The Auto Bailout Issue—Posner

We blogged on November 18 about whether the government should provide money to the U.S. auto manufacturers to keep them alive. (I was for; Becker was against.) In the short period since then, there have been important developments bearing on the issue, culminating this past Friday in the blocking by Senate Republicans of the Democrats' modest ($15 billion) auto bailout bill, and the announcement by the Bush Administration that it might, after all, agree to use part of the $700 billion financial-sector bailout to keep the U.S. auto manufacturers going until President-elect Obama takes office. So Becker and I have decided to return to the issue. The issue has a political and an economic dimension. From a political standpoint, the current position--no bailout legislation, but possible allocation of part of the financial-sector bailout money to the domestic auto manufacturers--represents, unusually, a victory for both political parties. The Republican Senators have stood up for principle--that freedom to fail is basic to capitalism, that wages and benefits should be set by free labor markets rather than by powerful unions, which are worker cartels, that government should not manage businesses, and that government expenditures should be minimized--and for the interests of Toyota and the other foreign manufacturers that have plants in the United States; for those plants are mainly in the South, which is the stronghold of the Republican Party. By opposing an auto bailout the Republican Senators have also distanced themselves from the Bush Administration, which is at once unpopular and believed by many Republicans to have betrayed Republican small-government principles. There is a grave risk that, as I argued in my November 18 posting, a collapse of the domestic auto industry could have serious adverse consequences for the U.S. economy as a whole, which would expose the Republican Senators to criticism. But that risk is buffered by the Administration’s apparent willingness to bail out the auto industry without new legislation. The Democrats (including the incoming administration) have scored points among their constituencies by standing up for union workers, for the “greening” of the automobile industry, for states in which the domestic auto industry is centered that voted Democratic in the November election (Michigan, Ohio, and Indiana), for the principle of active government, and for trying to avert a deepening of the current depression. The bailout bill was a mess, but a harmless one, if I am right that the domestic producers should not be allowed to collapse at a time of profound and, it appears, worsening economic distress. The bill was a mess because of the conditions that it would have imposed on the industry, conditions that earned the justified ire of the Republican Senators because of its failure to lean hard on the collective bargaining agreements negotiated by the United Auto Workers, because of the divided control of the industry that the bill if enacted would have brought about--divided among the manufacturers, a federal "car czar," and intrusive congressional oversight--and because of the considerable element of fantasy in the idea that Congress plus the President can revitalize the domestic auto industry. Nowhere is it written that the United States, let alone the midwest, where the domestic auto manufacturers are centered, has a comparative advantage over other countries, or other regions of the United States, in manufacturing motor vehicles. Evidently it does not, and Congress and the President cannot change that, as Japan learned from the failure of its "industrial policy" administered by Japan’s once-admired Ministry of International Trade and Industry. For the problem of the Detroit manufacturers is not just a matter of higher wages, to be solved by renegotiation of their collective bargaining agreements. The wage difference (actually the benefits difference--the hourly wages of the auto workers employed by the domestic manufacturers are only slightly higher than the wages of the workers employed in the U.S. plants of Toyota and other foreign manufacturers) is an important but not the decisive factor in the decline of the domestic auto industry. The difference in the wage and benefits package between employees of the domestic manufacturers and of the foreign ones in the United States has been exaggerated by treating as a part of that package the annual payments to retired workers divided by the number of hours worked annually by current workers. The money owed the retirees is a fixed cost, like any other debt. Eliminating those payments, like reducing the industry's bond debt, would improve the industry's balance sheet by reducing its fixed costs, but would not reduce the cost of making cars, or increase their quality. Merely wiping out existing debt, the main consequence of reorganization in bankruptcy, does not improve the efficiency or competitive position of the reorganized firm, which is why most reorganizations end in liquidation. What would improve the efficiency of the domestic auto manufacturers, besides reducing wages and current workers’ benefits, would be jettisoning union-imposed work rules; that was part of Republican Senator Corker’s ingenious proposal (of course rejected by the union) to condition a bailout on the union’s agreeing to a reduction in the wages and benefits of the Detroit auto makers' workers to the level prevailing in the southern automobile plants of the foreign auto companies. The adoption of his proposal would have been tantamount to putting the United Auto Workers out of business--if unionized workers have the identical wages, benefits, and working conditions as nonunionized ones, why would anyone pay union dues? I doubt that anyone in Congress or in either the outgoing or the incoming Administration really thinks that a bailout bill will place the domestic industry on the path to salvation. The conditions imposed to achieve the "reform" of the industry are window dressing. All three domestic manufacturers (yes, Ford included) are insolvent, and while they are unlikely to close down and liquidate completely if forced into bankruptcy--Americans will probably buy 10 million motor vehicles in 2009 and they are unlikely all to be made by foreign companies (the foreign share of the U.S. car market, including both imports and cars manufactured in the U.S. plants of foreign companies, is about 50 percent, though they could take up some of the slack created by the collapse of the Detroit manufacturers, since the foreign companies’ sales are down too). Even with an infusion of federal money, there will be many plant closings and layoffs and many bankruptcies and liquidations of auto parts suppliers and auto dealers. But formal declarations of bankruptcy by the domestic manufacturers would, I believe (as I argued in my November 18 posting), have a substantial added negative effect on the economy. Consumers are markedly reducing their purchases of durable goods because their savings are so depleted that they cannot, as in previous economic downturns, reallocate savings to consumption. Instead they are reallocating income from consumption to savings. The result is a downward spiral: consumers spend less, so output drops, resulting in layoffs that result in further reductions in consumption and in turn in output. The spiral will eventually bottom out, but it will bottom out at a lower level if hundreds of thousands of employees of auto manufacturers, auto parts suppliers, and auto dealers are terminated more or less all at once and consumers planning to buy a car in 2009 are scared off by the uncertainties associated with bankruptcy. (Will warranties be honored? Will parts be available? Will the dealership from which one bought a car survive? Will service standards slip? What about the car’s resale value? And should one believe the soothing assurances that bankruptcy is no big deal for the customers of the bankrupt firm, as long as it does not liquidate, when all the other soothing assurances by the government have proved unfounded?) Because motor vehicles are highly durable, it is easy to be prudent and defer replacing one’s existing vehicle until one’s economic situation clarifies. Granted, with General Motors having publicly acknowledged hiring a leading bankruptcy lawyer to counsel it and announced that it will be shutting much of its North American operations for a period of months, there is increasing public recognition that the Detroit automobile industry is bankrupt in all but name. But I still fear the psychological effect of a formal declaration of bankruptcy at a time when many--probably most--Americans are anxious about their economic situation. Individually, consumer prudence is wise; collectively, it will exacerbate the depression. The realistic goal of an auto-industry bailout is not to reform, revitalize, or restructure the domestic industry; it is merely to postpone its bankruptcy for a year or two, until the end of the depression is at least in sight and consumer confidence is restored to the point at which the bankruptcy of the domestic manufacturers can be taken in stride. To attain this goal does not require imposing conditions on the use that the auto manufacturers make of the bailout moneys. The conditions that the bill would have imposed and that any other form of government funding will impose are not an economic but a political necessity because of widespread anger at the incompetence of the industry; a majority of Americans oppose any bailout of the Detroit manufacturers. At the very least, the Obama administration should be allowed to decide the fate of the companies; that argues for a modest government loan that will keep them out of bankruptcy until, say, February.

