Tuesday, November 18, 2008

"Big Three" Bail Out: Good or Bad?

Yesterday afternoon I got an e-mail from a PR firm obviously hired by GM to mobilize grass roots support for a government bail-out of their customer (and presumably of other US car manufacturers). One of the things I enjoy about personal finance blogging is that all of a sudden you get all these solicitations from a variety of parties trying to push an agenda, a product or an idea - imagine what it's like to be a member of Congress - but I digress. Anyway, since this is a hot topic, I figured I would put in my two cents on the issue. So, is a bail-out for Detroit a good idea?

Let's examine the proposal: a $25 billion government capital infusion into the "Big Three", presumably with some sort of government over-sight and government ownership stake. It looks like the government is seriously contemplating an active role in the management of these companies. According to automakers, about 3 million jobs are at stake and supposedly $150 billion annually in personal income will disappear if GM is allowed to go bye-bye. Seems like the stakes are big. Now for some opinions:

I went and did some digging. According to Department of Transportation statistics (chart 1-16) the number of domestically produced cars sold in the US was about 5.4 million in each of 2004, 2005 and 2006. No later data is provided. This is a total of about 16.5 million vehicles over the period. Assuming that the number of domestic cars sold last year is roughly the same, the requested $25 billion bailout is equal to a taxpayer subsidy of about $1500 for every domestic vehicle sold over the past 3 years

The so called "Big Three" have been losing money for years. Readers may not remember or know this, but it was the Carter administration who had to bail-out Chrysler back in 1979. At the time, Congress "merely" guaranteed loans by the company. Now we are talking an outright cash infusion. Is it impossible to make money in this industry? Hell, no. Toyota and Honda seem to be doing very well, thank you. So why would we be thinking of throwing away a perfectly good $25 billion of tax payer money into a company like GM who burned through $7 billion in cash in the last quarter alone?

I do not underestimate the possible macro-economic implications of a failure of these behemoths. Clearly, an uncontrolled implosion of such large organizations would have a devastating effect on the economies of Michigan and surrounding states, and I am not advocating that the government allow such an uncontrolled implosion. However, the clear path to a successful resolution of this fiasco goes through bankruptcy court.

If GM cannot continue to fund its operations, it should file for bankruptcy protection. In such a case, a bankruptcy judge could release the company from the ridiculous constraints of its UAW union contracts, could sell off the company's assets to interested buyers who could continue to operate the factories and even take over some of GM's more popular brands. The company could try to raise new private capital and re-organize its operations. GM may or may not be able to make it out of bankruptcy court, but that is none of the taxpayers' business. 

As a society, we should care for the "Big Three's" employees, by offering them extended unemployment benefits, retraining services and actively encourage more capable owners to take over the operations of these companies. However, we have no obligation to guarantee that perennially inefficient and money losing operations continue to exist.

In fact, by allowing these zombies to continue their half-life existence, we are delaying the recovery of the entire auto industry, as healthy and well run auto companies are forced to face hail-Mary, market destroying moves from dying companies. How can we honestly say that we have a free market if we bail-out these companies at the expense of their competitors and, more importantly, at the expense of the taxpayers?

There is one more charge that I need to answer. I have previously argued in favor of a bail-out for the financial industry. Why do I oppose this one? Is my position inconsistent? I believe that my position is completely consistent. In the case of the financial sector, we were facing a classic case of market failure. The market was simply not functioning. People were not lending or trading simply because they had lost confidence. Moreover, the financial industry was in such shambles that the very basis of the capitalist system was being threatened. In this case, the situation is completely the reverse. In the case of the "Big Three" the market has spoken. It is not that all car companies are facing bankruptcy, it is that those big, lumbering, inefficient ones whose products the consumer no longer wishes to purchase that are facing failure. Others car companies, while suffering from the economic downturn, are still profitable and are doing fine. 

I am not quite sure if this was the reaction that the "Big Three" PR person was seeking to provoke from me, but there you have it. I am firmly against a government bail-out of the "Big Three", and my opinion appears to be diametrically opposed to that of the President Elect. I call this mistake one for Obama, but we shall see...

11 comments:

Ren said...

