Over the next few days, Congress and the White House will try to put together a bailout for GM, Ford and Chrysler. If they don't succeed, there will be a number of shopping days left before Christmas when GM institutes bankruptcy proceedings.
With all the publicity about its cash flow crunch, GM's suppliers are getting antsy about shipping parts without getting paid up front. Demands on GM's cash will increase at exactly the time when it is running out of cash. Some creditors may jump into court in an effort to collect on their debts quickly, before things completely fall apart. Without a bailout, the only way to stem the chaos would be a bankruptcy filing. And the filing would have to be made immediately in order to conserve as much of GM's dwindling cash reserves as possible. The company wouldn't want to burn down its funds and then file for bankruptcy, since that would leave it with no cash for a reorganization.
If there is no bailout, Christmas in bankruptcy could also be in store for Chrysler and major auto parts suppliers. Chrysler, too, has predicted that, without a bailout, it will run out of cash by the end of December. So its situtation is similar to GM's, and, without federal funds, it would have the same incentive to duck into bankruptcy court sooner rather than later.
The parts suppliers' problems could play out like this: if GM (and Chrysler) institute bankruptcy proceedings, they'll immediately stop paying trade debt in order to conserve their cash. Tens of millions and perhaps hundreds of millions of dollars of accounts receivable owed by GM and Chrysler to the parts suppliers would immediately be uncollectible in the ordinary course of business. (The parts suppliers would, in turn, stop shipping to GM and Chrysler until they got concrete assurances of payment for new parts, but that wouldn't get their old accounts receivable paid.) The nonpayment of accounts receivable would put the suppliers into a cash flow crunch, and could violate the terms (covenants) of bank loans they might have and bonds they might have issued. The cash flow crunch and covenant violations could put the parts suppliers in operational and legal jeopardy, giving them the incentive to file for bankruptcy as soon as possible in order to conserve their cash resources and avoid creditor lawsuits.
Once in bankruptcy, the future of these companies would be highly incertain. Consumers might well avoid buying a long term product like a car from a bankrupt company. Car buyers want warranties to be honored and replacement parts to be available. Without plenty of customers, the bankrupt companies' chances of successfully reorganizing would be somewhere between none and zero. The worldwide automotive industry has lots of excess capacity, because it was geared up for the boom times of 2006 and 2007, when auto sales were 40% or more higher than they are today. Toyota, Honda, Nissan and others would fire up their idle capacity and move with alacrity to supply more cars while GM's and Chrysler's creditors, suppliers, shareholders, management, and labor unions enriched lawyers sparring around in court. Lost market share would be difficult or impossible for the American companies to regain, because the trust between manufacturers and consumers would have eroded.
Ford, too, might have to follow GM and Chrysler into bankruptcy. It shares many suppliers with the other auto companies. If the suppliers are bogged down in bankruptcy, they may be unable to supply Ford adequately. Consumers may shy away from Ford, too, in the belief that it's near the brink. Of course, that belief could make a Ford bankruptcy a reality. Maybe a regulatory agency can prohibit short sellers from acting on the belief that a bank is about to go under. But the government can't force consumers to buy cars from an auto manufacturer they believe is about to go under.
Congress is expected to vote on the bailout next week. If there is no bailout, expect a GM (and very possibly a Chrysler) bankruptcy filing probably by late Friday afternoon or some time next weekend. They wouldn't need to file a bankruptcy petition at a clerk of court's office during regular business hours. All they'd need to do is find a bankruptcy judge with jurisdiction over the case and give him or her the filing, at home or somewhere else. Bankruptcy judges are cooperative about accepting petitions from publicly traded companies at odd hours. Filing during stock market hours could lead to messy trading--that is, messier than the mess that you'd have anyway.
