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The Current State of the U.S. Auto Industry

Not bailing out Detroit would be a disaster for the U.S. auto industry.

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As of the time this article is being written,  General Motors (GM),  Ford (F), and Chrysler LLC (the Detroit 3) have just submitted proposals to Congress and testified justifying why each firm deserves government aid. Assuming no private sources of capital or government aid appear, GM and Chrysler will be forced to file for bankruptcy this month. Ford has more time but is heading down the same path. This situation is very fluid and the outcome is very uncertain, but whatever happens will have a large impact on the entire automotive supply chain. The outcome for the Detroit 3 will likely take one of three forms, which we discuss in turn.

Option 1: No Assistance--Followed by Bankruptcy
First, if the government does not provide any assistance, GM and Chrysler will likely file for Chapter 11 bankruptcy. This could quickly lead to Chapter 7 liquidation as neither company has enough cash to operate in bankruptcy for very long. This outcome would be the economic equivalent of dropping an atomic bomb in the U.S. manufacturing sector. A Nov. 4 study by the Center for Automotive Research estimates such a scenario would cause 2.5 million jobs to be lost throughout the entire U.S. economy; over three years, it would cost the private sector $275.7 billion in lost personal income and would cost the government $108.1 billion. Bankruptcy in GM and Chrysler could cause Ford's distress to accelerate as supplier failures would hurt all automakers. Ford and GM have 80% supplier overlap and even healthy companies such as  Toyota (TM) and  Honda (HMC) use some of the same suppliers as the Detroit 3. This outcome is the least likely outcome, however, as we do not think the Obama administration will want to put more factory workers in key electoral states out of work, and Speaker Pelosi stated on Dec. 2 that bankruptcy was not an option.

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David Whiston has a position in the following securities mentioned above: CVR. Find out about Morningstar’s editorial policies.