Extempers have been busy over the last several months trying to understand the different elements of the current financial crisis. In the midst of understanding credit markets, bond markets, the $700 billion U.S. bailout package, and deteriorating housing market, it was easy to ignore the problems of one of the most crucial industries of the U.S. economy: the auto market. Within the last several weeks, the problems of the auto industry’s “Big Three”, General Motors (GM), Chrysler, and Ford have become dire, as the auto companies say they have spent most of the $15 billion they held in reserve during the third quarter. Faced with slumping sales at home and in the midst of restructuring their operations, GM has warned that without government aid it will not be able to make it through the year and Ford has warned that it will not last long into 2009 without government aid.
Faced with this situation, and a lame duck session of Congress, as well as for President Bush, you have the recipe for a tense political battle that will have ramifications far into the future. You also have the stage set for what will be the last major battle of the Bush presidency, and one that could make President Bush even more unpopular before he leaves office.
This brief will give a summary of the current woes facing the automakers, the different solutions proposed by each side, and ramifications for the eventual solutions that could be prescribed for the auto industry’s woes.
Background
The U.S. auto industry, with its large scale manufacturing resources, was part of the reason the United States emerged as a large economic power in the early part of the 20th century. In times of military conflict, the automakers emerged as valuable U.S. suppliers of goods and services and were also a comfortable place of employment for U.S. workers. Backed by the United Auto Workers (UAW), workers were able to get nice benefits packages that included pensions, healthcare benefits, and better wages than other industries. However, beginning in the 1960s, the Big Three U.S. automakers began to suffer from competition from overseas companies, such as the Japanese car company Honda. When the industry was able to lobby Congress to put trade quotas on the cars coming in from overseas, European and Japanese carmakers created factories in the United States, effectively avoiding the quotas altogether. This maneuvering also built up goodwill in U.S. communities on behalf of these international companies and increased the competitive pressures on U.S. automakers even more.
International automakers have long enjoyed an advantage over U.S. automakers because of the union issue. Companies such as Toyota and Honda do not face union demands like U.S. automakers and that gives them more flexibility with finances. The Big Three automakers have estimated that paying for retired employees and current employee benefits forces them to add $1,500 to the cost of a new vehicle, a cost pressure the struggling automakers can ill afford.
In order to stave off financial ruin, the Big Three have tried to cut back costs in recent years by closing plants, renegotiating employee benefits with the UAW, and bought out some of their employee’s work contracts. However, even by making these cuts mounting losses have continued in the face of the financial crisis, which have made it difficult for the Big Three to find the finances to fund operations and high oil prices during the summer, which greatly reduced demand for gas guzzling SUV-type vehicles that the Big Three thought would be the key to their future.
Currently, the U.S. auto industry accounts for over two percent of U.S. economic growth. This may look like a small number, but when you add in suppliers as well as the rest of the manufacturing grid that relies on automobile transport, over twenty percent of the manufacturing sector is dependent on the U.S. auto industry. If this industry is allowed to collapse it might make the U.S.’s oncoming recession much deeper, as well as steeply hike the unemployment rate.
Bush vs. Congress
Faced with mounting losses and dwindling balance sheets, the Big Three automakers have come to the U.S. Congress and asked for federal aid. The preference of Democratic leaders on Capitol Hill, including Speaker of the House Nancy Pelosi, is to include the automakers into the previously agreed upon $700 billion financial bailout package, which has seen funds be used for banks and other parts of the financial sector. Under this plan, the auto industry would get $25 billion of bailout funds in exchange for a federal stake in the automakers so that if they eventually turned a profit, the financial assistance could pay off for the government and for taxpayers.
The Bush administration argues against including the auto industry in the $700 billion bailout package. The administration says that if the auto industry is included it would open a Pandora’s box for other ailing industries in the United States to put in requests for bailout money, which was intended for making banks solvent and preventing a run on the financial system. The administration is not willing to throw the automakers to the wolves, though. Instead, the Bush administration and its few remaining allies on Capitol Hill prefer to accelerate $25 billion in loans that were approved previous by Congress that were marked for developing fuel efficient vehicles. The administration would like to transition this money into immediate aid for the car companies.
Since both plans are diametrically opposed, some type of compromise would hopefully be in order but that does not look to be forthcoming. Democrats should be able to pass their legislation through the House of Representatives, where they enjoy a comfortable margin. However, the lame duck Senate is where the Democrats hold a razor thin margin over Republicans, 51-49, and only two Republicans, Senator George Voinovich of Ohio and Kit Bond of Missouri, have supported the bailout package to rescue the auto industry. Without compromise, the chances of the Democrats breaking a Republican filibuster on this issue, of which 60 votes are required, look slim.
Republican opposition to the Democrat’s plan comes in the form of a moral hazard. Republicans argue that the free market be able to work out the auto industry’s woes and that an infusion of cash in the amount of $25 billion would only keep the auto industry alive for another six months at most. Also, Republicans, who were attacked on the campaign trail by Democratic opponent for supporting the financial bailout several months ago, are ill at ease to support an expansion of bailout funds to more industries, concerned that the U.S. government could end up owning vast chunks of the national economic grid. Finally, some Republican leaders like Newt Gingrich argue that the Republican Party could lose a generation of younger voters if they keep supporting large bailouts because younger voter’s tax dollars will be paying for these bailouts in the future.