Comments

[Mark]

Overall a poorly reasoned posting.
A 'bad-day' is to be expected from time to time ;)

The (less-frequent) Stern Finance blog posting (Altman-Philippon) makes a more reasoned and compelling case for Chapter-11, with govt largess focused on 'retooling' labor, warranty & spare-parts back-stop efforts:

http://sternfinance.blogspot.com/2008/12/where-should-bailout-stop-and-what-to.html

Hope that helps

[James N. Markels]

It would seem from Judge Posner's analysis that a financial bailout alone is no cure for what ails the Big Three. All three face systemic and crippling problems that have been developing over a long period of time. And frankly, their collapse was nigh whether the rest of the economy fell into recession or not. Given that, is pouring more money into these companies a truly wise investment?

[David Heigham]

Sorry. Becker is right. The least damaging routes out of a recession or out of a finacial crisis are to recognise the losses quickly and fully; and to put the real assets that remain back into productive, profitable use as soon as possible. For GM and friends, that means Chapter 11 now, not sometime in the indefinite future. Taking inconvenient reality on the that hurts consumer and business confidence in the very short run, but strengthens it thereafter.

Two incidental benefits are that prompt Chapter 11 treatment for GM and Chrysler just might enable Ford to take a tough enough line to save itself (I am a perpetual optimist); and more importantly will make the long line of other mangements who are hoping for a bail out face their real problems instead of scrabblig about with lobbyists.

