Monthly Archives: November 2008

Auto Company Bailout: Make it Hurt

Posted on November 18, 2008 | 9 comments

Politicians in Washington are debating whether the government should bail out the Big 3 American automakers: Chrysler, Ford and GM. In addition to the $25 billion in low cost loans the government has already committed to Detroit, the Democrats, including President-elect Obama, are pushing for more aid. I have long been fascinated by the utter incompetence of American car companies, and came out against the $25 billion in loans, so of course I have some thoughts on this push for additional help.

I’m going to ignore ideology (eg. in a free market we should let companies fail) and focus on practical issues. But practically speaking, giving money to the car companies would be rewarding failure. For 30 years the Big 3 have been getting spanked by Japanese, German and now Korean car companies. They have relied on trucks and SUVs to generate profit and have proven themselves completely unable to produce an appealing small car. They have also demonstrated a fantastic inability to retool their processes to compete with the imports.

NYU business professor David Yermack calculates that GM and Ford alone have invested $465 billion in capital since 1998 and have seen their combined market capitalizations drop from $117 billion to $6 billion today. These are not companies that spend money well, so why should the taxpayers give them any more? And let’s not forget that GM CEO Rick Wagoner made $3.3 million last year while Ford CFO Lewis Boothe made $3.1 million (I’m letting Ford’s CEO off the hook for his $9 million because he’s new and they had to pay up to recruit him from Boeing). Why should our money go to support multi-million dollar salaries for guys who are screwing up?

Conservative commentators (hello Wall Street Journal) blame much of Detroit’s problems on expensive union contracts and hefty benefits paid to retirees. The usual estimate is that retiree legacy payments add $1,500 to the cost of each vehicle. But even if you could take $1,500 off the price of American cars, they would still lose market share because the cars suck. A comparable Toyota is worth $1,500 more because it is better made and will last forever. Also, I should note that it was the executives of the car companies who signed those rich union contracts. That being said, the UAW is way out of line with the overall labor market. Gold-plated health benefits, ridiculous work rules and no-layoff clauses are no way to help your company beat the competition.

So the main argument against bailing out the Big 3 is that it would be throwing good money (OUR money) after bad. What are the reasons to support a bailout? It turns out that there are 3 million of them; that’s the number of jobs that analysts have tied to the auto industry. And the theory is that if we let the Big 3 fail, all those jobs will go away. The car companies are saying that nobody will buy cars from a bankrupt company. I don’t totally believe that – I think that Americans have flown enough airlines that were in bankruptcy to understand that a bankrupt GM doesn’t really go away – but nor do I agree with Yermack that Toyota and Honda can just take up the slack. Realistically, it will take years for the foreign car companies to ramp up production to take over for a failed Detroit company. There is also the argument that the auto industry drives America’s sophisticated manufacturing industry, which is essential for both national security and future economic growth. I don’t know enough about that to comment intelligently, but it makes some sense on its face. Finally, there are all those retirees with health insurance and pensions. If the Big 3 fail, the obligations to support all those people will fall on taxpayers anyway.

So maybe, on balance, some sort of bailout is a good idea. If even 500,000 jobs were lost and the Big 3 pensions put onto the taxpayers, that would not be good for the economy. But good idea or bad idea, the bailout is still going to happen; the Democratic leaders (Nancy Pelosi and Harry Reid) are pushing for it, and Barack Obama owes the unions big time for getting out the vote. And if it’s going to happen anyway, let’s at least push for it to be done the right way.

Any federal bailout of the Detroit automakers needs to A) be onerous to shareholders and executives, and B) force restructuring on the industry to make it competitive. Paul Ingrassia, who won a Pulitzer Prize for his Wall Street Journal coverage of the auto industry, argued for removing current management, wiping out shareholders and restructuring contracts. He is absolutely right. And wiping out shareholders has to include the Ford family, who continue to dominate Ford Motor Company. Michael Levine, a lecturer at NYU School of Law, adds that the dealer networks have to be restructured. It has long been known that the Big 3 have far too many brands and dealers relative to the cars they sell (GM has 7,000 dealers while Toyota has 1,500) but state laws protect dealers from being closed. These state laws exist because dealers are big players in local economies; unfortunately, they are not big players at the national scale, and these state laws need to be trumped by national concerns.

