The “Big Three” automakers Ford, General Motors, and Chrysler, and the United Auto Workers union, traveled to Washington today to ask for a bailout. They asked collectively for $34 billion, but some estimates suggest that they would actually need almost four times that. Let's just say that the banking committee wasn't whipping out its checkbook.
Whether they actually get the bailout or not doesn't change the fact that they shouldn't be getting it in the first place. Bailouts help the few at the expense of everyone else, and encourage the recipients of the bailouts to come back for more.
A bailout of the auto industry will save a few jobs for a little while. OK, it will save a lot of jobs for a little while. But in the long run, a bailout reduces everyone's standard of living. It's interference in the free market, and causes a misallocation of resources. It's a misallocation because the market has already given the company the thumbs-down, in that the company has not been able to deliver a product profitably at a price that the market is willing to pay. A bailout says to the market: “You're wrong. This company deserves to stay in business.”
In the absence of a bailout, here's what would happen to a failing business under free market competition:
- The common stock investors (if any) lose their investment. Investors higher up the food chain get only part of their investment back.
- The assets are sold at fire sale prices, usually to a stronger competitor seeking to increase its market share. The bidding is competitive.
- Some, or many, of the workers may not have jobs after the company is acquired. The ones that do continue to do what they do, perhaps more cheaply. Others don't, but they can now enter another field and be productive.
- The inefficient, inferior company goes away, and the efficient, superior company gets stronger.
- We all win because the resources have been re-allocated efficiently, as a result of what we, the customers, have already said we want: less of the failing business's products, and more of the succeeding business's products.
When the failing business appeals to the powers that be for a bailout, and it is granted, here's what happens instead:
- The failing business stays in business, despite the fact that it doesn't deliver its product as efficiently as its competitors.
- The workers keep their jobs, perhaps at above-market wages, despite the fact that this situation is not sustainable by the free market.
- The people footing the bill (us, mainly) don't have that money available to us to purchase the products we want.
- We all lose because the resources have been re-allocated inefficiently by force, against what we, the customers, have already said we want. We instead get more of the failing business's products and less of the succeeding business's products, and have to pay for this situation to boot.
Society functions most efficiently when its members are free to enjoy the fruits of their labor as they please. From all I can see, society enjoys Toyotas and Hondas more than it enjoys GMs and Fords. Why should we forced to pay for products we don't enjoy?
The same is true of things like subsidies, unions, tariffs, import quotas, regulation, price control, and antitrust actions. All of these things ultimately reduce our standard of living because they interfere with people choosing how to enjoy the fruits of their labors. John Pugsley's book The Alpha Strategy explains why these all hurt our standard or living in an exceptionally clear way. It was written at the end of the Carter administration but the explanation of these phenomena still holds.
I expect we'll get more of the same, but it will cost us all. Who's next in line for a bailout?
That might be true in a normal situation. But this is not a normal situation. The problem is not that the market has given the thumbs-down on the Big 3. All the car companies are seeing plummeting sales. Even Nissan is down 42% (see http://www.mercurynews.com/drive/ci_11122761). Because of the disaster in the banking industry all businesses are having problems getting the day-to-day loans needed to run their businesses. Without these operating loans, the companies either go out of business or they go bankrupt.
No problem, some say, they can just reorganize and come out of bankruptcy. Except to reorganize, they still need "Debtor In Possession" (DIP) loans (http://en.wikipedia.org/wiki/Debtor-in-possession_financing) to keep operating, or they need income. Again. with the problems in the credit market, they may not be able to get DIP financing, and with plummeting sales, they have little income. (Compare this to the airlines: when some of them went into Chap 11, they still had income because people were still going to fly, and DIP loans were easier to get.)
Kevin wrote: "this is not a normal situation"
Sure this is normal. The economy goes up for various reasons. The economy goes down for various reasons. Right now, we're in a down cycle. It's perfectly normal.
He also wrote: "all businesses are having problems getting the day-to-day loans needed to run their businesses."
I'd contend that a well run business doesn't need day-to-day loans. It should run off their cash flow. Poorly run companies that don't do this are the "weak" ones that get culled out during tough economic times, leaving the strong ones to survive. The down times are the times when things overall get stronger.
I know that the auto industry is important, but why should we bail out companies who consistently make poor decisions and have an unsustainable cost structure?
These bailouts will be paid for by future generations for years to come.
