Don't Bail Out the Big Three
by Daniel J. Ikenson
One day before the CEOs of General Motors, Ford, and Chrysler told the Senate Banking Committee that their industry faced imminent collapse without an emergency infusion of $25 billion, a new automobile assembly plant opened for business in Greensburg, Indiana. Although the hearing on Capitol Hill received far more media coverage, the unveiling of Honda's latest facility in the American heartland speaks volumes about the future of the U.S. car industry—and shows why the proposed bailout of Detroit's Big Three is so misguided.
The intellectual arguments against an auto industry bailout are well established. Taxpayers should never be forced to subsidize any company, let alone a poorly run company. Subsidizing the Big Three would be tantamount to subsidizing failure. That's bad policy.
Corporate bailouts are clearly unfair to taxpayers, but they are also unfair to the successful firms in a particular industry, who are implicitly taxed and burdened when their competition is subsidized. In a properly functioning market economy, the better firms—the ones that are more innovative, more efficient, and more popular among consumers—gain market share or increase profits, while the lesser firms contract. This process ensures that limited resources are used most productively.
Some iconic U.S. automakers are now in dire straits, but the car industry itself is not in crisis. Even if one or all of the Big Three failed, there would still be plenty of strong auto companies operating throughout the United States. The Big Three currently account for slightly more than half of all light vehicle production and slightly less than half of all light vehicle sales in the United States. The rest of the U.S. auto industry includes Honda, Toyota, Nissan, Kia, Hyundai, BMW, and the other foreign nameplate producers who manufacture vehicles here. These companies employ American workers, pay U.S. taxes, support local businesses, contribute to local charities, have genuine stakes in their communities, and face the same cyclical contraction in demand as do the Big Three. The difference is that they have been making more products that Americans want to buy and will endure this recession without any taxpayer assistance because they have more efficient cost structures.
The decline of the Big Three is hardly a recent phenomenon. Detroit has been losing market share for decades. It has not produced a top-five selling passenger car in years. Detroit's once-popular SUVs and large pickup trucks have fallen out of favor with consumers. The Big Three failed to sufficiently diversify into reliable, efficient, and aesthetic passenger cars when they were earning big profits and had the money to do so. Their bloated cost structures have given non-Detroit competitors a $30-per-hour advantage in labor costs.
Want proof that automobile production remains alive and well in the United States? Just look at the success of Honda's operations in Ohio, Toyota's in Kentucky, Nissan's in Tennessee, BMW's in South Carolina, and Hyundai's in Alabama, as well as the proliferation of new plants across the country, such as the new Honda facility in Indiana and the new Kia plant in Georgia.
What we are witnessing…is an attempted shakedown.
If one or two of the Big Three went under, people would lose their jobs. That's what happens in an economic recession, when less competitive firms are forced to contract. But the number of job losses wouldn't be anywhere near as large as Detroit is telling us. Realistically, the failure of one or two major auto producers would improve prospects for the firms and workers who remain in the industry. If GM fails, the market shares of Ford and Chrysler (not to mention those of the foreign nameplate producers) are likely to increase, as they compete for GM's former customers and best workers.
The bailout sought by Detroit would interfere with the adjustment process, while doing nothing to make the Big Three more competitive. A $25 billion infusion for companies that are losing $6 billion each month is not a rescue plan; it's an expensive way of kicking the can down the road.
Funneling $25 billion to the Big Three would amount to a waste of taxpayer dollars and also a tax on the successful auto companies, such as Honda and Toyota. Indeed, bailing out Detroit would discourage the successful companies from opening new facilities in the United States.
To dampen criticism, Congressional Democrats speak of a bailout "with strings attached." But even a strings-attached bailout poses problems.
First, Congress doesn't know enough about the auto business to dictate operational conditions. "Strings" that cap executive compensation will chase talent away. Strings that force Detroit to produce high-mileage vehicles when gas prices are plummeting will lead to a repetition of past mistakes.
