Tuesday, January 6, 2009, 7:06PM ET - U.S. Markets Closed.

Charles Wheelan, Ph.D. The Naked Economist

Why a Big Three Bailout Is Driven to Fail

Email this Page IM this Story Bookmark this Story Add to your Del.icio.us account Digg this Story Print this Story

Very Good (1730 Ratings): 3.810378/5

Posted on Monday, November 17, 2008, 12:00AM

Congress is contemplating a bailout of the American auto companies. My advice: Don't do it!

Yes, this is a time for government to act aggressively to stop the negative feedback loops that have infected the economy. But giving money to the dysfunctional Big Three is not a good way to do it.

Here's why:

1. Because a bailout won't help.

Sending loans to Detroit will not stop the slow rot that has been going on for 40 years. Management has presided over decades of poorly designed cars that have less and less appeal in the global marketplace; labor has been inflexible and unrealistic, making it harder and harder for the American firms to make a good car at a competitive price.

Traffic safety experts don't like the word "accident" because it implies that nothing could have been done to prevent it; they use the term "crash" instead because it leaves room for culpability. What's happening in Detroit is a crash, not an accident, and it's been unfolding for a long time. The current economic crisis has merely sped up the impact.

2. Because bankruptcy isn't a bad option.

The Big Three will not disappear if they run out of cash. They'll declare bankruptcy, like the airlines do every six or eight weeks. A working bankruptcy would enable the automakers to ditch the labor contracts and pension obligations that have made them uncompetitive.

The Big Three could emerge as leaner and more competitive. Or they could emerge as the Big One. Or they could end up as Toyota. Each of these is a reasonable outcome, and bankruptcy would speed it along.

3. Because there's no economic justification for a bailout.

How does sending cash to Detroit make the rest of us better off? Obviously it helps autoworkers and executives; indirectly it slows the bleeding in the Detroit area, which will continue to suffer as the automakers sink further. But there's suffering involved with any business failure -- when crops fail in Iowa or my drycleaner loses his lease in Chicago. (The latter actually happened; his name was Hugh and it was sad.)

We should inject government money in places where failure would otherwise spill over to the rest of the economy in pernicious ways, such as bank failures precipitating a credit crunch. Saving the automakers won't quicken the recovery, nor will leaving them alone cause pain above and beyond what we've got coming. The money could be better spent elsewhere.

4. Because the Big Three have been horrible corporate citizens.

As a policy person who works on transportation issues, I've watched this for years. The industry lobbied against transit funding; they fought higher fuel efficiency standards and green taxes (such as a higher gas tax); they fought Japanese competition by limiting imports rather than building a better small car. The industry made tons of money by making increasingly irresponsible cars at the same time that we were becoming more aware of global warming. And now we're supposed to bail them out? No thanks.

(By way of disclosure, I do have a dog in this fight. The last American car I owned was a Ford Explorer. It rolled over on Interstate 80 with the whole family inside, shortly after Ford CEO Jacques Nasser began appearing on television commercials to assure consumers that the Explorer was safe.)

5. Because a bailout would be a terrible start to the Obama administration.

Democrats have a well-earned reputation for throwing money at problems. Many of us hope that Barack will be a pragmatic leader who's willing to do battle with the left wing of his own party. The Big Three bailout may take place in the waning days of the Bush administration, but it's a Democratic initiative at a time when the Democrats ought to be planning a future under their new leader. Government cash for Detroit sends all the wrong messages.

How the Government Could Help

But wait -- didn't I argue that we ought to spend a lot of taxpayer money to intervene in the financial crisis? Yes. That was different. Any government intervention should fit three criteria:

Its primary focus should be keeping otherwise healthy institutions healthy (even at the risk propping up some businesses that should disappear). The ongoing Treasury Department intervention is rightfully designed to provide capital to viable firms that might otherwise get dashed against the rocks by this unique financial storm.
It should make the rest of us better off in the long run. One doesn't have to be a Wall Street investor to benefit from the Wall Street stabilization. We all need stable, healthy credit markets. Without that, this crisis will continue to spread like a plague.
It should be obvious how the intervention will restore a firm or industry to better health, rather than merely prolonging an inevitable decline.

Use the Money Elsewhere

The Detroit bailout fails on all three counts. Government money can be better spent. My first two (not mutually exclusive) choices would be a major infrastructure investment -- everything from fixing decrepit bridges to building high-speed rail links. Such a program would boost economic activity and leave us a more productive nation when it was done.

And/or I would use government resources to restructure mortgages at risk of default (with a significant penalty built in for both the bank that made the loan and the homeowner who can't make the payments). The key is to slow or stop the vicious cycle of foreclosure and falling housing prices: foreclosed properties are thrown on the market, which drives prices down, which puts more mortgages "underwater," and so on. Stopping that cycle is crucial to ending the crisis.

The federal government needs to act quickly and boldly. That's not synonymous with throwing money at unhealthy, irresponsible automakers.

Email this Page IM this Story Bookmark this Story Add to your Del.icio.us account Digg this Story Print this Story

Rate This story

Very Good (1730 Ratings): 4/5

Sign-in to rate!

