The Detroit-based automakers--General Motors, Ford, and
Chrysler--argue that they need more money from U.S. taxpayers. That
approach, however, is more likely to extend the status quo rather
than lead to reform. A far better approach is to restructure the
old-fashioned way, through a formal bankruptcy process if
necessary. Bankruptcy--and the prospect of it--would provide both
the incentive and means for making the hard and painful choices
that Detroit needs to make. Lawmakers should turn down pleas for
subsidies that would detour that process.
Just last month, U.S. automakers won congressional approval of
$25 billion in federal loans for manufacturing cleaner cars at an
estimated cost to taxpayers of $7.5 billion.
Since that time, however, the financial condition of automakers has
worsened, with the Big Three reporting losses in the billions.
General Motors has the grimmest news, warning that it could run out
of cash within months.
Armed with this bad news, the industry went back to Capitol
Hill. Pointing out that the recently approved $25 billion dollop of
aid would take months to process, the automakers asked for more and
President-elect Barack Obama and congressional leaders such as
Speaker Nancy Pelosi (D-CA) have broadly supported more subsidies.
The leading proposal now seems to be the provision of $25 billion
in federal loans--most likely taken from the $700 billion already
allocated to address the financial crisis--although the total may
be lowered to reduce opposition. The Bush Administration, for it
part, has opposed automaker access to the $700 billion but has
supported dropping conditions from the $25 billion already
Is the money really needed? There is little doubt that auto
manufacturers--or at least some of them--are in real trouble. In
October, GM's sales fell 45 percent, Chrysler's fell 34.9 percent,
and Ford's dropped 30.2 percent. Non-Detroit companies did not
perform much better: Toyota's U.S. sales decreased 23 percent.
But beyond that, there are substantial differences between
firms. Each of the three Detroit automakers reported big losses in
the third quarter, with General Motors and Ford each reporting
losses between $2 billion and $3 billion. Many non-Detroit firms,
however, did much better. The largest, Toyota (which is a major
manufacturer in the U.S.) still reported a small profit.
Among Detroit-based firms there are also substantial
differences. General Motors is perhaps worst off, reporting that it
may have only enough cash to last a few more months. By contrast,
Ford, while facing significant threats, is much more optimistic. In
fact, CEO Alan Mulally recently asserted: "With the assumptions we
have in place, we believe we have sufficient liquidity to make it
through this downturn."
GM CEO Rick Wagoner has gone as far to say that "the problems in
the auto industry are a direct result of the credit crisis."
And no doubt the current economic downturn--and related credit
crunch--have contributed to the industry's woes. But the
automakers' problems go far deeper than that.
The industry made a number of poor decisions well before the
credit crunch that led to their current position. First, Detroit's
dependence on big, non-fuel-efficient vehicles was its own doing.
The strategy--not shared by rivals such as Toyota--was long a
profitable one; for many years SUVs and minivans were a golden
goose for the Big Three. But now this strategy is proving costly,
as Detroit struggles to shift to more fuel-efficient vehicles.
High costs are also a problem for Detroit's Big Three. The
industry's high labor costs are well-documented.
But that is only the start. In April, The Detroit Free Press
reported that GM, Chrysler, and Ford have 15,710 independent
dealerships in the United States, compared to roughly 4,000 for all
the Japanese dealerships.
State laws, dealership contracts, and other factors all contributed
to Detroit's crisis.
But high current costs are only part of the problem. So-called
"legacy costs" leave Detroit paying an enormous sum of money for
mistakes made in the past. In 2004, GM, Ford, and Chrysler employed
approximately 370,000 people in their U.S. automotive operations
but supported more than 800,000 retirees with expensive pension and
health care packages negotiated through collective bargaining.
From 1993 to 2007, General Motors alone spent an average of $7
billion per year to fund legacy pensions and retiree health care.
