President Barack Obama ordered General Motors and Chrysler to accelerate their survival efforts and brace for possible bankruptcy, saying neither company had done enough to justify the taxpayer money they were seeking.
Obama, describing the industry as a pillar of the economy, nevertheless gave GM and Chrysler a little more time and money to wring further concessions from workers, creditors and other stakeholders.
"We cannot, we must not, and we will not let our auto industry simply vanish," Mr Obama said in White House remarks on Monday that were partly overshadowed by his decision to force out GM CEO Rick Wagoner.
US stock indexes tumbled on the harsher-than-expected government stance, which could push GM and Chrysler closer to a bankruptcy court restructuring that could threaten equity holders and force deeper losses on creditors.
A committee representing GM bondholders planned to meet later on Monday to discuss a debt restructuring plan, according to a source familiar with the situation.
With about $28 billion in debt to bondholders, the GM offer would translate into $2.2 billion in cash, $4.3 billion in debt and an additional stock-based payout in a recapitalised company that would all but wipe out current stockholders.
The Obama administration is giving GM 60 days to rework its survival plan. The new CEO of the biggest US automaker said a court-supervised restructuring in bankruptcy might be necessary.
Chrysler's operation would be funded for the next 30 days as it works to complete an alliance with Italy's Fiat SpA, considered the No. 3 US maker's best chance of surviving.
A source familiar with the negotiations said Fiat's stake in Chrysler could start as low as 20 per cent.
GM had sought more than $16 billion in new aid after getting $13.4 billion in December, while Chrysler wanted $5 billion on top of $4 billion at the end of 2008.
GM shares closed 25 percent lower on Monday while stock of Ford, which has not sought a bailout, closed down 2.8 percent. Chrysler is privately held by Cerberus Capital Management.
Jared Bernstein, a member of the government's auto task force, told Reuters Financial Television that a process that splits off the "bad" assets of GM or Chrysler, and sends those through a court-supervised bankruptcy, is a possibility, but US officials have not determined yet to pursue that option.
"I don't think we're at that level of analysis until we see the kinds of changes and adjustments, concessions that are going to be made over the next 60 days," Bernstein said.
With US auto sales near 30-year lows, Obama moved to reassure would-be car-buyers, saying the government would stand behind the warranties of GM and Chrysler. He also offered his support for a tax credit incentive of up to $5,000 to trade in older and less fuel-efficient vehicles.
The US auto industry, including cash-strapped dealers and suppliers, has cut 400,000 jobs over the past year while losing billions of dollars.
Deutsche Bank economist Joseph LaVorgna said in a note on Monday that a GM and Chrysler bankruptcy could eliminate a million of the roughly three million auto sector jobs.
"As we have long feared, a bankruptcy - even a controlled one - would put downward pressure on production, further upward pressure on the unemployment rate and likely negatively impact consumer confidence," Mr LaVorgna said.
Obama's auto task force rejected the turnaround plans submitted by GM and Chrysler following their December bailout. "While Chrysler and GM are very different companies with very different paths forward, both need a fresh start to implement the restructuring plans they develop. That may mean using our bankruptcy code as a mechanism to help them restructure quickly and emerge stronger," Obama said.
The Obama administration did not say how much working capital the government would extend to GM and Chrysler over the coming weeks, but GM has said it needs $2 billion for April.
The US government team raced to make the auto announcement before Obama heads to Europe for eight days of meetings surrounding the G20 conference which kicks off tomorrow.
Separately, Canada said plans set out by the Canadian branches of GM and Chrysler did not go far enough to make them viable, but it offered $3.2 billion in bridge loans to tide the companies over while they restructure.
Chrysler said on Monday it had reached agreement on a framework for an alliance with Fiat.
The next step for Chrysler is trying to reach cost-saving deals with creditors and the United Auto Workers, which could yield a $6 billion government investment if all restructuring and alliance pieces fall into place.
Fiat chief executive officer Sergio Marchionne said the talks with the Obama administration have been "tough but fair" and a deal will make Chrysler stronger and preserve US jobs.
GM's new chief executive officer, Fritz Henderson, said the company would address elusive concession agreements with bondholders and the UAW, conditions that are crucial elements of its 60-day window extended by the government to prove viability.
"Our strong preference is to complete this restructuring out of court," Henderson said. "However, GM will take whatever steps are necessary to successfully restructure the company, which could include a court-supervised process."
Wagoner and GM's board had long argued that bankruptcy by any of the major automakers would threaten thousands of jobs, including suppliers, and could lead to a GM liquidation.
Wagoner, who had presided over the company's rapid decline in the past five years and had run the automaker since 2000, was forced out at the request of the Obama auto task force, headed by former investment banker Steve Rattner. A majority of GM's board will also be replaced.
Europe's No. 2 carmaker by sales, PSA Peugeot Citroen, ousted CEO Christian Streiff on Sunday, replacing him with former Corus head Philippe Varin from June 1. PSA Peugeot Citroen shares fell 7.7 per cent in Europe.