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?

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9 responses to “Auto Company Bailout: Make it Hurt

  1. JC, nice to see a post on which you and I can agree in spirit. 🙂 I did have a few thoughts on your 4 goals.

    – Item 1 throws the current bums out; will compensation limits really induce good replacements to join?

    – Item 2 totals $6B per your post, so it’s not going to have much impact. What would you propose to do about the ~$150B in debt?

    – Item 4 runs against my “federalist” grain, but perhaps could be realized via a “restraint of trade”-type argument. I gather from other discussions that this dealer factor is more important than I realized.

    – Item 4, in my mind, is the big kahuna. It would be interesting to see Obama, Nancy, and Harry screw the unions. Sadly, I don’t see it happening.

    Cheers,
    KL

  2. KL, I didn’t know you cared. To respond to your points: 1) smart people can’t go to Wall Street any more, so salaries everywhere will come down. Besides, big shot CEOs are in it for the ego. 2) Wiping out shareholders isn’t about saving money. In a normal bankruptcy, the debtholders become the new shareholders. The finance arms complicate things, but fundamentally, if you lent money to a car company, you deserve to lose it. 3) The dealer problem is a huge drain on the car companies. 4) Yes. Although I don’t see the UAW as a problem the way the WSJ does, they are going to have to accept concessions.

    Added bonus — see the Onion’s metaphoric take on the issue: http://www.theonion.com/content/video/in_the_know_should_the_government

  3. The heads of the “Big 3” went to DC today to ask for more taxpayer $$$. And how did they arrive? Each in their own private (corporate?) jets. Pretty gosh-darn cost effective. I agree – management removal post-haste and a mandated end to corporate greed whilst sucking on the tax-payer teat!

  4. …The other automakers you cite (Toyota, etc) in your original post also have plants in the US and also employ UAW members. If the UAW is at all culpable here, you’d think those other car makers would be in worse straits too.

    Why is anyone blaming the UAW for the failings which lie solely at the hands of the Big 3’s execs? It defies logic.

    (c/p at Illinois Reason)

  5. Actually, very few of Toyota’s workers are unionized. In fact, the UAW has never unionized a factory wholly owned by a Japanese automaker. GM pays $80 per hour compared to $50 per hour at Toyota, including benefits. Both of those facts are from NY Times articles in Sep. 2007.

  6. Point taken, mistake admitted.

    My full reply is at Illinois Reason.

  7. Oh dear…

    Thoughtbasket, it turns your $80/hr figure for GM is just flat-out wrong…

    The average hourly wage for the Big 3 is only $24… Add in average “hourly” benefits package of about $11 and you get around $35/hour in salary and benefits… well under the $50 quoted for Toyota. (My hunch is that $50 rate used for Toyota is also quite inflated.)

    Why the disparity between quoted numbers and reality?

    Apparently some anti-union partisans were throwing the kitchen sink into the numbers by including the total costs for all benefits for all employees, present workers and (here’s the kicker) retirees.

    Presto change-o, an average worker’s hourly rate of around $35 salary + benefits turns into a (follow me here) total-salary-and-bennies-for-all-current-and-retired-workers-divided-by-only-the-number-of-current-workers of around $70 to 80….

    As Yoda might say: Paint a sinister picture by numbers, that fuzzy math does.

    (c/p at Illinois Reason)

  8. Corrections: Average wage at Big Three of $28 and bennies of $10…. (typing while sleepy).

    Still totals only $38 altogether.

  9. Excellent commentary. Your blog just got bookmarked.

    Rob N
    Why would you not include the total cost of labor when comparing against competition? This is not fuzzy math, it is reality. The heavily unionized Big 3 use defined benefits (often underfunded) while their competition in the US uses contribution type pension plans like the most other companies.

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