Headed for a Breakdown

A Bailout for Detroit Won’t Solve Anything — Bankruptcy Will

“Until they show us the plan, we cannot show them the money.”

Finally, the Nancy Pelosi led 110th Congress and I can agree on a policy. In rebuking the CEO’s of General Motors, Ford, and Chrysler, collectively known as the ‘Detroit 3,’ Congress has at least temporarily put a cap on government intervention in private industry.

Unfortunately, Congress’ motives are less pure than I would like. Were it not for the massive unpopularity of bailouts (which the public, for the most part, rightly views as handouts with political motives), I have little doubt about Congress’ desire to pass a bill trading government funds for a pledge to not build tree-shredding Sport Utility Vehicles.

The government’s past and current love of meddling in private businesses, however, lies at the root of the domestic automaker’s current problems. Detroit has always been able to build first-rate trucks, and recently, they have made tremendous strides in the quality of their cars. While the glaring lack of any decent compact sedan between them is a notable exception, there are plenty of companies that stay afloat with product lines far worse than what the Big Three offer (Kia or Mitsubishi come to mind).

The difference between the ‘domestics’ and their foreign competitors goes back to their roots. Before the advent of a truly global economy, GM, Ford, and Chrysler were called the ‘Big Three’ because they were by far the titans of the automotive industry, and America, with its massive territory and free-roaming populace, was the car capital of the world. Consumers craved ever bigger and more powerful cars and the post World War II era saw the proliferation of the iconic V8 powered American cruiser.

Collectively, they were the companies behind such iconic brands as Chevrolet, Cadillac, Mercury, and Dodge. By comparison, at the same time, Honda was still primarily a motorcycle company and Acura and Lexus were decades away from existence. With the feebleness of their competition, Detroit could afford to concede to the United Autoworkers Union’s demands for higher wages and astronomical benefits.

They could also live with the introduction of Corporate Average Fuel Economy (CAFE) standards — which were probably more effective at giving the UAW a monopoly over the Big Three’s domestic production than at raising average fuel economy. Key among the Congressional favors to the UAW was the ‘two fleet’ standard for computing fuel economy. Under this system, cars with a majority of foreign made parts fall into the foreign fleet, while cars built with domestically sourced components fall into the domestic fleet. Because both fleets are required to meet the standards separately, CAFE effectively forced Detroit to build a broad mix of cars in UAW controlled domestic factories.

Today, though, in a global economy, the Big Three faces competition from companies that aren’t constrained by labor agreements. Toyota, Honda, and BMW, among others, all produce cars in American factories, but they are free to set their own salaries and benefits without UAW intervention. The difference in costs between the union and non-union plants is startling: an estimated $2000 of pension plans, health care costs, and higher wages is built into every car GM builds.

These two factors combine to force Detroit into an awkward position. With a broad and historical network of plants and production facilities in the United States, the Big Three have a major financial commitment to building vehicles in the U.S. However, in order to satisfy CAFE regulations, they must produce a full variety of cars in these UAW facilities.

Due to the stringent CAFÉ penalties, in order to continue producing the hugely popular and profitable Explorers, F-150s, and Suburbans throughout the last decade, these companies have had to produce the patently awful Cobalt, Caliber, and Focus. Unfortunately, while it’s often possible to overcome the UAW imposed price deficit on large, high profit SUVs, small cars generate much thinner profit margins. To compete, GM and its cohorts need to either remove features from their cars to reduce costs, or sell them at higher prices.

Of course, that didn’t present much of a problem for the Big Three when demand for SUVs increased every year, but when oil spiked to over $100 a barrel, things went sour. Detroit’s legacy of labor costs, a slackening demand for SUV’s and a lack of competitive small cars have placed the domestics in their present predicament. Without the ability to cut their immensely uncompetitive labor costs, no amount of bailout money will return Detroit to profitability.

Bailing out Detroit now simply perpetuates a cycle of un-competitiveness that has lasted since the last Chrysler bailout decades ago. As much as General Motors currently claims that, “bankruptcy is not an option,” chapter 11 is more than an option — actually, it’s their only viable solution. Bankruptcy would allow the Big Three to shed their restrictive UAW contracts and return as smaller, more nimble companies.

A bailout would change nothing. Congress’s current demand for a new strategy from Detroit is unattainable. These automakers have already exhausted every other possibility for a turnaround, but as long as they are fundamentally burdened by higher prices and lower quality products, a government loan or bailout would simply be throwing good money after bad. The Big Three face fundamental problems with their business model that undermines any turnaround initiative they undertake.

Bankruptcy removes those issues. Under Chapter 11 reorganization, the domestics could begin hiring labor at the going market rate, with pay based on performance and with workers paying a fair share of their healthcare costs. It would allow a total shakeup of their industry, allowing a chance to replace old, ineffective strategies with functionally competent new ones.

Bankruptcy would also level the competitive playing field. Ford and General Motors would have the same ability to purchase labor as Honda and Toyota (companies with strong manufacturing networks in the United States) enjoy. The Big Three would not be constantly dogged by labor negotiations and strikes if they eliminated the union’s anticompetitive influence from their factories.

However, the federal government needs to play a part in this. First, they must realize that the reason the domestics can’t raise funds right now is because investors see them for what they really are — money pits. Cash goes in and it doesn’t come out.

Secondly, the next Congress and president need to realize and amend the stupidity of the current CAFE’s two fleet requirement. Although it effectively helped shield the UAW for years, it also helped make the Big Three uncompetitive and push profits out of America. Politicians and unions need to realize that having jobs with market determined salaries and benefits always beats having no jobs at all.

While they’re at it, Congress could also explore the logic behind forcing automakers to build cars that consumers potentially don’t want. Economics dictates that industry will supply the cars that consumers want, but taxing the automotive supplier quickly leads to the law of unintended consequences. Here again, government meddling distorts the market and leads to inefficiency, the exact opposite of what ‘economy’-minded policy should be promoting.

Perhaps the biggest reason the government should not bailout General Motors, Ford, and Chrysler, however, stems from the simple concept of precedent. If the government sets an example of rescuing failed business models, it removes capitalism’s crucial aspect of self responsibility.

If every business feels that they will be bailed out by the government if they make a bad decision, their risk-reward balance becomes highly skewed. As with Fannie Mae and Freddie Mac in the housing bubble, more bad risks leads to long term pain for the entire country.

America has the potential to regain its status as the world’s automotive power, and with future developments such as the Chevrolet Volt, they are poised to do so. Effectively competing, however, means being competitive in the global economy, not being hamstrung with ill-conceived regulations or punitive UAW contracts.

The Big Three have the potential to morph into the globally competitive powerhouses of industry they once were, but Congress must stop interfering and let capitalism run its natural course.