All of these objectives can be realized through a packaged bankruptcy, which was suggested by Edward Altman, a business professor at NYU (lots of NYU references in this post). Packaged Chapter 11 bankruptcies, in which the financing that takes you out of bankruptcy is pre-negotiated, are pretty common. The government would provide the financing, and that would address the concern that consumers won’t buy cars from a bankrupt manufacturer. In fact, a packaged bankruptcy is the only route I can see that achieves all important goals:

  • Management removed and compensation limits implemented
  • Current shareholders wiped out
  • Union contracts renegotiated
  • Dealer contracts renegotiated and state laws changed.

So please, politicians, I implore you: don’t give in to corporate and union lobbying and just hand the car companies money. Use this opportunity to force on the car companies the changes that they need.

An interesting side note is that this is another case of the metaphysical phenomenon of current actions sowing the seeds of one’s eventual destruction. For decades the Big 3 have fought against fuel efficiency, spending gajillions of dollars lobbying against the CAFE fuel economy standards instead of just building better cars. And now, because they can’t build a good small car, the Big 3 are begging for help. In the same way, Republicans have for years been resisting any legislative efforts to push fuel economy, and look what just happened to them. Congressman John Dingell of Detroit, although a Democrat, has been the Big 3’s biggest supporter in DC (his wife is an executive at GM), and now Henry Waxman is trying to take away Dingell’s precious chairmanship of the Energy and Commerce Committee. In all these cases, we are seeing people and groups being beaten by that against which they fought the hardest. Very Jungian, don’t you think?

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Posted in Business, Environment, Politics

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The GOP is Splitting in Two

Posted on November 7, 2008 | 3 comments

In the wake of sweeping Republican losses on November 4, we are seeing the GOP fracture into two wings. The first wing is the traditional, intellectual wing, as personified by George Will. This is the low taxes, small government, muscular foreign policy wing. The second wing is the Main Street, rail against the elites wing, as personified by Sarah Palin. This is the social conservative, religious right, law and order wing. These two wings always had a tenuous coexistence in the party, with the intellectual wing using wedge social issues to get the Main Street wing riled up, and then screwing them economically. The intellectuals provided the money and ideas while Main Street provided the votes.

This tenuous coexistence, however, has now turned into open hostility, with each side blaming the other for McCain’s loss. And as the GOP tries to figure out what it really is, and how to avoid a third consecutive stomping in 2010, these two wings are fighting for dominance. Unfortunately for the future of the Republican Party, the two wings can’t reconcile, and neither wing can win an election on its own. After all, even with the wings combined, they just got smoked by Barack Obama’s politics of hope. On their own, they are doomed.

The intellectual wing itself has two components – the rabid neocons and tax cutters versus the more moderate Rockefeller Republicans – but they both share a commitment to lowering taxes and shrinking government. They also share a slavish devotion to President Reagan. McCain, despite his campaign rhetoric in 2008, is part of this wing. As Joe Klein from Time described him:

He believed in the unilateral exercise of American power overseas, with an emphasis on military might rather than diplomacy. He believed in trickle-down, supply-side, deregulatory economics: his tax plan benefited corporations and the wealthy, in the hopes that with fewer shackles, they would create more jobs.

But widening income disparity and the financial crisis of 2008 have fundamentally discredited that economic approach. Reaganism failed. And while the Rockefeller Republicans might be able to craft a workable economic theory, they are so marginalized in the party that they can’t ever win. Moreover, there simply aren’t enough Americans driven by desire for lower taxes to support this wing of the party. There are too many citizens who actually want their government to provide something.

The Main Street wing of the GOP is the part that believes there is a “real America,” as opposed to the liberal “fake America.” It’s anti-elite, anti-intellectual and anti-media. Which is its main problem: it’s against everything and for nothing. It is fueled purely by anger and self-pity. This is unsustainable; without new ideas, this wing will wither and die. It will be consumed by a black tumor of hate, like Lee Atwater‘s brain.

