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November 14, 2008 Should the U.S. Government Bail Out GM?
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Washington is currently struggling with the issue of whether or not to bail
out the domestic auto industry, most immediately, GM. Democratic leadership in
the lame-duck Congress has asked President Bush and Treasury Secretary Paulson
to loan GM the $25-to-30 billion the company is asking for under the TARP
arrangement. That is a no-go for the administration. There is only $60 billion
left in the first tranche of the TARP and the remaining $350 billion second
payment requires Congressional approval, which could be contentious. Paulson is
under considerable heat for changing the terms of the TARP, announcing this
week that the Treasury would not be buying the illiquid mortgage-related assets
on the books of the banks as was originally intended. They would get far more
for their money by injecting capital directly into the banks by purchasing
preferred shares and it avoids the problems associated with pricing the
troubled assets. The problem is, however, if they are willing to bail out the
financial institutions and money market funds, why not nonfinancial businesses?
It becomes a ‘Main Street vs. Wall Street’ issue. GM and the other
Big-three automakers employ a lot of people and affect depressed regions of the
country. Obama favours an auto bailout and ran on that promise.
But where do you draw the line? Should the government bail out Circuit City
with its more-than 750 stores and employees all over the U.S. and Canada? Of
course not. So what makes the auto industry so special? Many say the industry
is strategic—no major developed economy should be without an auto
industry—or that it is needed for American security (building jeeps and
tanks?). Some have suggested that it is patriotic to protect GM, a symbol of
American capitalism. Or there is an economic argument that you don’t
allow the company to fold when unemployment is already high and rising and
Detroit and Cleveland are already suffering. You can also argue that the credit
crisis was the last nail in GM’s coffin and that $25 billion is small
change when you just handed another $50 billion to AIG and even more to Fannie
and Freddie. The Lehman Brothers bankruptcy was a clear lesson in the reality
of systemic risk. The fear is that if AIG were to default on its CDS
obligations that might start a chain reaction of defaults and failures. A GM
bankruptcy would be one of the largest ever, but it is still dwarfed by the
Lehman bankruptcy filing in September.
Economists would generally argue that creative destruction should be
permitted to take its course, allowing GM to file for Chapter 11 protection so
that the troubled company can restructure its debt, payrolls, union contracts
and physical plants. GM’s CEO Rick Wagoner and others suggest that
bankruptcy would have devastating effects; car sales would fall even further
because buyers would fear warranty risk and low resale value, and a GM bailout
would have the tangible benefits of saved jobs in depressed areas of the United
States (and Canada), and it could be a first step towards a coherent energy and
security policy.
There is, however, the matter of what strings to attach to a government
loan. Should current management remain when they haven’t shown they can
successfully compete? Management was changed at Freddie and Fannie.
The government is already subsidizing GM’s development of the Chevy
Volt, a plug-in series hybrid vehicle expected to be launched as a 2011 model,
road-ready in 2010. But the government seems to be assisting GM in building a
car that will do nothing to improve the company’s profitability or
competitive position. The car requires six hours of charging to give 40 miles
of gasoline-free driving. That provides an almost insurmountable challenge for
people who park overnight on the street or in public parking lots. The Volt
will have a small gas-driven engine onboard to recharge the battery for trips
of more than 40 miles, but technical experts suggest that the promised 50 mpg
in this mode is a fantasy. As well, even if the car is used mostly for shorter
gasoline-free driving, onboard gasoline goes bad after a few months so the
car’s tank will need to be drained periodically and the old gasoline
discarded.
The Volt absorbs a big chunk of GM’s development budget. Yet this is a
car, by GM’s own admission, that will not make money. And the government
has decided recently to give a tax credit amounting to $7,500 to every Volt
buyer. No kidding, the TARP legislation included a tag-on subsidy to the auto
industry. The automakers got $25 billion in low-interest government loans, and
buyers got a plug-in tax credit, making the Chevy Volt $7,500 cheaper. The tax
credit will only apply to the first 250,000 plug-ins sold, and will be phased
out over the course of the following fiscal year. It is estimated that it will
cost the federal government about $750 million.
The U.S. automakers have long held a privileged place in the American
economy. Other U.S. companies with legacy issues (highly-paid pensioners with
growing healthcare costs), such as the steel companies and airlines, have been
forced to go it alone, declaring bankruptcy, restructuring, merging or failing.
And there are U.S. manufacturers that manage to survive and thrive in a highly
competitive global environment (Caterpillar, GE and Boeing).
Long ago the Big Three should have had a showdown with the UAW to break its
labour monopoly. But the unions are politically very powerful and politicians
have repeatedly intervened to prevent the crisis that would ensue to finally
deal with the labour issue. The government gave loan guarantees to Chrysler
during the Carter years and Reagan’s administration imposed quotas on
Japanese car imports to help prop up GM. The government assistance in the past
clearly has not provided a sustainable solution.
If GM were to declare bankruptcy, it should do so with the support of the
government and a clear plan to come out of bankruptcy with at the very least
its warranty obligations intact and its parts suppliers still operating. While
GM arguably might deserve government support, GM’s bondholders and
stockholders have not been supported. Shares of GM have fallen more than 90%
over the past year amid sharply lower auto sales and fears of bankruptcy. The
government might well find that its support is best put to use within the
context of bankruptcy, rather than with an eye to preventing it. A chaotic
descent of GM into forced bankruptcy with no pre-packaged way out and no hint
of government support is not in the best interests of the U.S. (or Canada) as
we fall further into the worst recession in decades.
GM, however, needs a comprehensive makeover. There is no sense, in the name
of economic stimulus, to merely prolong the demise of the old failed economic
model. Regardless of whether GM declares bankruptcy or not, a successful
makeover will be wrenching.
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Should the U.S. Government Bail Out GM?
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