Surprise, surprise — GMAC needs more money. As you may recall, GMAC was the one institution that got a C- on the stress tests this spring that were impossible to fail. I imagine the analysts at the Fed really wanted to give it an F, but they couldn’t. In any case, it seems that GMAC is too big to fail, because of its importance to the auto industry. Yves Smith says, “The reason for more dough to GMAC is so GM and Chrysler can continue to finance auto purchases, not as a result of greater than expected losses on its existing portfolio. So this is cash for clunkers under another brand name.”

Again, not surprisingly, the government is treating the 50% ownership threshold as some sort of magic line. From the Times article:

“With all three helpings of federal aid, it is possible that the government could wind up owning at least half of the company. But GMAC and Treasury officials are discussing ways to structure the investment in a way that could limit the government’s ownership interests. One possible option would be to also ask some of its private preferred stockholders to convert their investments into common stock.”

So I have two ideas. The first is that if we put more money in GMAC, we should divide it in two and let the mortgage lending part fail. If we insist on keeping the whole thing afloat, that means we are subsidizing both the auto lending part (which is supposedly critical to the economy) and the mortgage lending part (which isn’t).

The second is that this would be a great time for JPMorgan Chase to get some good PR by stepping in and offering to replace GMAC as the funding source for GM and Chrysler dealers, so the government can abandon GMAC. Or even buying GMAC outright, including assuming all its debt and committing to subsidize the auto business, for $1 or so. Yes, that would make JPMorgan bigger, which I’m not thrilled about. But from Jamie Dimon’s perspective, it would show the potential benefits of having big banks that are willing to act in the national interest now and then, and it would be a little like Goldman declining to haggle over the price of buying back its warrants from Treasury.

Now the idea of relying on big banks to serve the national interest obviously sounds like bad policy to me. But if Jamie Dimon wants to take this problem off the taxpayer’s hand, I think he would be welcome to it.

By James Kwak

Back in December, when people actually had debates about whether or not Chrysler and GM would go bankrupt, one of the claims made by the anti-bankruptcy camp was that 80% of people would not buy a car from a bankrupt automaker. That number came from a CNW survey; here’s a summary from Motor Trend (hat tip Jane Hamsher):

A recent study from automotive market research firm CNW surveyed 6000 people intending to buy a new car within six months, and discovered that more than 80 percent of them would switch brands if the vehicle they wanted came from an automaker that went bankrupt. Breaking it down by company, Americans were more likely to abandon domestic automakers than foreign ones, with Chrysler faring the worst — a full 91 percent of buyers wouldn’t take home an Auburn Hills product if the company went bankrupt.

The theory was that bankruptcy would lead to an immediate collapse in sales which would lead to liquidation. (A later study, cited here, said that if the government were involved in the bankruptcy, the number of people who wouldn’t consider buying from GM would be 51%.)

This is what I said in December:

I strongly suspect that 80% is just a poorly worded and interpreted poll question. If you ask people in the abstract if they would buy cars from a bankrupt car company, of course they will say no. But in the real world, if the car they want is made by a bankrupt company, and they get a good deal, they will buy it. Just look at the November auto sales. GM was down 41%; Toyota, Honda, and Nissan were down 34%, 32%, and 42%, respectively. And everyone buying a car in November must have been aware that bankruptcy for GM was a serious possibility. (Besides, haven’t we been talking about a GM bankruptcy on and off for years?) Sure, bankruptcy will hurt sales a little. But 80% is just not credible.

Well, now we know. In May – during which Chrysler was in bankruptcy – Chrysler sales were down 47% from the year-ago period. Overall sales were down 34%, which means non-Chrysler sales were down around 33%. So as a crude estimate, if Chrysler were like the average automaker, for every 100 cars it sold last May, it would have sold 67 cars this May. Instead, it sold 53. That’s a 21% decrease – a lot less than the 91% predicted.

I’m not claiming I can predict auto sales better than other people – I know virtually nothing about auto sales. I’m just saying you shouldn’t rely on polls that ask people what they would do under some hypothetical scenario, since they don’t know what they would do.

By James Kwak

Those following the Chrysler bankruptcy know that the final holdouts are a set of Indiana pension funds, who have appealed the bankruptcy judge’s approval of the restructuring plan, attempting to force the company to explore other alternatives under a trustee who is independent of the government. They were lustily cheered on by The Wall Street Journal, elated to find good sturdy workingmen and -women willing to stand up to the Obama Administration and its “disdain for legal contracts,” and who could not be dismissed as speculators.

Well.

The pension funds in question bought the Chrysler debt in question last July for 43 cents on the dollar. (They stand to get 29 cents on the dollar in the restructuring.) I guess the difference between that and speculation is that “speculation” is something that bad people do; when pension funds by distressed debt, it’s called “investment.” I have no problem with pension funds buying modest amounts of risky investments, but they are taking the same risks that hedge funds are taking, and if they lose money on bad investments, that’s the fault of the pension fund managers.

Now, the popular defense of the Indiana pension funds is that they have a fiduciary duty to their beneficiaries to maximize the value of their assets. (Hedge funds should have the same duty to their limited partners, unless I’m missing something, but let’s set that aside.)  There is a deal on the table worth 29 cents on the dollar. Apparently they think Chrysler can do better by finding a a higher bidder (not likely at this point), or they can get more in liquidation. But that is far from a certainty, and the value of Chrysler is deteriorating as time passes; and if they manage to drag this out past June 15, Fiat can back out of the deal. So it’s not at all clear that their actions have a positive expected value for their beneficiaries.

Their cheerleaders, like the Journal, think that the little pension funds are standing up to the big evil government and defending the rule of law – namely, the order of priority of creditors in bankruptcy. (The issue is the relative treatment of the UAW and the bondholders.) But that’s not the job of a fiduciary; a fiduciary isn’t supposed to stand on legal principles and win Pyrrhic victories that harm the people it is supposed to serve.

Indiana Treasurer Richard Mourdock claims:

This is about the law, the law, the law. This is an unprecedented action to say that secured creditors can have their rights stripped away. We think it`s clearly illegal. As a fiduciary, I had no choice but to act.

The fiduciary duty is to get the most for the beneficiaries, not to enforce the law; Mourdock’s “no choice” language is pure bravado, especially when the law is as unclear as it is.

Steve Jakubowski wrote the most in-depth analysis I’ve seen. In short, there is a tension between the competing principles of (1) following the order of priority and (2) the “fresh start” policy of Chapter 11. There is a question of whether the Chrysler plan is an asset sale or a surreptitious reorganization. And there is also a question of whether it is more important to follow the order of priority or to get the most for the secured creditors. In that case, those might not imply the same outcome, since some of the key parties, including the government and Fiat, are free to walk away from the deal instead of giving the secured creditors a bigger share of it; that would lead to liquidation, which may be even worse for the secured creditors. (That was the conclusion of all the other secured creditors, although granted many had their arms twisted by the government.) Jakubowski says that the pension funds have a reasonable legal argument – perhaps a better one than Chrysler – but it’s by no means an easy case. And from a financial standpoint, they could still be shooting themselves in the foot.

