Tuesday, November 11, 2008

Bailing Out The Big Three

A lot of ink has been spilled recently on the proposed bailout of the automakers by the federal government, including a sensible editorial in today's Los Angeles Times ("Kick the automakers' tires first"), John Tamny's column today on RealClearMarkets ("Time to Pull the Plug on General Motors"), and Frank Ryan's column in today's Investor's Business Daily ("Bailouts Merely Institutionalize U.S. Mediocrity"). All make good points about the mistakes made by the domestic auto industry, but none of these address the need for the U.S. to have at least one viable domestic automaker for national security purposes: the world's superpower ought not have to rely on foreign manufacturers to build its tanks. Clearly, there is overcapacity in the domestic auto industry. The Lex column in last Thursday's Financial Times ("American Cars"1) underlined that point:

America’s love affair with the automobile has reached such a level that there is now one car on the road for every person old enough to drive.


Suburban sprawl and improved car quality have allowed many families to amass not just two but three, four or even five roadworthy vehicles. The median American car is now 9.3 years old, 50 per cent older than in 1990, which is an odd statistic given how easy it has been to buy a new one – until recently that is. The rate at which cars are scrapped should track sales in the long run but car sales have managed to exceed vehicles being retired by a third on average since 1990.

In a pinch, many Americans no longer need to buy a new car as their old one just keeps on running. And, even if their clunker dies, there is a surplus of used vehicles.

Political considerations aside, this would seem to be a perfect opportunity for private equity. A private equity firm could buy GM's senior debt as GM slid into bankruptcy, bring in new management (there's still no shortage of manufacturing expertise in this country -- think Boeing, John Deere, etc.), use bankruptcy to get out of labor contracts and cut costs, cut capacity, and rebuild GM as smaller, profitable company. A slimmed-down, profitable GM could then merge with what was left of the other two domestic automakers as the industry consolidated.

Of course, in the real world, there are plenty of political considerations. There's the politically powerful UAW, well-connected auto dealers, the prospect of hundreds of thousands of job losses in auto-related businesses, politicians who want to be seen as being pro-labor, etc. Perhaps the politically palatable solution might be to provide some sort of temporary financial assistance to the automakers, and give them a couple of years to work out a modus operandi with each other (i.e., mergers), their union and their dealers to reduce capacity and costs. That might allow the inevitable layoffs to be phased in after the economy recovers. If President Bush is smart, he'll do as the WSJ editors suggested yesterday ("Nationalizing Detroit") and let the Obama Administration and Congress handle this after January 20th.

1The graphic comes from this column.


Henry Ford III said...

Giving money to GM, F or C now is just a transfer of payments from the taxpayers to union workers.

There will never be a long-term solution without bankruptcy.

DaveinHackensack said...

"There will never be a long-term solution without bankruptcy."

In his column today ("Obama's Car Puzzle"), WSJ columnist Holman Jenkins writes that bankruptcy, by itself, wouldn't be enough, without the necessary regulatory changes.

Sivaram Velauthapillai said...

Private equity has already shown that it doesn't know what it's doing. I'm talking about, of course, Chrysler. If Cerberus can't fix Chrysler, I don't think any other PE shop can fix GM...

DaveinHackensack said...


Bankruptcy is the key difference in the PE scenario I suggested. In bankruptcy, a PE firm that owned the company's senior debt could renegotiate the labor contracts and otherwise cut costs and capacity. Why Cerberus bought Chrysler from Daimler knowing it would have the same monkey on its back as previous management, I don't know.