Bail out Detroit

My thinking on why Congress should bail out Detroit's big 3 auto makers:

1. The consequences of not bailing them out would be disastrous and probably more expensive than a bailout.  Normally this would be a disaster that could be managed with unemployment insurance, with new companies expanding to fill the gap and hiring workers, etc.  But this isn't a normal time.

2. It will function as a stimulus. Beyond the non-failure of 3 giant companies along with not losing millions of jobs obviously be a good thing, but maybe even the increase in economic security after a bailout would spur consumer spending. People delaying purchases right now because they don't know whether they'll be fired because of an industry collapse might have enough trust to spend money if a bailout comes through.  If 10% of US jobs really depend on the auto industry like Michigan Governor Granholm says, then this could actually be a big impact.

3. Chapter 11 bankruptcy doesn't really seem to be an option right now. Reorganization of giant companies require giant amounts of credit. That credit is currently unavailable.  So if you let GM and the rest go bankrupt, it looks like they'd just shut down and nothing would replace them.

4. I don't see any reason why American auto makers can't be profitable again if you take away the legacy health care costs (via universal health care) and replace management (untrained monkeys with dart boards would be an increase in decision quality over the current idiots).  It's obvious that labor costs themselves aren't the problem - unions are much stronger in Germany than in the US, and VW, BMW and Mercedes are doing fine.

5. There isn't much of a moral hazard problem, especially with CEOs having their pay cut to $1 a year.

6. They deserve it more than Wall St.  They make stuff, which is important.  Wall Street doesn't make stuff and they are thus less important.  This will obviously require some explaning:

Wall Street created imaginary wealth with financial instruments too complicated for anyone to understand (that was the whole point), and when the whole thing blew up they got $700 billion to try to rebuild a fantasy land.  The way I understand it, we need financial institutions for two things: lending and speculation.  Lending to provide capital to businesses, and speculation to even out prices.  But creating financial instruments so complicated that nobody understands what they are based on isn't speculation, because nobody knows what they are betting on.  Information, key in any transaction, isn't there.  Then you just get a situation where people buy these things because they think other people will buy them in the future, which creates a bubble underlied by something that nobody knows what it is.

This is the reasoning that tells me that most of what got Wall Street into trouble was useless activity in the first place.  Creating super-complicated financial instruments seems like a good way to take money from silly rich people and give it to smart rich people, but it doesn't do anything to grow the economy (via lending to businesses that actually produce things) or stabilize the economy (via speculation).

On top of this, Wall Street steals all the smart people that were urgently needed in Detroit board rooms.

So if Wall Street was judged important enough for a $700 billion bailout for basically adding nothing of value to the economy, shouldn't Detroit autmakers get $701 billion for adding something to the economy (even if that something is mediocre cars)?

Ultimately I think Detroit will get a bailout, but not for any of these reasons.  They'll get a bailout because the Democrats control Congress and there would be hell to pay if they didn't back up the Midwest unions.  Hopefully all the necessary provisions will be attached - firing management and putting some monkeys with dart boards and typewriters in charge instead, and pushing them towards a 'green' economy.

11 comments:

Dan tdaxp said...

This post is confused.

The emphasis on CEO pay makes for great episodes of Lou Dobbs Tonight but is a very small part of moral hazard. The CEO is just an employee, after all, hired by the Bored which is elected by the shareholders.

The primary moral hazard is that the shareholders -- who own the company and our collectively responsible for all decision making at the company -- will get bailed out.

Of course, this will be lessened if the government forces the Big Three through some form of de facto bankruptcy.

I do agree with your last point. The UAW is the labor union wing of the Democratic Party, and unless intra-Democratic politics is darker than I had thought, we should expect the Congressional wing to help their brothers out.

Adrian said...

The way I see the moral hazard issue, is that CEOs are unlikely to pursue really risky policies with the assumption that the gov't will bail them out if the policies fail, if the upper management of the company would be completely replaced in any gov't bailout. CEOs taking a big pay cut seems to me to be a step in that direction. For instance the most recent news says the companies won't be allowed to pay dividends. I don't know how you could eliminate the moral hazard problem regarding the price of the stock itself though unless the gov't simply took all the stock outright.

Some sort of bankruptcy might be the best option but I think a normal Chapter 11 bankruptcy like some people have been advocating (like Peter Schiff) would be a disaster for reason #3.