[gdgeiss]

It's interesting to see Judge Posner finally admit, point by point, that the US auto industry is not economically competetive and is not going to be anytime soon, bailout or no bailout, and then still advocate a bailout. His position seems to be that it's OK to knowingly waste tens (or more) billions of taxpayer dollars on an ultimately futile "bailout" so long as it is currently a politically expediant ruse....WOW!!!!

[Tom Worsley]

I am a auto parts supplyer working in Ontario and am waiting patienly for my layoff notice.

I wish the governments of north america would hurry up and decide who they should bail out.

Make no mistake about it. If the auto makers go bust then I too go bust along with millions of other outo makers in both our countries.

If the gov's do not bail out the oatomobile industry they will have to pay me and millions of others unemployment benifits and then pay to re-train me in a better paying job in a viable industry.

[Luca]

The Obama administration should not decide the fate of these companies; the market should. I am surprised, Sir, that you would disagree.

[Alex]

"The difference in the wage and benefits package between employees of the domestic manufacturers and of the foreign ones in the United States has been exaggerated by treating as a part of that package the annual payments to retired workers divided by the number of hours worked annually by current workers."

It's only exaggerated because the size of the employee base is shrinking. What would you have observers do when drawing a comparison? Simply neglect to record any liability that accrues over the years?

"Instead they are reallocating income from consumption to savings. The result is a downward spiral: consumers spend less, so output drops, resulting in layoffs that result in further reductions in consumption and in turn in output."

And profligate spending destroys capital. Consumption is not always good. Savings is not always bad. Moreover, savings is not digging a hole in the back yard and burying money but merely a time preference for consumption at a later date. The Federal Reserve's complete disregard for the integrity of the currency acts against this tendency to save. However, integrated capital markets and a freedom from compulsion to use USD will only accelerate its destruction. With the uncertainty of an arbitrary winner in long term contracts due to currency fluctuations in the air, the advantages of trade will break down and our economy will sink further into depression.

Give us a stable unit of account and the economy will do just fine. If letting bailouts and central planning loom then look forward to a skyrocketing VIX and a lengthened depression.

[Bill C.]

Yes, unions are a worker cartel. And politically organized dealers are a distributor cartel. Dealers won't go away if the protections of state dealer-protection laws are nullified by a bankruptcy judge (federal legislation is not in the cards because organized dealers have just as much clout in Congress as they do in state legislatures). But manufacturer distribution networks will be rationalized, streamlined, and made responsive to the market rather than to the respresentatives of the dealer cartel (NADA and its state-specific affiliates), meaning that good dealers will flourish.

"(Will warranties be honored? Will parts be available? Will the dealership from which one bought a car survive? Will service standards slip?)" Does anyone -- other than dealers, their employees, and their extended families -- believe that dealers are the only or the best providers of warranty service and parts? True, they are at present the only providers in most states thanks to the dealer cartel persuading state legislatures to ban all competitors. Allow proper competition in warranty service and parts and the good dealers will thrive while new market entrants keep them on their toes and help ensure lower prices and meaningful consumer choice.

[a Duoist]

The Big 3 are currently hemorraging cash at the rate of six billion per month. A fifteen billion dollar bailout defers the inevitable for only two and half months, until early March.

The TAXPAYERS should pay for this? The logic of Judge Posner's reasoning sanctions socialism, where 'socialism' is not simply public ownership of the means of production, but is government solutions for all aspects of human 'helplessness.' The logical extension of Judge Posner's reasoning for a bailout of the Big 3 is, eventually, voluntary totalitarianism.

[TruthSeeker]

Lynn Tilton (CEO of Patriarch Partners) was on CNBC Squawk Box on Friday…relevant insights to this discussion…Fixing the Financial Crisis: The truth of the situation can be ignored no longer (http://www.cnbc.com/id/15840232?video=960926779.)

This is the same woman who predicted the financial crisis on Bloomberg TV back in 2006 (http://www.blinkx.com/video/lynn-tilton-on-bloomberg/87JL8lMSQmrDI4ALaa5zdQ) so perhaps she’s worth listening to now.

