Saturday, November 15, 2008

Are the Wheels Coming Off?

A couple of weeks ago, amid talk (now quiet) of a federally-aided Chrysler-GM merger, the Washington Post's Steven Pearlstein made the case that letting the companies go into bankruptcy would provide them the opportunity for necessary restructuring:
The real flaw in the government-financed merger proposal is that it spares the companies from bankruptcy reorganization, the very process they need to get their costs and structure in line with market realities.

Only a bankruptcy court can reduce the burden of pension and health benefits to 600,000 retirees that are slated to cost the companies $90 billion over the next decade.

Only a bankruptcy court can override the state laws that make it difficult and expensive for Chrysler and GM to pare back a combined network of 10,000 dealerships, about 10 times more than Toyota has in the United States.

And only a bankruptcy court can impose on members of the United Auto Workers pay and benefit packages comparable to those paid at the nonunionized plants of foreign manufacturers that have been stealing market share from the Big Three for decades.
However, the New Republic's Jonathan Cohn writes that the financial crisis means a liquidation would be the likely outcome of a GM bankruptcy:
In order to seek so-called Chapter 11 status, a distressed company must find some way to operate while the bankruptcy court keeps creditors at bay. But GM can't build cars without parts, and it can't get parts without credit. Chapter 11 companies typically get that sort of credit from something called Debtor-in-Possession (DIP) loans. But the same Wall Street meltdown that has dragged down the economy and GM sales has also dried up the DIP money GM would need to operate.

That's why many analysts and scholars believe GM would likely end up in Chapter 7 bankruptcy, which would entail total liquidation. The company would close its doors, immediately throwing more than 100,000 people out of work. And, according to experts, the damage would spread quickly. Automobile parts suppliers in the United States rely disproportionately on GM's business to stay afloat. If GM shut down, many if not all of the suppliers would soon follow.

In that sense, GM, like Bear Stearns, is "too interconnected to fail" - think of the parts suppliers and dealers as "counterparties." Furthermore, the unemployment generated by a GM liquidation would have some serious "aggregate demand externalities." While there is some merit in Perlstein's argument for chapter 11, it is hard to believe the benefits would not outweigh the costs of an intervention at least to the extent necessary to ensure that any bankruptcy would be a restructuring rather than a liquidation (e.g., providing a guarantee for DIP financing).

Cohn's piece also has some useful debunking of outdated stereotypes about the US auto industry. Unfortunately some - e.g., Thomas Friedman - persist in believing that the industry's problems arise mainly from a myopic over-reliance on trucks while Toyota virtuously purveys hybrids (GM and Ford also make small cars and hybrids - and the Chevy Volt is coming soon - while Tundras and Highlanders can be found along with the Priuses on Toyota lots).

While there may be a grain of truth in it, what is missing from that line of argument is that much of the real financial burden on the automakers is the legacy of the American system of relying on companies to provide welfare state benefits like pensions and medical care. This certainly has put older US manufacturing firms at a disadvantage relative to newer firms, "transplants," and foreign factories (the fact that Ontario surpassed Michigan in auto production is partly attributable to health care costs). Rather than criticize the automakers for treating their workers too well, perhaps we should recognize that their problems partly stem a history of filling the gaps left by US social policy.

Although some strings should certainly be attached to any Federal money, suggestions like this (from Friedman) should be viewed warily:

Any car company that gets taxpayer money must demonstrate a plan for transforming every vehicle in its fleet to a hybrid-electric engine with flex-fuel capability, so its entire fleet can also run on next generation cellulosic ethanol.
There is a serious need to reduce carbon emissions and energy use in transportation. The way to do so is not to force automakers to make different cars that nobody wants, but to get consumers to want them. The simplest way to do this would be to raise the gasoline tax (or, more broadly, a carbon tax). The automakers - domestic and foreign - respond to consumer demand; vehicles have gotten larger because people wanted them that way, and they can get smaller and more efficient for the same reason.

Bob Herbert draws a parallel with the New York near-bankruptcy in the 1970's, where the federal government did ultimately intervene, after the Daily News ran the famous headline "Ford to City: Drop Dead."

Full disclosure: I grew up in the Detroit area (Jonathan Cohn is from Michigan, too) where one of the local TV stations used to run adds exhorting us to "stand up and tell 'em you're from Detroit." Moreover, I'm looking forward to the new, smaller Cadillac that should be available by the time the lease is up on my current (um... well... Japanese...) car; if the policymakers get it right, there might be a turbodiesel version.

Update (11/16): The Economist's story assumes chapter 11 would be available, but has some reasons why that could be worse than you might think.

Update #2 (11/17): Jeff Sachs wants a Volt. See also Felix Salmon. Hmm... I'm starting to think it may just be my patriotic duty to buy a Solstice GXP Coupe.

Update #3 (11/17): I find this speculation to be implausible, but it would be a silver lining to Detroit's woes.

Update #4 (11/18): Autoworkers do not make $70 an hour, as Felix Salmon explains.

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