Overhaul (15 page)

Fixed costs are those that tend to remain constant regardless of how many units you produce: items like interest and rent payments and the salaries of permanent staff. Most businesses account for wage workers as a variable cost because the companies hire and lay off workers based on production. But at GM, Ford, and Chrysler, it wasn't that way. They accounted for labor as a fixed cost—under the UAW contract, autoworkers got paid nearly the same whether they built cars or not. (The companies actually maintained "rubber rooms" where idled workers could job-hunt, watch TV, and work crossword puzzles while they collected pay.)

The evident absurdity of this state of affairs sapped morale and had a perverse effect on how the U.S. automakers did business. With fixed costs so high, they had an incentive to build as many cars as possible so as to reduce the average cost per car. Similarly, with variable costs relatively low, additional cars could be made without much additional expense. These factors played a major role in Detroit's addiction to discounts and incentives. The end result was what no businessperson would want—a low-profit-margin business that is vulnerable to any slackening in consumer demand.

I also learned how the automakers' size and power had helped mask their weakening position. At one end of the pipeline, these giants commanded favorable terms from their suppliers—they could wait to pay their bills. On the other end, they used their clout to force dealers to pay for cars before they even reached the dealers' lots. All this provided a massive cash flow benefit, as well as a powerful incentive for the automakers to stuff dealerships with as many vehicles as possible.

The list of only-in-automaking business practices went on and on. In addition, I had to race to master a whole new vocabulary—words like "homologation" (conforming a car to U.S. safety and environmental standards) and "subvention" (reimbursing the finance companies to offer low or zero-percent financing on cars). Yet I felt that being a newcomer to the industry wasn't such a terrible thing. I could look at Detroit's practices with fresh eyes and compare them with those of more profitable industries, such as information, entertainment, and communications, where I had spent much of my business life.

Now that the task force was officially open for business, there also began a parade of visits from auto industry stakeholders. Surprisingly, everyone from auto executives to union chiefs to suppliers came to us believing that the government should solve their problems. Some of our visitors were testy; all left disappointed that the government wasn't going to be everybody's piggy bank. The GM bondholders were typical of this. As part of the
TARP
loan agreement, GM was expected to slash its $27 billion of unsecured public debt by two-thirds. This meant getting investors to exchange at least $18 billion in bonds for much riskier GM stock. There was no way for GM to force them to do so: under the usual bond indentures, a lender's entitlement to interest and principal cannot be abridged without its consent. That meant GM needed volunteers.

But this raised a classic "free rider" problem, as economists call it. Why would any bondholder agree to have its investment dramatically reduced when, if other investors accepted the offer, it could keep its full entitlement? No company had ever achieved such a sizable debt reduction involving so many bond issues and thousands of bondholders outside of bankruptcy. GM had been talking to representatives of its biggest bondholders for weeks, without any progress, seriously jeopardizing its chances of being found viable on March 31.

Now these advisers appeared at our door, armed with a proposal. I almost fell off my chair when I saw that their solution to this dilemma was for the Treasury to guarantee some of the new debt. I held myself to a few polite questions, but I was seething. Yet another stakeholder asking for a handout.

Such sessions underscored the need to expand our team—quickly. I took a giant step in that direction by hiring somebody I found via e-mail: Harry Wilson, a fiercely driven young expert in corporate restructurings. His was one of the many unsolicited résumés I'd received when word of my possible appointment began to leak. Harry had grown up in a Greek immigrant family in a river town in upstate New York, where he'd seen his mother get laid off three times from textile mills as they'd closed one after the other. Harry had been the first in his family to earn a college degree, from Harvard, and he'd gone on to earn an MBA at Harvard Business School. He had done private equity deals and industrial restructurings at four distinguished Wall Street firms. And he was a registered Republican! His e-mail touched me, especially these lines: "Steve, I will end on a personal note. There is only one reason I am sending you this email: I have a very deep interest in public service, particularly given the good fortune I have enjoyed in my own life, and ... I think my skills and personal characteristics are an ideal match for those needs. In short, I can't think of a better way for me to serve my country in the near term than this role, and I think our country needs all the talented people it can get (regardless of political affiliation)."

