Auto Industry Bailout in a Nutshell

This week I have been reading a lot about the controversy surrounding whether American car makers should receive a bailout from the Feds. What surprises me is that so many people seem to have such strong-willed opinions about the situation, despite not knowing a damn thing about it.

Essentially, Congress has two choices. They can either give Ford and GM a pile of cash, roughly $25 billion dollars, and in return GM and Ford would promise to cut costs and improve efficiencies, and basically sit tight while waiting for the economy to improve.

In the event the Feds don't give Ford and GM the cash, both companies will file for bankruptcy. That does not mean the companies will cease to exist, instead, Ch.11 bankruptcy allows companies to eliminate some of their unsecured, non-priority debt. Under Ch.11, the companies bargain with creditors to pay back a certain percentage of debts, and then make payments under this plan for several years. After successfully making the payments, they would emerge from bankruptcy protection with less debt and presumably better operating conditions.

The main argument against forcing Ford & GM into bankruptcy is that American consumers would lose confidence in the companies if they were bankrupt, and people would not buy cars from them. I see this as a weak argument. There is nothing stopping Congress from passing legislation that would guarantee all warranties and service of GM & Ford vehicles during the Ch.11 re-structuring. The main challenge at that point would be communicating this to American consumers, but I really don't see that as being too big a challenge.

So, the question then becomes which is financially advantageous; would Ford / GM save more money by discharging their unsecured, non-priority debts than they would lose in lost sales from consumers who wouldn't buy cars from a bankrupt company? I suspect that if Congress were to guarantee the warranties & service obligations of the companies while in bankruptcy, that would solve the consumer confidence dilemma to a sufficient degree that the money saved under a Ch.11 restructuring would exceed the lost revenue from diminished consumer confidence. I don't really have any evidence to back this up, but that is my hunch.

The main argument in support of forcing Ford & GM into bankruptcy is that doing so would allow the companies to decrease their operational costs. This is also a somewhat disingenuous argument. People who favor bankruptcy say that the main reason Ford & GM are not competitive is because of the unions and health care and retirement costs. This isn't really accurate for a number of reasons, but to keep it simple, here is the most basic explanation.

Ford & GM's current cost of labor as a percentage of total vehicle-production cost is actually very similar to foreign competitors. In other words, the current union & non-union workers of GM & Ford don't really cost much more than comparable Toyota workers. What is expensive is the retirement benefit expenses for the millions of retired auto workers that GM & Ford have to pay. These retired workers receive benefits under what is called a defined benefit program. These aren't really popular anymore, and have been replaced with defined contribution plans like IRAs and 401Ks that shift liability to the individual, not the company.

Under existing Federal ERISA law, all defined benefit plans of American companies are guaranteed by the Federal Government. This is where the argument for bankruptcy gets fishy. People argue that if the companies go into Ch.11, they will be able to get rid of their expensive union deals and save money. That is true, but only because they would hand-over the entire defined benefit plans to the government, and the American taxpayer would be forced to pay the pensions of all the retired Ford & GM workers. So, bankruptcy would allow GM & Ford to weasel out of many of their debts, but the main expense of the retired union benefits would just be transferred to the American taxpayer.

It is further untrue to lay blame for GM & Ford's failure on the expense of the plans. The plans themselves are not too expensive, what is the problem is that Ford & GM have intentionally underfunded the defined benefit plans, instead using the otherwise designated funds for other things, such as increasing production of high profit margin vehicles like SUVs, and funding their banking divisions, which have now suffered mammoth losses because of the collapse of the unregulated financial industry. In other words, under bankruptcy, American taxpayers would be paying for the retirement of millions of workers, largely because Ford & GM executives gambled away the pension money on other things.

So really, at the end of the day neither bailout or bankruptcy is an ideal solution. It is naive to argue that one is truly more 'fair' or 'smarter' than the other plan. Both of these remedies would do little to change the fundamental problem of Ford & GM, they have greedy and incompetent management that for years has made terrible decision after terrible decision.