Economy and Politics: Bailing out Detroit?

With the election over and the bank bailout no longer really news, the persistent mutter in the media now is about the desperation of GM, Ford, and Cerberus (the private owners of Chrysler). It's a little hard to believe, I think, that the Big Three, who for so long were synonymous with American industry, could be this close to death, and yet, the facts are actually pretty much there for anyone to see:

• Big Three profitability, particularly for GM and Ford, has been tied for over a decade to trucks and SUVs. It's not that they weren't selling cars, mind you. They even sold a few good cars, believe it or not. It's that they weren't selling cars at a profit.
• Much like the mortgage debacle, the Big Three inflated their sales numbers, if not their actual profits, through cheap credit and easy leases. 
• Big Three labor costs are very high.This is part of the reason they can't make an ordinary car at a profit.
• When the price of gas spiked, automobile buyers quit trucks and SUVs cold turkey. US manufacturers were caught flat-footed by this, but worse, even if they hadn't, it's not really clear what they could have done about it, when they can't make a car at a profit!
• With lots full of trucks they couldn't give away, let alone sell, dealers found themselves needing to borrow to obtain vehicles that would sell, only to find they couldn't get credit.
• Making this worse, lots of trucks and SUVs were leased, not sold, in the last three years. In past years, these were easy to sell, "pre-owned", at a profit when they came back, a great deal if it works, because they got both the lease money and an eventual profitable sale. Now, instead, they've got lots full of used trucks they can't sell alongside all the new trucks they can't sell.
• Once dealers started to get credit again, customers couldn't, so even customers who wanted to buy, couldn't.

So now, Detroit is saying, "Help us!" And some people are saying, "Yes, for heaven's sake, help them! Help them now!" and others are saying, "Why should we pay to save their short-sighted asses?"

Unfortunately, the answer to that question is simple. It's the only simple answer, really, in this whole mess. We need to at least consider a government bailout, because there are roughly three million jobs associated with the Big Three. If any one of them, especially the largest, GM, were to fail, that would be monumental hit to the broader economy. 

Michigan would take the biggest hit, of course, but there are automobile and truck plants scattered throughout the country in all sorts of odd places. Senate Minority Leader Mitch McConnell (R-KY), for example, has a vested interest in seeing some sort of bail-out happen, because there's a plant in Kentucky. Here in Saint Paul, there's a Ford plant that's probably going to close in the next few years no matter what happens, but if Ford were to suddenly hit the wall, the controlled, mitigated shutdown that Ford planned would become a sudden closure that would put hundreds on the dole queue all at once.

Exacerbating this situation is a belligerent United Auto Workers leadership. Their feeling is that this crisis is entirely management's fault, and therefore their membership shouldn't have to concede a single penny or in any way suffer the consequences. They are, however, wrong. UAW intransigence is one of the reasons Detroit can't make money on a small, inexpensive, efficient car and instead had to predicate their profits entirely on gas-guzzling monstrosities. 

As brave as they're feeling right now, with GM on the ropes, they're going to feel pretty stupid if, three months from now, there is no GM, and all of their GM-based members are out on the street. They're also going to be pretty angry at President-elect Obama, who right now really does have the worst job in the world: almost-President. He can't actually do a damned thing right now, but he's under a lot of pressure to save the world. There's 70 days 'til he's actually President, and GM might well fail before that.

One argument I don't buy, by the way, is that Detroit could have avoided this by going green much earlier, like Toyota did. This is too simplistic an argument. The Prius--my personal favorite automobile, hands down, and the one I drive--is not a cheap car by any stretch of the imagination, but it also doesn't make Toyota much money. It was expensive to develop, is expensive to build, and because of issues getting enough good batteries, for a long time was in extremely short supply. I think they're currently making a profit off of them, but for a long time, they weren't.

The Prius is not why Toyota is standing, albeit a bit wobbly, while GM is battered, bruised, and crawling on broken limbs to the phone to dial 911 with its broken nose. It doesn't hurt, but it's not the reason. The reason is that Toyota's overall business model and practices ensures that they can actually make money off their cars as well as their trucks. Some of this is that they made efforts to make their entire product line, even non-hybrids, at least a little more efficient; and also have a reputation for making solid, reliable cars. People are willing to pay a little more for that, if they can, so Toyota can sell their cars for a little more than GM et al. can. Some of it is that they're not burdened with the same labor costs. 

From the outside, it appears that Toyota's management actually thought in terms of long-term sustainability, while GM, Ford and Chrysler all focused on immediate profitability. They might well have had contingency plans for the day when oil started to rise and demand for the guzzlers slackened, but they were all expecting it to be gradual. They didn't foresee or plan for a sudden spike putting the fear of G-d into the market, and they certainly didn't foresee or plan for the possibility that such a spike would coincide with a general, world-wide collapse of the financial system.