Harry's employer references were glowing. But just because he had put his hand up for a job didn't make him easy to convince. The burly thirty-seven-year old, who looked like a fairer, younger version of Al Gore, had a whole list of questions and concerns that reflected the diligence and care that we would later see in his work. Was the task force free to attack the auto industry problem without regard to politics? he wanted to know. Was its goal with GM and Chrysler the fundamental restructuring that both companies sorely needed? I told Harry candidly that while I believed that the President, Tim Geithner, and Larry Summers were committed to doing the right thing, only time would tell if the administration would withstand the political pressure to pull punches, particularly from strong supporters like the UAW. There were risks, I admitted, but the opportunity to work on such an important matter far outweighed them.

After thinking it over, Harry agreed to join the team. Now all we had to do was get him hired. As he began the same vetting ordeal that Ron and I had gone through, one of the
TARP
chiefs made a transformative observation. If the task force was going to continue to oversee the deployment of
TARP
money, he said, then the staff should be on the payroll of
TARP,
which had its own streamlined hiring process. Even better,
TARP
had more money for hiring than did the Treasury, whose budget had been strained to the breaking point by the financial crisis. So we were able to bring Harry on board in ten days—overnight, by D.C. standards. Importantly, his addition cemented the principle that our hiring would be done without regard to political views and ensured that Team Auto would be something of a team of rivals.

The flow of ideas and suggestions from outside the task force continued to climb. Some served as useful affirmations of, or correctives for, our thinking. Others were bizarre. A friend passed along an e-mail from an architect suggesting that GM and Chrysler get out of autos and manufacture housing instead. An otherwise sensible acquaintance forwarded an e-mail from an investment group purporting to want to put "$50 billion to $150 billion" into the auto industry. "This seems important enough to pass on," he wrote.

We labored to find an acceptable solution to the supplier crisis in time for our next meeting with Larry, set for Monday, March 2. "Given Larry's concern about Laos, I'm particularly worried about going to him with a structure that he will have an easy time poking holes in," I said to Deese from home on Saturday night. The issue ate up most of the next thirty-six hours. By the time we appeared in Larry's office late Monday afternoon, we had boiled down our supplier ideas to two. The more modest idea—if you can call a $5 billion to $10 billion proposal modest—was a kind of insurance fund that would guarantee payment to GM's and Chrysler's suppliers. Suppliers would have to pay a hefty fee to participate, but we believed such a program would relieve them of a major worry.

Our second idea, far more ambitious, would be a kind of mini-TARP—a fund to provide so-called debtor-in-possession, or
DIP,
financing for suppliers that declared bankruptcy.
(DIP
financing enables a bankrupt company to keep the lights on and pay other essential bills while it reorganizes.) We had qualms about the scope and workability of this idea. Which suppliers would qualify? Where would we draw the line? How would we screen dozens or hundreds of applicants? "I ran a fund and it is a big undertaking," I said to Todd Snyder, who was pushing the idea.

The discussion moved fast once we got into Larry's office. We quickly agreed that the administration's goal should be not to save suppliers per se but to save only those that were of critical importance to the automakers. This decision evolved into a mantra for dealing with the myriad parties besieging us with requests: "We cannot solve the problems of every company in every industry."

As often happened with Larry, the meeting ranged beyond the immediate agenda into a discussion of the many other issues facing us. Diana sat thinking how the auto problem just kept "radiating out" to include not only suppliers, but dealers, finance companies, and on and on. Focused on our suggestion that GM and Chrysler be treated differently from one another, Larry told us he wanted us to come back to him with a preview of how the movie was going to end for all the companies that needed help, from GM on down.

