Should the Government Bail Out the Auto Industry?

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.

43 responses to “Should the Government Bail Out the Auto Industry?

  1. Good post. People have to drive and have to have a repository for their cash. The Chrysler bailout in the seventies netted the government $660 million in profits. They may not be just throwing taxpayer money to the wind. There was some decent info on this at:
    http://www.thebailoutblog.com

  2. Would this split GMAC (the profitable part of GM) from GM and lay the autoworker pensions and health benefits on the auto manufacture company alone? Is this similar to “leveraged buyouts” of the 80s when the profitable portions of companies were separated from the unprofitable and as much debt and obligations as possible piled on the unprofitables?

    Why would the unions would go along with this, unless they got a part of Cerberus?

    How would the merger deal with the dealerships?

    Big auto is a big mess due to years of mismanagement.

  3. as i understand it, gm will be the low cost producer (even lower than toyota) by 2010-11 because it was able to get a nice deal struck with the unions. they need to stay alive until then.

  4. Yes, I’ve heard that as well, and it’s a valid point. If the numbers really show that GM will be profitable with the lower cost structure and really just needs enough cash to make it until then, then fine. Count me as a skeptic, though – I would still want to know what cars they plan to be selling in 2011, and how many of them. Because while costs have been one problem, lack of good cars has been another.

  5. The auto industry should not be bailed out. They fought for decades fighting better fuel standards and shipped jobs overseas for years. They know because they have so many jobs that we will be forced to bail them out no matter what risky decisions they make. Spending 4bil a month between the big 2 would barely give them 10 months, and that’s not counting retooling. They have had many many years to retool but failed to want to claiming loss of jobs and costs. Well, now that we have more loss of jobs then they claimed and more losses what do they have to show for it? Nothing.

  6. No, they should persue new auto technology approaches and a new auto plan for the USA. They need to build electric plug-in cars with solar panels to attach to our homes so we can plug the vehicle in while it is in our garages using a solar panel. They should build natural gas (CNG) trucks and autos.

    America needs a new auto change that does not rely on foreign energy sources.

  7. The US automakers had so much cash in the past decades, remember Ford buying Volvos, Jaguars, Land Rovers and etc? They made so much profit selling trucks in the past decades and failed to invest in technology, in their own long-term future. US Automakers failed to fix problems and made themselves more competitive when they could and now they wanted the government to bail them out. What kind of world is this? The government can’t bail out every mismanaged business.

  8. mismanagement has got to be it. I remember my economics teacher in high school telling us about how the auto industry did not want to switch to finding more efficient ways for building cars because this would put many people out of jobs & say too in the oil industry. I thought it was stupid. Why would the auto industry not was to switch, the consumer would save much more. I was young and basicly thought the auto industry is comfortable where its at now, taking long vacations sipping on pina colada’s Im sure handing out bonuses & now 2008 Opps idiots should have started converting years ago. Supply and demand American’s are becoming fruigle cause we do not know what to expect around the corner. For a while anyways car sales in my opinion will be at a stand still, then here comes something else to deal w/ LAYOFFs cause nobody is buying the cars to pay the factory workers salaries. I almost applied to work for the auto industry, but I am glad I did not.

  9. @arminda Mismanagement is correct, but you have the style wrong. I dealt with them as a vendor on similar issues many years ago. The contrast between the Japanese and US management was captured in how two of them approached a large investment in robotic assembly tools.

    The US buyer had as a goal “Buy $2 billion in robotic systems.” That is what happened.

    The Japanese buyer had as a goal “Improve product quality, assembly flexibility, and product cost.” That is what happened.

    That is how they were able to spend the same amount on robotic systems and yet achieve such different results. The US buyer got robotic systems that were generally superior in terms of features. The Japanese buyer got a better manufacturing facility with simpler, lesser featured robots.

  10. Government shouldn’t bailout the auto industry, but it should bring pressure on the oil industry to help their bedfellows out.