Down times are what separate the strong companies from the weak. The weak go away, or they should, anyway.
Debtor-in-possession financing is for troubled companies. Are the Big Three "troubled?" They look more like dead men walking to me.
"I’d contend that a well run business doesn’t need day-to-day loans."
This statement indicates that you don't actually know much about how large businesses operate. Many large businesses take very-short-term loans on a regular basis to smooth out their cash flow. It's called "commercial paper" (see, for instance, here: http://en.wikipedia.org/wiki/Commercial_paper). The commercial paper market was nearly frozen for a good chunk of 2008, which caused serious trouble for businesses.
And, no, this is not a "normal" down cycle. The entire structure of American finance has changed.
Thanks for this great post, and for the great comments left by your readers. It's been hard for me to decide just where I stand on a bailout. Living in Southeast MI, I know many people who will be affected if the Big 3 are allowed to go under.
On the other hand, the thought of yet another bailout just stinks to me.
Your article really clarified the issue, at least for me. You're right; the market has said no to Big 3 cars, at least for the most part.
Stronger companies who are giving us what we want will survive. Weaker companies will not.
Thanks for the insightful post.
The crazy thing is that the media is ignoring the fact that failure is a healthy cycle of business. It clears the market of big-business bureaucracy, allowing more agile companies to reap the benefits of good business.
This government mandated, politician manipulated, cigar-smoking pork spending will only aid in short-term aid while ignoring the long term consequences.
It's like … well, I can't think of a good metaphor.
We're already so far in debt as a nation, that 100% of personal-income taxes just go to pay off the interest of the federal debt.
This means in a decade or two, we'll be at the point of no return. We won't be able to pay off the debt. We lose.
🙂 This comment felt very, very good. 😉
I agree with you, and Tom. I think it is rewarding bad behavior. Capitolism only works when we allow it to. When companies are losing money…it is partly because people are choosing with their money. If Ford, GM, and Chrysler can't keep up with their competitors, then that is the nature of the game. They aren't selling what the people want. I just did an editorial piece on this on my blog last week: http://beefupyourpiggy.blogspot.com/2008/11/soapb…
Great blog! Keep it up!
Hm. A friend of mine who sells Toyotas said their huge dealership sold three cars all month…and one of them was used. I don't see anyone rushing to "bail out" Toyota.
So…here in the Age of Globalization, why should we bail out auto manufacturers that wilfully design and produce inefficient, unsafe vehicles? Just because they and their ancillary industries employ 1% of the U.S. population? Possibly that 1% could find better ways to make a living. Maybe flipping burgers, if there's anyone left who can afford to buy at McDonald's or Burger King.
It's a very slippery proposition, no matter how you look at it.
Bankruptcy and reorganization is the answer in my book.
The sad part is, these liars at the head of these companies are trying to say they need a bailout to save jobs. However, we all know there will be massive layoffs once they get the money- they simply don't have the cashflow to continue current operations. Better to let the jobs be lost while we still have the $34 billion.
I'm not getting behind the bailout but "we" don't "all win" in the absence of a bailout. If the Big Three go belly up, hundreds of thousands of people stand to lose their jobs. They are "us" too and I don't imagine they'll feel much like winners.
Everything develops wavingly. We know it for sure . For some years we saved money,bought cars, furs and jewelry,widen business structures. Now we do quite oppositr things. This is the way created not by us.
I don't feel bad for the automakers, and feel that no bailout should be awarded. I don't think many in congress are viewing it as 'despite you not giving the market what it wants, we're going to give your company another chance,' I think it's more along the lines of 'we don't want any more fear over the economy among the American public, nor a large number of people hitting the unemployment lines.'
You are the best commenter on the planet! I should just give up and take lessons from you.
@Kevin:
These companies have not been doing well for a very long time. Their troubles have certainly been exacerbated by recent events in the financial industry but are by no means simply a function of them.
I think the majority of Americans, except those who live in the rust belt, oppose the automakers' bailout.
Why throw more good money at badly run companies? They had their chance in the 70s and as you may remember, Chrysler was already bailed out once before.
In a free enterprise system, it's sink or swim. Govt has no business spending taxpayer dollars on private companies with overpaid executives.
excellent ,Thanks for the post
How about giving that $34 billion to rising small companies that really deserve it?
It has been mentioned in the economic classics that nothing good comes out of interfering with the free market.