Over the next few days, we scrambled to fast-forward our thoughts to what the announcements that we knew were coming by March 31 might look like. Even at that early date, we found ourselves in agreement about most of the important issues. For starters, it was abundantly clear that neither GM nor Chrysler had demonstrated viability. Neither had extracted sufficient sacrifices from its stakeholders. We were skeptical about Chrysler's prospects as an independent company and inclined to believe that a partnership with Fiat was its only real hope. We saw GM as more likely to survive, but were convinced that new leadership would be required. My thought was to replace Rick Wagoner and divide his responsibilities between a new chairman and an interim CEO. I also felt that much of the board should be replaced.

Though I'd met Wagoner only once, to my mind there was no question but that he had to go. It wasn't personal; it was business. We did not know of another industrial company in history that had burned through so much cash as fast as GM had on his watch. It had vaporized $20 billion in twelve months and was in the process of burning another $11 billion in the first quarter of 2009, all of which was now coming out of the pockets of taxpayers. Even more compelling was the fact that GM said it would need still more bailout money to tide it over. After nearly a decade of experience as a private equity manager, I believed in a bedrock principle of that business: put money behind only a bankable management team. To my mind, no private equity firm on the planet would have backed Rick Wagoner or GM's current board.

I knew Rick must have many admirable qualities, the foremost of which was an unshakable belief in his company and himself. Yet he also set a tone of friendly arrogance that seemed to pervade the organization. His performance at the Senate hearing the previous November had been typical; he and his team seemed certain that virtually all of their problems could be laid at the feet of some combination of the financial crisis, oil prices, the yen-dollar exchange rate, and the UAW.

We gave considerable attention to timing. On the one hand, as we all knew, any reorganization would take time, and two of such magnitude could be lengthy indeed. On the other hand, every day that went by meant more taxpayer money was going down the rat hole. We played around with timetables in thirty-day increments, starting with thirty days for each company to get its act together: Chrysler, to secure the Fiat partnership; GM, to scrap its rosy scenarios and retool its plan. Because of its scale and complexity, GM would then need more time, at least an additional sixty days, to win the necessary concessions from its creditors, suppliers, and unions. Chrysler's fate was clearer: if it failed to bring about the Fiat partnership, it would be liquidated. If GM failed to achieve the necessary concessions from its stakeholders, the result would be bankruptcy. We didn't yet know exactly what a GM bankruptcy would mean, but we could see no alternative to it. And we began to muse about how to be sure GM moved forward with more energy than was its custom. One idea was to send a team to Detroit to "monitor" the company's progress. We chose that word to avoid giving the impression that the government would be stepping in to run GM. But as events unfolded, I am sure that Harry Wilson never thought of himself as a monitor. By the time he was finished, neither did anyone at GM.

Of course, developing a straw man would be easy. For us to pin down facts and be certain we had a detailed plan that would succeed would be a lot more difficult.

I had my first face-to-face encounter with Sergio Marchionne a few days later—a trim, likeable guy with a high forehead, wire-rimmed glasses, and the ever-present black sweater. He gave an elaborate description of the turnaround at Fiat. Then his team laid out a plan for saving Chrysler, with frequent interjections from Sergio, acting as a kind of color commentator. Assume that consumer demand doesn't re-cover but stays flat at ten million vehicles for eight years, they began. They showed how, just by adding Fiat's small-car designs to its lineup, Chrysler would gain market share and make enough money to survive. They had Chrysler's market share growing by close to 40 percent. If you accepted that, and then assumed that overall demand would re-cover in less than eight years, Chrysler would obviously make a lot of money.

Sergio knew how to turn on the charm and was selling hard, but we weren't buying it. "Those are nice assumptions, but where are you going to get that market share? Who are you going to take it from?" Harry asked. "They're going to respond over time with new models of their own." Sergio didn't really have an answer to that. Nor had our guests given much thought to how a combination of the two companies might be structured. For its part, the Fiat team was also disappointed in the meeting; they thought our lack of experience in the auto industry showed.