  11. Is any one see what has been going on; we are bailing out major corporations that have taken away pendtion and benifits with the CEO’s & the good fellow board of directors Scheming hundred of million and some cases over a billion for the share holders.We should not be bailing out any corporation we should be putting some top people in prison, @5 billon in cash missing in Iraq, ect; this would not have even been believed to be allowed let alone conceived morally.

    May G-D help us all,
    Robert Milner

  12. I know a few people i,ve talk to say they are selling just for the corporate bail outs as a protest & some shareholders distrust of corporate indulgents with there money.

  13. I want to know How many jobs this 700 billion dollar bailout created to enable people to pay there morgages instead of the banks foreclosing on them

  14. Absolutely, NO Bailout for the Auto makers. They have had over 35 years to re-tool, improve reliability, etc. They refused. All they want is a handout, well middle class americans need a handout too but I don’t see that coming. Maybe a protest and a revolution is in order now . We need to refuse to bail out these corporations. My sister lost her business of 25 years in new orleans after Hurricane Katrina, government did NT bail her out, she went under and now struggles with that loss and the flooding of her home and the rebuilding, etc, etc. Many good hard working americans are suffering and nobody cares, especially the government. NO MORE BAILOUTS TO CORPORATIONS !!!!!

  15. 1 in 10 Americans make a living from the auto industry. It would be nuts to pretend we don’t have to work with the industry to insure it’s (and our) survival. All the anger towards past profit or mismanagement does not overbalance the fact that doing nothing to help the industry would eventually (if not immediately) hurt the entire nation. If you had an infection in your leg, would you not treat it? If left alone, the fall of the auto industry would cause a huge economic loss for everyone in the USA.

  16. In the case of the auto-makers’ bailout, it’s a relief to have a national issue that is so straightforward: American cars tend to break down and fall apart therefore people are not buying them. If GM and Ford don’t want to go out of business, they should start making decent cars. To bail them out would be to reward their terrible manufacturing standards.

  17. Who should help the drowning U.S. auto industry? In light of the history of the past century, the answer is obvious: the MAJOR OIL CORPERATIONS. God knows they’ve got the money, and they owe the auto companies big time. Let Congress call in the auto companies and Big Oil, and have them work out a deal—guaranteed loans, whatever. Congress can put its official approval on the deal. It’s the only fair solution.

  18. I think that the goverment should not bail out the auto industry! Even though lots of people work for the auto industry it will just put the government into more debt and it won’t help the economy in long term basis because they will just continue what they are doing and will go back in debt!!!!!

  19. Let me ask, where did the Japanese get their technology? If you can answer this than you ought to know their technology is no better than American technology, if the government can bail out so many banks, and insurance giants, they can do something for the auto industry. What needs to be done is to think of our country first and our own livlihood. The Government needs to put higher taxes on the foriegn vehicles like what is done in other countries with the way they tax the American vehicle. It is terrible the way the auto worker is treated. For the most part they are middle class Americans trying to carry a load, while the “upper middle class”tries to get blood out of a turnip

  20. I don’t think the idea of letting oil companies bail out the auto industry is a good idea. Why take a profitable company and weigh it down with a losing industry. We won’t have any business or jobs left in the US with that tactic. At current prices of a barrel of oil, oil company profits are suffering too, we just don’t get to hear about that from our media. It doesn’t fit their agenda. A Chapter 11 reorganization is the auto companies best hope. The current economy is a tragedy for all of us, and our do nothing congress would not act on the warnings for several years. Why did so many of the same people get reelected? What is it going to take for Americans to take back their country? Go to the website of the US senate, take a look at the budgets for each senator, it’s a travesty.

  21. first of all..these are loans, so this can’t strictly be called a bailout!

  22. Well, if you give someone a loan on better terms than he or she could get on the open market, that’s a subsidy. Right now GM can’t get a loan on any terms because no one trusts them to pay it back.

