Sunday, December 07, 2008

Robert Stern, professor of business at New York University's Stern School of Business, opposes federal aid to Chrysler. On his blog, he makes the argument that

Although I am not opposed to the idea of providing aid to the auto manufacturers, there is a difference between an investment and an expense. Injecting capital into GM and Ford represents more of an investment. An injection of capital into Chrysler would represent nothing more than an expense.

Ford and GM are on stronger footing than Chrysler in terms of design, quality, operations, global footprint, and so on. Therefore, the plight of GM and Ford bear greater resemblance to a liquidity problem. By providing capital to those two firms, we are making an investment in firms whose products are more fundamentally sound, but that find themselves temporally underfunded. The money would therefore help tide them over until the crisis abates.

By contrast, Chrysler is closer to insolvency than its larger brethren (see Is the End Nigh for Chrysler for details). Any money invested in Chrysler is therefore likely only to delay the inevitable. Moreover, Chrysler is less systemically important than either Ford or GM. It is not even 1/3rd the size of Ford. It’s owners are not dispersed individuals and institutions to which many American pensions are tied. Rather, it is owned by Cerberus, a private investment firm. This raises another issue - whether the use of taxpayer money to bail out Cerberus, a private investment company that was the poster-boy for excess during the credit-fueled private equity binge, is justified in the first place.

For all these reasons (and more), the U.S. taxpayer would be better served making an investment in GM and Ford, and leaving Chrysler to its own devices.

In another post, on the investing website Seeking Alpha, he argues that

As far as I am concerned, Cerberus should be left to reap what it has sown. If it wants money to invest in Chrysler, it should do so itself, or find private sources of external funding.

Sure enough, Cerberus has engaged in its own method of crying for capital. First, Cerberus offered to forgo profit on its investment should the U.S. government inject capital into Chrysler (see A Benevolent Cerberus). Next, Cerberus tried to assign blame for Chrysler’s fiasco to Daimler (see Cerberus Claims It was Misled, …hat tip Tom). According to the Connecticut Post:

Relations between Chrysler’s current and former owners turned ugly Wednesday when private equity firm Cerberus Capital Management LP accused Daimler AG of “intentionally and materially” misleading Cerberus before the German automaker sold Chrysler last year. [editor: the Connecticut Post article that Salomon quotes is dated 11/26/08 - no more than a couple weeks ago.]

These tactics are not only transparent, but reek of desperation. The company is attempting to mask the true, underlying problem: Cerberus made a lousy investment in a severely troubled auto manufacturer.

In my opinion therefore, before the taxpayer seriously considers an injection of capital into Chrysler, Cerberus’s investment ought to be completely wiped out. That would only happen in bankruptcy. Then, and only then, might the U.S. taxpayer reconsider.

In addition to his argument about structural importance (e.g. GM's collapse would have profound national implications), Salomon seems to be making a bit of an ethical distinction between Ford and GM, which are owned by public shareholders, and Chrysler, which is owned by a private for-profit company. I'm not sure that the distinction is worth drawing - whoever invested in GM or Ford also made a lousy investment and doesn't deserve to be rescued by the government.

Incidentally, Businessweek has an article on how private equity companies essentially "strangled" Mervyns, a retailer, with a series of bad decisions. Private equity firms purchased the firm and then sold the real estate. The retailer had once owned its stores, but now had to rent the real estate from the new owners. Unfortunately, the rents were double what the old mortgage payments were.

The private equity shops split Mervyns into two companies, one holding the real estate and the other operating the stores. This way, they profited off the real estate. However, they had to cut costs drastically at the retail operation, which is now filing for bankruptcy. They also laid off a number of employees suddenly and without severance packages. In addition, there were three firms involved in the buyout, and the way they structured the deal caused competing incentives that prevented them from acting expeditiously to save the retailer, or at least liquidate it in an orderly fashion. I should emphasize, though, that Mervyns wasn't doing all that well. It may well have gone into bankruptcy if left to its own devices.

This is not to suggest that this is typical of all private equity buyouts. However, it's worth mentioning because Cerberus was one of the firms involved in the buyout, although they later sold their stake to one of their partners. If this behavior is typical of private equity firms, then perhaps this is part of what's driving Salomon's additional hostility to Cerberus. Of course, I'm not exactly very sympathetic to Cerberus either.

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