Joe Donnelly, a Democratic Indiana congressman, is opposing Mourdock, saying that the action is likely to leave the pension funds worse off than the restructuring plan, and in addition threatens thousands of Chrysler jobs in Indiana (many in his district).

So what’s going on here? Either Mourdock really thinks that the chances of getting more than 29 cents outweigh the very real risk of getting less (and of blowing up Chrysler in the process). Or Mourdock (and Mitch Daniels, the Republican governor of Indiana?) believes that the order of priority of creditors in bankruptcy is more important than maximizing value for their retirees. Or Mourdock is trying to shift the blame for losing pension fund money on distressed Chrysler debt. Or he wants to score political points and embarrass President Obama.

In politics, anything is possible.

Update: If you care about this issue, you should read Steve Jakubowski’s latest.

By James Kwak

Many discussions of auto company economics include the assertion that SUVs and pickup trucks are more profitable than small cars, and so a shift from the former to the latter – as discussed by Felix Salmon, for example – will not be good for the auto companies, particularly GM and Chrysler (since they are in the news these days). I accept that as a historical statement, but I don’t understand why that is the case.

Textbook micro tells you that price equals marginal cost, so the gross margin on every product is zero; that’s clearly no help here. Profit margins should be higher in product segments with less competition, but basically every manufacturer makes a small, midsize, and large SUV, so I don’t think that’s the explanation.

I can think of a few other possibilities:

1. Small cars help manufacturers meet their CAFE targets, and so manufacturers are willing to accept lower profit margins on them. That is, each small car allows them to sell one more big car, so the marginal benefit of selling the small car includes the profit on the big car. There may be something to this, but not as much as you would think, because CAFE targets are scaled by vehicle footprint (length x width), so big cars have lower fuel economy targets; the more big cars you sell, the lower your overall target. It’s possible that the targets are carefully engineered so that, all other things being equal, it is easier for small cars to hit the small-car targets than for big cars to hit the big-car targets; if so, that would lead to manufacturers accepting lower profits on small cars.
2. The customer lifetime theory: The goal is to get a loyal customer for life and upsell him to bigger and bigger cars – you sell him a Civic out of college, an Acura RSX when he gets his first bonus (oh, wait, no more bonuses . . .), an Accord when he gets married, an Acura MDX when he has kids, and an S2000 when the kids go to college. In that model, the Civic can be a loss leader, because it pays for itself with the later models.
3. There’s more scope for differentiation with big cars. The bigger the car, the more bells and whistles you can throw in. Differentiation from the competition creates pricing power.
4. Big-car buyers are less price sensitive; they are buying the cars with their bonuses (sorry, forgot about that) or their home equity lines (whoops, none of those, either), while small-car buyers are saving up tips from waiting tables.

However, except for #1, all of these theories just say that you get higher profit margins on cars that you sell to people later in life (2), that are fancy (3), and that are expensive (4). And I don’t see any reason why these have to be big. You can imagine a world in which most cars are small-to-medium-sized, but they range from undistinguished ones like a low-end Honda Fit to expensive luxury cars with all the bells and whistles, like self-parking systems and haptic warnings when a car is in your blind spot, and with the latest fuel-efficiency technologies. In that world, manufacturers could rake in the profits on the high-end small-to-medium cars.

Anyway, is it really all about CAFE standards? Or is there another reason why big cars are inherently more profitable than small ones? I figure someone out there must know.

Thanks.

Update: There have been many helpful comments, so I’m not going to single any out. I would say there are two main explanations.

The first is that SUVs offer a better ratio of perceived value to production cost. That is, there’s an amount of stuff you need to build a functioning car; once you’ve done that, it doesn’t cost twice as much to make it twice as big, because you’re just adding raw materials. (I’m simplifying, obviously.) But people, being not that bright, think something is worth twice as much if it is twice as big. I still think competition should eliminate this larger profit margin, but see the second argument . . .

which is that SUVs and pickup trucks have been less exposed to foreign competition, so instead of having twelve or so viable competitors in the small-car segment, you mainly had three for SUVs.( Some commenters did not agree with this, pointing out that Toyota and Honda have been building pickup trucks for a long time.) With fewer suppliers, you can charge higher prices.

I should clarify that I don’t think there is anything wrong with the hypotheses I listed above; my point was that hypotheses 2-4 do not depend on SUVs/pickups being bigger, but on other characteristics of them. So there is no fundamental reason why, in the future, the profit margin on big things should be bigger than the profit margin on small things. Similarly, if the advantage is due to less foreign competition, then I think that would have gone away in any case, since just about everyone makes an SUV now (every major Japanese or Korean manufacturer, Volvo, Mercedes, BMW, VW, etc.) – though maybe not a pickup.

If the answer is the perceived value/production cost advantage, then that is arguably fundamental to big things as opposed to small things.

By James Kwak

In the same post I discussed yesterday, Keith Hennessey cites the same NHTSA report – the Final Rule governing CAFE standards for model years 2011-15, issued in January 2008 – to make this point: “The proposal will have a trivial effect on global climate change.” (It’s point 5 in his post, and was also picked up by Alex Tabarrok in his endorsement.) Hennessey cites the NHTSA report accurately, but the report itself is misleading.

What does the report say? Look at Table VII-12 on page 624. There are three scenarios that we are concerned with: No Action (which Hennessey calls, and I will call, “Baseline”); Optimized (“Bush Plan”); and Total Costs Equal Total Benefits (“Obama Plan”). If you want to know why Optimized is Bush and TC = TB is Obama, see my previous post. In the year 2100, the projected carbon dioxide (“CO2″) concentration in the atmosphere, in parts per million, is:

• Baseline: 717.2
• Bush: 716.2
• Obama: 715.6

That’s pretty convincing – or is it?

To answer that question, we’ll have to look at the report that those numbers are drawn from: the enormous Final Environmental Impact Statement, whose summary is here. You can see that the two documents tie by looking at Table S-9 on page 14 of the FEIS, which matches the table in the report Hennessey cites.

First, U.S. light vehicles account for a disproportionately large, but still absolutely small share of global greenhouse gas (GHG) emissions. From page 5:

Emissions from the United States accounted for approximately 15 to 20 percent of global GHG emissions in the year 2000. With more than one-quarter of these U.S. emissions due to the combustion of petroleum fuels in the transportation sector, CO2 emissions from the United States transportation sector represent approximately 4 percent of all global GHG emissions. Emissions from passenger cars and light trucks account for about 60 percent of emissions from the U.S. transportation sector.

So the greenhouse gas source targeted by CAFE accounted for 2.4% of global emissions from all sources. If we’re going to look at a 2100 projection, though, we have to take into account the fact that that percentage is certain to go down over the century as countries like China and India become more developed under any scenario. I’m going to guess that by 2100, even in the baseline, U.S. cars and light trucks would fall to 1.6% of global GHG emissions; that means that on average, over the century, they would be producing 2% of global emissions. 