  23. We cannot stand by and do nothing about this. It is time for the US Government to give advantages to US Companies (again). For years the foreign automakers dumped millions of units here due to our “free trade”, which was fine, and is the American way. Now, it’s time to help out not only three American icons, but the millions of lives and jobs that rely on them–directly or indirectly. Wake up people, this is the fabric of American industry and culture that is threatening to be torn apart at the seams.

  24. WTF… aren’t the car manufacturers the ones that killed the ELECTRIC car? Then they go and build SUV’s that eat gas by the gallon, then they jack the prices on new cars to the point where most people on the planet can barely afford to drive them, and eventually lead to the demise of global gas by not selling affordable non-gas vehicles. Where the F** will it end?
    Now after years of neglect and utterly and irresponsible and yes extremely greedy behavior by the CEO’s they have the balls to ask for tax payers money to solve the problem they created in the first place… WTF, well I for one say NO!! If anything bail me out for not making enough money to afford to buy a house. I have not in my life ever benefited from the car industry or any industry for that matter. All I see is the price of living going UP and UP, year after year. If I can survive, so can you mother_***s!! And leave my tax money alone!

  25. No, the auto industry should not be bailed out. I believe they can get their costs under control, make better, more affordable products, so they can actually sell more autos. I would suggest they start by reducing the salaries of the top people who are now making 28 million or so per year. Also, the execs should try flying second class on commercial lines, instead of flying private jets. Or, perhaps these execs should be replaced by people who know how to run large companies and live simply.

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  27. I think that the government needs to step in, but not with giving all the funds to the auto manufacturers, but maybe give them 1/3 of the funds direct, and then give the american people a government rebate for purchasing a “New” american made vehicle. this way the money will not only help bail out the auto manufacturers but would also start consumers purchasing and put the money back into the communities. I would suggest rebates in the area of 2,000 paid directly from the government and not effecting the rebates, etc the manufacturers offer.

  28. I think a lot of you guys are missing the point on the bail out. It is not whether the company can recover or not with or without the bailout in the long run, because no one can really answer that question due to the complexity and the myriad of colluding factors. The focus has to be on right now!! If the auto industry fails, we are looking not only at a recession but a potential depression. There will be over 10 percent unemployment, which of course will be disasterous to say the least. As a result a ripple effect will ensue that will reach technology companies, financial companies, etc… Simply put, the question we should be examining is whether America can survive the fall of the big three.

    To the automaker’s defense in terms of poor management, was that they have noticed a large problem about 5 years ago. They have been urgently changing and reducing their costs through reducing factories, going lean, renegotiating with the UAW for a new deal, investigating in hybrid cars, etc… The largest difficulty the automakers were dealing with was erasing the negative perception in terms of quality and environmental neglect. Of course, they created the problem. But the point here is that they were defintely on the right track until this economic slump caused by Wall Street and Main Street neglect pushed them over the edge.

  29. If you seriously believe that 1 in 10 jobs are somehow tied to the auto industry, I have a bridge I’d like to sell you. The analysts claiming this ludicrous fact are tied to the very industry asking for the handout. It would only take one analyst to publish such a claim and have every news organization sensationalizing the story.

    Given enough “degrees of separation”, I could easily make the same claim with every industry in the US. I could probably tie a sneaker manufacturer to Space Shuttle parts.

    Free market society means you reap what you sow.

    No bailout with my hard earned tax money!

  30. First, I have facts from experts to back my story up. If you have figures that says otherwise, please post here. But if you just use logic, you can hash this out. The three 0EMS are directly linked to tier 1, tier 2, tier 3 suppliers, dealerships, numerous financial investments. Within their automobiles, they need technology in the form of software as well such as with CAE programs, FEA, algorithms, ecms etc… Additionally, there are many plants that are soley dependent on big three plants. If big three leaves, their entire city becomes a ghost town. Essentially, if big three fails, the entire Midwest is in trouble. And if that happens, well you can do the math.