I'm still not convinced that the financial industry bail-out was a good idea. I think it is more similar to the auto industry than you make it out to be, as there do actually exist many smaller banks that neither needed nor received assistance. Further, that bail-out just makes further bail-outs like this one all the more likely.

At the very least, the financial industry bail-out could have been done in a less-moral hazard way. For example, rather than try to help the failing institutions, provide incentive to the healthy institutions to pick up the slack.

Mr. ToughMoneyLove said...

The GM PR folks didn't bother to send me a fact sheet because I had already come out against the bailout. This a UAW bailout at its core and unless and until the UAW comes to the table with concessions that lower relative labor costs on domestic cars, the heck with them.

Shadox said...

Mr. Toughmoneylove - I couldn't agree more. These companies are run in a ridiculous fashion - the unions control every aspect of the business and their contracts give them such ridiculous pay and benefit that their companies are literally falling apart under the weight of these programs. According to the GM PR "fact sheet", GM alone carries on its back pensions and health care for 800,000 retirees... how can a company survive under such conditions? FYI - this morning I heard on NPR on the way to work - that the $25B in bailout money is expected to take the companies to 2010 when UAW concessions kick-in and the car market is expected to bounce back.... why not get those concessions to start immediately?

Ren - clearly there are some things about the financial institution bailout that did not operate well. However, I don't blame Paulson or Bernanke - these guys were like generals in the heat of battle. Sometimes its hard to make perfect decisions under fire.

The problem with the financial system is that by its nature it is an interconnected system. Every trade has a counter party, and if some of the big guys fail, hundreds of the smaller guys fail with them because their counter party in trades suddenly disappeared. With the financial industry there really was no choice but to create emergency liquidity and support the survival of key players. Could it have been done better? Sure, in hind sight, but you don't hold a general responsible for making tactical mistakes when he's in the middle of a war.

AHP said...

If people would understand that the Detroit Three have more competitors on an uneven playing field and that they still sell nearly half the cars with more innovation than people realize, they wouldn't be so unpatriotic. Other countries support their companies' with socialized healthcare and pensions while our corporations have to foot the increasing bills. We have wide open borders while other countries close markets and impose tariffs on our products. Fairness has to be restored somehow and loans are needed in the interim.

If we had a country without the auto industry, millions of jobs would be lost (in medical, legal, advertising industries, dealers, small businesses), our trade deficit would grow and we would have no manufacturing base to make tanks and parts for weapons. Service industries generally don't provide nearly as much boost in trade and the jobs generally don't pay as well.

Read the facts, American car companies vehicles are amongst the most fuel efficient in their segments...

http://www.freep.com/article/20081117/COL14/811170379

It's ironic that the Detroit Three wouldn't be in such a mess if it weren't for the greed of the banking industry. We helped them out, didn't we? Instead of pushing numbers around and creating fake wealth leading to catastrophe, the car companies have been making great products that people get a lot of utility out of.

UH2L

AHP said...

And as for the financial bailout, it wasn't a random market failure, it was a market failure brought about by greed and incompetence courtesy of the industry itself, nobody else! In the case of the auto industry, there is oil speculation, credit crises, trade unfairness, currency manipulation, legacy costs, and competitors without the burden of healthcare and pensions because, ironically, they are from more socialist countries.

And when you say "the market has spoken", you make it sound as if nobody buys products from Detroit companies. Half of the market is not nobody.

Shadox said...

AHP - in the interest of full disclosure, you should have mentioned that you work for the automotive industry. At least that is what your profile seems to indicate.

Let me deal with your points one at a time:

1. Are you seriously making the accusation that people who consider a bail-out for Detroit to be a horrible waste of tax payer money are unpatriotic? Interesting. Here I thought that we were talking about an economic point of view, not about patriotism. However, I will say that I don't consider American auto workers and managers who work for GM any more American than the thousands upon thousands of Americans who work for Toyota and Honda in US plants.

2. Other countries impose tariffs and close their borders? Just this morning I heard on NPR that GM has a nearly 10% market share in China; and it is a well known fact that outside the US GM is actually making money - e.g. its European operations are doing fine. It is here, on its home turf, and under the watchful eye of the UAW that these companies are failing. Miserably.