She proposes direct lending to businesses through a new “Provisional Federal Bank (http://www.patriarchpartners.com/Lynn_Tilton_WashPost_NYT.pdf)”…Liquidity must be made available not solely to big banks where Treasury-injected capital has been amassed to fill the cavity left by gambling losses, but rather expressly to deserving American companies and their people who will reignite our sputtering economy. A provisional Federal Bank must be initiated to foster enterprise and to provide job opportunities for every American.”

[frighteningly parisan]

I think the real fear for Republicans is that this will happen "under their watch" and further degrade their economic reputation... best to "prop up the beast" until February. "Of course the coming years will be tough," they'll say. "What do you expect when you elect a Democrat?"

[nathan]

http://www.nytimes.com/2008/12/14/books/review/Greenberg-t.html?partner=permalink&exprod=permalink

Bail Out the Writers!
By PAUL GREENBERG
Published: December 14, 2008

Excerpt:
According to my rough calculations, it could cost as little as $10 billion to solve the writing crisis.

[Auto Parts for Brains]

The domestic automotive industry has been struggling even before the recession was acknowledged by the government and the public. The current economic trend added to the decreasing confidence of consumers to purchase goods will not only aggravate the situation it is already in but might possibly give it the final fatal blow.

As for the bailout, I think the government should study carefully whether giving the companies added time will be enough to get them on their feet again. Or is it just delaying the inevitable.

[nathan]

a nitpicky edit

in my preceding post, it was not an "excerpt" but the one sentence blurb available when you click on "permalink" at the NYT (click "share" then "permalink").

[Old Curmudgeon]

I find it amazing that this thread is devoted entirely to car manufacturing economics. The high cost of manufacturing American cars may indeed be a problem, but THE problem is that Detroit has been making lousy cars for decades, and has alienated much of its customer base that by now prefers reliable and attractive "foreign" cars (many made in the US in state-subsidized plants) in place of Detroit junk. After decades of stiffing people with junk, they rebel and buy competitors' products. Why is that so hard to understand?

Think Chevy Vega, Cadillac Cimarron, the Cadillac V4-6-8 engine, the Oldsmbile Diesel, the Cadillac Allante, the Pontiac Aztec, etc. If GM sold those things cheap, would you buy them?

[robert]

A suggestion by another writer was to deal with the problem by making Detroit an economic empowerment zone (think a domestic version of the former Hong Kong) so that both political parties could be staisfied while, at the same time, the public would not feel as if the government was throwing good taxpayer dollars after bad.

[James N. Markels]

Further to my last post, it appears that Judge Posner thinks that the Big Three should indeed be allowed to go bankrupt -- just not right now. Hence his statement: "The realistic goal of an auto-industry bailout is not to reform, revitalize, or restructure the domestic industry; it is merely to postpone its bankruptcy for a year or two, until the end of the depression is at least in sight and consumer confidence is restored to the point at which the bankruptcy of the domestic manufacturers can be taken in stride."

So the issue isn't whether the Big Three should go bankrupt, but rather when. Judge Posner argues that now is a bad time, as there could be serious economic ramifications from doing it now. I think there will be ramifications regardless of when it happens. I do not know whether we are better off delaying the inevitable. If we pump $15 billion into those companies to keep them afloat until the economy comes back (with no assurances that the economy will indeed recover within a year as is hoped), all we are doing is having taxpayer funds cover a small portion of what the companies' creditors are owed. Since that money will also be paying salaries and benefits, it could be seen as direct welfare to workers that might otherwise be out of work.

However, knowing that a bankruptcy is inevitable, and knowing that wholesale changes in the domestic automobile manufacturing industry are necessary before consumer confidence can be regained, why not start on those changes sooner rather than later? I think Judge Posner would agree that consumers would view the Big Three, post-bankruptcy, with a less-jaundiced eye -- the bankruptcy giving the impression that a real house-cleaning occurred. This cannot happen soon enough. Although it's rough for a lot of companies to go bankrupt at once, right now creditors will be more realistic about their accounts and be willing to negotiate in a Chapter 11 setting with more elasticity. The Big Three would probably get a better deal going bankrupt now rather than when the economy is coming back and creditors think there is more pie to be distributed.

[PlanetRalph]

Professor Posner's argument seems to depend on the public being willing to buy cars from taxpayer supported, non-viable companies that will go bankrupt in 2 or 3 years. I would be much more likely to buy a car from a company in chapter 11 that is reorganizing itself to be viable and competitive long term.

Professor Posner also seems to think that a community of "living dead", taxpayer supported auto companies helps the overall economy and does not crowed out innovative, viable companies that may emerge from the parts of GM and Chrysler.