Obviously, if all we do is reduce emissions from one source that accounts for 2% of the total, we’re not going to have a noticeable impact on global warming. If we want to know if we’re doing “enough” in this one little area, the right question to ask is: if we were able to reduce emissions from all sources by the proportion that we are able to reduce U.S. car and light truck emissions, would that have an impact? To answer that question, we have to multiply the impact of the CAFE standards by 50. Then the numbers look like this:

• Baseline: 717.2
• Bush (assuming similar reductions of all other sources): 667.2
• Obama (same assumption): 637.2

That’s starting to look better, but in the baseline, CO2 ppm in 2030 are 455.5, so we’re still really high.

Second, however, the much more misleading part of this report is its assumptions about what happens after 2020.

To begin with, we have to understand what the various scenarios are. It’s not clearly spelled out, but the Summary implies that the baseline scenario is one in which the 2010 CAFE standards are extended to cover the 2011-15 period; see for example footnote 13 on page 13. Most of the other scenarios estimate what would happen with different CAFE standards for model years 2011-15. The important point is that they only measure the impact on model years 2011-15. Relative to the baseline, they don’t even assume that higher standards in 2015 will lead to higher scenarios in later years; they assume that after 2015, CAFE standards revert to the baseline. For example, see footnote 10 on page 8:

NHTSA uses 2060 as the end point for the analysis [of fuel consumption] because it is the time at which 98 percent or more of the operating fleet would be made up of MY 2011-2015 or newer vehicles, thus achieving the maximum fuel savings under this rule.

(Footnote 11 on page 11 says essentially the same thing, in the context of toxic air pollutants.) You see? They are assuming that higher standards for MY 2011-15 will have no effect on standards in later years.

This is absurd. Even if NHTSA never wrote another CAFE standard for any year after 2015, the fact that, under either the Bush or Obama plan, CAFE would be higher in 2015 than in the baseline implies that fuel efficiency will remain higher than in the baseline for some time to come, if not forever. 

For greenhouse gases, however, the analysis is not quite so ridiculous. To see the assumptions, however, we have to leave the summary and go to the Cumulative Impacts section. There, at the bottom of page 53, we see this:

For each alternative, NHTSA assumed that passenger car and light-truck CAFE standards would continue to increase over MY 2016-2020 at their average annual rate of increase over MY 2011-2015. . . . NHTSA assumed further that the fuel economy standards for model year 2020 would remain in effect through the end of the analysis period [2100].

So for greenhouse gases, they are not assuming that fuel efficiency reverts to the 2010 level in 2016. Instead, they assume that fuel efficiency continues to increase in a straight line until 2020 – and then remains flat for the next 80 years. 

This is still absurd, though slightly less so than assuming that fuel efficiency gets worse in 2016.

Graphically, the report is estimating the impact of the alternative scenario (Bush or Obama) versus the baseline like this:

Obviously, it’s true that if you improve fuel efficiency for 10 years, and THEN YOU STOP, you are not going to have a large impact. The point is to continue improving fuel efficiency. And you cannot simply choose your fuel efficiency independently in each year; the achievable CAFE standards for 2021 depend heavily on what the actual standards are for 2020. Put another way, the policy objective is to get on a long-term improvement trajectory that will get us where we need to be, as in the following picture:

The policy whose impact we are trying to estimate is a policy that targets a certain rate of improvement in fuel efficiency, as drawn above – not a policy of improving fuel efficiency for ten years and then stopping, which is what NHTSA estimated. It is true that neither Bush nor Obama proposed setting CAFE standards for the next 91 years, but the rate of improvement over 2011-15 does determine the potential improvement in 2016-20, and the rate of improvement in 2016-20 determines the potential improvement in 2021-25, and so on. To say, as the NHTSA report does, and Hennessey and Tabarrok echo, that increasing CAFE standards for ten model years will not solve global warming is narrowly true but deeply misleading. It’s like telling someone who’s about to go for a short jog, “Don’t bother – once around the block isn’t going to get you ready for a marathon.” Sure, you have to train for months – but you have to start with that first run. And if you don’t go once around the block today, you won’t be able to go twice around the block tomorrow.

This isn’t a Bush vs. Obama thing. Both Bush and Obama said we have to go once around the block today, and twice tomorrow, and so on for a week. (Obama said we should go a bit further each day than Bush, but you’ll note that the difference between Bush and Baseline is bigger than the difference between Obama and Bush.) The issue is that the NHTSA said one week of training wouldn’t be enough to run the marathon. You can’t conclude from that that one week of training is pointless.

The immediate question is, how much bigger is A + B than just A? In the picture above, A + B is 4.8 times as big as A. (Think of A as one slice that is 85 years long on average; B is eight slices, ranging from 75 years long to 5 years long; all the slices are the same width.) This is not quite accurate, first because model years phase into the overall fleet over time, and more importantly because we don’t know how long fuel efficiency increases can be roughly linear. (At some point, if we have practical fuel cell cars, there could be a huge jump upward.) But it will do as a crude ballpark estimate. If we go back and apply a factor of 4.8 to the improvements we saw above (extrapolated over all GHG sources), we get this:

• Baseline: 717.2
• Bush: 477.2
• Obama: 333.2

Now we’re talking.

Of course, these numbers are crude estimates. But this is the order-of-magnitude impact we’re talking about – hundreds of parts per million, not 1.0 or 1.6 parts per million. By extrapolating over all GHG sources, and by assuming continued effort past 2020, we add two orders of magnitude to the NHTSA estimates. These things won’t happen by themselves; we need to do what we can about those other GHG sources, and maintain the political will for more than a few years. But increasing CAFE standards can have the right order-of-magnitude impact; it’s not a waste of effort.

By James Kwak

Note: There are two somewhat significant updates at the bottom, just before the Appendix.

CAFE stands for Corporate Average Fuel Economy – the average fuel efficiency that is calculated annually for every manufacturer that sells cars or light trucks in the U.S. and compared to standards set by the National Highway Traffic Safety Administration, part of the Department of Transportation. (If you want to know more about how CAFE is measured, see the Appendix to this post.) Yesterday, President Obama proposed new, higher CAFE standards for models years up through 2016, by which point aggregate efficiency should reach 35.5 miles per gallon. 

The typical conservative response to regulations like this is that they impose costs on the economy. In this case the main argument is that mandating higher fuel efficiency standards makes cars more expensive to produce; so car companies have to charge more for them; so fewer people will buy cars, and fewer people will be employed in the auto industry. I was planning to try to pre-empt this argument, but Keith Hennessey, former head of the National Economic Council under Bush II, beat me to the punch. His post summarizes some findings from a 900-page report produced by NHTSA in January 2008, when the Bush administration released the latest version of the CAFE standards. One of his main points, taken from that report, is that the Obama standards will cost 49,000 jobs. That’s relative to some baseline that I haven’t been able to identify, but it’s 38,000 jobs more than the Bush standards. The table is on page 586 of the long report; the Bush plan is “Optimized” and the Obama plan is “TC = TB.” Hennessey’s post has been picked up by Marginal Revolution (where I found it) and by The New York Times, so I decided I should stay up late and write a response.

Hennessey’s insight was to notice that the Obama plan looks similar to a plan analyzed under the Bush administration – TC = TB – and rejected in favor of Optimized. If you look at the first chart in his blog post you’ll see why he makes this guess, and it seems good to me. Based on that assumption, he can take the NHTSA’s analysis of the TC = TB plan and apply it to the Obama plan.

