To Bail Our or Not to Bail Out: the Saga of the US Auto Industry

At this hour, members of the Auto Industry are arriving in Washington with their collective hats in hand. They come seeking a $25 billion dollar bail out package. Their reasoning, failure to secure a bailout from Congress would result in the cataclysmic collapse of not on the industry itself but thousands of American auto workers would face dismal consequences.

While this all sounds very compelling the reality of the matter is totally different. The truth is that Ford, GM and Chrysler have been down this road several times. In fact, the US Government bailed out Chrysler in the mid 1980’s; and it was with the leadership of the CEO Lee Iacocca that allowed Chrysler to repay what amount to a loan back to the Federal Government.

The Auto Industry would have us believe that failure to bail out the Big 3 would ultimately result in the decay of our overall economic structure. This is patently false. We live in capitalist society, there are winners and there are losers. In the alternative, the Big 3 do in fact control their own destiny. How so you may ask? Well in order to answer that question we have to examine how the Auto Industry got itself into this mess in the first place. For some time Detroit has been cranking out Yukons, Escalades, F-150’s, Hummers and a whole host of large, cumbersome, gas guzzling vehicles. In fact, Detroit was still producing these vehicles even when the price of gas was pushing $ or even $5 dollars a gallon in certain parts of the country.

One does not have to be a PhD Economist to understand that if you produce these types of vehicles when gasoline prices are reaching unprecedented levels you will, more likely than not, be unable to sell any of your product. Yet Detroit failed to recognize this and kept cranking these vehicles out day after day month after month. But Why? I mean after all I am assuming the CEO’s of Ford, GM and Chrysler are smart enough to realize what I have just discussed. The truth is they may be and most likely did. However they had to keep producing these vehicles, whose average retail price is in the 35,000-40,000 range. This can be attributed to one crucial piece of information that the media (save for Thomas Friedman of the New York Times) and the Michigan delegation in Washington have conveniently failed to share with us. That fact is the United Auto Workers.

I would venture to place a well thought out bet that the entire premise of discussing this bailout comes down to a bailout not of a failing industry that is in dire need of a business plan re-tooling, but a bailout of the long over-inflated UAW contracts. A comparison is in order at this point to bring this into some perspective. The average hourly cost in Detroit to produce a vehicle is roughly $78 per hour. Conversely the average hourly cost at Honda or Toyota is roughly $22 per hour. The hourly rate for Detroit takes us back to the reason why they continued to crank out those large and expensive products. Two words-Profit Margin. You see in business a product’s profit margin is what business looks at to determine if it makes sense to continue offering for sale to the general public. In the case of the Big 3, the vehicles they were producing have high profit margin, thus if they could continue to sell these vehicles they could continue to operate even with these exorbitant union wages they would have to pay. The thing is when gasoline and oil prices spiked, Detroit did not have a fall back or safety valve-hemmed in by powerful union bosses, Detroit was wedded to both the inflated wages and the need to continue to crank out an inferior product that many American consumers had simply fell out of love with.

So now that we can see that Detroit is responsible for its own mess and has put them in this predicament, what are the consequences of refusing to bail out the Auto Industry?

Undoubtedly, the Big 3 would eventually be forced into Bankruptcy and this may be the best thing that could ever happen to it. Ford, GM and Chrysler would most likely file for Chapter 11 protection. This means the business would still operate much like the Airlines do almost on a bi-yearly basis. Chapter 11 would force the Big 3 to re-organize, to shuttle those divisions or parts of their organization that have been a drag on their overall production and have been bleeding the bottom line. However, you will not see any member of the Michigan delegation either in the House or Senate and certainly not Gov. Granholm advocating this course of action.

The reason for this is quite simple and it takes us back to my earlier point regarding the UAW. Filing for Chapter 11 protection would render any and all existing union contracts null and void. Most likely either the Bankruptcy judge or an Arbitration panel would require the UAW to sit down and negotiate with management to arrive at a mutually agreeable package that would benefit the workers and allow management to maintain some level of profitability. This is something the union does not want to have to deal with—and they have no problem making that opinion known to Gov. Granholm or the Michigan delegation in Washington. As long as the Unions maintain their hold on the politicians in and from Michigan we will never see any of them advocate for Chapter 11 protection.

Chapter 11 could also force these companies to produce a better product line. A favorite defense from the various CEO’s involved in this mess is the state of the American Economy. No doubt the overall economic status of things has caused some decline in sales; however Detroit’s main competitors, Honda and Toyota are doing quite well-and they are in the same economy as the Big 3. The difference? Honda and Toyota adapt to changing economic conditions. Honda and Toyota produced smaller, more fuel efficient and arguable a better quality of product than Detroit. So it’s no great shock that Honda and Toyota are doing better than Ford, GM and Chrysler.

There is an economic theory called “Creative Destruction” which dictates that out of the ashes of chaos will emerge a leaner, stronger and more profitable business entity. This may be exactly what needs to take place in Detroit. If we simply through more money at the problem what guarantee do we have that any of the Big 3 will drastically re-tool their business model, change their product line, sit down with the leaders of the UAW and work out a mutually beneficial contract arrangement and fundamentally alter the way the have been doing business for the better part of two decades in order to remove themselves from their current doldrums they find themselves in?

GM is burning through $2 Billion in cash per month. If they keep going at this rate they alone could chew through the entire bailout package in less than 2 years. What then will be the solution? Where will Congress go next to find more resources? I fear that providing Detroit with a bail out package would be similar to being an enabler for a substance abuser. And we all know the best way to treat a substance abuser is two fold (1) force them to admit they have a problem and (2) have them stop their destructive behavior.

It may be time for Detroit to take these necessary and painful steps.