The U.S. Auto Bailout: Bridge to Bankruptcy, or Road to Salvation?

by: Andy Singh November 18, 2008 | about stocks: F / GM    

Andy Singh

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One of the most important, but dividing, issues currently facing America and Congress, as the economy continues to crumble, is the need or not for a US automakers bailout. The US owned automakers directly or indirectly touch most of us and their future is considered vital to the nation’s economic recovery. Here is a look at the pros and cons of bailing out Detroit's car makers (formerly known as the Big three).

Pros – Why the bailout is necessary

- Approximately 10% of US employees are employed in the auto industry or by its suppliers/dealers. Of this, the Big three and their suppliers employ more than 2.5 million people, amounting to nearly 2 percent of the nation’s work force. So by letting them going under or having to undertake massive cost cutting layoffs could result in a sharp spike in US unemployment and further depress consumer spending. It will virtually wipe out the Detroit economy. Supporters of the bailout say it is critical in stemming massive unemployment and downward spiralling of the US economy.

- GM, Chrysler and Ford (F) are iconic brands and letting them fail will further shatter market confidence. The perception that the US government is unwilling to help such brand name and economically important companies will accelerate their demise and place greater pressure on other (struggling) iconic companies that may need government assistance down the road.

- A bailout with strict conditions will allow a government mandated restructure of the US automakers and forcefully overcome resistance of the strongest union in the nation, the United Auto Workers (UAW) union, that has strongly pushed back on change to the relatively generous terms it is used to operating under.

- The pressure on the US automakers is intense and the fear of failure (or bankruptcy) is making financial institutions reluctant to lend to them and their customers. Additional funding support through the bailout will provide more breathing room for restructuring/cost cutting, while allowing the automakers to benefit from increased new car demand resulting from lower oil prices and a potentially improving economy.

Cons – Why the bailout is a bad move

- Throwing good money after bad. Spending billions of taxpayer dollars with no promises to reform the root causes of US automakers' chronic lack of competitiveness will end up being a massive waste of funds. Given the automakers and their union’s opposition to change in the past, this may be a real possibility.

- By extending the bailout to the car industry, it will be only a matter of before other struggling sectors and industries (like retail and steel) line up for their share of bailout funds. Workers and investors in other key industries have the right to ask, “why do they deserve it more than us?"

- It is questionable how effective government funded bailouts have been. The financial sector bailout plan – TARP – has already spent half of its $700 billion budget and little has changed in the economy which continues to worsen. While the financial sector will recover in the long term because it is more efficient (due to competition and lower entry barriers), it is questionable if any amount of help will be able to help the chronically under performing US automakers.

- Some free market advocates have argued that Bankruptcy may be a more effective way for the US automakers to restructure operations. They will emerge smaller, more focused and operationally effective without using tax payer funds. The risk with this strategy is that customers stop buying cars from the bankrupt automakers and will instead turn to the viable foreign owned companies like Toyota (TM) and Honda (HMC). Once these customers and market share is lost it will be very difficult for the US automakers to become profitable again and emerge from bankruptcy. UAW President Ron Gettelfinger has said that “Chapter 11 and 7 bankruptcy would mean a liquidation, or going out of business for a [US] auto maker.”

My view is that the bailout of the Big three US automakers will happen and the proposed $25 billion package will be approved by year end. Despite critics on both sides, the US automakers bailout proposal has strong bipartisan support and the President-elect has publicly stated his backing of a constructive bailout plan. It is just too important (perceived and actual) to the nation’s economic recovery. The key will be how the bailout package is structured for short term and long term reform. For it to be successful the US automakers will have to undergo a radical make-over in terms of labor rates and union structures, past and current worker benefits and accelerating the move to cleaner energy vehicles. Further their executives, need to be replaced by new talent whose focus will be on making the companies as efficient as possible to compete in the 21st century and to eventually repay (with interest) the taxpayer funded bailout.

Disclosure: None

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This article has 3 comments:

  •  
    Nov 18 04:56 PM
    The problem is not this $25 Billion bailout for the Automakers and unions...but the next one, and the next.

    Give them this one-time bailout, with the firm, written understanding that if they can't then make it...they will go straight to Chapter 11.
    Reply | Link to Comment
  •  
    Nov 19 09:02 AM
    Give them the money ........ or we will find ourselves in a "greater depression" .........! Ask king george iii bush-it to return to Crawford early!
    The earlier the better....... the "decision-maker&q... who has never "erred" has more than "mission-accompli... his legacy of failure.
    Reply | Link to Comment
  •  
    Dec 09 12:35 PM
    Please take a look at The DiMora Initiative - an informed perspective on the proposed $34 billion bailout of General Motors, Ford, and Chrysler and a forward-looking initiative and call to action to envision the new American automotive industry for the 21st Century. DiMora Motorcar wants your opinion!

    blog.dimoramotorcar.co.../
    Reply | Link to Comment
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