Optional interlude on “Optimized” and “TC = TB”

The Optimized plan is the one that, according to the analysis, maximizes net benefits to society – that is, benefits of the regulation minus costs of the regulation. The TC = TB plan is the one that gets the highest fuel efficiency while ensuring that the net benefits are not negative. The conceptual idea is that there is that there are diminishing marginal net benefits to higher fuel efficiency – you use less fuel and emit less carbon dioxide (“CO2″), but it gets more and more expensive to squeeze more efficiency out the engines, so the cars cost more and more.

I acknowledge this point, but I don’t put a lot of faith in it, because the calculation of benefits is highly dependent on your assumptions, such as the price of oil and the monetary value of reducing carbon emissions. In this study, the NHTSA used a range of $0 to $14 per metric ton of CO2, and used the midpoint ($7) in its estimates. The higher your estimate of the aggregate cost of CO2 emissions, the higher your optimal fuel efficiency standards will be.

Back to jobs

The argument that higher fuel efficiency standards reduces jobs goes like this. The diagram below shows the market before regulation. Auto companies will supply cars at some price that includes their cost plus the profit margin they need to pay off their debts and provide a return to their shareholders. (You could draw the supply curve with an upward slope and everything that follows would be essentially the same.) The more expensive the car, the fewer people will buy it. At equilibrium, the price is P0 and Q0 cars will get produced and sold.

Optional interlude on demand and supply curves: The curves show the quantity offered (supply) and bought (demand) at each price. Where they intersect is where the market should end up. This is incredibly confusing to people who know math but do not know economics, because the axes are backwards from the way they are in every other quantitative field that I know of. I believe this is the fault of some English guy named Marshall.)

Then regulation comes along, increasing costs for car makers. The Obama people have been using the number $1300, so let’s use that number. This acts something like a tax. The price charged goes from P0 to P1, where P1 = P0 + $1300. At the higher price, fewer people will buy the car, so quantity declines to Q1. Fewer people get cars (bad) and fewer cars get produced, meaning fewer jobs in the auto industry (bad).

However, there are two problems with this argument in its simple form. The first problem is that it isn’t the same car – now it’s more fuel efficient. That’s good, and it means that people will be willing to pay more for it. In other words, the demand curve shifts outward, so at equilibrium, quantity will be Q2, which is somewhere between Q0 and Q1. Q2 will still be less than Q0; otherwise, the free market would have come to that equilibrium by itself. (If people valued the increased fuel efficiency at $1300 or more, the industry would already have done it, at least according to a pure free-market argument.) So things are not as bad as in the picture above.

The other thing is that there is actually $1300 of additional stuff in the car, which someone has to build. So even if fewer vehicles are being made, they are not the same vehicles. If we take manufacturing cost as a proxy for labor inputs throughout the entire supply chain, then these vehicles require more labor than the pre-regulation vehicles. (You could say that you get the increased efficiency from more sophisticated components – but someone has to design and build those components, and if they were as easy to design and build as the less sophisticated components, then they wouldn’t cost any more.) So as a crude approximation, in the pre-regulation world the auto industry employs B + C people, while in the regulated world it employs A + B people. And there’s no way to tell from a conceptual drawing which is greater.

That’s the theory. But how do things work out in the real world? First I’ll look at the consumer side, then I’ll return to the production and jobs side.

Consumers

The first thing to note is that the manufacturing cost of every vehicle will not go up by $1300 – that’s just an average. It’s also not as simple as saying that the manufacturing cost of gas guzzlers will go up more and the cost of fuel-efficient vehicles will go up less, because car companies can meet the standards any way they want, and increases anywhere in the fleet help. (They can’t just change their mix, as explained in the Appendix.) All other things being equal, you would expect more investment to go into the gas guzzlers, because the marginal returns to investment should be higher than in the Prius; but other things are not equal, like maybe the marginal bit of engine efficiency gets you more bang in the Prius than in a pickup truck, because it is already lighter and more aerodynamic.

On top of that, car companies have sophisticated pricing strategies that involve all sorts of cross-subsidization. For example, American manufacturers until recently sold small cars at small profit margins while selling large cars and trucks at huge margins. All other things being equal, you would expect them to discount the more efficient models and increase prices on the less efficient models with the same footprint (see Appendix), because that would have the net effect of increasing their CAFE, but again many things are unequal.

But let’s assume that prices will go up by some amount. Does that mean that fewer people will be able to afford cars, as implied by the diagrams above? Maybe. The flaw with all those diagrams is that they assume that there is only one car at one price, when in fact there are dozens of models, each with dozens of potential variations, all at different prices. For example, let’s say that in an unregulated world you would buy a top-of-the-line Toyota Camry XLE, with an MSRP of $25,575. Whoops, everything is now $1300 more expensive (let’s assume). Are you going to switch to mass transit? No, but you could switch to the Camry LE V6, which is $1300 less than the XLE. Or you could give up the navigation system, which has an MSRP of $1200. Or, if you want all the options, you could switch to a Ford Fusion, which is a little less expensive than a Camry, but which I hear is a very good car. 

So would fewer new cars actually get sold? Maybe, at the margin, there are some people who are already buying the very cheapest new car out there (or the cheapest model in the class they need), and will be forced out. However, it is also possible that one or more manufacturers will come out with an even cheaper car to supply them – or simply keep a low-end model or two in their existing form, without additional manufacturing costs. In any case, the net effect should be smaller than in the theoretical one-model world, where there is no ability to switch into a cheaper substitute.

And, to take a normative stance for a minute, it’s not as if this is perpetrating some great injustice on the American consumer, like forcing people to take mass transit. There is a big used-car market in the U.S. (where my family has bought two of the three cars we have ever owned), and, believe it or not, there is no Constitutional right to a new car. Theoretically, increased prices for new cars could ripple into the used car market – eventually – but you can still substitute into slightly cheaper models. At the bottom end of the spectrum, people who can barely afford any car are looking at things like my 99 Chevy Prizm – and I doubt that new CAFE standards are going to boost its resale value by more than a few cents.

Producers

So, I think I’ve outlined a number of reasons why job losses should not be as great as in a crude “$1300 tax” analogy in a world where only one car model exists: demand for cars will go up because they are better; there is more stuff in the cars that has to be built; and people can substitute into different new cars instead of being forced out of the new car market. The fact remains that the NHTSA report cited by Hennessey estimates 49,000 job losses relative to the baseline scenario which, I assume, is the world prior to the 2008 Bush Administration change to CAFE standards for model years 2011-15. So we need to look at what’s behind that number.

In the main report, the entire discussion is on pages 584-86, and this is what we have on methodology: 

The calculations assume that compliance costs are passed onto consumers in the form of higher prices. These higher vehicle prices (net of the benefits of added fuel savings and added resale value) lead to reduced demand for vehicles. Estimates of sales losses are made using the price changes and the elasticity of demand for new vehicles (-1.0). Losses in sales are translated into losses in jobs by dividing through by the average number of vehicles produced per full time jobs in the automotive industry (approximately 10.5 vehicles per job).

