Why and How to Bail Out Detroit (Continued)

17.11.2008

One reason nobody is excited about bailing out the auto industry is that it defies the free market. If the companies can't make it on their own, shouldn't the government just let them die? It's a reasonable argument. But today in the Washington Post, an economist with some pretty cood intellectual credentials--Jeffrey Sachs--makes the case for a bailout anyway.

...the automakers cannot turn to ordinary borrowing to tide them over until that happens because of the ravaged capital markets. The risk spreads of corporate bonds over U.S. Treasuries are the highest ever, and many borrowers can't get credit at any price. That's why the government has embarked on nearly $1 trillion in direct interventions. A small part of that should be used for the auto industry.
In this environment, the normal market test of consumer demand can't be used to judge which industries should survive. We are experiencing the steepest temporary decline in consumer spending since the Depression. Consumer financing for autos has collapsed. Households are retrenching after the greatest wealth loss in equities and housing in history.

Sachs' excellent article makes one other point, which I neglected to mention in my own take on the auto industry. Among the reasons Chapter 11 may not be a great option for the auto industry is the potential impact on consumer demand. As many industry analysts told me, people are perfectly willing to fly on an airline that's in bankruptcy. They have faith in safety regulations plus, in many cases, there are few if any alternatives for getting from one city to another (at least by a convenient, affordable route). But a widely cited marketing survey has shown consumers would not buy a car from a company in Chapter 11, because they'd worry about service warranties and the availability of parts in the future.

One thing to keep in mind: Offering the auto companies a bailout is not an alternative to restructruing. It's really about managing a restructruing, already underway, in part to avoid a catastrophic shock to the economy. And that's going to mean, among other things, management and unions giving up more.

As it happens, this is precisely what President-elect Obama implied last night on "60 Minutes". Here's the key exchange with Steve Kroft:

Kroft: You have a situation right now where you have General Motors, which is in dire straits.

Mr. Obama: Yeah.

Kroft: May run out of cash by the end of the year, maybe by the end of certainly, if we believe what we read in the papers, by the time you take office.

Mr. Obama: Yeah. Well, let's see how this thing plays itself out. For the auto industry to completely collapse would be a disaster in this kind of environment, not just for individual families but the repercussions across the economy would be dire. So it's my belief that we need to provide assistance to the auto industry. But I think that it can't be a blank check.

So my hope is that over the course of the next week, between the White House and Congress, the discussions are shaped around providing assistance but making sure that that assistance is conditioned on labor, management, suppliers, lenders, all the stakeholders coming together with a plan what does a sustainable U.S. auto industry look like? So that we are creating a bridge loan to somewhere as opposed to a bridge loan to nowhere. And that's, I think, what you haven't yet seen. That's something that I think we're gonna have to come up with.

Kroft: Are there a lot of people that think that the country would probably be better off and General Motors might be better off if it was allowed to go into bankruptcy?
Mr. Obama: Well, you know, under normal circumstances that might be the case in the sense that you'd go to a restructuring like the airlines had to do in some cases. And then they come out and they're still a viable operation. And they're operating even during the course of bankruptcy. In this situation, you could see the spigot completely shut off so that it would not potentially permit GM to get back on its feet. And I think that what we have to do is to recognize that these are extraordinary circumstances. Banks aren't lending as it is. They're not even lending to businesses that are doing well, much less businesses that are doing poorly. And in that circumstance, the usual options may not be available.

The government obviously has enormous leverage over the terms of an auto industry bailout. From the inteview, it sounds like Obama understands that and is willing to use the leverage, even with labor, although he also understands why rescuing the Big Three still makes sense, at least in this environment.

--Jonathan Cohn

Posted: Monday, November 17, 2008 10:32 AM with 2 comment(s)

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lsernoff said:

The whole thing hinges on the UAW. If there is no give on their part, particularly with regard to health benefits, for retirees and active workers, that are beyond the imagination of nearly all of their fellow citizens, they will go down like a remora with the shark that feeds it.

Sachs is right about the reluctance of car buyers to purchase a car from a maker who won't be around in the future. Absent significant UAW concessions, who will believe a bailout of the big three can long delay their demise?

The Chevy Malibu is recent testimony that Detroit can design, and UAW members can build, a car that is competitive in engineering and quality with competing "import" cars being built here by other American workers. But first, the companies and the union have to convince the buying public they are here for the future with products they should want to buy.

November 17, 2008 11:25 AM

CRS9TNR said:

Listening to the Republicans tell the Detroit Automakers about relevant products and how they failed is painful.

The Republicans failed about as spectaculr as you can.

Remember that the Big 3 came to Washington in January 2006 and wanted to work on this issue before the economic crisis hit.

Remember, the governement sent stimulus checks in May and that failed big.

Remember it was Indymac, Freddi Mac & Fannie Mae that froze up the credit markets.

Detroit tried to fix this before it was a problem and Washington wouldn't listen. They tried to work within the markets, but the markets failed. Now George Bush wants to wag his finger and tell them it all their fault. Sorry George, but you managed to screw up the whole economy.

If you want to see how the Free market works, watch the Bancruptcy Proceedings. GM will use every legal means available to recover and it will be ugly. The government has big exposure and Detroit will be required to have them step up to those responisibiliities. Why build cars in the US, when you can import a suibstantial amount like the competition? Dealer Problems, let those folks litigate like everyone else.

I've been through a few Chapter 11 reorganizations. It's crazy and it always start with some silly, small thing. They can't ship a part because it's held hostage for payment. A check bounces and suddenly everyone knows. And once it starts, all you wish for is for things to be the way the were before it started.

If Washington was smart they would be asking a lot of questions, instead of a moron like Karl Rove running his mouth to Fox News. Talk about Asymmetric Information, GM, Ford & Chrysler have been intimately involved in about a dozen large bancruptcies in the last few years. They know what they are doing and will maximize the restructruing. Washington will be asking if this is legal as they find out just how much exposure they have.

November 17, 2008 7:38 PM