The GM Bailout

The auto industry is on Capitol Hill today, asking for money. The argument goes that if General Motors goes into bankruptcy, the job loss and the resultant tax revenue loss will push our economy from recession to depression. But the question is not only whether we should bail them out – it’s how we should do it.

There are several different models to follow. The first, used to revive Chrysler 29 years ago, is a loan guarantee. In this model, the federal government put up no money directly at all, but simply guaranteed a loan that Chrysler got from a private source, making taxpayers liable for the bill if Chrysler ultimately defaulted. Other than the taxes Chrysler would ultimately pay if it survived, there wasn’t a lot for the Federal government to gain in this scenario, but those tax revenues were significant. The bailout also came with an attached string: Chrysler could only get the money if it found a way to save a large amount in the way it did business. Essentially, the bailout gave Chrysler leverage with the union. There’s some wisdom there, I think, in that it’s in large part the higher wages that the big three pay their union employees that make them unprofitable vis-à-vis BMW, Toyota, and other manufacturers that make products in the United States.

The average auto worker for the big three makes over 75 dollars an hour; for the others, over 45, so this isn’t a living wage issue.

The second model, used with the big banks, is to loan the money to the recipients directly. In this model, the government hopes to get interest on its money. The way the government chose to loan money to the banks was by taking preferred stock. If the company in question goes under, preferred stock gets paid only after every other debt the company has, which in the case of the banks would mean not at all. Preferred stock differs from common stock primarily in that it has no voting rights. In short, it provides the government with almost no safety, and virtually no leverage.

The third model, used with AIG, is to buy a real stake in the company. The company issues enough common stock to justify the payment from the government, diluting the value of its existing common stock. GM, for instance, is worth about 2 billion dollars on the market, and wants to get 25 billion dollars. After it got the 25 billion dollars, it would be worth 27 billion, so the value of 25 billion dollars of shares is 25/27th of the company, or around 93%. In short, as with AIG, the government would end up a controlling interest in General Motors, and could, theoretically, start slashing executive pay and possibly union worker pay. It could use its position to pursue goals other than profit, too, such as investing in more fuel efficient vehicles than the market really would indicate.

The reason, ultimately, that the second model carried the day with the big banks is that they didn’t want or need a bailout (at least not yet); the reason for getting them cash was to encourage them to make loans so that the rest of the economy would work better. It’s no model for the auto industry, which has come begging; if we give them that kind of deal, there’s going to be an endless line for handouts. The nation has to extract significant concessions in return for supplying money.

Part of the problem with any bailout is that it gives the bailed out company an advantage relative to it’s already solvent, not-bailed-out competitors. In short, it rewards incompetence over competence, and thereby turns the free-market system on its head.

At this point, with energy policy so important to our country, I’d rather have the country buy control of General Motors and run it in the country’s interest for a while. The country’s interest isn’t completely different than the course needed to make the company solvent, and yet it should be striking enough (no SUV production, for instance) that there are plenty of places for GM’s competitors to make money.