So it looks like they did take into account the fact that the vehicles are worth more. Another thing to note is that the estimate covers the entire auto industry, so the 49,000 jobs number includes overseas jobs; the number of domestic jobs would be considerably lower. But it’s not clear whether there is one model with a single type of car, or a more sophisticated model. 

The main report cites Chapter VII of the Final Regulatory Impact Analysis (FRIA), which I cannot find on the NHTSA web site. I am looking for the FRIA for the Final Rule for model years 2011-15, which became effective in January 2008. I can find something called the Preliminary Regulatory Impact Analysis for those model years, which is actually dated April 2008, and is probably pretty close.

In that report, the relevant section, “The Impact of Higher Prices on Sales,” begins on page 259. There is a long explanation of how they estimated the increased value of a more fuel-efficient car, which looks pretty rigorous. But this is a crucial paragraph:

A sample calculation for Ford passenger cars under the Optimized 7% alternative in MY 2011 is an estimated retail price increase of $782, which is multiplied by 0.911 [to reflect the increased resale value of the car, less some increased costs of ownership] to get a residual price increase of $712. The estimated fuel savings over the 5 years of $281 at a 3 percent discount rate results in a net cost to consumers of $431. Comparing that to the $21,821 average price is 2.39 percent price increase. Ford sales were estimated to be about 1,300,000 passenger cars for MY 2011. With a price elasticity of –1.0, a 2.39 percent increase in sales could result in an estimated loss in sales of 3,104 passenger cars at a 3 percent discount rate.

So the model assumes a world where every manufacturer makes exactly one passenger car and one light truck and applies a price elasticity of -1.0. Now, it’s possible that that price elasticity was estimated using a similarly aggregated model of the world, so perhaps this approach is accurate. But I’m also worried about the $782 estimate for retail price increases. The methodology for estimating manufacturing cost increases is complicated, to say the least. It is based on estimates of the cost, effectiveness, and availability of specific new technologies (pp. 88-93). Then these are applied to data from the manufacturers about their production plans (see pages 126-28). As far as I can tell (I admit, I didn’t read every word), the algorithm takes these car company plans as a given, meaning that it does not allow them to shift their production plans in response to changing CAFE standards. This seems unrealistic to me. 

While I’m skeptical, I don’t have any strong evidence that the estimated sales losses are too high. However, there is a bigger problem on page 271:

There are three potential areas of employment that fuel economy standards could impact. The first is the hiring of additional engineers by automobile companies and their suppliers to do research and development and testing on new technologies to determine their capabilities, durability, platform introduction, etc. The agency does not anticipate a huge number of incremental jobs in the engineering field. Often people would be diverted from one area to another and the incremental number of jobs might be a few thousand.

The second area is the impact that new technologies would have on the production line. Again, we don’t anticipate a large number of incremental workers, as for the most part you are replacing one engine with another or one transmission with another. In some instances the technology is more complex, requiring more parts and there would be a small increase in the number of production employees, but we don’t anticipate a large change.

[The third is lower sales.]

It seems to me that they are ignoring the fact that more complicated, more expensive cars with more stuff in them require more labor to build. Essentially, this study is saying that it will cost more to build more fuel-efficient cars because they require new technologies that must be developed and manufactured at a higher cost than the old technologies – yet those new technologies and components will not employ any more people than the old technologies. If they don’t employ any more people – anywhere along the supply chain – why are they more expensive? I doubt that the new technologies use more iron or copper than the old ones; if the increased value doesn’t come from raw materials, it must be added by people, somewhere along the line. A little might go to intellectual property licenses, but that can’t amount to all of the incremental cost. 

Anyway, something seems deeply wrong to me here. In short, this approach denies that box B on my last diagram has any impact on employment. 

In the end, I’m willing to acknowledge that higher fuel efficiency standards should mean slightly lower new car sales, which could lower auto employment a little. But the 49,000 number is definitely high for at least two reasons: (a) it ignores the additional jobs required to build more complicated, more expensive cars; and (b) if you’re looking at this from a U.S. standpoint, it includes foreign automakers. And it may be high because it doesn’t fully reflect substitution between car models, either by manufacturers or by consumers.

I have something to say about the environmental impact as well, but that will have to wait for tomorrow, as this is already my longest blog post ever.

Update: Lying in bed last night, I changed my mind. I’m not willing to concede that higher fuel efficiency standards mean fewer auto industry jobs; they might, but it’s not certain.

The elasticity of a product is the amount that purchases of that product will change in relation to changes in its price. We say that gas and cigarettes have low elasticity: double the price of gas, and people will still buy almost as much of it; the same goes for cigarettes. Elasticity is expressed as the ratio of the proportional change in sales to the proportional change in price. So if the elasticity of cars is -1.0, that means for a 3% increase in price, you will get 3% fewer cars sold.

The implication, which I missed last night, is that almost the exact same amount of money gets spent on new cars (1.03 * 0.97 = 0.999) – there’s just more money per car. If the price goes up because manufacturers are able to raise prices, keeping the cars the same, then more money (per car) goes to their profits, so employment can go down. The same thing is true with a tax, where more money goes to the government. If the price goes up because the cost of steel goes up, then more money goes to steelmakers, so employment in the auto industry can go down.

In this case, though, the price increases are because the cars have more car stuff in them, increasing their manufacturing costs. So the amount of money being paid into the auto industry is the same and the profits are the same, and money going to raw inputs is the same. So auto industry employment can only go down if labor’s share of costs goes down, or if per-worker compensation goes up. In the absence of a reason why one of those should be happening, I don’t see why employment would go down.  

Also, thanks to Oliver, I fixed a typo in the first paragraph – 2006 should be 2016.

Update 2: RJ raised the safety question in this comment. Dominic J, winstongator, odograph, and StatsGuy responded in replies (directly below the original comment), saving me the trouble of doing the research. Thanks.

Appendix: Interesting Facts About CAFE

There are many things I didn’t know about CAFE until I did the research for this post. Here are three that may be interesting.

1. CAFE does not fall into the miles-per-gallon trap. If you take two cars, one that gets 10 mpg and one that gets 20 mpg, and drive them the same distance, you will not get an overall average mpg of 15; you will get 13.3. Try it yourself if you don’t believe me. You do not have this problem if you use gallons per mile instead; in that case your two cars would use 0.1 and 0.05 gallons per mile, and on average they would use 0.075 gallons per mile, which is exactly what you would expect. 

This is the formula that CAFE uses:

where N is the total number of cars, Ni is the number of model i, and MPGi is the MPG of model i. It says it uses MPG, but if you stare at it long enough you’ll work out that the denominator of the fraction is calculating how much gas it would take to drive every car one mile, which is a gallons-per-mile calculation, and everything works out.

2. There is a different standard for each vehicle “footprint,” which Hennessey helpfully defines as “the shadow made by the vehicle when the sun is directly overhead.” So if you have bigger cars, you are allowed to have lower gas mileage. One implication is that you can’t meet higher CAFE standards simply by dropping SUVs and increasing sales of small cars, since your aggregate standard (that you have to meet) is a weighted average of the standards for each of your models – weighted by the number of each model that you sell.

