Unpacking Claims on the Auto Bailout

Recently, the President has been making a tour of the nation’s "Big 3" auto manufacturers, visiting a GM plant and a Chrysler plant at the end of July, and speaking at a Ford plant in Chicago today. As the President continues his visits, there seems to be greater support among many pundits for his decision to bail-out the auto industry.

Many commentators have argued that the program is an unheralded success that has saved millions of jobs at a minimal cost.

Yet, it is hard to evaluate these claims. Proponents of the auto bailout lack a proper comparison point, since it's impossible to know what the outcome would have been given different actions. In the worst-case scenario, it is certainly possible that the failure of GM and Chrysler could have cost a million jobs and devastated the Midwest.

But is that the only outcome? Corporate bankruptcy is not a death sentence, and plenty of companies have successfully recovered under bankruptcy. Potentially, GM and Chrysler could have reorganized themselves with new infusions of private capital. Crucially, bankruptcy would offer the chance to rewrite union and pension contracts to more sustainable levels, while offering the companies increased flexibility in closing plants and tarnished brands.

First, let’s remember that not all of the Big 3 received (or even asked for) the same assistance during the crisis, so they shouldn’t be lumped together in this debate. Of Detroit’s Big Three car companies, Ford was the only one which refused to take any bailout money last year. Contrast that with GM taking $50 billion in funding while granting the federal government a 60% ownership stake and Chrysler taking an $8 billion infusion in a governmentally arranged bankruptcy. And how is Ford doing now? Fantastically, according to CNBC: “Ford shares have been on a tear, nearly doubling in the past year. The automaker has finally turned a profit, delivering four consecutive quarters of income growth, the longest streak since 2005.” Of course, it’s not all rosy – Ford still has $27 billion in debt on its books and some hard times ahead, as we discussed here. But the design adjustments Ford has made recently, including revamping its line of small cars, demonstrate precisely the kind of free market success story that Ford hopes will carry them into the black in years to come.

GM isn’t doing so swell. Their biggest recent success was a bogus announcement that they repaid a large portion of their bailout debt ahead of schedule, which was tarnished when the TARP inspector general pointed out that taxpayer funds were used to repay that debt.

Why not have allowed GM and Chrysler to fend for themselves? GM and Chrysler would inevitably lose market share to their more efficient competitors -- either through consumer choice, through liquidation and sale of existing plants and equipment. Consolidation of brands and companies in the hands of surviving firms would enable the industry as a whole to better figure out the path to profitability.

At the time, many argued that the failure of GM and Chrysler would have had a massive ripple effect, causing many regional auto part suppliers to also fail – many of which supplied specific parts for specific vehicles, and were therefore unable to adjust their operations in time to stay afloat. Auto part suppliers would certainly have been hit, but it is worth questioning whether a multi-billion dollar bailout was the only way to save them. Over time, auto suppliers would shift to supplying parts for GM’s competitors. In the short-run, if no private financing was available, the government could have restricted itself to supplying short-term loans to affected firms.

The costs of auto industry bankruptcy would have been high, but corporate failure is always hard to deal with, and there is no good reason to privilege the claims of auto companies over the thousands of other struggling firms.

Meanwhile, by avoiding certain short-term costs associated with messy corporate failures, the Administration has invited a slew of additional problems:

1) Costs to Market Discipline. Letting the free market operate would have ensured the sanctity of contracts, while promoting a process of creative destruction in the marketplace. GM would be punished for its failure to react to a changing environment, while firms that made tough cuts and decisions in the past (like Ford) would be rewarded through increased market share. Now, Ford is actually at a competitive disadvantage because it chose to reinvent itself rather than asking the government to pick up the tab for its failure to innovate. Market discipline is crucial to generating competitive marketplaces, and it is sad to see so few voices standing up for the rule of law. Fortunately, the American public knows better – by overwhelming margins, they opposed the decisions to bail out private auto companies.

2) Costs of Government Ownership of Private Companies. When the Obama Administration announced the bailouts of the auto companies, it promised that these companies would continue to be run in a non-political manner. Yet the effects of public ownership are already apparent. Rather than being hands-off, the government continues to interfere with the private market that could otherwise force efficiencies. Auto dealers are exempt from the CFPB after intense lobbying, and have also convinced Congress to avoid necessary dealer shutdowns. GM has used government funds to purchase a subprime auto dealer. It’s worth noting that, even in the worst of times, GM’s dealership arm – GMAC – never made auto loans to subprime individuals.

Moreover, GM has changed its corporate strategy to emphasize the sorts of energy-efficient electric cars that are Administration favorites. This may prove to be a good investment. But why should the government be responsible for dictating the direction of corporate investment through its ownership of individual companies?

3) Financial Costs. The government incurred a substantial financial hit in granting as much as $60 billion in bailout funds to GM and Chrysler. Many Administration advocates claim that a substantial portion of this money will now be repaid, but the risk to the taxpayers when the bailouts were extended remains the same.

Suppose that the government had spent the same amount of money at a roulette table, and happened to recoup its funds. Would we say that was a good investment? No – because gambling, like auto bailouts, contains a substantial amount of risk. We need to account for the ex ante risk inherent in the government decision, because events could easily have turned out worse. The government may be lucky enough to recoup the amount of its direct financial investment, but this actually reflects very poorly on the policy. The government would not be receiving proper compensation for the amount of risk it took to bail out companies, and should be very cautious about making similar commitments in the future.

Finally, it’s worth taking a step back to see what the taxpayer has received on its enormous investment. While Obama has trumpeted the figure of 55,000 auto jobs added since June 2009, this remains a puny number both in absolute terms, as well as relative to auto employment overall--which exceeded 1.1 million in 2005. It also comes out to over $1 million in taxpayer assistance per job created. The story in car manufacturing is similar to the picture in a variety of industries. Output and production are both up, but employment has lagged behind. Corporate welfare has turned out to be enormously profitable for auto executives, but has saddled the taxpayer with enormous risk and costs, while doing little to benefit American workers.