Second, strings will make it easier for the Big Three to come back for more federal aid after they blow through the first $25 billion. Their CEOs will be able to say that they complied with the conditions of the original bailout, which happened to make matters worse for them.
Bailing out Detroit is unnecessary. After all, this is why we have the bankruptcy process. If companies in Chapter 11 can be salvaged, a bankruptcy judge will help them find the way. In the case of the Big Three, a bankruptcy process would almost certainly require them to dissolve their current union contracts. Revamping their labor structures is the single most important change that GM, Ford, and Chrysler could make—and yet it is the one change that many pro-bailout Democrats wish to ignore.
The Big Three, the United Auto Workers (UAW), the Michigan Congressional delegation, Michigan Governor Jennifer Granholm, House Speaker Nancy Pelosi, and Senate Majority Leader Harry Reid all know that $25 billion is nowhere near enough money to fix the problems ailing Detroit. The politicians must know that bankruptcy is the better course for auto companies and their workers (indeed, it could save 100,000 jobs). But they also know who fills their political coffers, and the UAW leadership is opposed to Chapter 11 because its labor contracts would be deemed toxic and abrogated by a bankruptcy judge.
The U.S. auto industry needs a shakeout, not a bailout. What we are witnessing, unfortunately, is an attempted shakedown. Let's hope it doesn't succeed.
A Path Out Of the Woods
We need China to see that its interests are aligned with America's. If not, things could get very, very ugly
For weeks the world has eagerly awaited word from the Obama transition team about the people who will head up the next American administration—the new secretaries of state and Treasury, the attorney general. But one of the more crucial positions in the Obama administration probably isn't going to be filled for months and will likely get little attention when it is—the post of U.S. ambassador to China.
Everyone knows that China is a major power and our representation there is important. But right now, we need Beijing like never before. China is the key to America getting through the worsening economic crisis. The American ambassador in Beijing (OK, this is a metaphor for all those officials who will be managing this relationship) will need to make sure that China sees its interests as aligned with America's. Or else things could get very, very ugly.
There is a consensus forming that Washington needs to spend its way out of this recession, to ensure that it doesn't turn into a depression. Economists of both the left and right agree that a massive fiscal stimulus is needed and that for now, we shouldn't be worrying about deficits. But in order to run up these deficits—which could total somewhere between $1 trillion and $1.5 trillion, or between 7 and 11 percent of GDP—someone has to buy American debt. And the only country that has the cash to do so is China.
In September, Beijing became America's largest foreign creditor, surpassing Japan, which no longer buys large amounts of American Treasury notes. In fact, though the Treasury Department does not keep records of American bondholders, it is virtually certain that, holding 10 percent of all U.S. public debt, the government of the People's Republic of China has become Washington's largest creditor, foreign or domestic. It is America's banker.
But will the Chinese continue to play this role? They certainly have the means to do so. China's foreign-exchange reserves stand at about $2 trillion (compared with America's at a relatively puny $73 billion). But the Chinese government is worried that its own economy is slowing down sharply, as Americans and Europeans stop buying Chinese exports. They hope to revive growth in China (to levels around 6 or 7 percent rather than last year's 12 percent) with a massive stimulus program of their own.
The spending initiatives that Beijing announced a few weeks ago would total almost $600 billion (some of which include existing projects), a staggering 15 percent of China's GDP. Given their focus on keeping people employed and minimizing strikes and protests, Beijing will not hesitate to add tens of billions more to that package if need be.
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A few weeks ago, I wrote a profile of Tim Geithner that explored his relationship with Larry Summers during their eight years together at Treasury in the 1990s. The two men had formed such a productive partnership that I wondered if there were some way of reuniting them under Obama. Invariably the answer from sources was “no.” Both had achieved “principal” status (Geithner spent the last five years as president of the New York Fed, Summers was Bill Clinton’s final Treasury Secretary) and there was, alas, only one top job.
