Three Reasons Why We Should (and Should Not) Bailout GM (and maybe Ford)

Although it doesn't look likely at the moment, The Big Three from Detroit have gone to Congress asking for money to bail them out.

I'm working under the assumption that Chrylster is unsavagable. Also, as a disclaimer, your author owns seven shares of GM stock. That's right, $20 bucks! Drinks on me!

Why the U.S. Government Should Bailout GM (and maybe Ford)
1.) According to David Cole of the Center for Automotive Research if:

Detroit’s production falls by 50%. He estimates that in the first year that
would cost 2.5m jobs: 240,000 from the carmakers themselves; 795,000 from
suppliers and 1.4m from other firms indirectly affected. The cost in transfer
payments and lost taxes would exceed $100 billion over three years. Some of Mr
Cole’s assumptions are likely to be too pessimistic, but his blood-curdling
forecast and others like it have helped to convince legislators that the $50
billion of help that the carmakers are asking for would be cheap at the price.

If the Center for Automotive Research's cost/benefit analysis is even sort of on target, giving the money to GM and Ford is a no brainier.

2.) The long term prospects of each company are actually pretty good. Both have a strong presence in Europe (especially Ford) and other emerging markets (especially GM). They have both started producing competitive compact and fuel efficient cars (everyone seems to rave about the Focus) moving away from the SUVs that American drivers demanded for such a long time. And in 2007 GM and Ford struck a deal with the UAW union which allowed them to cut costs by about $1,000 a car.

Should they have been making more fuel efficient cars? Probably, but that's easy to say today. The SUV market in the 90s and early 2000s was not a result of Ford and GM forcing American buyers to buy big gas guzzling cars. SUVs were attractive to American consumers because gas was so cheap... thanks in part to the U.S. government levying such small taxes on gasoline.


3.) Lehman Brothers - When the Treasury let Lehman Brothers die everyone seemed to support the decision. But it quickly became evident that letting Lehman 'die' might have been a huge mistake. The financial world simply was not ready for a bank as big as Lehman Brothers to go "buh-bye". Is the American economy ready to lose a few million jobs? And what about the pressure the bankruptcy of GM and Ford would have on the Pension Benefit Guaranty Corp--the Federal agency that insures benefits to retirees in the auto industry and other industries?


Why the U.S. Government Should NOT Bailout GM (and maybe Ford)
1.) When Becker speaks, I listen:

Nevertheless, I believe bankruptcy is better than a bailout for American consumers and taxpayers. The main problem with American auto companies is that during the good times of the 1970s, 1980s and 1990s, they made overly generous settlements with the United Auto workers (UAW) on wages, pensions, and health benefits...

It is not that cars cannot be produced profitably with American workers: the American plants of Toyota and other Japanese companies, and of German auto manufacturers, have been profitable for many years. The foreign companies have achieved this mainly by setting up their factories in Southern and border states where they could avoid the UAW, and thereby introduce efficient methods of production. Their workers have been paid well but not excessively, and these companies have kept their pension and health obligations under control while still maintaining good morale among their employees.

Bankruptcy would help GM and Ford become more competitive by abrogating significant parts of their labor contracts with the UAW.

2.) A.I.G. - What a mess this has become. This is in part the fault of the Treasury which basically has given A.I.G. billions upon billions of dollars without out any oversight. Conservatives cannot complain about welfare anymore after the A.I.G. fiasco. These guys are paying themselves bonuses for running the company into the ground... why? Because they don't want to lose the talent that nearly caused the company to disappear. Congress and taxpayers are right to be cautious about handing any private company billions of bucks after watching A.I.G. reward themselves for being total fucking morons (pardon my French).

3.) While I don't agree with much of Mitt Romney's reasoning he does make an important point in his Op-Ed today:
Without that bailout, Detroit will need to drastically restructure itself. With it, the automakers will stay the course — the suicidal course of declining market shares, insurmountable labor and retiree burdens, technology atrophy, product inferiority and never-ending job losses. Detroit needs a turnaround, not a check.
A bailout does not guarantee further restructuring within Ford and GM. Both companies need further diversification in their products--the pickup truck and SUV business was lucrative until gasoline became expensive. And since both companies relied far too much on those big gas guzzlers and didn't really have smaller, fuel efficient cars to offer consumers, they're in the position that they're in today. Giving them a few billion won't guarantee a change in philosophy in Detroit, something we should all be worried about.