3. A US without the auto industry - no one is talking about eliminating the auto industry from the US. There would be plenty of car production in the US without them. People would still buy the same numbers of cars, only they would buy them from other manufacturers. Building cars in the US is still a good idea - hence the many plants being opened (mostly in the South away from UAW control) in the US by "foreign" car companies. And I am certain that you did not try to make the point that our military might is dependent on the "Big Three" since I have not recently seen an Abrahams tank roll off the GM assembly line. I am pretty sure those are manufactured by General Dynamics...

4. American car companies are most fuel efficient in their segments? Is that why Toyota and Honda commercially introduced hybrids first? A full DECADE before GM who introduced its first hybrid LAST YEAR? Is that why these manufacturers have consistently and for decades aggressively lobbied against any increase in fuel economy standards? Is that why they have for years hidden behind loop holes in the cafe standards that set different standards for so-called "light trucks" that people dry to the supermarket? Is that why they are still lobbying against California's regulation of CO2 tail-pipe emissions? Give me a break.

5. "In the case of the auto industry, there is oil speculation, credit crises, trade unfairness, currency manipulation, legacy costs, and competitors without the burden of healthcare" - wow. Everyone is to blame here... oil speculation, trade unfairness, currency manipulation, aliens from Tralfamodore... everyone, that is, accept for the United Auto Workers and the incompetent management. I don't know what to say. By the way, I completely agree that health care is a problem nationwide, however, last time I checked, Microsoft, Boeing and Caterpillar are also providing healthcare to their employees, and they appear to be... profitable... could there be something more here?

6. The market HAS absolutely spoken. Yes the "Big Three" are still selling a large portion of domestic vehicles however, their share of the market has been declining consistently since the early 70's. In 1970 according to DOT statistics (see the source chart in my original post), domestic production accounted for about 84% of US car sales. I would say that going to below 50% is a pretty precipitous drop. Besides, if the market loves Detroit cars so much, let GM and its ilk go into bankruptcy, reorganize and continue to sell their cars to the clamoring masses. Why do they need my money?

Greg said...

The question that needs to be answered is 'What will a bailout fundamentally change in the "Big Three" so they will become profitable and not need another infusion?'

AHP said...

I used to work in the auto industry, but my comments are valid either way. It seems like you work in banking? Even so, that doesn't automatically invalidate your opinions or logic on it.

1. Are you seriously making the accusation that people who consider a bail-out for Detroit to be a horrible waste of tax payer money are unpatriotic?

+ I'm not saying it's unpatriotic to not support the bailout or to work for a foreign manufacturer, but it's unpatriotic to dismiss considering our home-grown products. It's also unpatriotic to pretend to fully understand the situation without knowing the auto industry or to make a decision based on a grudge against companies based in this country (or the UAW).

2. Other countries impose tariffs and close their borders? Just this morning I heard on NPR that GM has a nearly 10% market share in China; and it is a well known fact that outside the US GM is actually making money - e.g. its European operations are doing fine.

+ China is an exception. Check how closed the Korean and Japanese markets are for Detroit Three products. It is very tight if not closed. And also don't forget about the way Japan has manipulated its currency to keep their prices artificially low. Our government needs to stand up for our companies to keep trade fair.


3. People would still buy the same numbers of cars, only they would buy them from other manufacturers. Building cars in the US is still a good idea -

+ This shows your lack of knowledge of the auto industry. Suppliers to the Detroit 3 often supply Honda, BMW, and Toyota here. If the Detroit 3 go under, then many suppliers go under. Then, that means no parts to build cars for the transplants, (in addition to many supplier jobs being lost).

And I am certain that you did not try to make the point that our military might is dependent on the "Big Three" since I have not recently seen an Abrahams tank roll off the GM assembly line. I am pretty sure those are manufactured by General Dynamics...

+ General Dynamics wouldn't be able to make enough if we entered into a World War. Check out this link which shows how Chrysler alone made significant contributions to the military efforts of WW2.

http://www.allpar.com/history/military/preparing.html

Without a manufacturing base and enough tooling and machining capability, you can't just flip a switch and start making heavy machinery. I suppose our government could take over the transplant plants, but that might be illegal.


