December 05, 2008

Automotive Bailout

I’m not generally interested in cars (I don’t own one, I live close to the metro and good bus routes) but am aware that American lifestyles are very much shaped by cars, and the owner who love them.

Here’s what I understand on the automotive industry of 2008, from wikipedia (warning: extreme plagiarism ahead):

What’s Going On?
The Big Three U.S. manufacturers, (General Motors, Ford and Chrysler) indicate that, unless they can obtain additional funding over the short to medium term, there is a real danger of one or more companies declaring bankruptcy.

A Series of Poor Decisions
The Big Three seem to have made some bad decision in the management of their companies. Some examples include:

Poor Competitors since the 1960
In the 60s, Volkswagen and Honda started importing cheap, well-made cars. Detroit convinced Congress to impose quotas on foreign-made cars. The foreign companies responded by opening their own plants in the United States.

Low Car Standards
Japan requires autos to achieve 45 miles per gallon (mpg) of gasoline and China requires 35. The European Union requires 52 mpg by 2012. By comparison, U.S. autos are required to achieve only 25 mpg. When California raised its own standards, the auto companies sued.

Pushing the Gas Guzzlers
The Big Three have, in recent years, manufactured expensive, fuel-guzzling SUVs and large pickups, which are much more profitable than smaller, fuel-efficient cars. Manufacturers make 15% to 20% profit margin on an SUV, compared to 3% or less on a car. When gasoline prices rose above $4 per gallon in 2008, Americans stopped buying the big vehicles and Big Three sales and profitability plummeted.

Strong Union = Unusually High Wages + Benefits
The workers union, the United Auto Workers (UAW), offers both pension and healthcare benefits, which far exceed competitors. UAW workers are paid $10-20 more per hour than foreign competitors who employ American workers. Average annual wages for production workers at the Big Three were $67,480 in 2007, and $81,940 for skilled workers. In Canada, GM’s 2008 average labor costs were $69 per hour, and Toyota's at $48 per hour, with similar productivity.

Read an interesting Q&A with UAW, which repels some myths.

Pay for Redundant Employees
In 2005, the Big Three U.S. automakers paid more than 12,000 employees (who were idled as a result of their jobs being unnecessary due to technological progress or plant restructurings) their full salary and benefits in "jobs bank" programs, created to protect workers' salaries and discourage layoffs, as part of the automakers' deals with the UAW. Some of those workers were placed in retraining where they were taught bicycle repair, home wiring, poker, and silk-flower arranging. Others were enrolled in community service initiatives. Others did not work.

Large Number of Brands
GM has eight brands, while Toyota has only three. More brands require additional marketing and product development expenses, which drives higher costs relative to the competition. However, reducing the number of brands requires closing or consolidation of dealerships, which is very expensive.

Asking for Money…Uses Up a Lot of Money
On November 19, 2008, there was a U.S. Senate hearing on the automotive crisis in the presence of the heads of Chrysler, Ford and General Motors. The auto manufacturers explained that they would need financial aid of $25 billion if they were to avoid bankruptcy.

On November 19, 2008, the Big Three CEOs attended the meeting in Washington, D.C. to ask for a taxpayer bailout in private luxury jets. The cost of a private jet is $20,000 versus $500 for a commercial flight. They later all drove separately to Washington in hybrid electric vehicles after being criticized for arriving in private corporate jets

The Big Three spent almost $50 million to lobby Congress during the first nine months of 2008.

What is a Bailout?
I’ve been trying to find a good definition to the term “bailout”, but either the definition uses a number of words that also need explanation, or is too simplified. My understanding is that:

A bailout is a large sum of money the U.S. Government gives failing companies, such as banks or automotive industries, to allow them to continue their daily business (paying their employees, manufacturing cars, and renting show-rooms for example) over the short-term.

Governments or groups of investors can give bailouts. Bailouts can take the form of loans, bonds, stocks or cash. They may or may not require reimbursement.

This year alone, the U.S. Government bailed-out the following companies: Bear Stearns, Morgan Stanley, Goldman Sachs, JPMorgan Chase, Wells Fargo, Fannie Mae and Freddie Mac, American International Group, and Citigroup.

Republican Senators are unwilling to provide aid, some even suggesting that bankruptcy might be the best option as it would free manufacturers from the employment deals agreed with the unions.

The Democrats, however, insist that the U.S. Government needs to take action quickly, in line with President Elect Obama's stance on the matter.

On November 24, 2008, Congressman Ron Paul (R-TX) wrote, "In bailing out failing companies, they are confiscating money from productive members of the economy and giving it to failing ones. By sustaining companies with obsolete or unsustainable business models, the government prevents their resources from being liquidated and made available to other companies that can put them to better, more productive use. An essential element of a healthy free market, is that both success and failure must be permitted to happen when they are earned. But instead with a bailout, the rewards are reversed – the proceeds from successful entities are given to failing ones. How this is supposed to be good for our economy is beyond me.... It won’t work. It can’t work... It is obvious to most Americans that we need to reject corporate cronyism, and allow the natural regulations and incentives of the free market to pick the winners and losers in our economy, not the whims of bureaucrats and politicians."

Michael Capuano (D-Mass) said, "My fear is you're going to take this money and continue the same stupid decisions you've made for 25 years.”

Democratic party leaders Nancy Pelosi and Harry Reid sent a letter to the CEO's of the Big Three asking them to present by December 2, 2008, a "credible restructuring plan" involving "significant sacrifices and major changes to [the] way of doing business," to qualify for further Government assistance. The letter includes a variety of principles and requirements, including a situation assessment, forecasts under various assumptions, taxpayer protection, transparent reporting to an oversight body, dividend and executive pay restrictions, and approach to covering healthcare and pension obligations.

What do you think? Should the car companies receive a bailout, given that the car industry is such a big deal in the United States? Or should they compete like everyone else in this Free Market economy?

1 comment:

strudel said...

I see you are on the way to get the Pulitzer. Big columnist, duh? Anyway, the answer it quite easy. In Italy we had one big company car, Fiat. Fiat was over protected and subsidized. Its shares were in the hands of a family, the Agnelli (Lambs). Fiat had any kind of ties (and bribes) with banks, trade unions and politicians. And we had bad cars at a high cost. One day (around the year 2000), Fiat went bankrupt. Now Fiat makes good cars and sells them all over the world. (Search Mike? Romney in the Nyt and read his story).