  31. After the oil crisis in the 1970s, the American auto industry pleated that it “needed time to grow strong enough to compete with the imports on the free market” and the Reagan Administration agreed to limit auto imports. The auto industry did not respond with the promised development of more fuel-efficient cars but merely increased its price an average $2,600 per new car and achieved record profits while selling fewer cars than in their record sales year in 1977! (Hudgins, Edward, 1985, The Heritage foundation, The costly Truth About Auto Import Quotas, http://www.heritage.org/research/energyandenvironment/EM74.cfm). This incident indicates that governments have to be more critical prior to interfering as they cannot only hurt consumers but can also ruin international relations with import restrictions.

    Despite of this fact that we got screwed, I believe that our politicians in Washington will bailout the American Auto Industries. Why you asked? Because they already sent their lobbyists carrying bags full of money up capitol hill and deposited into those politicians’ campaign contribution funds.

  32. bla bla bla this is all crap

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  35. Lower the dang prices of cars and put a cap on it ,so’s the american people can afford them and there wouldn’t be a bail out needed.
    The price of a car is the same price of a house ,let’s see do i want a roof over my head or a car? Da

  36. John’s quote: “1 in 10 Americans make a living from the auto industry.”
    John is obviously pro bailout.
    Well John…if indeed 1 in 10 Americans make a living from the auto industry, THEN WHAT ABOUT THE OTHER 9 IN 10 THAT DON’T BUT ARE IN EQUALLY AS MUCH TROUBLE? Crap…let’s just bailout everybody!
    The taxpayer…the little guy…from whence this 700 billion is coming from, is suffering as well due to high fuel, housing, mortgage, utility and insurance costs!
    We should not be putting monies into private enterprise.
    Give yer heads a shake folks.
    Give them money…and they will come back begging for more a few months down the road.
    Let the chips fall where they may!

  37. Thanks…this really helped with my English home-work.

  38. I don’t think we should bail them out neither. It’s not fair to the public to pay for them to be in business. It is already bad enough for all our 401k’s to be taken away for some Christmas bonus.

    If they do get bailed, I promise to never own an American car in my life!

  39. The American people losing their homes need thbailout money. Big Corporate business already made their profits on the overpriced autos they sold us. Give it back to the Citizens. Then we’ll bail them out by spending it paying off our cars, homes, etc. Whose here to bail out the little guys like us? Giving us the money equal shares will help the economy because we’ll spend it and promote economy. DO IT! Take a poll on this suggestion. I dare you!

  40. Robert Bernstein

    I understand the taxpayer’s loan to GM is protected as senior debt. Can you explain our protection considering Chrysler being a private company?

  41. Right now we are at war in an area of the world we have had a lot of issues because of our need to have influence and control of there resources. We are feeling the influence of this being a finite resource. We are seeing environmental issues rising. Now the auto industry is falling. Bailouts are a weak attempt to try and swim up stream when you know the current is only going to get stronger. Instead I would love to see the money allocated for the bailout used to invest in new markets. Basically the government is acting as our stock brocker, if your stock broker invested that much of your money into GM or other companies on the verge of failing you’d fire them right?
    Where should the money go? Well how about a stronger infrastructure? More trains, light rail etc…this will create jobs that would be lost in the auto industry, cut our need for foreign oil, cut our need to own automobiles, possibly cut pollution, car accidents, DWI’s etc…
    Of course there are some that will still need vehciles but maybe house holds that have 2+ cars could go down to one?
    Maybe more money could go to revamp the medical insurance industry, and provide more money for research into solar and wind power.

  42. wow, i believe we shouldnt cause then we would have to completely rely on foreign oil and foreign car industries which forces the US to become weak enought to be invaded by the country involved witht the contract

  43. Ariel Lundberg

    I think they are just wanting money beacuse all of the banks and every one is get getting money. How do you really know what they are going to spend it on. They already tryied and was turned down because they will not sell their their jets.