Friday, November 14, 2008

Weighing policy options in a bailout of the US automakers

The notion of too big to fail comes to us thanks to our friends in the finance industry. It started in 1980, according to Wikipedia, when the then 7th largest US bank made some idiotic investments and faced a run on the bank. Regulators reluctantly offered assistance instead of letting it fail.

The US is now in a bit of a tight spot. The financial industry is in turmoil. The banks that are too big to fail got government assistance. Some smaller ones have failed or been nationalized. Unfortunately, General Motors chose this very opportune moment to announce that they are soon going to run out of cash. Chrysler and Ford are only marginally better.

Creative destruction is a core tenet of capitalism. In exchange for allowing innovation and wealth, we run the risk that firms will occasionally fail. Sometimes, they fail spectacularly. I'm a staunch opponent of unfettered capitalism. However, unsustainable businesses must either fail, or the government must prop them up. If they aren't critical to infrastructure, like nonprofit hospitals, I would ultimately choose to let them fail.

In particular, the American auto manufacturers abused their political power to escape proper regulation. They also refused to position themselves for a future with higher energy costs - and don't tell me you didn't see it coming.

Additionally, one can make the case that rescuing the automakers would amount to protectionism.

Indeed, Tom Friedman, writing for the NY Times, seems of half a mind to let them fail.

Not every automaker is at death’s door. Look at this article that ran two weeks ago on “ALLISTON, Ontario, Canada — Honda of Canada Mfg. officially opened its newest investment in Canada — a state-of-the art $154 million engine plant. The new facility will produce 200,000 fuel-efficient four-cylinder engines annually for Civic production in response to growing North American demand for vehicles that provide excellent fuel economy.”

The blame for this travesty not only belongs to the auto executives, but must be shared equally with the entire Michigan delegation in the House and Senate, virtually all of whom, year after year, voted however the Detroit automakers and unions instructed them to vote. That shielded General Motors, Ford and Chrysler from environmental concerns, mileage concerns and the full impact of global competition that could have forced Detroit to adapt long ago.

Indeed, if and when they do have to bury Detroit, I hope that all the current and past representatives and senators from Michigan have to serve as pallbearers. And no one has earned the “honor” of chief pallbearer more than the Michigan Representative John Dingell, the chairman of the House Energy and Commerce Committee who is more responsible for protecting Detroit to death than any single legislator.

In the end, Friedman says to nationalize them.

“In return for any direct government aid,” he wrote, “the board and the management [of G.M.] should go. Shareholders should lose their paltry remaining equity. And a government-appointed receiver — someone hard-nosed and nonpolitical — should have broad power to revamp G.M. with a viable business plan and return it to a private operation as soon as possible. That will mean tearing up existing contracts with unions, dealers and suppliers, closing some operations and selling others and downsizing the company ... Giving G.M. a blank check — which the company and the United Auto Workers union badly want, and which Washington will be tempted to grant — would be an enormous mistake.”

I'm not averse to temporary nationalization, unlike small-government conservatives. However, the fact remains that it will be organizationally challenging to oversee the entire auto industry. Congress has a finite amount of time, energy and attention. The financial rescue plan included oversight provisions for the Treasury, but these haven't been put together yet. Assembling enough people with the appropriate skill set takes time, energy and money. Then you have to consider their recommendations and act on them. I'd consider nationalization to be entirely appropriate here, but the government may be biting off more than it can chew, in terms of organizational capacity.

Additionally, there is the question of whether it will actually be possible to restructure the automakers into a sustainable business. Perhaps the North American market isn't large enough for 3 domestic automakers on top of all the foreign ones. I've previously said that at least one of the Big 3 should go bankrupt, and if the government stepped in I would like them to downsize the combined operation significantly - only I'm sure the UAW would go berserk. I have no sympathy for the predicament they stupidly put themselves in. However, I have sympathy for the predicament of workers who will be out of a job, and I consider organized labor to be a critical counterbalance to big business and its political power.

As the Morningstar video I linked above says, the estimated total costs to the US of allowing the Big 3 to go under would be on the order of $370 billion. I believe that figure includes costs to all of society (government and individuals). I believe it includes lost tax receipts and personal income, and additional government expenditures for unemployment insurance and health care. That is a lot of money. The financial rescue package of $700 billion drew tremendous anger, and that is not an expenditure, it is an outlay (much of it should be recovered in time).