Sometimes Doing Something Is Better Than Nothing

Interesting tid-bit I ran across in the Economist this morning especially for those who don't think the bailout was or is a good idea:

Acting quickly also helps to cap the final bill for taxpayers. Sweden’s rescue of its banking system in 1992 pushed its gross public debt up to 73% of its GDP from 55% a year earlier. But the bad assets that the state took off the banks’ hands eventually turned a small profit. By the end of last year, Sweden’s public-debt ratio was 47% of GDP, well below international norms. Japan’s government, by contrast, allowed its bad-debt problem to fester. The fiscal support needed to prop up a struggling economy has led to a doubling of its public debt since the mid-1990s: it stood at 170% of national income by the end of last year.

Pretty much, doing nothing can have dire consequences. Many historians and economics believe that the lack of action by the Hoover administration in the late 1920s and into the 1930s only made the Depression worse. While FDR's New Deal programs had limited success, that may have been in part because it was too late—and it's hard to claim that the New Deal was a failure.

But one of the big criticism that I've come across concerning the stagnation of the Japanese economy since the early 1990s has been the lack of policy initiatives and action—and when they finally came their impact has been limited. Too little too late? The Nikkei 225 was at 18,650 at the start of 1995; today it sits at about 9,457 (losing about half of it's value).

Meanwhile, Sweden's quick response to crisis is probably part of the reason as to why we have not seen stagnation in their economy. (Sadly, I can't find a value for the OMXS30 from the mid-90s, but I'm pretty sure we'd see the OMXS30 up over the last 13 years or so).

While the bailout might not be ideal and it might now fix this countries financial problems quickly or completely, it is something. And historically, doing something has been much better than doing nothing.

Today's Downwards Turn in the Market

In talking to some friends this morning, most of them have had said sarcastically something along the lines of, "good thing we did the bailout."

The market dipped below 10,000 for the first time since 2004 thus making the bailout look foolish on the short term. Wasn't the bailout supposed to save the market?

Yes and no. The bailout was more to keep the credit markets up and running. Hopefully that has been solved, and I think it has. Because I noticed something interesting:

CME Group stock is up about 5% on the day (I'm writing this at about 2 p.m. eastern).

Why does this matter? Because CME Group about 85% of all derivatives trades (and a lot of swaps) happen at either the Chicago Board of Trade or the Chicago Mercantile Exchange. If investors were still worried about a credit cruch, I doubt CME stock would be up today since credit is needed to trade derivatives. Yes, part of the reason the stock is up is probably because of the first mover advantage that CME holds in the swap market, but investors are figuring that volume at the CME exchange will increase.

So, my thinking is, as pension funds sell off stocks, they're taking their money and investing it in other products. CME reported it's second highest volume month ever in September. What that means is that investors are trading other products—even though corn and oil are down today, maybe investors are shorting? I don't know first hand.

But I do know the CME stock is up and they had a huge volume month in September. That says to me that investors aren't as worried about a credit cruch today as they were last week. They're getting out of stocks because they see it as a bad investment (I'm sure not being allowed to short is playing a roll in all this). If investors were worried about credit, would we see CME stock up today? I doubt it, since if there was still major worries about a credit cruch, CME volume would decrease, thus cutting into CME's earnings.

If you disagree and think CME's stock being up is because of swaps, fire away. Policy is my thing, finance is something I only attempt to be rational about.

Framing the Bailout

Last night I talked about how poorly the bailout plan was framed by political figures and government officials; since the policy was never clearly explained to the American public, they were against it. This lead to House members who might be facing a tough reelection to vote against the plan... and now a lot of people in the House (and John McCain) and Hank Paulson have a lot of egg on their face. So TPB offers up a little advise to Hank Paulson, members of the House, and any other government official as how to sell the bailout to the American public.

1) Change the Name of Plan - as I said last night, bailout sounds too risky—a last ditch effort without thinking everything though. McCain, who now has a lot to lose with yesterday's failure, has already realized this by calling it a rescue. At this point, I don't think it needs to get fancier than that; as long as policy makers are no longer calling it a bailout I think this problem has been resolved.

2) Explain to the Public Why They Need the Money - As the The Swamp reported today, Hank Paulson and company went about the bailout all wrong:

As the fingerpointing continues following the House's failure to pass the $700 billion bailout, a lot of blame is going to Treasury Secretary Henry Paulson Jr. for first trying to run roughshod over Congress and the sensibilities of taxpayers until he realized that approach was doomed to failure.