4. American car companies are most fuel efficient in their segments? Is that why Toyota and Honda commercially introduced hybrids first? A full DECADE before GM who introduced its first hybrid LAST YEAR? Is that why these manufacturers have consistently and for decades aggressively lobbied against any increase in fuel economy standards? Is that why they have for years hidden behind loop holes in the cafe standards that set different standards for so-called "light trucks" that people dry to the supermarket? Is that why they are still lobbying against California's regulation of CO2 tail-pipe emissions? Give me a break.

+ Not everybody wants or can afford a hybrid and it's true that the GM was late to the hybrid party for which I don't forgive them. But hybrids are a small part of the market. For cars and trucks that most people buy, there are very efficient Detroit-based alternatives. The press and other people call Detroit products "guzzlers" without knowing the facts and that unjustifiably hurt their reputation and sales. GM should get some credit for working on the EV1, and now the Volt plug-in hybrid as well as hybrid buses which save millions of gallons of fuel every year.

All corporations are meant to make profits. Looking for loopholes and taking advantage of the regulations is what any company will do (including the companies that are not from Detroit). The fault lies more in the regulation allowing for these workarounds. I wish the government had slowly increased the fuel economy standards against the will of the auto industry. And I don't think you realize how much goes into making cars significantly more fuel efficient. It takes significant effort and will drive up the cost of the cars. The buying public used to pay more for power not fuel efficiency and then gas approached $4/gal and everything changed suddenly. We still don't know if they'll pay for fuel efficiency, (besides the small hybrid customer base).

5. "In the case of the auto industry, there is oil speculation, credit crises, trade unfairness, currency manipulation, legacy costs, and competitors without the burden of healthcare" - wow.

+ The UAW and management have caused some of the problems. I'm not dismissing them. It is however partially the government's responsibility to make sure that its industry is not put at a disadvantage by global circumstances. The issue is not who is to blame. Rather it is, what should be done to help our country the most in the long term. Would you rather have companies go back on their healthcare and pension promises to the UAW employees and put more of a burden on the government's budget? (The Detroit 3 have already saved the government billions by providing good benefits.) Would you rather have millions of people lose jobs and lead to more unemployment benefits being paid out while the tax revenues dry up?


6. The market HAS absolutely spoken. Yes the "Big Three" are still selling a large portion of domestic vehicles however, their share of the market has been declining consistently since the early 70's.

+ The Detroit 3 had fewer competitors in the 70's than they do now, so some market share attrition is bound to occur by virtue of there being more choice. I would argue that if it were not for the banking crisis, the Detroit 3 companies would not have needed assistance. Their restructuring efforts and new products would have allowed them to survive. What is bothersome is how there is such a negative spin about the Detroit 3 in the media which exacerbates the problems. This has made it hard for them to get fair consideration in the market. This includes their using terms like "guzzlers" as if none of their products are efficient and then treating the Japanese companies as darlings just because they make a couple of hybrids. The press also doesn't give credit for recent quality improvements showing how the Detroit 3 are very close or sometimes surpass the Japanese in quality. When there is a recall, the ones for the Detroit companies are in the headline while the ones for the foreign competitors show up lower in the article. Look for these things and you'll see what I'm talking about.

To add a final note, I just learned that Germany is willing to support Opel, GM's European arm. It's amazing how other countries are shrewd and smart enough to protect their industry because they realize its importance while many of us here in the US seem content to just let it fade away regardless of the costs.

I still can't believe how you defend the banking industry more than the auto industry. They have screwed us over far more than the auto industry has and I would argue that their situation is more of a direct result of their own greedy decisions and less a result of circumstances beyond their control. They made fake unbacked products and put our investments and whole economy at risk. At least the Detroit 3 were trying to make profits by making real products.

Shadox said...

I am not in the finance industry and have never been. I am an executive in a high-tech company which has no affiliation with any financial institutions (other than our banks and investors, of course).

If not wanting to give my money away to failing auto companies is unpatriotic, than fine, call me unpatriotic. I believe that the traditional term is capitalist, but suit yourself.