News reports at the time we write this blog indicate that the Bush Administration and Congressional leaders are trying to put together a $15 billion bridge loan to tide the auto companies over until Barack Obama is inaugurated. Clearly, George W. Bush figures auto company bankruptcies could be really bad, and doesn't want that mess as part of his already very messy legacy. The Democrats hold the better hand. If there is a bailout, they can claim most of the credit for it. If there isn't a bailout, the GM and Chrysler bankruptcies will have begun on George W. Bush's watch, and the Dems can blame the Republicans. Then, with their increased control over the legislature in the next Congressional session, the Dems will be able to ride to the rescue with a massive stimulus package and secure the loyalty of large swaths of the electorate for potentially a long time. The leaders in both parties understand this dynamic. While many Republican (and some Democratic) lawmakers would rather drink horseradish straight up than vote for an auto company bailout, there seems to be a good chance that enough of them will go along with a bailout so that they can pass the hot tamale to President Obama when he takes office. If that happens, he'll truly learn what it means to have the buck stop with him.
Showing posts with label Auto company bailout. Show all posts
Showing posts with label Auto company bailout. Show all posts
Friday, December 5, 2008
Thursday, September 4, 2008
The Logic of Bailing Out the Auto Companies
The three American auto manufacturers--GM, Ford, and Chrysler--are reportedly planning a lobbying campaign to secure $50 billion in loans at favorable interest rates from the federal government. This money will supposedly allow them to shift more rapidly to fuel-efficient models, a laudable goal. The political winds are behind this idea.
As a matter of principle, a taxpayer funded bailout of the auto companies is a bad idea. In a market economy, private enterprise should profit by dint of its own diligence and perspicacity. And it should takes its lumps without looking for government subsidy. If you have to pay for your mistakes, you'll learn to avoid making them. And the American auto companies have made a boatload of mistakes, ranging from decades of mediocre quality and design to betting the ranch on a single factor--the price of oil. They thought that clever marketing could fool consumers into buying inferior products, and competed against each other when the real competition came from overseas. Even now, one wonders whether they'd make wise use of $50 billion of low cost federal loans. Optimism in this respect isn't necessarily warranted.
Nevertheless, there is a good reason to bail out Detroit. The U.S. is too heavily invested in real estate. Since the Great Depression of the 1930s, the federal government has been subsidizing home purchases one way or another, with tax deductions, federal deposit insurance, and the creation of a vast secondary market for mortgages. Things really got out of hand in recent decades, with Fannie Mae and Freddie Mac reaching Brobdingnagian size and the Federal Reserve keeping interest rates lower than a snake's belly. When you do anything to excess, you'll pay the price, and we're paying the price now.
As real estate values sink lower while mortgage defaults spread like a Medieval plague, the financial markets clamor ever more loudly for a federal bailout of defaulting homeowners. Since just about everyone on Wall Street, from big firms to institutional investors to hedge funds, has substantial investments directly or indirectly linked to real estate, the cries for government intervention ring from sea to shining sea. The Bush administration has been unable to resist these demands, recently making explicit the federal government's formerly implicit guarantee of Fannie and Freddie while promising to assist many distressed homeowners.
But the welfare queens on Wall Street still aren't satisfied, as calls are yet made for federal purchases of distressed properties and more subsidies for home loans. With this being an election year and the Bush administration having abandoned all pretense of favoring a market-based economy, surely more hair of the biting dog is headed for the real estate and mortgage markets.
That, however, will only continue America's over-investment in real estate. The heart of any industrial economy is its manufacturing sector. America's manufacturing sector has been suffering through hard times since Richard Nixon scowled from the Oval Office. It has survived, although with many adjustments and major losses. The recent decline of the dollar has improved export business. But American manufacturing is a hollow shell compared to the mighty juggernaut that built vast quantities of aircraft, ships, tanks and trucks for the victorious Allies in World War II.
Subsidized loans for the American auto companies would help protect America's manufacturing base. The auto companies employ hundreds of thousands, and their suppliers employ hundreds of thousands more. The health of the U.S. economy cannot be sustained by yet more government funded bets on real estate. Business enterprises produce more overall wealth than real estate. This is evidenced by stock market prices, which have historically increased about 3% above the rate of inflation, while real estate values have increased about 1% above inflation. If the Bush administration is going to continue its socialization of the economy, it should diversify its focus and give a little to manufacturing. More concentrated bets on real estate will only set the stage for the next bubble and collapse, with even greater losses to be borne by taxpayers.
Boosting America's wealth is the only way to deal with the demographic problem of an aging population. While increased immigration could improve the ratio of workers to retirees, the political landscape precludes relaxing the borders. So emphasizing economic growth is perhaps the only way to keep retirees and workers from being less well-off than their parents.