3. CAFE compliance is based on actual vehicle sales, not predicted sales. I was a little suspicious about this.

By James Kwak

Keith Hennessey, the last head of the National Economic Council before Larry Summers, has a blog post out (hat tip Alex Tabarrok) reviewing yesterday’s announcement by the Obama administration on their proposed new CAFE (Corporate Average Fuel Economy) standards. It links to a very informative report that I’m still digesting. (I was planning a post on the economics of CAFE for today, but now I need to read part of that report.)

Update: I found a mistake in the way Hennessey used a table and I posted about it here. Hennessey graciously acknowledged the mistake, fixed it on his post, and left a comment here. So I decided to delete my criticism. I really should have sent him an email first, and I feel bad about that. 

By James Kwak

I was talking to an old friend last night about the Chrysler bankruptcy and, in particular, whether Chrysler (and Treasury, and the UAW) will be able to get around the order of priority of creditors in bankruptcy – which ordinarily would favor the senior secured lenders who are trying to block the proposed plan. I thought I would do a little research, but then (again via Calculated Risk) I found Steve Jakubowski’s analysis of precisely this issue, which apparently everyone on the Internet has already been linking to. It’s actually Part 3 of a series; you may want to start with Part 1.

My summary, for those who don’t like reading citations from court opinions: The issue with the “restructuring initiative” agreed-upon by Chrysler, the government, Fiat, and the UAW,  is that it only pays the senior secured creditors $2 billion in cash for $6.9 billion in secured debt; since secured creditors’ claims should come first, they argue they would get more from a liquidation. In particular, the VEBA created to fund retiree benefits is owed $8.5 billion; it is getting $4.6 billion debt and 55% of the equity in New Chrysler.

The government’s plan is to get around this by creating a new entity, New Chrysler, and having the existing entity, Old Chrysler, sell its assets to New Chrysler. Technically speaking, Old Chrysler is not being reorganized; it is just selling assets. However, as Jankubowski explains, a bankruptcy court can block such an asset sale if it is effectively a reorganization by another name. The Second Circuit (the appeals court that would hear the appeal of the bankruptcy proceeding) has said that such an asset sale may go ahead if there is a “good business reason” for it – a test that is spelled out, not entirely clearly, in other court opinions.

Behind the legal test, the underlying legal principle at issue, discussed in Part 3, is whether the “absolute priority” rule, which determines the order of claims by creditors in bankruptcy, prevails over the general policy consideration that bankruptcy is intended to enable companies to return to healthy operations. To simplify greatly, Chrysler and the government’’s argument is that without the “asset sale,” the company will simply disintegrate; the creditors’ argument is, or could be, that that doesn’t matter.

If you want to know what corporate law is like, I recommend reading the posts in full.

Update: It looks like the creditors’ opposition may fall apart, although we can’t be certain. well, at least you learned something about bankruptcy law.

By James Kwak

This post was written by my friend Ilya Podolyako, an occasional contributor here and a third-year student (though not for much longer!) at the Yale Law School.

In the last couple of days, a few disparate news pieces attracted my interest. First, as I mentioned in my last post on industrial policy, an accelerating, worldwide decrease in consumer disposable incomes is beginning to percolate through the manufacturing sector. As a result, Caterpillar, DuPont, and United Technologies posted double-digit declines in sales. Second, reports surfaced that Fiat, Obama’s designated buyer for Chrysler LLC, was looking instead to purchase GM’s Opel division. Third, Sen. Diane Feinstein (D-CA) introduced a “cash-for-clunkers” bill that would provide a credit of up to $4500 toward the price of a fuel-efficient car for individuals or government-owned fleet operators who turn in a low-mpg “clunker.”

What do all these data points have to do with each other? In my mind, they highlight the need for a structured approach to the U.S. industrial sector. The current policies are completely random and occasionally conflicting, which is not surprising, considering that they are coming from different branches of government who seem reluctant to talk to each other. For example, the purpose of the Feinstein bill seems to be to support the auto industry by lowering the effective price of a new car while also boosting aggregate fuel efficiency. Presumably, these measures would help the ailing American automakers transition from making money on SUVs to making money on hybrids. Yet in this context, a government-financed sale of Chrysler to Fiat doesn’t make very much sense. If we are concerned about rescuing the American auto industry from the bottom up, why are we selling bits and pieces of this industry to foreign companies? Imagine if GM, Chrysler, and Ford did not exist – in this world, the government could surely find a better way of spending money to combat climate change than paying Toyota and Honda to chop 20% off the sale price of a new car. Just because other countries do it, doesn’t mean we should too.

Similarly, I am skeptical of the wisdom of helping Fiat buy Chrysler when it is also looking to buy Opel. Sergio Marchionne, Fiat’s CEO, has openly stated that the company is looking to increase production volume and break into the US market. In fact, given Chrysler’s persistent inability to make cars profitably (it has failed to do so as a standalone public company, a unit of DaimlerChrysler, and a privately owned entity), the company’s main value lies in its U.S. dealer network. At the same time, Opel has designed several automobiles that had potential with the American public, such as the Sky roadster and Aura sedan. According to GM’s 10K, Opel (which accounts for the bulk of the company’s European operations) actually had an increase in both total sales and revenue from 2006 to 2007. Basically, the unit seems to be quite capable of functioning as a stand-alone, profitable car company. There is thus a real possibility that if Fiat goes through with both the Chrysler and Opel acquisitions, it will end up selling Opels at Chrysler dealerships across America, where they would compete with whatever remains of the GM portfolio.

I don’t support protectionist trade policies, but having US government pay for the above outcome seems like an unambiguously bad idea for everyone on this side of the Atlantic. To avoid the wealth transfer, Treasury could condition the promised $6 billion loan on Fiat’s promise to avoid certain follow-on acquisitions, but then the Chrysler sale may fall through altogether, exposing the fundamental instability of the Obama auto rescue plan.

Finally, an L-shaped recovery likely means more trouble ahead for industrial manufacturers outside of the automotive sector like GE or Caterpillar. If either of these companies nears insolvency, I doubt that the Obama administration would jump on the opportunity to help sell off their operations piecemeal to foreign buyers. In the optimal case, the government would just let the companies go through bankruptcy using private sector financing and scrutinize the purchasers of any sensitive assets for national security risk using an existing apparatus. Considering that the auto bailout plan hasn’t required GM or Chrysler to preserve any particular number of jobs, I just don’t see why the Two-Out-of-the-Ex-Big-Three should be treated any differently.

The Administration’s current approach to the industrial sector appears even more haphazard than its efforts to right the financial markets. The government is spending non-negligible amounts of money on dubious short-term goals that conflict with both the acute needs of certain demographics (auto workers, residents of Michigan) and the long-term interests of the American taxpayers. Federal agencies timidly pick up the tab for corporate liabilities like pensions without proportional claims to their profits. This behavior is the exact opposite of the type of directed industrial policy I suggested could be worth trying.

