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HOW TO BAIL OUT GENERAL MOTORS

Posted by Gilmour Poincaree on November 19, 2008

NEWSWEEK (print edition) – November 24, 2008

ROBERT SAMUELSON by Robert Samuelson

So it’s come to this: general motors, once the world’s mightiest industrial enterprise, is now flirting with bankruptcy. Ford and Chrysler may not be far behind. Car and truck sales have collapsed. GM is rapidly exhausting its cash reserves and may soon be unable to pay its bills. Here’s the dilemma: GM and other U.S. automakers ought to be rescued to minimize damage to the economy, but the rescue should require tough conditions that neither the Democratic Congress nor the incoming Obama administration seems willing to support.

In a booming economy, a GM bankruptcy might be tolerable and useful. It would remind everyone of the social costs of mediocre management and overpriced unionized labor. But far from booming, the economy is declining at an apparently accelerating rate. Confidence among small businesses has dropped to a 28-year low, according to a survey released last week by the National Federation of Independent Business.

No one knows what further havoc a GM bankruptcy might inflict. A study by the Center for Automotive Research (CAR) estimates that 2.5 million jobs would be lost in the first year. The logic: if any of the “Big Three” went bankrupt, many suppliers would also fail; because car companies share suppliers, all U.S.-based manufacturers would suffer crippling parts shortages. American production would virtually stop until new supplier arrangements emerged. “It takes 6,000 to 14,000 parts to make a vehicle,” says Scan McAlinden, CAR’s chief economist. “If you don’t have one, you can’t make it.”

This may be too pessimistic. In a Chapter 11 bankruptcy, GM would “reorganize.” It would suspend many existing debt payments and continue normal operations. Perhaps. The snag is that even in “reorganization,” GM would require new loans and these might not be available. “Historically, when companies go bankrupt, there’s ‘debtor in possession’ financing-investors lend you money, but they get repaid first. That market has evaporated because of the credit crunch,” says auto analyst Rod Lache of Deutsche Bank. No loans, no production. Another possible pitfall: worried about warranties and service, customers might shun a bankrupt GM’s vehicles.

Why run these risks when the 6.5 percent unemployment rate seems headed toward 8 percent and almost a quarter of the 10 million jobless have been out of work for six months or longer? Just to satisfy a purist “free market” ideal? It doesn’t make sense. But neither does it make sense simply to heave taxpayers’ money at automakers. The objective is not to rescue the companies or workers; it is to shore up the economy and improve the U.S. industry’s competitiveness. A bailout won’t succeed unless other things also happen.

First, auto companies’ existing creditors need to write down their debts. Even with federal aid, companies will shrink. Economist McAlinden estimates that the country has surplus assembly capacity of about 4 million vehicles, much owned by the Big Three and destined to be shut. GM will need a $25 billion government loan to get through the recession and cover closing costs, says Lache. But GM already has $48 billion of debt. Unless the Old debt is sharply written down, GM would be overburdened and its rendezvous with bankruptcy would merely be delayed. Already, shareholders are essentially wiped out.

Second, labor costs need to be cut. By Lache’s estimates, GM’s hourly compensation- wage plus fringe benefits- totaled $71 in 2007 compared with Toyota’s $47- Health benefits for retirees (many in their 50s, having retired after 30 years) are expensive. These costs contributed to GM’s massive cash drain, $31 billion since 2005- But the United Auto Workers opposes making concessions. Just the opposite. Government aid, says UAW president Ron Gettelfinger, is needed “so that auto companies can meet their health-care obligations to more than 780,000 retirees and dependents.” The bailout should be more than union welfare.

Finally, automakers need a consistent energy policy. Congress demands that companies produce more fuel-efficient vehicles (35 miles per gallon by 2020, up from 25mpg now). But politicians also want low gas prices. These goals are contradictory. To encourage consumers to buy fuel-efficient vehicles, Congress should mandate higher gas prices. Gasoline taxes could be raised gradually (say a penny a month for four years, possibly offset by other tax cuts). Wild swings between low and high fuel prices have crippled the U.S. industry by erratically shifting buyer preferences- to and from SUVs.

In bankruptcy, a judge can modify a firm’s labor contracts and debts. GM needs the benefits of bankruptcy without the uncertain-ties, but the political process- so seem to be discussing are mostly rhetorical gestures against high Other firms from executive compensation (already limited) and in favor of more fuel efficiency (already legislated). The lame-duck Bush administration hasn’t helped the conversation. It rejects additional assistance without saying why; if aid is forthcoming, it doesn’t suggest what might be useful conditions.

We are now seeing the first political side effects of the open-ended $700 billion rescue of financial institutions. With so much money going to so many recipients, boundaries and rationales need to be established. When is public intervention justified? Who deserves support and why? Otherwise, political firepower will increasingly rule. The reason for imposing tough conditions on the auto industry is not only to improve the odds of success, but also- by the sacrifices required- to make the process sufficiently unpleasant so that countless other companies and unions won’t demand similar handouts. In 1979, when it rescued Chrysler from bankruptcy, the Carter administration insisted on concessions from management, investors and labor. We should do as much or more.

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One Response to “HOW TO BAIL OUT GENERAL MOTORS”

  1. bigvike said

    I say let them fail now. A bailout is throwing good money after bad. Executives are idiots. They had an electric car 10 years ago! They crushed them all! Why? Why! Now they can’t figure out how to make one in a cost effective manner. Barney Frank says the blue collar workers will suffer. I defy you to find a blue collar worker not in the UAW that makes $60-$70 an hour. Give me a third of that and decent benefits and I will work on a production line all day. If they haven’t saved enough to be prepared for this then it is their own fault. All good things must come to an end, and they should know they had it too good for too long. I know there will be repercussions for the rest of us. But we have to hit bottom before we can climb our way out. They will fail regardless of wether or not they get the $25 billion. Don’t underestimate the fact that average consumer knows this and will not buy a vehicle because the company that would honor the warranty will be out of business.

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