GM and Chrysler are huge companies with lots of valuable parts. I think allowing GM and Chrysler's creditors to realize the value of those parts by combining them in innovative ways is by far the best course for the country and the industry.

One example, Tesla motors, the Saturn Vue Hybrid, a license to all Chevy volt technology, and the Saturn dealer network might combine to be a viable, growing, exciting company. That kind of combination can't happen until the value in GM is unlocked through bankruptcy.

Chevy/Cadillac/Opal with the cream of all the GM dealers, without UAW work rules and without all the other brands, overhead, and debt obligations would surely be a very viable company as well.

The Chinese seem to like Buicks. Maybe a Chinese or global company would buy Buick for the brand's value in China.

There is a lot of value for workers, creditors and the country if companies turn from rent seeking in government bailouts to building innovative companies.

Ralph

[Sharon]

I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

Sharon

http://www.autoloans101.info

[spencer lord]

i luv ur blog. it is at the top of my roll. it's just superb. happy holidays.

[J]

and it strikes me that one of the problems of favoring one solution or the other is that the auto biz is so large and complex that no sidewalk superintendents have the whole picture.

Who, for example, knows how much advantage has been given to the "transplants" in terms of tax bennies, free land and infrastructure to lure auto plants to low wage areas generally in our southern states? I DO know that in Sen Corker's TN there is practically a pre-bailout of the new VW plant; over half a billion in tax breaks to bring in a plant costing but 1.4 billion.

Further while MUCH is made of "high labor costs" they still amount to about 10% of the retail price of a vehicle with dealer margins and "prep" being more costly than assembly labor.

Do the "transplants" themselves have a more viable biz plan?? I don't think so. While GM has retirees of 400,000 Toyota (US) has but a few hundred and despite all the hoopla about product acceptance the Big Three maintained a 50% market share and the sales of ALL brands are off a fairly similar 35%. In short the transplant's day will come as well if they too are saddled with retirement and H/C costs. Which brings up another question for our, supposed, "capitalists".

As, or after, a man or woman has devoted their lives to the production of the company who exactly should be responsible for a modest retirement and their H/C? It seems a question our nation itself fears to ask, much less to answer.

Under our current patchwork of H/C we KNOW that the auto mfgs are paying for the health care of other, working, family members who work for companies that do not offer such benefits.

Perhaps some of those work for Walmart whose pay and benefits are so low that taxpayers routinely subsidize this richest of companies' bottom line by a billion or more each year, via foodstamps and other low income rebates, with virtually no political fanfare at all. While Walmart is far richer than the companies building our cars and paying decent wages is THIS a viable model to be emulated in the future??

Lastly, our automakers are perhaps the earliest to have to deal with such rapid increases in automation and productivity that workers were displaced by the thousands in less than the length of a career.

Question: As we discover that perhaps 80% of our workforce can produce all that we need or can sell in an increasingly competitive world, WE will face the same question as that of the automakers; What do we do with surplus labor that will never be employed again? Or at min will never be employed at a wage to finish raising their family or provide for any sort of retirement?

The strong feelings on both sides of the Big Three issues are surely fueled by ideology as to the overall economic model of our future. In this corner! we have the devil-take-the-hindmost, wage race to the bottom set, and in the other those who think it is virtually a right for an individual to have productive work and in return for that work a wage and benefits package reflective of sharing in the overall wealth of this "richest" of nations. This will be the debate of the day and it's not likely to be solved by ideology handed down from a history of dealing with
scarcity instead of over-production.

[Suspension System]

This will be the debate of the day and it's not likely to be solved by ideology handed down from a history of dealing with
scarcity instead of over-production.

[aaron4unitruth]

There are many reasons why the bailout of Wall street and the auto industry is wrong but most importantly because the federal government is far more powerful than it was ever meant to be. Now the government can be a stockholder? Sounds too much like socialism.

http://www.theartdeptchronicles.blogspot.com

[aaron4unitruth]

There are many reasons why the bailout of Wall street and the auto industry is wrong but most importantly because the federal government is far more powerful than it was ever meant to be. Now the government can be a stockholder? Sounds too much like socialism.

http://www.theartdeptchronicles.blogspot.com

[Jack]

Aaron: All games need umpires. Having neglected their umpire role.......... there seems little choice but for them to take to the field (us!) to take to the field and cold-start the game.