By Ilya Podolyako

My Yale Law School colleague Ilya Podolyako comments on the Obama administration’s plan for the auto industry and the tension between public goals – preserving jobs, increasing fuel efficiency, etc. – and private goals – profitability.

By now, the dust seems to have settled around Obama’s rescue plan for two-thirds of the long-ago “Big 3″ (in 2007, Chrysler ranked 12th in the world in total auto sales; GM has ranked 2nd; Ford, which is not receiving government assistance, was 4th). The policy itself seems prudent enough. The President’s Task Force on the Auto Industry recognized that due to its small scale, reliance on light trucks, and objectively low product quality, Chrysler is not viable as a stand-alone company. On the other hand, General Motors has large economies of scale and makes certain well-received products (the report mentions the Chevy Malibu and Cadillac CTS by name, though one could add the Cavalier, Corvette, and Escalade to those lists), but faces exorbitant legacy costs for its nearly one million retirees and low margins on its fuel-efficient vehicles. Given this fact pattern, the plan does as good of a job as anyone could in offering a helping hand to iconic American manufacturers while preserving some incentives for efficient private-sector operation.

My problem with the restructuring proposal comes not from any one of its details, nor even its general spirit. At this point, I feel fairly neutral about heavy-handed government involvement in US industrial policy. Admittedly, I am from Michigan and really like cars (despite consistent problems, I keep driving Fords, though I am not sure why), so I have some emotional connection to the industry to balance against the gross, obvious inefficiency of pouring money into enterprises that, by their own admission, will at best break even by 2014. I also do believe that a GM bankruptcy would lead to the net loss of a significant number of jobs that would permanently cripple Michigan’s already desperate economy.

I am concerned, however, with the absence of any apparent long-term vision for the “American” automobile industry within Obama’s proposal. A New York Times story provides a nice contrast to our own state of affairs when it explains that “Chinese leaders have adopted a plan aimed at turning the country into one of the leading producers of hybrid and all-electric vehicles within three years, and making it the world leader in electric cars and buses after that.”

Mechanically, the Chinese policy does not seem to be that different than that of the United States. If anything, it is facially less intrusive into the affairs of the automakers, though the fact that the government continues to own a controlling stake in most such entities makes this difference illusory. The national government will provide research funds for the development of alternative-fuel vehicles, coupled with direct subsidies for consumer purchases of such products. The PRC’s policy motivations look similar to those present on our shores too: cut down on pollution, preserve national stability in the face of shrinking foreign oil supplies, and foster industrial excellence.

The issue is that whereas the Chinese government is content with spending public money for an indefinite period to promote these well-defined (and fairly reasonable goals), the U.S. executive branch cannot be. American leaders are directly accountable to voters, who generally dislike state-directed industry. Yet this feature of our political system runs counter to the motivations for the automaker bailout. These seem to be, in order of importance:

1. National pride: The United States of America became a superpower while leading the world in car manufacturing; people in and out of government associate the two phenomena with each other. Accordingly, they want to retain the symbolic value of GM or Chrysler.
2. Job preservation: No explanation necessary, though the jobs in question are localized. No one has made the argument that the collapse of GM or Chrysler would pose a systemic risk to the national economy as whole.
3. Environmental considerations: The President appears to believe that U.S. automakers can play an important role in the larger effort to reduce greenhouse gas emissions by manufacturing fuel-efficient cars.

The above considerations are fundamentally political; they are not the ingredients of a profit-making business. With these goals, inquiry into the potential viability of GM or Chrysler as a private enterprise matters only as a way to distract voters frustrated with selective government handouts.

But this strategy is both unsustainable and unwise. First, if Obama intends to keep the auto-companies as a federal jobs program, he shouldn’t pay large, institutional investors in the process. That’s what TARP II, EESA, and PPIP are for. Second, one would think that for both the employment and the environmental goals, there is no need to combine the bureaucracy of the Department of Treasury with that of General Motors. I am willing to accept that, given the track record of private sector management at the Big 3, the government may have at least as good of an idea of what consumers want as the people who designed the Pontiac Aztec. Of course, if that is the case, members of the Auto Task Force should be managing the R&D and Manufacturing divisions directly instead of making a slightly reshuffled deck of top executives drive back to Washington every two months for progress reports. Third, selling off GM’s relatively well-performing European operations, along with its prized partnership with China’s SAIC, would diminish the company’s stature as an American powerhouse while undercutting the very economies of scale that give it remaining strength.

So, where do we go from here? If Obama’s goals for the intervention are actually those that I identified, he should be frank with the population, if only because the current plan is so clearly incompatible with business logic. The proposal should function for now and buy the Administration some time to recoup political capital, but in these tumultuous times, the notion of a gently nationalized car industry may not do too poorly. On the other hand, if Obama wants to see GM and Chrysler survive as smaller, profit-making companies, he should write off the $20 billion in aid that, under the current plan, would stick with the “good” GM, let the bondholders go through bankruptcy, and use his stature to negotiate some sort of a politically favorable but economically sustainable agreement with UAW.

By Ilya Podolyako

Back in the early days of the Clinton administration, James Carville was credited with saying something like this:

I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 basball hitter. But now I would like to come back as the bond market. You can intimidate everybody.

The story back then was that bond investors, by buying or selling Treasury bonds, could lower or raise the government’s cost of borrowing and interest rates across the economy, depending on how they felt about government policy.

Today bond investors have discovered a much more direct lever over government policy. I’ve already written about the importance of bondholders in dealing with the financial sector. This week we are seeing their power over the auto industry.

GM faces roughly the same problem as the banks we have been talking about so much. Its assets, broadly speaking – not only factories, designs, and patents, but its general ability to make money by selling cars – don’t cover its liabilities. Those liabilities are largely bonds ($28 billion – I believe that excludes the recent bridge loans from the government) and union contracts ($20 billion owed to a health care fund, along with ongoing payroll). In order for GM to avoid bankruptcy,  the creditors (bondholders and the union) need to voluntarily give up some of their claims. This is what is known as restructuring.

Now why would a bondholder do this? Right now you are holding a piece of paper that says GM will pay you $100 million plus interest. Why would you give that up for $8 million in cash, a new piece of paper saying GM will pay you $16 million plus interest, plus about0.3% of the equity (stock) in GM, which is apparently the deal on the table?

You would only do this if you think the alternative is worse. The alternative, in such a situation, is bankruptcy, where a judge will decide how much you get. And clearly at least some bondholders are afraid of this alternative, since bonds were trading around 16 cents on the dollar on Monday. But this is a special case, since we know that for both political and economic reasons the Obama administration does not want the American auto industry to disappear, and many commentators (Yves Smith, for one) think that a bankruptcy would have that outcome.

The result is a high-stakes game of chicken. Bondholders are betting that President Obama will not take the risk of forcing GM into bankruptcy. If that is true, the government’s only option will be to sweeten their offer to bondholders, or to give up on restructuring and bail out GM the old-fashioned way (large low-interest loan, equity injection, etc.). Either way the value of GM’s bonds would go up.

Obama, by contrast, has to show that he is serious about the bankruptcy option, if he is to have any hope of scaring the bondholders into agreeing to a restructuring. I think this is the most likely explanation of his statement that bankruptcy might be the best medicine for GM and Chrysler – which drove one series of bonds down from 19 cents to 10 cents in trading today.