So I was thrilled to hear yesterday about the dream-team pairing that will make Geithner Treasury Secretary and Summers a top White House adviser. Geithner is one of the most able technocrats to have risen through Treasury’s ranks, which makes him the perfect pick to run its sprawling bureaucracy; Summers is one of the top two or three economic minds of his generation, which makes him a guy you want in the room with the president.
But, beyond the pairing of person and job, it's the way these guys complement one another that's really key here. Geithner is the rare bureaucrat with the smarts and the self-confidence to effectively challenge Summers when he’s off base. As I wrote earlier this month:
Geithner had become a check on the bandwagon-jumping Summers's intellect could inspire--and which Summers, to his credit, reflexively resisted. "When you're talking to the Treasury secretary or the under secretary, there's a strong tendency for everybody to leap on what that person is saying and agree," says one co-worker. "Tim's fundamental function was to interrupt that process."
Former colleagues told me that Geithner had a particular knack for reeling in Summers when he’d get bogged down on some esoteric point of marginal relevance to the problem at hand. He’d say something like, “That was enormously clever Larry, but on the other hand...” then home in on the question that needed resolving. The value of this skill is hard to overstate.
The two men also developed an incredibly effective good cop/bad cop routine, which I'm guessing they might reprise:
Summers was the bad cop--the outspoken sheriff with strong views about how to structure the international financial system. Geithner was his antidote--a master of process and protocol and Treasury's ambassador to global forums like the G-7. At one point, after a series of rapid-fire bailouts by the IMF, the Europeans began agitating for checks on the organization's ability to dispense money, something Summers strongly opposed. In response, Geithner hinted that the United States might start relying on other institutions--like the newly formed G-20 group of industrialized and emerging economies--to respond to financial crises. The Europeans were highly sensitive about the status of the IMF, where they had outsized influence. They quickly backed down.
So what might the division of labor between Geithner and Summers be like this time around? A couple bets:
1.) Substantively, Geithner will have the chief responsibility for resuscitating and reforming the financial markets, an area where he’s developed extensive expertise at the New York Fed. Summers will, in turn, be the guy the administration defers to on broad macroeconomic decisions--how big a stimulus bill should be, how the money should be allocated between unemployment benefits, aid to states, infrastructure projects, tax cuts, etc. (One thing to keep in mind about Geithner: He’s one of the least territorial people ever to work in government, with the possible exception of his old boss Bob Rubin, who was also famous for this. If Geithner thinks a colleague is in a better position tackle something, his impulse is to get out of the way.)
2.) Geithner and Summers will also have complementary procedural roles when dispensing advice to Obama. Summers’s instincts are pretty activist--he tends to favor aggressive government intervention during a crisis. Obama is innately cautious. Even when his head tells him to be aggressive, his gut tells him to slow down. The problem with a combination like this is that it can lead to stalemate: The activist guy pushes and the cautious guy clams up.
Which is where Geithner comes in. Geithner has, over the years, displayed a knack for getting to where Summers is headed, but with less indigestion all around. For example, in the fall of 1997, Geithner, Summers, and then-Treasury Secretary Bob Rubin had to formulate a response to the Korean financial crisis, which was on the verge of spreading around the globe. Summers wanted a huge show of force--accelerating an existing IMF package and kicking in a U.S. bailout to boot--which made Rubin queasy. Geithner helped broker the compromise that won Rubin over. (It involved asking private banks to re-schedule Korea’s debts so the country wouldn’t need as big a bailout.) I can imagine a similar situation arising under Obama.
3.) Geithner will take the lead on all things political. He’s developed strong relationships up and down Wall Street over the last five years, so he shouldn’t have trouble selling his reform agenda there. He also has extensive experience navigating Capitol Hill, having helped advance the Clinton administration’s debt relief agenda there during the mid-to-late ‘90s, over deep conservative opposition. Anyone who can convince the Jesse Helmses of the world to ease up on third-world countries can probably guide a stimulus bill through Congress.
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