Managed Bankruptcy Is The Only Solution

"The American auto industry is vital to our national interest as an employer and as a hub for manufacturing." ~Mitt Romney

Next week, on December 11, we “celebrate” the 78th anniversary of “The Event” that turned a recession in the United States into “The Great Depression.”

On that date in 1930, the Bank of the United States failed. The name of the bank suggested that it was an official government bank. It was established in New York City in 1913, the same year the Federal Reserve was created. But in fact it was a private bank and had by 1930 become the fourth largest in the country, with 450,000 depositors. But many Americans thought it was a government bank like the Federal Reserve, and when it failed, all hell broke lose. Its collapse sent shudders throughout the financial community, causing thousands of other banks to fail, and turning a deep recession into the Great Depression.

Monetary economist Milton Friedman said it was the single most important event that triggered the Great Depression.

The sad thing is that when the Bank of the United States officially closed its books a few years later, it paid back 90 cents on the dollar to all its depositors.

In other words, for a small investment by the Federal Reserve, the Bank of the United States could have survived, and we could have avoided the Big D. The Federal Reserve failed its duty to be the “lender of last resort,” and the results were devastating.

Could Congress be making the same mistake by not rescuing the Big 3 auto makers? How vital is the Big 3 to the American economy? Will their failure precipitate the Big D?

Yesterday the Big 3 automakers — GM, Ford and Chrysler — submitted their business plans to the Senate Banking Committee in support of the bailouts they are seeking.

GM alone seeks nearly $20 billion and says it needs $4 billion to even survive this month. All three of the automakers propose various cutbacks, consolidations and rely on their 2007 labor agreements which will cut costs but not solve the basic problems of the industry-killing deals all three have with the United Autoworkers Union.

Tomorrow, the Senate Banking Committee will hold a hearing on the bailouts. But unless the senators raise the idea, the only thing that can really save the Big 3 — a structured bankruptcy – won’t even be discussed.

As an economist, historian and past owner of many Big 3 automobiles, I’m in an ideal situation to analyze and bemoan the decline and fall the American automobile industry.

Over the years, my wife and I (and our children) have bought and sold foreign and domestic cars, both new and used. We don’t buy cars based on patriotism, and I would never say, as some American veterans do, “I would never buy a German or Japanese car.” My criteria is simple: Is this the car best for my family at the price I can afford?

We’ve enjoyed owning all kinds of cars — sports cars (MGB, Mustang), sedans (BMW 320i, Volvo, Toyota Camary), luxury cars (Jaguar, Chrylster LHS, Lincoln Continental), family vehicles (Dodge Caravan, Chevrolet Cavalier station wagon), and even a collectible (baby blue 1958 MGA).

Sad to say, our experience with cars is probably similar to most Americans: the foreign makes are more reliable than the Americans. Our worst car was an AMC Hornet, which was in the shop more than out.

But one American manufacturer has been a consistent winner for us: Ford. I’ve owned two Mustangs and one Lincoln Continental over the past 15 years, and have had no problems whatsoever. These cars just keep running and running and never seem to need any repairs. Maybe I’ve been lucky, but I don’t think so.

Financially, Ford is in better shape than General Motors, with higher gross margins and twice the market cap. It also has a very profitable foreign division. Ford is not facing imminent collapse like GM and Chrysler, and is only seeking $9 billion “standby line of credit.”

But GM and Chrysler are bleeding money fast, and without outside help, are likely to declare bankruptcy soon (maybe by New Years) if Congress doesn’t act. And that’s despite huge price cuts on their new vehicles, and a dramatic drop in the cost of gasoline. The recession has hit new car buying for domestic as well as foreign makes. Normally Americans buy 16 million cars a car; this year it’s down to 10 million. U.S. car sales plunged 31-40 percent in November alone.

As an economist, I recognize the danger this nation faces if the “Big 3” collapse. The Big 3 may now be the “Little 3” in terms of market size (Mattel, which makes toy cars, has a market cap bigger than GM, which makes real cars!).

But the Big 3 are still important in terms of employment. Over a quarter million auto workers would suddenly lose their jobs in the US if they shut down operations, and indirect job loss (suppliers, car dealers) could approach a million workers, and the unemployment rate could jump to 8 percent. (The loss of up to 3 million jobs, alleged by some pundits, seems awfully exaggerated to me.)

Is the American auto industry so vital to our national interest as an employer and hub for manufacturing that Congress should extend to the Big 3 a quick $25 billion loan… $34 billion in aid?

Or is this throwing good money after bad? Will the Big 3 be back next year asking for billions more?

Let’s not overlook the fact that no private hedge fund or foreign investor have come forward as partners to invest in any of the Big 3 like they have with other U.S. companies. That suggests that a shakeout is inevitable in the auto industry, and the outlook for American industry remains bleak, even with dramatic cutbacks in wages, executive pay, car lines, health care and retirement benefits, and employment, as the Big 3 have promised.

The company execs and the United Auto Workers union know their back is to the wall and are making concessions. Alan Mulally (Ford), Rick Wagoner (GM), and Bob Nardelli (Chrysler) are all willing to work for $1 a year. And UAW leaders have an emergency meeting today to discuss cuts in their overly generous benefits (health care, retirement).

But is it enough? Frankly, nothing will get the attention of the auto makers more than a “managed bankruptcy.” That really is the only workable solution at this stage. It appears Congress does not seem to be in a mood to bail out another section of the economy, no matter how vital. The best the Big 3 can hope for is perhaps getting some of the $700 billion bailout money.

Airlines like Continental have successfully gone through Chapter 11 bankruptcy and emerged healthy. Of course, the auto industry is different, with its need for auto repair and warranties. The federal government might need to assure car buyers that their warranties are not at risk. But a managed Chapter 11 bankruptcy would allow the firms to sharply cut labor costs and benefits, just as the airlines have done. And that’s vital to a healthy industry.

A government managed Chapter 11 bankruptcy is probably the best course of action to take without causing wholesale job destruction. It would allow the auto firms to drastic cut the average labor cost from $73 to $44, what foreign transplants pay their workers. Right now $2,000 of the cost of a new American car goes toward worker benefits (health care and retirement). Reorganization will force the unions to accept much less.

In short, the UAW has a stranglehold on the Big 3 which needs to be broken. The Big 3 must learn from America’s other auto industry, especially in the South, which account for a quarter of U.S. car production. States like South Carolina, Mississippi, Alabama, and Tennessee offer low-cost, non-union labor, and more flexible rules, and foreign auto makers are flourishing there.

On a broader scale, the unions — the primary cause of the Big 3 debacle — need to be humbled, given their hope to build on the Obama election and boost their power and size through the dangerous “card check” bill that will come before a Democratically-controlled Congress in 2009. (See “Obama’s Payoff to Unions.”)

In the words of Mitt Romney, “Detroit needs a [full-scale] turnaround, not a check….In a managed bankruptcy, the federal government would propel newly competitive and viable automakers, rather than seal their fate with a bailout check.”