Also, much like the intellectual wing, the Main Street wing isn’t large enough to win on its own. There aren’t enough voters who buy into its false dichotomy. This wing, however, has a chance. If it were to embrace a truly populist economic strategy, it might be able to peel off enough blue collar Democrats to build a winning coalition. Even the Wall Street Journal notes that “new Republican voices are popping up to argue that the importance of working-class voters means the party needs to develop economic policies more obviously directed toward the working class than the capitalist class.” But that would require a complete reworking of Republican economics: supporting unions and trade protection at the expense of corporate interests and wealthy individuals. It would require an approach that sounds strikingly similar to….the Democrats.

This is the problem facing GOP strategists as they figure out what to do. They want to chase the voters, but that will require moving away from their core philosophy, because that’s what the voters are doing. As Politico put it, the GOP is “a party that is overwhelmingly white, rural and aged in a country that is rapidly becoming racially mixed, suburban and dominated by a post-Baby Boomer generation.” Some strategists want to pursue growing demographics, namely black and Hispanic voters. But how do you do that when your two wings cater to wealthy WASPS and white rednecks, respectively? Both wings of the GOP have painted themselves into electoral corners, and there is no obvious way out.

Perhaps the recent election marked the generational shift that we all knew was coming. For the past 20 years government has catered to, and been run by, people of our parents’ generation – those who grew up in the 1940’s and 1950’s – often leaving those of us from later decades mystified at the decisions being made. And we kept wondering, as old fogeys (Ted Stevens!) retired or died, and young folk grew old enough to vote, when our generation would start making decisions. Nobody WE knew hated blacks, or thought that poor people should be abandoned, so why was government pursuing such crappy policies? Why was the GOP so out of touch with our generation? After all, when you belong to a generation where a third of you have tattoos, it’s hard to see how branding a black candidate as “Muslim” is going to work. And it didn’t: Obama won, while conservative congressional candidates lost.

The GOP isn’t dead; its basic message of small government and individual liberty will always resonate. But it needs to do a lot of work to retool that message into a governing philosophy that will appeal to the new generation.

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Posted in Politics, Trends

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Shock & Awe – The Good Kind

Posted on November 5, 2008 | 1 comment

Last night’s results created the type of shock and awe that we can all use. Not so much shock for me, since I’ve been confident of an Obama win for about a week, but definitely awe.

I was watching the results last night with about 20 friends, and we are generally a boisterous crowd. But when Obama gave his acceptance speech, we were utterly silent. That silence was not because we wanted to hear Obama’s dulcet tones; it was because we were struck speechless by the import of the moment.

America’s first black president. Think about it. We did; in mute awe my friends and I contemplated the greatness of that achievement. None of us are black, but we all recognized how important this was. Obama’s election probably won’t solve all the country’s race problems, but it sure feels like a big step. How can you not love a country where a black man named Barack Hussein Obama can rise from modest means to become president?

Yet our awed silence transcended Obama’s race, for there was a sense that his election represented a transformation of American politics. Votes for Obama were votes against divisiveness and for unity. They were votes against dishonesty and for solutions, against paralysis and for progress. They were votes that swept aside the past eight years, years of Bush and DeLay, of crony capitalism and Terri Schiavo. We were silent because Obama’s victory justified – wait for it – the audacity of our hope, our hope for change.

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Treasury Plan Turns Taxpayers into Dumb Money

Posted on November 4, 2008 | Leave a comment

Yesterday’s Wall Street Journal ran an article about how the Treasury’s bank buyout fund is luring “thousands of banks.” When the program was first announced, banks were afraid to apply, thinking it would make them look weak, but now they are afraid not to apply, since not having government money could make banks look like they were too weak to qualify.

But the article also noted that banks are thronging the Treasury because the Treasury capital – taxpayer capital – is so cheap. Here is the money quote:

Now institutions across the U.S. worry that if they don’t try for the money, the market will judge them as too unhealthy to qualify, or lacking the savvy to deploy cheap government capital on acquisitions and investments.

Many years ago I worked for a venture fund that was captive to a small investment bank. All the other VCs looked at us as dumb money. “Nobody else will invest in it, call those guys…they’ll do anything to get a banking fee.” Dumb money is who you call to bail out your losers. Dumb money accepts whatever price you offer, and doesn’t ask for better terms.

The Treasury department, acting on behalf of the taxpayers, is dumb money. WE’RE dumb money. That sucks.

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