Speaking Jose…

An 800 Word Rant on the Auto Bailout
November 13, 2008, 11:58 pm
Filed under: Events, politics | Tags: , , , ,

Two and a half years. That’s how long I’ve been working on my MBA so far (its a part time program). Spent the last two years learning how to read a balance sheet, how to calculate net present value and internal rate of return, how to talk to creative employees versus analytical employees. I might as well have gone to Culinary School. The free market ideology is getting its butt kicked (with help from a Republican President no less!) and everyone seems to be getting in line for the payout.

Here’s my beef with the bailout for automotive companies, its not that they shouldnt get one. We already threw out the concept of government interfering with financial markets a few months and $700 Billion dollars ago. Washington D.C. has already set a precedent and for better or for worse, they will likely do a bailout. Whats really ticking me off is that no one seems to really be upset about this (minus some libertarians) and that no one in Detroit seems to be asking “Do we deserve a bailout?”

Bailouts should be reserved for extraordinary circumstances outside of a company or industry’s control. The airlines were bailed out after September 11 because of the harm caused to the industry from outside, non-economic forces. Fannie and Freddie did not get into trouble because of some unexpected outside force, they started down that path because of bad management and a government that turned a blind eye to the situation until it was standing in front of them screaming like a 5 year old throwing a tantrum at Toys-R-Us. Similarly, the majority of banks and the insurance giants got into trouble by using risky business practices and not being able to rectify their activities in time before it was too late.

So what should we do about the Big Three? Should bad management decisions (both by the companies and the UAW leadership) and slow innovation be rewarded by providing a fresh infusion of (depending on who you ask) $25 to $75 Billion dollars? Wait, stop and think about that amount. It sounds like a lot doesn’t it? Warren Buffet, richest man in the world, has an approximate Net Worth of $62 Billion through early 2008. This is a lot of dough on a per company basis, anywhere from $8 Billion (a seventh of a Buffet) to $25 Billion (over a third of a Buffet) to each company. (The original $700 Billion financial bailout was to be split up through a larger number of banks, institutions and direct investments by the government.)

So what will the money going to? The Automakers were originally scheduled to receive $25 Billion to help retool plants based on the higher fuel mileage standards (to me this was more palatable than a bailout when it first came out, the government changed regulations and offered funds to help speed the process along). The middle $25 Billion was seen as a loan to the Big Three to help keep them afloat while the credit markets slacken enough for them to get more capital (they may have to wait a while based on their current credit rating). The latest $25 Billion add on was a request from the UAW to help fund retiree health benefits (this helps the bottom line some, but does it really help GM, Ford, Chrysler design a better vehicle or build it more efficiently). 

Notice what’s missing here? No one is suggesting that the companies and the Union come up with compromises to help make labor and health costs more competitive. No one is suggesting that the companies shed excess capacity and labor to improve the balance sheet and reduce their debt load. no one is really suggesting that the companies change how they do business right now. Instead, it is likely that we will be reading the same headlines three years from now and wondering what can be done next.

So why is government intervention screwing up the free market ideology? Because, by propping up failing companies, the government is removing the risk of failure from the market. Removing this risk both reduces the potential rewards for entering the market (there is no premium paid to those taking on a higher risk if Uncle Sam will cover any losses). It also increases the likelihood that companies with bad business plans or management will survive in the market, which will hurt the market as a whole (weighed down by companies that can not pull their own weight). If we let the Big Three to either go into Chapter 11 bankruptcy or merge or be bought by a competitor, there will be pain to the economy and to other companies. Yet this is key in a free market, since the failure of a company leaves stronger survivors and allows new, smarter entrants to the market that learned from mistakes of those who failed.

Just my $0.02.

Jose Alvarez


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