Over in the real economy, perhaps the biggest story is the impending and highly likely merger of GM and Chrysler, in which GM would swap its 49% stake in GMAC, its consumer finance company, to Cerberus (which owns the other 51%), in exchange for Chrysler, which is currently owned by Cerberus. It seems that the deal may hinge on financial assistance from the government, at least according to six governors attempting to pressure the dynamic duo of Paulson and Bernanke to help out. Until Thursday, GM was seeking $10 billion from the Treasury Department’s $700 billion bailout fund – yes, the same one that has been used to recapitalize banks – but Paulson’s preference is that GM tap a $25 billion low-interest loan program set up by the Energy Department in September.
It’s easy to argue for bailing out the auto industry, with its hundreds of thousands of factory workers, as opposed to the financial sector and its Wall Street bonus babies. (It’s less easy to argue for bailing out Cerberus, which is a private equity firm.) But I want to point out one difference.
The business of a bank is borrowing and lending money. Banks currently face two problems. The first is a crisis of confidence: people who lent them money aren’t sure they will get it back, because no bank – no matter how sound – could pay back all its creditors at once. (The whole point of a bank is to borrow short and lend long.) If this were the only problem, government deposit insurance and the new loan guarantees would take care of it, and the banks would be fine. The second problem is a potential solvency crisis: it’s possible that banks’ assets have declined in value to the point where they are worse less than, or not much more than, their liabilities. The answer here is recapitalization: giving the banks more capital, in exchange for ownership shares. If you give banks enough capital to offset the losses on their assets, there’s no general reason to believe they can’t go forward and make profitable loans, especially with the cost of money as low as it is. They don’t have to do anything particularly intelligent or risky with the money; it’s just to compensate for past mistakes. If you do have a reason to believe that a specific bank will not have a viable business in the future (for example, its whole business was subprime lending), you don’t recapitalize it – and we know that Paulson has been turning at least some banks down.
The auto business, like most businesses, is more complicated. You have to design and manufacture cars that people want, and for which people will pay more than they cost to manufacture. You have huge investments in fixed assets (factories that can’t be easily converted to new uses), technologies (hybrid engines, or the lack thereof), and human capital that constrain your ability to develop new products and offer them at competitive prices. In this kind of business, it’s possible that no amount of cash will make a company viable going forward. GM is currently losing about $1 billion of cash per month, according to analyst estimates. If you loan GM $10 billion (or make a $10 billion capital injection), and nothing else changes, all that means is GM survives for 10 months longer before everyone gets laid off. The $10 billion loan only makes sense if that money, or those extra 10 months, will enable GM to somehow become a profitable company on a going-forward basis.
This is a different kind of question than you have to ask about a bank before recapitalizing it. Bank of America and JPMorgan may need more capital in the future to compensate for the deterioration of their past loans, but few people expect that they won’t be able to make money in the future. With GM, there is a real question as to whether it can become a profitable company at all. The story is they just need to buy time until the Chevrolet Volt comes out, but there’s not a lot of evidence that by the time it does, it will be competitive with whatever Toyota and Honda have engineered by then.
I’m no expert on GM, so I’ll leave it there. It’s possible that GM is on the brink of a turnaround and it just needs $10 billion more in loans. I really hope that’s true. (And in any case, the Energy Department has already allocated $25 billion in low-interest loans for US auto manufacturers.) The point I want to emphasize is that the criteria to use in deciding whether to bail out GM are different than the ones to use in evaluating banks – and have nothing to do with which one we have warm and fuzzy feelings about.