The Rescue of the US Auto Industry, Module G: The Auto Warranty Commitment Program

The US government’s strategy for assisting the struggling US auto industry was largely ad-hoc and evolved considerably over time. Treasury’s original stated purpose for intervening was to prevent the immediate collapse of GM and Chrysler—at the time two of the three largest US automakers—an event that was widely expected to be destabilizing for the entire industry (COP 2009). The AWCP constituted just $0.6 billion of the $79.7 billion in TARP funding ultimately disbursed in support of GM and Chrysler’s restructurings and to assist other key players in the industry as well, including two auto finance companies (General Motors Acceptance Corporation and Chrysler Financial) and auto parts suppliers (Treasury 2018).

Canada established a warranty guarantee program similar to the AWCP. The Canadian Warranty Commitment Program, announced on April 7, 2009, supported new vehicle warranties for GM and Chrysler customers with the “goal . . . to increase consumer confidence and encourage Canadians to buy new cars” (Industry Canada 2009a). The program ended on September 16, 2009, after both companies emerged from bankruptcy (Industry Canada 2009b).

The Canadian government stated:

Under the Canadian Warranty Commitment Program, the federal government is committed to honouring consumer warranties on new vehicles purchased from GMCL or Chrysler Canada for a limited period while improved restructuring plans are put in place (Industry Canada 2009a).

It described the warranty program as one that “paralleled the US warranty program announced by President Barack Obama on March 30, 2009” (Industry Canada 2009a).

It appears that segregated information about the warranty commitments appears not to be publicly available.  The Auditor General of Canada criticized the lack of publc information about the use of the government’s loans, including the warranty program: “Industry Canada had limited documentation on the actual use of a $2.8 billion loan made to GM Canada for capital expenditures, warranty claims, and other general corporate purposes.” (Auditor General Canada, Section 5.45).

Created with the enactment of the Emergency Economic Stabilization Act (EESA) in October 2008, the Troubled Assets Relief Program (TARP) enabled the US Treasury to “purchase and insure certain types of assets for the purposes of providing stability to and preventing disruption in the economy and financial system” (EESA 2008). In addition to targeting distressed mortgage-related holdings of US financial institutions, the law also enabled Treasury to purchase “any other financial instrument that the [Treasury] Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promoting financial market stability” (EESA 2008). That clause proved essential when, in December 2008, it became apparent that no resolution for the auto industry would take hold in Congress (Nye 2021). As a result, the Bush Treasury used the flexibility built into EESA to justify extending GM and Chrysler emergency loans (Bush 2008).

President Obama announced the warranty protection plan in a speech delivered to the public on March 30, 2009, speaking directly to American consumers whom the program targeted. Before discussing the AWCP, the President explained why the government was assisting the automakers. He described the process that had been applied, including judging their restructuring plans to be inadequate, and the decision to provide further working capital to give the companies a second chance. In particular, the President explained how bankruptcy might be employed as a “tool” to speed the restructuring of the automakers.  He then explained how the AWCP would work in broad terms, while also taking pains to describe such things as automatic enrollment for purchases of eligible cars (Obama 2009). The President’s speech was supplemented by the release of a program fact sheet on the White House and Treasury websites (Treasury 2009a).

Even though President Obama announced the program in support of GM and Chrysler, in its fact sheet Treasury confirmed that “any domestic auto manufacturer [was] eligible to participate in the program” (Treasury 2009a). No other manufacturers chose to participate (Treasury 2018).

The looming threat of a GM or Chrysler bankruptcy had the potential to negatively and possibly significantly affect demand for the companies’ vehicles. While President Obama attempted to position bankruptcy as a valuable restructuring tool, there was great risk that consumers would view the announcement as confirmation of the firms’ precarious futures, and thus be hesitant to purchase one of their vehicles (COP 2009). For consumers, bankruptcy put at risk the fulfillment of warranty benefits and would likely result in the closure of many dealerships and service centers as well as a huge drop in vehicle resale value (COP 2009; GM 2008). Given these risks, it was thought that some consumers would avoid GM and Chrysler offerings entirely in favor of vehicles sold by financially sound automakers.

As a result, on March 30, 2009, at the same time that he announced the possibility of a GM or Chrysler bankruptcy, President Obama also took the step of announcing a government-funded protection plan for warranties on vehicles the companies sold while restructuring. While concern over the future of GM and Chrysler would remain, the program was intended to alleviate a major risk associated with bankruptcy and, to the maximum extent possible, bolster consumer confidence in their vehicles (Treasury 2009a).