The problem he faces is that the government’s credibility in a situation like this is weak, both because of the political and economic risk of a GM bankruptcy, and because of its flinching in a similar situation involving GMAC in December.

And who is on the other side of the table? Why, it’s PIMCO, the fund manager that has patriotically volunteered to be one of the participants in the Treasury Department’s public-private investment funds to buy toxic securities.

Correction: Nemo points out in a comment below that there was no statement by Obama, just a leak.

Robert Siegel gave GM a priceless gift today: a feature segment on All Things Considered, with a bunch of softball questions and a paean to the Chevy Malibu (which was, to give credit where credit is due, the 2008 North American Car of the Year, which includes foreign imports). Then Bob Lutz, GM’s vice chairman, fumbled the gift and dropped it on the floor, where it smashed into a thousand pieces. When asked what it was like to operate using money borrowed from the federal government, he said:

I’ve never quite been in this situation before of getting a massive pay cut, no bonus, no longer allowed to stay in decent hotels, no corporate airplane. I have to stand in line at the Northwest counter. I’ve never quite experienced this before. I’ll let you know a year from now what it’s like.

At my old company, it was a point of pride to search on price-comparison sites for the cheapest hotels you could find. (I know the argument that it saves money for expensive execs to fly corporate jets rather than flying commercial, because at their hourly rates it’s not worth the time spent waiting in line. I think those arguments are bunk, because they assume that the ten minutes you spend waiting in line are ten minutes of work you will not do that day, while my experience is that in high-level positions the amount of work you do is a function of the amount of work you have to do, not the amount of time you have.)

It may be true, as Bob Lutz claims, that GM makes good cars again. (I happen to own and drive a GM car that I am very satisfied with, but it’s a Chevy Prizm, which may not count.) But GM’s brand reputation today is that it is out of touch, and stories like this don’t help.

I’m a little late to the GMAC bailout story, but after reading all the newspapers and blogs I usually read, there are still some things I don’t understand. I’m particularly confused about the announcement that GMAC will start lending to anyone with a credit score above 620, down from their previous minimum of 700. (The median credit score in the U.S. is 723.)

1. What is the relationship between GM and GMAC? I know that Cerberus owns 51% of GMAC and GM owns the other 49%. I also know that, in order to become a bank holding company, both were forced to reduce their ownership stakes. In any case, GMAC is an independent company that should not be run for the benefit of GM. Its obvious that GM benefits if GMAC reduces its lending standards. But how does GMAC benefit?

2. If a loan to someone with a credit score of 621 was a bad idea on Monday, why was it a good idea on Tuesday? The only theory I can think of under which this makes sense is that GMAC thinks that loans to people with credit scores of 621 are profitable, but they couldn’t get the capital cheaply enough until they got their government bailout money.

3. Who is going to pay the bill when these loans go bad? It looks to me like GMAC is making a big gamble by trying to pump up its lending volume with higher-risk borrowers, right in the middle of the worst recession since . . . 1981? the 1930s? (In any case, it won’t be able to get anything like the lending volume it used to have, simply because fewer people are buying cars.) Isn’t this a situation where a company is choosing a high-risk strategy because its only option is to watch its revenues shrink away to nothing because the demand for credit has plummeted? But if that’s the case, how smart is it to go chasing after high-risk borrowers because the low-risk ones are suddenly saving their money? And now that GMAC has gotten the Henry Paulson seal of approval (remember, TARP money was not supposed to go to unhealthy “banks”), I think there’s a fair chance they are counting on Treasury to bail them out of their next round of bad loans.

Of course, it could be said in GMAC’s defense that they are just doing what Congress wants them to do: take TARP money and use it to make loans more available to consumers. But this goes back to the fundamental schizophrenia of TARP: it was conceived to keep banks from failing, but most people think its purpose should be to increase credit. And in this case I suspect GMAC’s taxpayer money is being used to sell GM cars that people wouldn’t buy otherwise, and when it runs out GMAC will be back for more.

I’m probably misusing the word, but I just think it’s incredibly ironic that, thanks to the Senate Republicans who blocked the compromise worked out between the White House and the Democratic majority to extend short-term loans to the automakers, the Bush Administration has now reversed its position and is open to using TARP money to keep GM and possibly Chrysler alive. Who ever thought we would see the day that this administration would prop up the Big 3 – and who thought it would happen because they were forced into it from their right?

I admit – I have auto bailout fatigue. But given the amount of virtual ink that has been spilled on this topic here, I think I owe you a place where you can express your thoughts on the current plan.

The Times says we are close to a vote, although Senate Republicans may block it. Here is the draft bill. The news article says it would take the form of $15 billion in short-term emergency loans. Reading the bill itself, though, I can’t find the number “$15 billion” anywhere. This is what I read:

1. The President can appoint a person (or persons) to implement the bill, apparently colloquially known as the car czar.
2. Once the bill passes, the car czar can make bridge loans or lines of credit right now. Those loans can be for as much as is needed under the plans submitted to Congress last week.
3. The money is coming from “section 129 of division A of the Consolidated Security, Disaster Assistance, and Continuing Appropriations Act, 2009, relating to funding for the manufacture of advanced technology vehicles,” which I’m guessing is the pre-existing bill providing $25 billion in loans for R&D for fuel-efficient vehicles. That money will be then be replenished. It’s not clear whether this creates a $25 billion cap or not (how many times can the car czar draw on that money after it’s been replenished?).
4. The loans are at 5%, increasing to 9% after 5 years. The government also gets a warrant to buy up to 20% of the loan amount in stock, at a price equal to the average price during the 15 days prior to December 2.
5. The short-term loans are conditional on the government, the automakers, and all interested parties (including unions and creditors) being able to agree on a comprehensive, long-term restructuring plan by March 31, 2009. The car czar can extend this deadline by 30 days, but that’s it.
6. The car czar has a lot of power to monitor the auto companies and make sure they are meeting the targets of their restructuring plans; if they aren’t, he can call in the loans.
7. There are some other fun but peripheral provisions, like getting rid of corporate aircraft, dropping lawsuits against state greenhouse gas regulation, and executive compensation limitations.

The big point is #5 (in my list). In short, this isn’t a comprehensive bailout: it’s a bridge loan to buy time to come up with a comprehensive bailout. This is roughly what Simon predicted (although I can’t remember where). It enables the Bush administration to avoid having a car company fail on its watch, and enables the Democratic majority to say that they are doing something for the automakers, while deferring the hard questions. I assume that all of the controversial questions, like how big a concession the unions have to make, and whether or not it’s possible to force creditors to take equity in place of debt, will re-emerge over the next few months.

Of course, we may still have the live TV drama of not quite knowing if the Republicans will provide the needed votes, like we had with the first TARP vote. I would also be shocked to see President Bush sign a bill that requires car companies to drop their lawsuits against greenhouse gas regulation.

Let me know if I read the bill wrong.

Update: More from Felix Salmon on why it may be hard to get bondholders to agree to restructuring short of bankruptcy.