Dan tdaxp said...

IIRC, the collateral for the AIG "loan" is 85% of AIG stock. This means that stockholders are able to run the company now, but if they unable to pay it back the company is effectively nationalized.

The CEOs already have stock in the company, so their nominal pay is a small part of their compensation anyway (if the companies recover).

Worse, the CEOs will one day leave, while the stockholders are there forever. The current Chrysler CEO was not there during the 1980 bailout. But the Chrysler shareholders were.

Terry said...

Tyler Cowan disagrees: Why an auto bailout won't work

cflanders said...

Your main argument seems to be the fact that if Detroit goes bust, unemployment will climb exacerbating the existing conditions. Agreed. So it sounds like the bail out is nothing more than a disguised "make work campaign." If that is the case, I'd rather them do something more useful than build cars no one wants, like building new infrastructure. At least then in 15 years we can look back and actually have something for the money spent.

Not that anything I just said would actually happen, they will be bailed out by democrats in congress, but wanted your thoughts.

Adrian said...

Well there's nothing intrinsic in American car companies that forces them to build useless cars. And a lot of American cars are quite good, like the Ford Focus or the Chevy Impala. But it's management issue that makes them also build useless cars. So if you fix the management issue, then it's not just make-work.

Dan tdaxp said...

If organization structure, labor pool, management practices, promotion practices, etc. are not "intrinsic" to a company, I am not sure what is.

Bailing out American-based auto makers is a great way to start a trade war with other industrialized countries, or at least an invitation for them to subsidize inefficient domestic competitors against us. Still, I don't know how one would argue that lending $15 billion to GM would result in better cars than lending an additional $15 billion to Toyota, etc.

Adrian said...

Well Sweden has already bailed out (American-owned) Saab and Volvo, Canada is pushing a bailout package of $4 billion Canadian, etc. I suppose the US could be the noble martyr and be the only country to not bail out their auto industry in order to get rid of the apparent surplus in production but I don't think many Americans would be happy with that.

"organization structure, labor pool, management practices, promotion practices"

That can all be changed, especially structure and promotion. Plenty of organizations reinvent themselves. And it's not really a problem with the labor pool - American cars aren't poorly constructed.

Dan tdaxp said...

Well Sweden has already bailed out (American-owned) Saab and Volvo, Canada is pushing a bailout package of $4 billion Canadian, etc. I suppose the US could be the noble martyr and be the only country to not bail out their auto industry in order to get rid of the apparent surplus in production but I don't think many Americans would be happy with that.

A strange paragraph.

So your point is because other countries are giving American companies money, they are martyring America?

Really, it's appropriate Bush is behind both the Detroit Bailout and the 2003 invasion of Iraq, as the same incoherent sales job was unleashed by the White House for both of them.

That can all be changed, especially structure and promotion. Plenty of organizations reinvent themselves. And it's not really a problem with the labor pool - American cars aren't poorly constructed.

Perhaps -- but then, if anything that can be changed in a company is not "intrinsic" -- then what is?

Adrian said...

All countries want to have a successful domestic auto industry. Therefore all countries will attempt to save their auto industries. The countries that don't will probably lose much or all of their domestic auto production because of the massive disadvantage those companies will have compared to companies that do get bailed out.

"if anything that can be changed in a company is not "intrinsic" -- then what is?"

That's my point, pretty much nothing is. i.e. Nokia used to be a paper mill and is now a communications/software company.

Dan tdaxp said...

All countries want to have a successful domestic auto industry. Therefore all countries will attempt to save their auto industries. The countries that don't will probably lose much or all of their domestic auto production because of the massive disadvantage those companies will have compared to companies that do get bailed out.

But by this standard, American has a strong and vibrant domestic auto industry, centered in the south and featuring Toyota, BMW, and other "domestic" manufacturers.

If we're so concerned about industrial policy wrt automobiles, why not invest in successful enterprises as opposed to failing ones? Generally, if you want to encourage success, you reward success and starve failure.

That's my point, pretty much nothing is. i.e. Nokia used to be a paper mill and is now a communications/software company.

Then the original statement is meaningless. If nothing is intrinsic about Detroit, it adds nothing to say that this- or that- is not intrinsic.