the devastation was most acutely felt in Detroit, where America’s biggest and least fuel-efficient cars and trucks were manufactured.
In the 1950s, Barron’s described the Detroit automakers as the big two and a half—with Chrysler Corporation, the perennial sales laggard, as the half. When the embargo hit, Chrysler suffered the most of the Big Three.
By the mid-1970s, the company was hemorrhaging cash. Chrysler lost $52 million in 1974, and a record $259.5 million in 1975. As smaller, less expensive and more fuel-efficient cars from Japan and Europe gained increasing market share in 1970s, Chrysler found itself in an ever-deepening hole. It looked like it might have to declare bankruptcy.
But the United States is a big country, filled with big-assed people who love their big, comfy cars. As soon as the energy crisis ended, it was back to business as usual. The return of Motor City muscle made 1976 a hugely profitable year: The company’s net income was $422.6 million.
Make small, efficient vehicles? The idea was laughable. The oil embargo was looked at as an aberration, and once prices had stabilized, it was back to manufacturing big iron. Despite the drop in fuel prices, though, Honda and Toyota continued to make steady gains in market share that decade—and beyond.
Although Chrysler had renegotiated terms with its top lenders, this merely bought the automaker a few years, allowing it to survive from one crisis to the next. The year 1977 was profitable, but less so: Net income was $163.2 million. Chrysler’s models were getting long in the tooth, and retooling factories was an expensive process. By late 1978, the company was again running in the red, losing $204.6 million, as the fall of the Shah of Iran and a new oil embargo sent fuel prices to record high levels. By 1979, Chrysler was looking at its first billion-dollar annual loss.
As the decade came to a close, it was apparent to management that they were running out of money and would be unable to resolve their financial situation on their own.
Management decided it was time to visit Uncle Sam.
The Chrysler bailout was everything Lockheed—its predecessor in the bailout time line by nine years—was, and more. It was bigger and more expensive. Lockheed had loan guarantees worth $250 million; Chrysler’s were for six times that amount. The rationale for the rescue of Lockheed, the country’s biggest defense firm, was national defense. With Chrysler, it was the U.S. economy, and saving 200,000 jobs.
But the big difference between the two was that the Chrysler rescue package was much more complex. The terms of the Chrysler loan guarantees required an additional $2 billion in commitments or concessions from “its own owners, stockholders, administrators, employees, dealers, suppliers, foreign and domestic financial institutions, and by State and local governments.”7
The Chrysler bailout of 1980 was not quite a prepackaged bankruptcy reorganization. It left the company with the same management team, the same union contracts, the same pension obligations, and the same health care coverage; all the bailout did was buy the company a few more years. Indeed, the prebailout industry looked almost identical to the postbailout industry. None of the Detroit automakers, Chrysler included, received any long-term benefits from the bailout.
What Congress did was postpone the inevitable.
In the television series Star Trek, Captain Kirk is accidentally transported to another starship Enterprise in an alternative universe (“Mirror Mirror”). Kirk quickly figures he is in a changed parallel universe, as the entire social fabric is radically different. Not only that, but his science officer, Mr. Spock, wears a beard. What was the cause of these changes? It turned out that because of a single change in the earlier history of that universe, everything else was radically different.
If only we had access to the universe with the bearded Spock.
This is the investigative challenge of any philosophical inquiry into bailouts—there is no control group. We don’t get to examine the counterfactual outcomes had the government not intervened into the private markets. Hence, we have only the net result of taxpayer largesse as our frame of reference in the real world. We can, however, imagine the possible what-might-have-beens had a few votes been changed.
Without seeing the alternative, it is easy for Chrysler’s congressional supporters to point to this as a successful bailout: After all, the government-guaranteed loans were repaid, employees’ jobs were saved, and eventually Chrysler itself was purchased by Mercedes-Benz. The German company even managed to find a greater fool, Cerberus, to take the Detroit dog off its hands.
But was Chrysler really a successful bailout after all? Judged on the shortest-term basis of mere survival, we can begrudgingly say yes. Lacking access to our alternative universe—one where bailouts were voted down in Congress, and companies such as Lockheed and Chrysler had to fend for themselves in the private sector—we can only imagine how things might have turned out.
Let’s use the Chrysler bailout as a hypothetical model of what might have happened in the event the government did not succumb to political pressure to bail out Chrysler.
We do not know precisely what that world would have looked like if Chrysler were forced to fend for itself in the marketplace, like all other competitive companies in the United States. But we can easily imagine it. Chrysler executives said had they not received government assistance, they would have had to file not Chapter 11 reorganization, but Chapter 7 bankruptcy.
Let’s consider this alternative universe—where Spock wears a beard, and where Chrysler was allowed to suffer its own timely demise. A Chrysler in bankruptcy may very likely have caused several distinct business shifts, with far-reaching repercussions for the American automobile industry and the broader economy at large.
The sight of Chrysler in flames may very well have sent paroxysms of fear into the senior management of General Motors and Ford. All three companies had been engaged in long, slow declines, but the baby boomer generation’s growth and consumption habits had masked the decline somewhat. Sure, the Big Three were selling more and more vehicles each year, but they were losing market share; their slice of the expanding pie was shrinking.
It is easy to see why. Their cars were no longer attractive, and the vehicles’ reputation for mechanical reliability had deservedly slid in the face of superior German and Japanese machinery. Gas mileage was consistently mediocre. Rather than working to engineer improved mileage, corporate management chose to wage a political fight against Corporate Average Fuel Economy (CAFE) standards instead. It is one of many post-Chrysler actions that in hindsight have proven to be disastrous.
Had senior management been forced to confront one of the Big Three actually going under, it would h
ave served as a wake-up call to the (all too many layers of) management of the remaining two companies.
What happened instead was a failure of imagination at Ford and GM. Instead of causing introspection and contemplation, there was snickering and gloating. Neither company recognized that they were both suffering from the same disease that afflicted Chrysler—costly union contracts, expensive pension funding obligations, and ruinous future health care costs. The perennial third-place Chrysler was simply weaker, and so it showed the effects of its poor capital structure sooner than the other two.
A Chrysler bankruptcy could have been the impetus for major changes in Dearborn and Detroit. Instead, both firms generated more of the same ungainly, oversized, ugly cars. Quality wouldn’t dramatically improve for two decades, and the cars lagged in mechanical reliability for years. Fuel efficiency also lagged, especially against Japanese vehicles.
Chrysler survived, but a slow necrosis gradually handed over the dominance of the U.S. automobile market to the Japanese, Koreans, and Germans. For the first time ever in May 2008, the majority of automobiles sold in the United States were not made by U.S. companies. In 1980, the U.S. manufacturers’ market share had been 75 percent.
If that’s your idea of a successful bailout, I’d hate to see what your idea of a losing one is like.
Had Chrysler gone belly-up, the loss of 123,000 jobs at Chrysler would’ve scared that the bejesus out of the United Auto Workers (UAW). The union had grown powerful and influential over time, and had developed a ruinous us-versus-them mentality with the management of the Big Three. A massive loss of jobs would have served notice that the current state of business was simply unsustainable and could not continue without major repercussions in the future.
One can imagine that in the face of such tragic economic destruction, the UAW might have begun negotiations with a completely different set of objectives. The UAW’s senior management should have been tossed out, and a new operating arrangement negotiated.
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