Go Detroit! And take Washington with you

Last week’s election results probably gave Detroit its best fighting chance at a government bailout as Democrats are typically more sympathetic to the automobile industry than Republicans. After all, the United Auto Workers union went to mat for Barack Obama, so you had to figure that it wouldn’t be long before congressional Democrats ramped up the rhetoric to save Detroit, especially given the accelerating infirmity of the US auto industry.

Yesterday morning’s Wall Street Journal lead story details the attempts in Congress to free up money for the car industry, including the novel idea that bailout funds intended for the financial industry (the so-called TARP, or Troubled Asset Relief Program) be re-routed to Detroit, something the Bush administration has resisted.

The Bush team has cited repeatedly its lack of legal authority in using TARP money to bail out the automakers, which should be taken for what it is – a genteel Washington way of saying “Screw Off.” After all, this administration has rarely made mention of limits on its authority or legal prerogative.

In fact, the TARP program, as it was originally explained, was meant to purchase and warehouse rotting mortgage-backed securities currently on bank balance sheets, thereby freeing up the credit markets. That is not, however, what happened. Not long after TARP was passed, the Fed and Treasury Department decided it would be better to take equity stakes directly in the banks themselves. Now, Treasury Secretary Henry Paulson wants to address the consumer side of the equation (through greater availability of student loans, car loans, and credit cards…just what America needs to boost its negative savings rate). Given all this change (I call it frantic button-pushing), for the administration to suggest that it doesn’t have the legal authority to change course seems disingenuous.

While the administration’s stated reason for inaction is dubious, I can completely understand the desire to let Detroit hang itself. One suspects that, if he had his druthers, Mr. Bush would tell Detroit what Gerald Ford told New York in 1975 (“Ford to City: Drop Dead”). Given my free-market, private capital bias, I would be apt to say the same thing.

However, there are some complicating factors to consider here: first, there is a viable argument to be made that, if a car-maker files for bankruptcy protection, its sales will fall off of a cliff, providing little to no revenue to effect a turnaround. Second, if one car-maker files Chapter 11, it will force the others to do the same in order to remain competitive (the assumption being that bankruptcy protection would give a car-maker significant leverage with unions and creditors). Third, there are supply-chain issues that would amplify the bankruptcy of any one car-maker, putting all manner of auto part manufacturers under even greater distress.

Let’s take up these things in turn. First, on the negative impact bankruptcy would have on customer sales, I think you have to consider that much of the damage is already done. Everyone about to buy a Big 3 automobile or truck, raise your hand! Good luck with that manufacturer’s warranty. You see, you don’t have to file Chapter 11 to be shunned, and I think much of this situation is already baked into the latest sales numbers, which are abysmal.

Second, the notion that one of Detroit’s car-makers going under would pull down all three, I’d have to say that’s probably correct, but who cares? At this point, sure, we could plug in some short-term financing and allow Detroit to muddle along, but what the American car industry really needs is something transformative to happen. This is more likely to happen under bankruptcy protection, where everything would be on the table for review, from the manufacturers’ collective bargaining agreements with unions to their obligations to creditors and pensioners.

On the third issue – that of collateral economic damage – again, I think this is significant, but not decisive, in thinking through a bailout. It is true, you can’t measure Detroit’s impact by just looking at the Big Three. According to the Center for Automotive Research (CAR), General Motors, Ford, and Chrysler employ about 240,000 workers, but when you count into the mix the auto parts industry and other businesses, that number jumps to nearly 3,000,000. So while the failure of US automobile manufacturing wouldn’t wreak the amount of collateral damage that banking would, that pool of three million workers is pretty significant and presents a major policy problem in figuring our what to do.

Obviously, the impact would be felt more harshly in some areas versus others. Michigan, for instance, which is already saddled with one of the worst economic forecasts in the country, would be devastated. Other areas, like some counties in Kentucky with a lot of Big Three manufacturing, would also take a hard hit.

But the question we have to ask is – what good would a bailout do long-term for the auto industry and its workers?

Sadly, without a major, major overhaul, the Big Three automakers are simply uncompetitive for a variety of reasons, some of which can be fixed quickly and some that can’t. For the American people, there is not a strong enough argument to be made that Detroit can reform and prosper after a bailout, and at that point, a bailout becomes merely throwing good money after bad.

I do believe that American car manufacturers can thrive and profit, but in order to do that, the unit costs have to come down, the creativity behind the manufacturing process must increase, and the whole industry needs to position itself on the cutting edge of new green technology.

I have lambasted the US auto industry for its poor management, so I’m not going to reprise all those gripes here, but I will say that nothing fundamentally has changed in recent years other than the financial condition of the car-makers. The downturn in SUV and truck sales, which have kept Detroit afloat for over a decade, was entirely predictable; the general downturn in all car sales was also eminently foreseeable. Simply put, Detroit never used its short-term, cyclic strength of the past decade to effect change in the industry. In terms of production technology, it has been lapped by the Japanese; in terms of capacity, it still makes too many vehicles generally and far too few next-generation cars; in terms of quality, the place where you’d think the higher cost per unit might yield an advantage, American cars have no marketable advantage, because much of that cost is not spent in R&D, but is consumed by legacy costs.

In fact, in the latest J. D. Power & Associates’ survey measuring initial quality, foreign manufacturers claimed the top spot in 10 of the 17 vehicle categories. The Americans tended to do well in pick-up trucks and large cars, but lagged behind in other vehicles, vehicles that are becoming more important as energy and environmental concerns weigh upon the consumer. Only 12 of J. D. Power’s 35 five-star vehicles are made by US car companies.
President-elect Obama has argued that we should use Detroit’s poor financial condition as an opportunity to reform the industry – in other words, use the bailout to mandate change, such as improved CAFE standards and increased production of hybrid and electric models, mandates that have been watered down or thwarted over the years by the auto industry’s lobbyists.

As far as this goes, I’m on board with the idea; however, let’s not kid ourselves about what this means in practice. Detroit’s business model is already unprofitable. A new raft of regulation and government mandates will not change that basic fact and will make Detroit even less profitable in the short term. Without real change on the labor side of the issue, Detroit is doomed regardless, and that is precisely the area where Democrats will fear to tread. I think taxpayers – and the auto industry itself – would emerge in a stronger position if the Big Three were to go through a pre-packaged bankruptcy that would re-set the labor/management relationship in light of the companies’ financial condition and outlook.