These legacy costs create a catch-22 for automakers: Not only are
they nearly impossible to trim outside of bankruptcy, but as firms
downsize existing operations, they become a proportionately larger
burden on the company.
Consequences of a Bailout
Proponents of a bailout argue that taxpayer funding would
provide carmakers critical breathing space to address these
problems. But that involves more than a little wishful thinking.
Many of the needed changes have already been put off for
years--more "breathing space" would likely allow them to be put off
Moreover, no matter what stern public warnings policymakers
issue with the cash--for example, urging carmakers to
restructure--there will doubtless be unwritten political "no fly"
zones. One can just see the headlines: "Government Funds Job Cuts,"
"Taxpayer Money Funds Dealership Closings." Put bluntly, the types
of changes that are needed will be painful and unpopular, and it is
difficult to imagine politicians allowing them, never mind
insisting on them.
The Bankruptcy Option
There is an alternative method of facilitating needed
restructuring: bankruptcy. While often seen as a sign of failure,
the bankruptcy process is often the best way for troubled
enterprises to get back on their feet. Debts are reduced or
cancelled and contracts terminated or renegotiated, allowing firms
to get a fresh start. And if a firm still cannot be made viable,
bankruptcy also provides for an orderly and clear process for
getting assets--including plants and equipment--back into
productive use by others.
There are, of course, losers under bankruptcy. Management is
more likely to be replaced, but that might be deserved.
Shareholders lose their investment, but stock values are plummeting
This is not to say that bankruptcy is necessary for every firm.
Ford, for instance, is still expressing confidence that it make its
way through without it. Chrysler, the smallest of the three Detroit
firms, could possibly be merged with stronger partner, such as
Nissan. But if other options fail, bankruptcy is a natural and
Some argue that a declaration of bankruptcy would, in itself,
drive auto customers away by raising concerns that crucial
post-sale warranty service would not be available. But the auto
firms have hardly kept their woes a secret. The word is already
out. Rather than spawn concerns, a bankruptcy proceeding could
actually reduce such worries by providing a path to recovery.
The most sweeping argument against bankruptcy is that the
automakers are just too big to fail, citing the millions of people
employed by the Big Three automakers and by firms dependent on
them. But bankruptcy does not mean an end to operations: Firms
routinely continue operations while in the bankruptcy process.
Moreover, even the worst-case scenario--liquidation--does not mean
vaporization. The assets of a firm do not vanish. Rather, they are
resold to others more able to make productive use of them.
Of course, jobs will still be lost. But Detroit will almost
certainly have to shrink under any viable restructuring plan. And
in the longer run, addressing the hard questions and making the
hard choices--rather than postponing them through taxpayers
bailouts--will lead to more jobs and a better economy.
Delaying the Inevitable
The Detroit automakers are in trouble. While perhaps triggered
by current economic downturn, the crisis has been long in the
making, fed by bad business decisions and failures to control
costs. The industry needs to change and change quickly, on its own
if possible, through bankruptcy if necessary. Yet, the remedy
proposed by these firms--ever more taxpayer cash--will only delay
that change. Whatever the cost, subsidy is an unsafe course for
consumers, the industry, and the U.S. economy. Congress must say
"no." If it does not, President Bush should have his veto pen at
James L. Gattuso is Senior
Research Fellow in Regulatory Policy and Nicolas D. Loris is a
Research Assistant in the Thomas A. Roe Institute for Economic
Policy Studies at The Heritage Foundation.
See James L. Gattuso and Nicolas D. Loris,
"Putting the Brakes on the Automaker Bailout," Heritage Foundation
WebMemo No. 2060, September 11, 2008, at http://www.heritage.org/Research/Budget/wm2060.cfm.
Should Washington bail out Detroit? That is the question facing
Congress as it reconvenes this week for a special post-election
session. Nearly everyone agrees that, with losses piling up,
Detroit automakers need to change the way they operate and change
soon. The real issue is how best to do that.