Is an Automaker’s Road to Bankruptcy Paved with Customers ’ Beliefs?

Durable goods producers can face a pernicious feedback loop between their financial health and the demand for their products. Financial distress can reduce demand for a firm’s products if it causes consumers to worry about the firm’s ability to supply flows of goods and services—such as warranties, spare parts, and maintenance—that are typically bundled with the primary durable good. This drop in demand harms the firm’s profitability, exacerbating its financial distress, which in turn further heightens the demand impact. In principle, this cycle can spiral until the firm falls into bankruptcy. The feedback mechanism might even sustain “bank-run-like ” self-fulfilling expectations (e.g., Douglas W. Diamond and Philip H. Dybvig, 1983): if consumers suddenly believe a firm is distressed, even incorrectly, the resulting demand effect could push the firm into distress and even bankruptcy. Concerns about such effects in auto manufacturing played a prominent role in policy discussions during the recent recession. Some feared that the already struggling General Motors and Chrysler would be further harmed due to consumers ’ worries about warranty viability. In March 2009, the U.S. Treasury announced the creation of the Warranty Commitment Program