It would be nice if the automakers waited until after the recession to go bankrupt. As it is, it looks like the US government will have no choice but to organize some sort of assistance. My opinion is that if they make it a straight loan, the companies will squander the money anyway. The US would be best of if it nationalized or semi-nationalized the automakers akin to what it did with AIG. My preference would be to place them in conservatorship, meaning that the unsustainable operations will be wound down in a controlled fashion. A lot of their international operations are profitable and these can be sold or retained. Of course, nationalization brings its own risks as I discussed above.


Authentic Connecticut Republican said...

It looks like the folks in DC are hell-bent to give the stimulus package another try seeing as the first one didn't have any real effect.

This time it's the car industry.

While the sanity of blowing cash around and running the national debt up even further is questionable; it seems inevitable - so this time let's target unemployment, create AMERICAN jobs and pump up the economy all at one time.

Consider the following:

Manufacturing costs of motor vehicles are 65% labor (i.e.: W-2 income), that's not all direct but due to suppliers. GM alone has over 1300 suppliers. (That's a lot of jobs!)

1 in 10 Americans makes all or part of their income due to the automobile industry.

Money turns over 5 times in a year.
Thus a vehicle with a manufacturing cost of 20K produces 13,500 in W-2 income which in turn becomes a total of 65K in 12 months due to the 5 turnovers.
(This isn't magic, it's simply how the economy works.)

Our domestic car makers are saddled with legacy costs, most of which will reduce dramatically in 2010 due to contract changes. They need to survive to get there.

Our own over-zealous government with a virtual alphabet soup of regulatory agencies has been no help either.
Foreign competitors have worked off-shore collectively to meet various US gov't. imposed emission and safety standards, thus dramatically reducing those R&D costs. American car companies are prohibited from that by our FTC.

Make no mistake; it’s no surprise that once again government has been a major part of the problem.

Here's the solution.

Instead of either shipping cases of cash off to car makers; or sending us all another check:

Send out a voucher for say $1,000 good on a motor vehicle for the percentage of the vehicle that's domestic. (Civic = 70% Ford Explorer=80%)

Let those not interested in a new car sell or give away their vouchers (Ebay would be loaded with them in no time flat) and those that are so inclined can use as many as they can get their hands on up to the full MSRP of the vehicle.

This would bail out the car industry without giving them a dime directly
Further it would reduce the overall age of the nation’s cars which would in turn;
increase overall fuel economy
& decrease pollution.

Strengthen the dollar!

Since vehicles with a higher domestic content would be moving better this would reduce our imports, strengthening our dollar which would in turn further reduce what we pay for anything imported gas!


Instead of simply bailing out a few big companies, this would cause such a run that it would create employment throughout the industry affecting over 1300 suppliers and their workers.
That would give the economy good swift kick right where it needs one!

Pays for itself!

Since money turns over 5 times, and the vouchers are only good for the domestic content of the vehicle, every dime would be spent in the United States creating taxable income.
What is the income tax on 65,000 anyway?
(Remember? 20K manufacturing cost = $13,500 W-2 income x 5 = $65,000)

Another Stimulus Package?

I'm sure you'll agree that this makes more sense than simply sending out checks; many of which will be used to buy new flat screen TV's usually made in Malaysia or some such place.

W said...

Greetings, and thanks for that proposal. You obviously put a lot of thought into it.

I did forget to mention that 1 in 10 Americans have some economic relationship to the auto industry. I believe that was mentioned in an NY Times article today.

However, I disagree with your proposal. I do not think that enough Americans would be able to buy new cars. They would not only have to sell their vouchers, they'd also have to sell their old vehicles. You neglect to consider who would buy the old vehicles. Dealers already have a surplus of SUVs which aren't moving. Who would buy them?

Your proposal would only affect those Americans who want to upgrade to a new, more fuel-efficient vehicle, but are unable to do so. Do you have numbers on how many people this is? Do you have an estimated fuel savings?

I seriously doubt this would get as much money moving through the economy as you're thinking. Additionally, I'm presuming the Federal Reserve would have to issue new currency to pay for this, devaluing existing currency. That, or the Treasury would have to auction more bonds, adding to the national debt.