Bush’s plan is opposed by Democrats and their environmental allies because they believe that the $25 billion that was put down for loans to the auto industry should only be used for the purpose it was allocated: to pursue more fuel efficient vehicles. The environmental lobby wants to hold the U.S. car industry to better fuel standards and sees the Bush administration’s plan as a way to distort that benchmark by allowing the auto industry to use the $25 billion to save their balance sheets instead. Pride also plays part of this equation as the environmental lobby and Bush have never seen eye-to-eye during much of his presidency, fighting over timber cutting, global warming solutions, and offshore drilling along the way. With President Bush less than two months from leaving 1600 Pennsylvania Avenue, the environmental lobby does not want to cave into a lame duck president and would love nothing more than to win their final battle against Bush here.
A final option that is available to the auto industry in case the U.S. government does nothing is to file for Chapter 11 bankruptcy. Extempers who might be coaches now, such as myself, might remember that several U.S. airlines, such as United, entered Chapter 11 bankruptcy years ago in order to remain financially solvent. Under Chapter 11, a company can cancel some of its debt and enter a period of protected restructuring. Economists agreed that the U.S. auto market will complete its current restructuring plan by the year 2010, but the big question is whether the Big Three automakers will make it that far.
The argument in favor of a Chapter 11 filing is that it would not effect the operations of the auto sector abroad, where much of their growth is coming from. Emerging markets such as China, India, and Russia are going to be sources of great demand in the future for the auto industry, with China expected to overtake America as the biggest consumer of vehicles by the end of this decade. In fact, as The Economist indicated in its special report of the auto industry in this week’s edition, 65% of GM’s sales in the first quarter occurred outside of the United States. By filing for Chapter 11, the Big Three could focus on their business in the United States with financial pressures while continuing to enjoy success abroad.
However, there is also an argument against the auto industry filing for Chapter 11, and most of it concerns the industry acquiring a negative stigma. The auto industry, in its arguments against filing for Chapter 11, point to consumer surveys that show that 80-90% of consumers would no longer buy vehicles from the Big Three and would switch to foreign carmakers. This is because of there being a great deal of uncertainty over the Big Three’s future. After all, it makes little sense for consumers to buy a car from a company that may eventually go bankrupt and then no longer have their car be serviced with proper parts or have a dealer to trade it into later. Weighing this scenario, it appears that consumers are not willing to take a gamble on the Big Three automakers, which is why the Big Three are asking for government aid. The Big Three say that if they file Chapter 11 bankruptcy, their American operations would never recover and they would permanently lose market share.
Ramifications
As with any major decision in government, there will be political and economic ramifications to the decision that Congress and President Bush reach on how to best deal with U.S. auto manufacturers. On the political side, there are risks for both parties. For the Democrats, the auto industry aid package could eventually hurt them in the 2010 midterms if the Republican Party is able to convince voters that the Democrats are trying to nationalize sections of the U.S. economy or if the bailout fails and Republicans are able to accuse the Democrats of making bad economic choices. Taxpayers of all political persuasions do not like to see their tax dollars wasted and the Democrats decision to stand by this financial aid package carries the risk that it will not pay off. However, if the bailout to the auto industry did pass and did succeed, the Democrats could increase the strength of their political hold in the Midwest in states like Indiana, Ohio, and Michigan, all of which voted for Barack Obama in the presidential election two weeks ago.
Extempers know that the last several years have not been kind to the Republican Party. I broke down the internal party struggles facing the Republicans last week. In the midst of several leadership battles, the Republican Party also has to decide where to draw the “line in the sand” on this issue. While it might be easy for the Republicans to abandon President Bush on this last vote, they have decided to stick with his position. In fact, the Republican Party’s line on economic bailouts has gotten firmer over the last few months and it appears in the short-term that politicians are gravitating towards a more fiscally conscious approach to government that has been demanded by influential party strategists and leaders such as former Speaker of the House Newt Gingrich. However, this firm line on being strict with finances is not gaining support at a time when people are looking to the government to spend money on solutions to their economic problems. Furthermore, if the auto industry is forced to go into Chapter 11 and business plummets, which the most dire economic models predict, resulting in millions of job losses, the Republican Party could become further isolated on the political map and could be forced to forfeit states like Pennsylvania, Michigan, Indiana, and Ohio in the long-term. The last state is especially dangerous for the Republican Party because no Republican candidate has ever won the presidency without winning Ohio.
There are also very negative ramifications for the U.S. economy if the Big Three collapse. David Cole of the Center for Automotive Research has speculated that if the Big Three auto industry collapses, the U.S. could be looking at 2.5 million job losses in the first year alone. Also, the U.S. federal government could be looking at over $160 billion in tax revenue losses over the next three years, a dangerous sum when an extemper starts to add up the myriad of government programs that keep stretching the federal budget each fiscal year. To find out more about these forecasts, a video has been posted on YouTube that I believe is mandatory viewing for any extemper: http://www.youtube.com/watch?v=72cHfOKoA1c . The video is entitled “The U.S. Auto Industry and the Ripple Effect.” The video lasts 3:57.