1318 Comments

Showing comments 1-5 of 1318Next >>

Sort: first to last

tuttlejeff@ymail.com - Monday, December 29, 2008, 4:33PM ET Report Abuse
- Overall: 2/5
I am very much a free market advocate, but the naked truth is that the big three did not get to this point in a free market system, and we wonât get out of this problem with a free market solution. They got to this point because of huge barriers to entry (massive design complexity, huge government regulations, monstrous tooling requirements, and cumbersome distribution), which the executive side leveraged for comparably large wages, and the unions leveraged for even more off base wages and benefits. If the government wanted to prevent this scenario, they should have attacked the barriers to entry, promoting competition, not whining that the unions and management took every dime they couldâthat is what every business and worker does. For those chanting bankruptcy, I would like someone to actually provide details on how to handle the bankruptcy of the highly leveraged supply base along with the big three. Remember that a stop ship of just one component during that time will shut down an entire plant. Youâre going to have to sort out about 1200 bankruptcies at once, and, if you screw up just one part per plant, youâre shipping no vehicles and over time you have 2,000 dealerships declaring bankruptcy as well. With the trickle down effect into other areas, a 30-40% state unemployment is easily within reach. An airline bankruptcy isnât even in the same league as the line of dominos ready to fall with the auto industry. The big three need to get real with wages, compensation, and benefits at all levels, but the public needs to get real with the true consequences and complexity involved in this situation.
Yahoo! Finance User - Saturday, December 20, 2008, 2:41PM ET Report Abuse
- Overall: 5/5
Viewpoints like the ones expressed below by the one star reviews are what make me worry about this nation's future. Mr. Wheelan's points about workers in the car industry receiving a freeride for years could not be more true. While I certainly sympathize with the inconvience that is created through the loss of one's job, adjustment costs are a crucial aspect of the free market system. Giving more money to firms that have been generating losses for years is only going to extend the losses and make it harder to restructure down the road. Those at the top all the way to the bottom of the the automobile companies have been taking a protectionist stance for years, a stance that is virtually impossible to stand upon for very long in a global economy. If left to file for bankruptcy the big 3 will have to face reality right now. Their way of doing business is flawed and hopefully the humility of bankruptcy will cause then to take a careful look in the mirror, as well as allow them to clear out the unnecessary spending. I find it hard to generate too much sympathy for union workers when I consider the fact that for years they have earned wages higher than other well educated professionals in our society, most notably teachers. They've earned these wages for jobs that I am confident at least 80% of the world's adult population could complete with a month of training. The credit markets are a different beast, but a bailout of the car industry will only push America even closer to a socialist state. Those at the top and the American public need to step back and take a look at the path we are sending ourselves down. If we are so petrified of some adjustment costs and some free market competition, then maybe we should go back to an agrarian society in which each family should live as a self sufficient entity. The U.S. automakers need to learn how to compete or dedicate their resources to other causes, by pushing more money into a broken system we are simply worsening the problem and creating an inevitable collapse that will produce even larger adjustment costs in the future. The lobbying, lending, and union negotiations need to stop, and the cost cutting, research and development spending, and quality control measures need to increase. The Big 3 will not just evaporate after filing bankruptcy. Their infrastructure including: dealerships, factories, and inventory is too vast for them to just disappear. If Americans are educated through marketing campains by both the car industry and the government then their confidence will not be swayed in the automakers, and the result may be a creation of national pride that generates increased purchases and devotion to the U.S. automobile industry.
Yahoo! Finance User - Friday, December 19, 2008, 11:15AM ET Report Abuse
- Overall: 1/5
I find this article stupid and very irresponsible.This "expert" doesn't have an idea about the dimension of this problem.I can't explain how is that a moron like this have a column here.
Yahoo! Finance User - Friday, December 19, 2008, 1:41AM ET Report Abuse
- Overall: 1/5
Ph.D. obviously stands for puny headed dope in this case. I love your comment "A working bankruptcy would enable the automakers to ditch the labor contracts and pension obligations that have made them uncompetitive." Spoken like a true Nazi. Who cares about the people that worked their entire lives trying to better themselves and have a decent retirement? Not you I guess. It's too bad that rollover incident didn't leave you in a state in which you couldn't work and had to live off public assitance. You might feel a little different.
Hotblack D - Thursday, December 18, 2008, 10:40PM ET Report Abuse
- Overall: 5/5
Thank you for pointing out the oft overlooked truth that for big corporations filing for bankruptcy does not equal going out of business. There won't be millions of unemployed autoworkers the next day, although many overpaid lazy union employees might end up with a real wake-up call. Bankruptcy restructuring could bring about real change. A bailout certainly won't. But the Big 3 have already launched their post-bailout advertising. Have a look at http://farm4.static.flickr.com/3084/3097157920_d7c983aa6b_o.jpg

Showing comments 1-5 of 1318Next >>

Meet the Experts

Harold Maass of The WeekThe Best of Today's Business
Ram CharanWhat Every Company Should Know
Charles Wheelan, Ph.D.The Naked Economist

Rhonda AbramsThe Passionate Entrepreneur
Jeremy Siegel, Ph.D.The Future for Investors
Jim CitrinLeadership by Example

David BachThe Automatic Millionaire
Laura RowleyMoney & Happiness
Suze OrmanMoney Matters

Robert KiyosakiWhy the Rich Get Richer
Ben SteinHow Not to Ruin Your Life
Penelope TrunkThe Brazen Careerist

Jack M. GuttentagThe Mortgage Professor
Carrie Schwab PomerantzMoney-Smart Families
Anya KamenetzGeneration Debt

David JacksonThe Green Investor
Mick WeinsteinThe Week's Best Stock Blogs

» View all experts

The columns, articles, message board posts and any other features provided on Yahoo! Finance are provided for personal finance and investment information and are not to be construed as investment advice. Under no circumstances does the information in this content represent a recommendation to buy, sell or hold any security. The views and opinions expressed in an article or column are the author's own and not necessarily those of Yahoo! and there is no implied endorsement by Yahoo! of any advice or trading strategy.