The AWCP required a participating auto manufacturer to establish an independent bankruptcy-remote SPV to guarantee the warranties; the guarantees did not flow from the manufacturer or the government. Guarantees normally do not require upfront payments by the guarantors; rather, auto manufacturers typically establish an accounting reserve to cover the expected cost of providing warranty services on each newly sold vehicle. The AWCP required Treasury and the participating manufacturers to pre-fund the SPV so that the funding backing the guarantee would be set aside. In the event of either company’s failure, the SPV, a separate legal entity, would remain financially able to meet the warranty commitments (Treasury 2009a).

If GM or Chrysler were to fail, its SPV would be given a 10-day period during which to try to locate a third party willing to accept the warranty obligations in exchange for the funding it held. If the 10-day period passed and no suitor was found, Treasury’s program administrator would seek to carry out this. During this time, the program administrator would be responsible for fulfilling a range of duties, including structuring the processing of claims, assuring their validity, cutting down on fraud, and doing “other administrative functions” as needed (Chrysler and Treasury 2009; GM and Treasury 2008). The government believed it would not be difficult to find a suitor. “Because of the significant funding of the reserve account, Treasury is confident that qualified third parties will be interested in taking over the warranty obligations” (Treasury 2009a).

Each participating automaker and Treasury together contributed funding equal to 125% of the expected cost of fulfilling warranties on eligible vehicles they projected to sell while restructuring, with 88% contributed by Treasury and 12% contributed by the participant (Chrysler and Treasury 2009; GM and Treasury 2008).^FNBased on available information, it is unclear how long each company expected to be in restructuring and thus over how long of a timeframe they projected these costs. GM and Chrysler were responsible for providing 15% of this amount (as 12% of 125% is 15% of the overall total)  and funded the remainder with a Treasury loan (Treasury 2009a). Treasury did not state why it divided the funding in this manner.

The companies calculated the expected cost of warranty obligations using historical data on warranty payouts in years past. If at any point during the program warranty cost expectations increased by more than 10% (for example, by the companies selling more vehicles than expected or due to an unforeseen increase in the average cost of fulfilling each eligible warranty), the companies were required to deposit into the SPV additional funds to cover this increase (Chrysler and Treasury 2009; GM and Treasury 2008). The administration agreements do not detail how this historical data would be used to compute the expected cost of warranty data.

Treasury originally committed up to $1.1 billion for the program and ultimately disbursed $640.7 million in loans. Treasury extended Chrysler a loan worth $280.1 million on April 29 and GM a loan worth $360.6 million on May 27 (Treasury 2018).

Treasury’s loans to each manufacturer had an interest rate of the greater of (1) the three-month Libor plus 350 basis points, or (2) 550 basis points. The loans were payable by 30 days after the termination of the facility, which was June 30, 2010, for Chrysler and July 31, 2010, for GM (or, whichever was earlier, 30 days after the entrance of the warranty SPV into an arrangement with a third-party administrator or 30 days after notice of a successfully completed restructuring) (Chrysler and Treasury 2009; GM and Treasury 2008). There is no data available that explains why Treasury chose these dates to terminate the facility or why the dates differ for the two automotive companies.

Treasury’s loan was designed to comprise 88% of the total funding in each warranty SPV. If the AWCP ended with the funding in each company’s SPV having gone unused, Treasury would be entitled to receive         what it had accrued. However, if one of the companies failed and its SPV had to be put to use, Treasury had no recourse other than its investment plus any interest that might remain after the program’s end. Treasury stood first in line (ahead of the companies) to receive any funding left over (Chrysler and Treasury 2009; GM and Treasury 2008)

To be eligible, a vehicle had to be new and sold by a participating automaker while it restructured. For those purchasing an eligible vehicle, registration for the program was “automatic.” As explained to consumers on the AWCP Fact Sheet: “You do not have to do anything to receive the US commitment to your warrantee [sic]. It is automatic” (Treasury 2009a).  President Obama stated the same in his speech announcing the program (Obama 2009). Individuals owning a GM or Chrysler vehicle at the time of the program’s announcement, or purchasing a used car during the restructuring, would continue to be covered by outstanding warranties, but would not receive benefits under the AWCP (Treasury 2009a).