Like the bank bailout--which, by the way, will now officially not happen the way it was originally advertised; there will be no government buy-out of toxic assets, after all--I'm not really happy with the idea of throwing good money after bad companies. But I shudder to imagine what will happen if a million or more workers are tossed out into the cold at once.

First of all, let me pimp an article by my friend Chris, in which he expands a bit on the theme of liquidity: "Financial Lubricants".

One of the things being stressed this afternoon in the press, even as the markets rebound a bit, is that the money market is not rebounding at all. It's almost entirely jammed up, right now. Banks are just not lending to other banks, at least, not on favourable terms. Only the central banks of various nations (including the Federal Reserve) are being more open, but of course, all that does is put taxpayers on the hook for that borrowing.

This is part of what Paulson means when Congresscritters ask him why we should be on the hook for a $700bn credit line and he retorts that that the taxpayer is already on the hook. We are, through the Federal Reserve, lending money to banks who can't get it any other way. We're taking whatever collateral they can give us (at least, so I assume), and often, it's going to be crap, because that's all they've got. Of course, most of these banks really will pay back their notes--short term lending like this is supposed to be low-risk. But there's still likely to be some crap in there.

Meanwhile, the Senate appears poised to try to take the lead over the next day or so, rather than letting the House embarrass itself again right away. The theory presumably is that if the older, wiser heads of the Senate can get something passed, it will be easier to ram it down the House's collective throats. I'm not sure I'm buying it. I think too many of the people who said "no" really mean it, and at least some of the people who said "yes" really meant "no" and will find the courage to say so. I'm also not convinced that any attempt to even talk about the bailout won't face a filibuster.

***

So about the bailout itself. I'm still not convinced it's the right answer, but the more I understand about what Paulson was trying to do right from the start, the more I get why he and others think it's not an awful idea, anyway.

The idea, as near as I can decipher it, is to give Treasury a line of credit--a really bloody huge line of credit--with which to purchase "distressed" assets, like mortgage-backed securities whose mortgages are in the sewer. The theory, as I think I've said before, is to get them off the books of the banks, so the banks on the one hand no longer feel like they have to hoard cash to keep their balance sheets black, so they can lend again; and on the other hand no longer only have crap mortgage-backed bonds to use as collateral for being the borrowers.

Meanwhile, Treasury, which doesn't care if it holds on to a bunch of rotting meat for years, can wait paitently for the market to improve, and sell the securities as their value improves (or at least try to get more out of them) at a more leisurely pace. The bet being made is that while many of these securities are crap right now (because they're based on mortages whose underlying property values are no longer adequate, regardless of their interest terms or forecloseability), the housing market will eventually recover. 

Therefore even if some of these properties wind up foreclosed upon, there will be greater value available, later, than there would be now. The bailout bill's line of credit would wind up repaid and might even yield a profit, even if some percentage of the distressed securities really do turn out to be irredeemable turds.

***

And so now we come to the real reason why the bailout is itself an irredeemable turd and really ought to be rejected a second time: the bailout is doing exactly what the market was doing. It's betting that the housing market will eventually improve to the point where these securities are actually worth something.

Now...that's not really a completely incredible bet. Yes, the housing market is still falling and it doesn't have an obvious bottom in sight, but there does have to be a bottom, and then, it will bounce and start coming up again. There will, one day, be a demand again, and demand creates value.

It's the time-frame that makes the bet a shaky one. What if it takes five years just for the market to hit bottom. Or ten. Nobody wants it to, of course, but what if it does? And then takes another five to ten years to come back up to levels where the securities are worth a damn?

Even if it doesn't take that long, we can't assume that the value of these securities won't continue to fall after the government purchases them. One thing that's been made clear is that Treasury is not going to be able to buy them at absolute firesale prices. As much as the banks want them gone, they aren't going to accept pennies on the dollar. They're going to at least want something like the current value.

And there, at last, is the rub. We don't know their current value, not for certain. Not in aggregate. To investigate that, we would need to look not only at the securities themselves but the underlying mortgages and their terms, and then the value of the property securing that mortage, for every single one of these monsters. 

That, in the end, is why Paulson asked for so damned much money. Nobody really knows how much he's going to need to make this work, even if all the other conditions work out exactly the way he wants them to. They picked a nice big number that was lower than the deeply scary $1tn mark and figured it would probably be enough to at least get things started, even in the worst case.

There are too many unknowns, here, even now. And in the time it would take to nail them down, the credit freeze's side-effects would have begun rippling outward even further. Trickle-down economics might not work for prosperity, but there's no real question that it will work for pain. Something really does need to be done that unfreezes the money market.

But this bill ain't it.