Should We Bail Out the Big Three?

It wasn’t too long ago that we were agonizing over whether we wanted to see a bailout package approved to rescue financial companies like AIG. Because it was said that doing nothing would result in the credit markets drying up and causing businesses to perhaps shut down, Congress held their noses and voted for it. The results so far have some banks using the bailout cash to buy other banks instead of using it for loans which is not what anybody had in mind for this money. So from this we have learned a lesson that if our government is going to offer money for bailouts, we have to be especially careful to attach enough strings to the offer to make sure the money has the desired effect.

So now the Big Three automakers, GM, Ford, and Chrysler are financially reeling and asking for government loans to keep them going. While nobody is going to help a smaller company stay alive in such a situation, the automobile industry and all of the other industries that support it represent a huge number of US jobs. Is this another example of companies that are too big for us to allow them to fail?

I think that this is really a tough call because if presents a conflict between what we should do as a matter of principle and as a matter of practicality.

As a matter of principle, this is a no-brainer. Free enterprise capitalism owes its success to the principle that the strongest companies, the ones that do the best job of satisfying its customers, will survive and thrive while the weakest ones die off. Governments that try to meddle in this process to keep the weak companies alive are doing a disservice to its citizens.

Making this situation more uncomfortable is while it may be bad for government to get involved with rescuing companies in the first place, our recent experience with the financial services bailout tells us that if we also need to attach enough strings to the money, sometimes even dictating to the company how it should be structured. So the government is not only helping to finance a private company, it is also running it. This takes us even further from the free enterprise system we prize.

And especially with these companies getting more than their share of criticism over the years (much of it deserved) for being unresponsive to the car buying public, it is easy to understand a lot of the sentiment especially from conservatives like David Brooks in his NYT op-ed piece Bailout to Nowhere that allowing the Big Three to go into bankruptcy may be best for us in the long run.

This is an excruciatingly hard call. A case could be made for keeping the Big Three afloat as a jobs program until the economy gets better and then letting them go bankrupt. But the most persuasive experts argue that bankruptcy is the least horrible option. Airline, steel and retail companies have gone through bankruptcy proceedings and adjusted. It would be a less politically tainted process. Government could use that $50 billion — and more — to help the workers who are going to be displaced no matter what.

While many believe that bankruptcy is the equivalent to going out of business, there are two main types of bankruptcy available to US businesses. Chapter 7 bankruptcy is the kind where the company does go out of business and its assets are sold to satisfy creditors. But under what is called Chapter 11 bankruptcy, the company stays in business and gets a breather from creditors in exchange for submitting to some control from the courts and possible restructuring of the company to give it the best chance to eventually pay back the debt. So for those who advocate bankruptcy like in this Fortune article GM: Better off bankrupt, they are referring to Chapter 11 bankruptcy.

But alas there is the conflicting practical aspect to all of this. In normal times, forcing the Big Three to file for Chapter 11 bankruptcy instead of getting bailed out makes sense. But these are far from normal times. We have an economy that is in the worst shape since The Great Depression of the 1930s. While Chapter 11 bankruptcy is seen as strong medicine for these ailing companies, the cure during this weakened economy may prove to be a fatal blow to these companies leading to Chapter 7 bankruptcies which most people agree would be a disaster for the US. Among other things, pensions and health insurance from these companies may be lost. Can we afford to take a chance of this happening?

There are a couple of other arguments against forcing the Big Three to resort to bankruptcy. One is that credit even for financially strong companies is still tight. For companies in bankruptcy, adequate lines of credit may prove to be impossible to obtain. The other argument is that car shoppers may be reluctant to buy from a company who they fear may go out of business.

Automotive News, an auto industry publication makes their case in an editorial titled The Cost of GM’s Death.

Even if GM could get debtor-in-possession financing to keep the lights on (which it can’t), Chapter 11 means a collapse of sales and a spiral into a Chapter 7 liquidation.

GM’s 100,000 American jobs will die. Health care for a million Americans will be lost or at risk. Hundreds of GM’s 1,300 suppliers will die. Their collapse could take down Ford Motor Co. and Chrysler LLC, perhaps even North American transplants. Dealers in every county of America will close.

The government will face greater unemployment, more Americans without health insurance and greater pension liabilities.

Criticize Detroit 3 executives all you want. But the issue today is not whether GM should have closed Buick years ago, been tougher with the UAW or supported higher fuel economy standards.

In the next two to four months, GM will run out of cash and turn out the lights. Only government money can prevent that. Every other alternative is fantasy.

While President-elect Obama is in favor of government financial help for the Big Three, many Republicans in Congress are cool to the idea. While it is unclear that anything will happen during the lame duck session, perhaps the coming year and a new president will result in a meeting of the minds and a way to help the US auto industry weather this financial storm that is battering so many other businesses.

As a condition of the government loan, it is reasonable to first require the management of the Big Three to offer a viable plan (perhaps involving some company reorganization) to show how they can turn their fortunes around and compete with the Toyotas and Hondas.

I would like to conclude with an excerpt from Bob Herbert’s NYT op-ed article 'Drop Dead' Is Not an Option:

It’s easy to demonize the American auto industry. It has behaved with the foresight of a crack addict for years. But even when people set their own houses on fire, we still dial 9-1-1, hoping to save lives, salvage what we can and protect the rest of the neighborhood.

This whole matter needs some intensive thought. At the moment, Washington has tremendous leverage over the failing auto industry. The government should craft a rescue plan that is both tough and very, very smart. That means dragging the industry (kicking and screaming, no doubt) into the 21st century by insisting on ironclad commitments to design and develop vehicles that make sense economically and that serve the nation’s long-term energy security requirements.

What I would like to see is creative thinking on both ends of the bargain. Let the smartest minds design a bailout that sparks a creative revolution in the industry.