I have no grudge against the UAW, but I understand how big labor operates. Ridiculous work rules than prevent management from running the company are simply unacceptable in this day and age. Clearly the "Big Three's" labor contracts are a heavy weight around their necks. Other companies in this country employ large numbers of workers without running into such pain. Can you explain the reason for this difference? I propose unions are a big part of it.

I agree that our government should insist on fair trade. However, too often the call to "fair trade" is really the slogan of protectionists who are really pushing for trade barriers, increased tariffs and preferential treatment. I would think that our definition of fair trade is very different.

Again - if the same number of cars is being purchased - since clearly people need the same number of cars - why would fewer parts be sold? In reality, what is most likely to happen is that if GM goes into bankruptcy, their factories would continue to operate and cars would still be produced. In the long run, the good brands are likely to be acquired by competitors and manufacturing plants will continue to build cars albeit for other producers. Just like United flew into and out of bankruptcy, so could GM and co. Assuming they are strong enough to emerge. If they are not, than it is time for them to die.

Of course, companies are in the business of lobbying government and using loopholes to their own benefits. I don't blame them for doing that. I blame government. However, I don't sympathize with companies who lobby against public interest, get their wish, and then get screwed by their own lack of judgment and foresight. To them I say "go solve your own problems and don't come crying to me".

Finally, please don't mistake my support for the financial industry bail-out as sympathy for those companies. I think that those guys are complete jerks that should get what's coming to them. I supported the bail-out not because I care about them, but because I care about the rest of us, and the economic implications of letting these companies fail were simply not acceptable for the world as a whole. I may be wrong, but I don't judge the situation to be similar in the event of a collapse of one or more of the Detroit companies.

You clearly have strong and well thought out opinions on the subject. While I strongly disagree with your conclusions, I really appreciate the fact that you have taken the time to debate with me and to voice out your ideas on my blog. Thank you!

Retired Syd said...

There's something I'm missing from all this discussion of the automaker bailout. I'm under the impression that the reason the automakers are in trouble is because not enough people are buying their cars.

So tell me again how infusing $25 million into the industry will suddenly get people to buy those cars?

Yes, I understand that jobs will be lost if they go under, but do you remember the dot-com bust? A lot of jobs were lost then too, and we went into recession. I don't remember anyone saying we should infuse the dot-coms with $25 million so we could prevent the loss of jobs and prevent a recession.

AHP said...

Shadox,

I enjoyed our discussions too and it all made me think more about the issue. I appreciate your comprehensive, intelligent responses as well. You have some good points. This is the kind of debate I like on my blog as well. It has only happened on a few of my posts. The fact that you work in a high tech company means you don't have to deal with the legacies of old companies, so you are fortunate.

I guess the last thing I'll say is that the loan is only a good idea based on the premise that it would help the car companies get through the financial crisis and that they would emerge, (without having to file bankruptcy), as viable businesses. I think they would, while others disagree. If we weren't in this financial hurricane, the Detroit 3 would have been able to get financing privately. I'm not impressed with the showing of the auto execs yesterday at the hearings. They were not compelling and the fact that they flew there on private jets made headlines, although they should have argued that the saved time is worth more than the expense of a private jet relative to flying commercial.

I don't see bankruptcy as a viable option because it will lead to a sharper drop in sales and reduced profits. People don't buy cars if they can't be sure of parts and service availability for 3 to 10+ years. One survey said 80% of people won't buy cars from a bankrupt auto manufacturer. Since they are much cheaper than cars, airline tickets are bought and used up quickly so people have no qualms with buying from bankrupt airlines.

What's interesting is that many people think companies should go bankrupt to get out of their obligations when to do so as an individual is almost seen as unethical and as a cop-out.

If the government would take care of the healthcare and pension that GM, Ford, and Chrysler are burdened by, the companies could be much more competitive. Perhaps that is the answer. If the companies go under, the government will end up paying for it in some form anyway. Another alternative, (which my mom thought of), would be to go bankrupt and come out as a new company with new brands. That would be very very expensive and not all consumers would go for it.

Take care,
Atul