Do the American auto companies deserve government subsidies? Absolutely not. They're responsible for the problems they now have--Toyota and Honda simply made smarter bets on fuel efficient car and engine designs, while maintaining better overall quality. But America has to diversify away from real estate. Almost all of the federal bailout money for Wall Street and real estate will go to the undeserving. Since the Bush administration is proceeding to socialize much of the economy, it ought to do it in a way that offers long term benefits rather than short term expediency.
As a matter of principle, a taxpayer funded bailout of the auto companies is a bad idea. In a market economy, private enterprise should profit by dint of its own diligence and perspicacity. And it should takes its lumps without looking for government subsidy. If you have to pay for your mistakes, you'll learn to avoid making them. And the American auto companies have made a boatload of mistakes, ranging from decades of mediocre quality and design to betting the ranch on a single factor--the price of oil. They thought that clever marketing could fool consumers into buying inferior products, and competed against each other when the real competition came from overseas. Even now, one wonders whether they'd make wise use of $50 billion of low cost federal loans. Optimism in this respect isn't necessarily warranted.
Nevertheless, there is a good reason to bail out Detroit. The U.S. is too heavily invested in real estate. Since the Great Depression of the 1930s, the federal government has been subsidizing home purchases one way or another, with tax deductions, federal deposit insurance, and the creation of a vast secondary market for mortgages. Things really got out of hand in recent decades, with Fannie Mae and Freddie Mac reaching Brobdingnagian size and the Federal Reserve keeping interest rates lower than a snake's belly. When you do anything to excess, you'll pay the price, and we're paying the price now.
As real estate values sink lower while mortgage defaults spread like a Medieval plague, the financial markets clamor ever more loudly for a federal bailout of defaulting homeowners. Since just about everyone on Wall Street, from big firms to institutional investors to hedge funds, has substantial investments directly or indirectly linked to real estate, the cries for government intervention ring from sea to shining sea. The Bush administration has been unable to resist these demands, recently making explicit the federal government's formerly implicit guarantee of Fannie and Freddie while promising to assist many distressed homeowners.
But the welfare queens on Wall Street still aren't satisfied, as calls are yet made for federal purchases of distressed properties and more subsidies for home loans. With this being an election year and the Bush administration having abandoned all pretense of favoring a market-based economy, surely more hair of the biting dog is headed for the real estate and mortgage markets.
That, however, will only continue America's over-investment in real estate. The heart of any industrial economy is its manufacturing sector. America's manufacturing sector has been suffering through hard times since Richard Nixon scowled from the Oval Office. It has survived, although with many adjustments and major losses. The recent decline of the dollar has improved export business. But American manufacturing is a hollow shell compared to the mighty juggernaut that built vast quantities of aircraft, ships, tanks and trucks for the victorious Allies in World War II.
Subsidized loans for the American auto companies would help protect America's manufacturing base. The auto companies employ hundreds of thousands, and their suppliers employ hundreds of thousands more. The health of the U.S. economy cannot be sustained by yet more government funded bets on real estate. Business enterprises produce more overall wealth than real estate. This is evidenced by stock market prices, which have historically increased about 3% above the rate of inflation, while real estate values have increased about 1% above inflation. If the Bush administration is going to continue its socialization of the economy, it should diversify its focus and give a little to manufacturing. More concentrated bets on real estate will only set the stage for the next bubble and collapse, with even greater losses to be borne by taxpayers.
Boosting America's wealth is the only way to deal with the demographic problem of an aging population. While increased immigration could improve the ratio of workers to retirees, the political landscape precludes relaxing the borders. So emphasizing economic growth is perhaps the only way to keep retirees and workers from being less well-off than their parents.
Do the American auto companies deserve government subsidies? Absolutely not. They're responsible for the problems they now have--Toyota and Honda simply made smarter bets on fuel efficient car and engine designs, while maintaining better overall quality. But America has to diversify away from real estate. Almost all of the federal bailout money for Wall Street and real estate will go to the undeserving. Since the Bush administration is proceeding to socialize much of the economy, it ought to do it in a way that offers long term benefits rather than short term expediency.
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