Auto Company Bailout: Make it Hurt

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?