The Big 3 are in Big Trouble. And the clearest way out of this trouble is through a structured bankruptcy. A bankruptcy would allow the automakers to restructure contracts that limit their control over their businesses. It would also allow them to pare their production capacity to levels that agree with their current share of the market.
A bailout of these companies reinforces bad management practices, and is the truest example we can have of moral hazard. If the rationale for the bailout is to protect the labor, then money is far better spent by direct government programs. The Big 3 have demonstrated incompetence time and again in handling labor; it would be foolish to expect them to do otherwise with government funds.
The financial crisis is harming businesses. This is, however, a recent problem. What is not at all a recent problem is the inability of the automakers to sanely manage themselves and position themselves for continued health. The problems that they face are systemic, only exacerbated by the current market, and in no way caused by it.
Systemic problems facing the Detroit 3:
- Loss of market share
Do you remember when you first saw a Japanese car? For most of us, it was in the mid-1970's. The first Toyota models to grace our American market were not excellent. It would take another decade for the Japanese cars to be seen as equals with their American counterparts. Another decade still, in the 1990's, the first flagship Japanese brands became available: Lexus, Infiniti, Acura. These Japanese cars had discernable superiority in quality in comparison to the Americans.
- Cost inefficiency
There are many places where the Detroit 3 cannot compete on cost. Labor costs, pension costs, franchise costs all tie their hands. It costs GM roughly $2000 more to build a car of similar value to one built by a non-Detroit entity. The details of these cost inefficiencies are more than I want to elaborate on in this diary, but the cost differences are real, and they are not new.
- Management of an industry in decline
Our economic model in this country is tightly focused on growth. The balance sheets of public companies are scrutinized quarterly for reassurances that growth is occurring. The management of the Detroit 3 has made strategic errors repeatedly in attempts to prop up their failing industry in the eyes of shareholders. The current prices of these stocks should tell you how well they are doing.
Bailouts, and Why they're a Bad Idea
- Moral Hazard
It has been said already, but bears repeating, that giving money to the Detroit 3 only prolongs the day of reckoning. This needs to happen sooner rather than later. The business situation in which they find themselves in untenable. No amount of cash is going to fix their systemic problems.
- Government is the better protector of labor
The auto industry's mouthpieces have been out in full force to make sure that everyone is a scared as possible regarding the possibility of a Detroit failure. Full page ads have been issued in major newspapers, and Congressional Hearings are underway. Their primary focus is jobs lost, which is a reasonable concern.
That said, if jobs are to be lost, then the government is far better equipped to provide the social safety net for workers. Paying the automakers to keep the party going does no one except the management of those companies any good. $25 billion goes a long way in helping folks repair their lives.
Why Bankruptcy may be Best
- Freedom to renegotiate contracts
As stated above, Detroit is in an unenviable cost situation. This will not change unless the contractual obligations in which they find themselves can be altered. The most common method for opening contracts in bankruptcy.
- Freedom to rightsize the business
The US has 4 times the capacity it needs to make cars. Detroit owns the vast majority of that overcapacity. Efficiency gains in automaking and improvements in quality have vastly reduced the capacity needs. Excess capacity is waste.
- Institution of new management
Bankruptcy also provides an opportunity for these companies to get fresh eyes looking at the problems that are faced in the upcoming years.
Labor
I understand that the ideas layed out above are going to mean lost benefits, lost wages, lost jobs and economic blight for many communities. I don't relish any of those ideas. That said, I am assured that the government knows how to support individuals in tough economic times, and that things can be done to alleviate as much pain as possible.
Strong medicine is required to fix Detroit. As with any medicine, the sooner one gets to taking it, the sooner one can start getting well.