Chrysler and GM survived because of the President’s willingness to let them go bankrupt.

In a speech today at the National Press Club, Steven Rattner defended the Administration’s decision to intervene in the auto industry and was harshly critical of the insular culture at General Motors, and years of mismanagement and leveraged debt at Chrysler.

Failure to act, however, was not an option in the Task Force’s view since it would mean the immediate loss or elimination of more than two-thirds of American-owned auto manufacturing capability, cost more than a million jobs in the short run, dramatically deepen and prolong the nationwide recession, and push unemployment rates in several states above 20%.

The question was how to act effectively, and not just buy time for the failed companies.

The Auto Task Force, of which Rattner was a key member, was just being formed when both Chrysler Corporation and General Motors Corporation submitted mandated “viability plans” on February 17. These plans were required when Congress declined to act on behalf of the failing companies before Christmas, and President Bush decided in late December to provide $17.4 billion of TARP funding to GM and Chrysler and kick the problem down the road to the incoming administration.

“Those plans evinced a state of denial as to the magnitude of their problems, the necessary changes and the conditions under which the Administration might provide further assistance,” Rattner said, in a speech sponsored by the Brookings Institute.

It was clear to him that both companies needed massive reductions in their costs and liabilities, including their legacy health care obligations, their labor costs, and their manufacturing footprints.

The government as piggy bank

“The President and his senior advisers were of one mind: No more money except in the context of shared sacrifice and restructurings to become truly viable.”

The next set of surprises came as the Task Force began meeting with various stakeholders at the failing companies. Rattner said the Task Force was startled when bondholders, labor unions, and senior management presented “asks” from the government.

“We had foolishly assumed that stakeholders eager to help would come with gives,” he said.

Thus the stage was set for the bankruptcy proceedings and the so-called 363 sale, which allowed the new companies  to purchase healthy assets, shed non-productive ones,  and begin operating as solvent automakers immediately after emerging from what tured out to be a 30- or 60- day process, which critics has predicted would take years.

This Uncle Piggy Bank attitude also doomed aloof management and complacent members of the board directors at GM.

However, the core challenges remained – how to save GM and whether to save Chrysler?

Just let Chrysler go?

Rattner says Chrysler was a tougher challenge, “having been larded up with debt, hollowed out by years of mismanagement, and operating as just a North American player.”

It didn’t look like Chrysler was worth saving, particularly since most of its waning business was in trucks, minivans and SUVs. Moreover, if it failed these sales would likely be picked up by GM – making it stronger – and Ford.

“From a highly theoretical point of view, the correct decision could be to let Chrysler go. But facing a short-term job loss of 300,000 amidst the worst downturn since the Great Depression, a liquidation felt like an unacceptable risk, if Chrysler could be viable,” Rattner said.

“However, to underwrite Chrysler’s viability, we believed it needed a strong corporate partner. The only apparent possibility was Fiat, which had been recently revived by its own new management team. Fiat also had stylish small cars and fuel sipping engines.”

Thus Chrysler was, for the moment, given a reprieve.

GM’s insular culture

Unlike the debate over saving Chrysler the question at GM was how to save it. General Motors as global company with improving products, the largest market share in the U.S. and strong operations in important countries like China was worth saving.

“At GM, we faced a bigger management challenge than even its reputation led us to expect. Take, for example, the lack of financial discipline. We saw no indication of the finance staff pushing back on the operating divisions to achieve better results, as is customary. Analyses seemed engineered to support pre-ordained conclusions. Symbolically, we never heard the words shareholder value,” Rattner said.

“The cultural deficiencies were equally stunning. At GM’s Renaissance Center headquarters, the top brass was sequestered on the uppermost floor, behind locked and guarded glass doors. Executives housed on that floor had elevator cards that allowed them to descend directly to their private garage without mixing with lower ranking colleagues.

“In that insular world, Chairman and CEO Rick Wagoner and his team appeared to believe that virtually all their problems resulted from some combination of the financial crisis, oil prices, the yen-dollar exchange rate and the UAW,” Rattner said.

It was also obvious to him that any CEO who had burned through $44 billion of cash in 15 months should not continue. However, it was “less clear whether GM would be better off with Rick’s deputy, Fritz Henderson or with an outsider,” as Ford had done.

“If ever a board needed changing, it was GM’s, which had been utterly docile in the face of looming disaster.”

Rattner said that after much discussion, Secretary of the Treasury Tim Geithner and National Economic Council Director Larry Summers decided to recommend a package that would include replacing Rick with Fritz, changing at least half of the board and making an outside director chairman.

The rest is history, still in the making…

Thus the stage was set for the President’s March 30th speech, which consisted of a set of “extraordinarily tough and muscular steps.”

Rattner said he was “stunned” when the Wagoner firing leaked first and news reports came in that the government was “somehow out of bounds for asking a CEO who had lost $13 billion of taxpayer money in three months and was now asking for more to step aside.”

However, the more important news for the future of the companies was the President’s willingness to have both go through bankruptcy, if necessary.

This “dramatically changed the nature of the discussions that we were having with the stakeholders, particularly the senior lenders to Chrysler,” and allowed the restructurings to move forward when all the affected groups realized that they would not be given a straight handout. Now the “gives” began in earnest. And ultimately the new companies emerged with stronger balance sheets, lower debt and operating costs.

In the end, Rattner said; “Like any patient that undergoes major surgery, a successful recovery is far from assured.

“For Chrysler, the biggest challenges are its need to regenerate its product line up and to manage a significantly leveraged balance sheet.

“In the case of GM, the overarching question mark is whether without an infusion of new blood, its management team can implement the massive cultural change that is needed.

“But by dramatically lowering the break even point for both companies, we believed we were creating a healthy margin for error. Most importantly, we based our projections on conservative projections for car sales. Adjusted for new drivers, about 15 million cars a year need to be sold in the U.S. just to keep the fleet from aging, compared to the current sales rate of around 10 million,” he concluded.

Moreover, the business plans the companies ultimately imposed on themselves at the Task Force’s insistence, and with much sacrifice among all involved, use 10 million annual sales as the break even number – precisely where the U.S. market sits today.