No one bothered to tell the American public why they needed handover $700 billion. Paulson and Congressed failed to explain what the money was for and who were to recieve it. By taking this approach, policy makers allowed opponents to frame the issue by focusing on executive pay and how it was bad investments by the guys and gals on Wall Street that lead to this mess. 'Main Street should not have to bail out Wall Street' became the simple rallying cry.

What Paulson, or someone who has fiscal/financial authority in the eyes of the American public, needs to explain is why this money is needed. It shouldn't be too hard, "Over the past few years a lot of people made bad investments, but we are not asking for money to bailing them out for their mistakes. Instead, we need the $700 billion to rescue the American economy from a liquidity crisis—right now businesses are finding it difficult to borrow money from other companies, which means they are having a hard time paying their bills or investing in their business, and maybe even pay employee wages. The money will be used to inject cash into the economy to help increase the flow of money between businesses and avoid anyone from having a pay check bounce."

I think this is the key for supporters of the bailout now—to frame the issue as a personal matter. Your pay check may not cash on Friday if something isn't done. That will get peoples attention even if it is a bit alarmist. But it's a much better message than "give me $700 billion because I said so."

-- Finally, I fould this to be a decent read and worth at least looking at.

Framing the Bailout

This morning I considered the bailout to only be a formality. Not a perfect solution, but eh, it sort of had to happen. Some disagreed. But most people I know who know a thing or two about this stuff i.e. markets and capitalism—not to mention an economist I like to call Gary Becker—saw the bailout as a necessity. I agreed.

So when I found out this afternoon that the bailout was voted down by the House, I was shocked. Now what? I didn't get it... why was it voted down? Why would a member of Congress vote it down? Sure there is going to be opposition, but this thing kind of sort of has to be passed in some way shape of form. Is/was it perfect? Of course not. But it had to be passed just too keep the economy afloat... and then it wasn't.

I called my father and at some point in the discussion, my mind went back to 6:35 this morning when on the train three people were talking about the bailout and all three agreed that the guys who were going to get the money from the government didn't need it. It was their fault after all. I stood there thinking, 'if only it was that easy'. I sort of wanted to launch into full Mr. Know-It-All mode, but it was 6:35 in the morning.

As my father and my conversation progressed, the reason for the failure of the bailout became more and more obvious—it was a poorly framed issue. When I say 'poorly framed' what I mean is that a policy like this has to be sold to the people, and the sellers of the bailout did a horrible job at marketing the plan. Framing is simple, it's pretty much taking something complicated and explaining it in a sentence or two. The details are for later in the conversation. Framing the issue is simply putting the policy in the best light and making it easy to understand. Catch-phrases work "Ending welfare as we know it"; however poorly framed issues are almost always deemed to failure, privatizing social security anyone? How about the Clinton heath care plan... but back to the bailout, it was a poorly framed issue:

1) The name, bailout sounds too reckless, like a thrown together plan from a Western, a 'it will never work, but if it does, it will be cool!' sort of idea from a bad action movie. The plan should have been called something else—a life jacket/life saver (sorry I'm tired as hell) or 'government investment' both might have worked—in order for the policy to succeed. And Nate Silver over at 538 backs me up on this.

2) The real problem is that the bailout was never explained in an easy way for people to understand. People see the "D.C. wants to give Wall Street $700 billion" headline and they think, 'Why? The Wall Street guys are the ones who made the bad deals!'. And they're right.

But we're way beyond that at this point. This isn't about being over leveraged, giving out mortgages to people who didn't deserve one, or even executive pay any more. But no one in the Bush Administration, the Fed, Congress, or even economists themselves are saying this. Instead they're talking about how we need this and then saying things no one understands (as NPR pointed out today).

So what is needed in order for this to pass, is for someone, anyone, to explain what Hank Paulson wants Congress to do in order to help the U.S. economy. In other words, someone has to frame the issue and sell it to the American public, or else you 'll get what happened today—any member of the House in a close race voting against the plan.

So how do you sell it? That's tomorrow, I'm tired and need Hines Ward to catch one more pass to put my fantasy game away.

Shock

I'm in shock. I know no one ever wants to give away $700, let alone $700 BILLION, but the House rejecting the bailout is shocking. I really don't know what else to say other than, if you don't have a government job right now, start saying prayers and writing letters to your Congressman/woman to pass the bailout.

More soon...