car7858's Blog

Wednesday, November 12, 2008

Bail out Detroit 3? Letting automaker fail costs more than price of loan automaker fail costs more than price of loan David Cole

Philosophically, I don't like bailouts. But the likelihood of one or two of the Detroit Three automakers ending operations is very real. When you look at the scope of the domestic auto industry problems and the complicity of the federal government's role in them, Washington needs to do something to help the Detroit Three.

To permit any of the domestic automakers -- Chrysler, Ford Motor Co. or General Motors Corp. -- to collapse would scar the U.S. economy further when it can ill afford another blow. At stake are millions of jobs and tens of billions of dollars in lost tax revenues. Federal officials must decide: Is an ounce of prevention worth a pound of cure?

The popular complaint is that the domestic auto industry got itself into this mess, and it should suffer the consequences. But the reality is the Detroit Three wouldn't have cash flow problems if the federal government hadn't caused the financial crisis, in part, by ensuring that Americans who couldn't afford a home suddenly could buy one. The resulting subprime mortgage crisis helped lead to the credit crunch, which has caused a dramatic decline in auto sales.

The federal government also contributed to the auto industry's problems with its lack of a realistic energy policy. The price of this hit home this summer, when the price of gasoline spiked to $4 a gallon and caused a massive shift in the types of vehicles consumers would buy. Now that the price of gas is below $2 in some areas of the country, there will be far less demand in the short run for the fuel-efficient vehicles that the government wants the automakers to sell in greater quantities.

So the government's complicity in the subprime mortgage mess and energy policy have brought the industry to the edge of the cliff. The cost of keeping the Detroit Three automakers in the automotive game will be dramatically lower than the cost of letting the industry go down.

If GM, Ford and Chrysler had to shut their doors, according to our center's calculations, the economy would lose nearly 3 million jobs in the first year. That is because the auto industry has the highest jobs spinoff of any manufacturing enterprise. For example, for every auto assembly factory job, there are another eight to 10 jobs outside of the plant.

Those job losses would translate into a first-year loss of more than $150 billion in personal income, about $25 billion in loss personal income tax revenue and another $21 billion in Social Security receipts.

If one of the automakers went down, it still would result in the loss of nearly 2.5 million jobs. That's because the closing of an automaker would have a ripple effect on its tightly knit supplier base. Severely fragile parts makers would be pushed into bankruptcy, causing an interruption in the supply of components to the remaining carmakers. The job losses would be less in the following two years, but the damage would have been done.

It still would result in the loss of $125 billion in personal income in one year and $276 billion over three years along with tens of billions of dollars in lost tax revenue.

Clearly, the price of helping the Detroit Three with a $25 billion bailout would be far less than paying the unemployment benefits of auto workers and suffering the lost revenues from the shutdown of an automaker and suppliers.

Critics have said it would be better to let the automakers file for bankruptcy and get their financial houses in order. The problem with this approach is that industry experts know that consumers won't buy expensive products from a bankrupt company. That still leads to serious decline in sales and to 2 million lost jobs very quickly.

Keeping GM, Ford and Chrysler in the automotive game potentially could have a big payoff. The domestic carmakers have negotiated signficiant cost reductions in their labor contracts with the United Auto Workers. The savings alone for GM is $1,000 a vehicle.

In addition, the very low level of current sales and surprisingly low inventory of vehicles are creating a pent-up demand for new vehicles once the credit crunch subsides and the economy improves. The market promises to shift from the buyers' market of the past decade to a sellers' market where fewer financial incentives or discounts will be needed to sell a vehicle with the industry's reduced manufacturing capacity.

GM currently spends $3,500 to $4,000 a vehicle on incentives. If that number were cut to $2,000, it would translate into an immediate $10 billion improvement on the bottom line. Couple that with the fact that the automakers have improved the quality of their products, and the industry is poised for a significant recovery.

But the government needs to give the Detroit Three a bridge to this brighter future. A bridge loan now would be far less expensive than letting one or more of the domestic automakers fail.

David E. Cole is chairman of the Center for Automotive Research in Ann Arbor.