Simple Questions about the Auto Bailout
I was speaking to an extremely well-informed person yesterday who told me that he thought a GM bankruptcy would inevitably become a fire sale liquidation, create a cascade of bankruptcies of the other Detroit auto companies and suppliers, and therefore kill 2 – 3 million jobs. He said that he doesn’t like to exaggerate, but that this would be “Armageddon”. I take his concerns seriously, but there is a distribution of possible outcomes in the event of a Big 3 bankruptcy, and no matter how confident anybody manages to sound about it, the outcome is highly uncertain. I also started to think about what this downside would look like.
An industry think tank developed a (much criticized) study that produced this 3 million jobs lost estimate. Note that the vast majority (2.7 million) of these projected 3 million job losses would be indirect job losses (the so-called “supplier effect”) and spinoff job losses (basically, people lose jobs at 7-Elevens formerly patronized by people who had jobs at the Big 3, and then these former 7-Eleven employees shop less at K-Mart, so other people at K-Mart lose their jobs and so on), and so are dependent on econometric models that are, to put it mildly, not 100% validated. Even in this case, note that within three years, these models estimate that about 1.2 million of these indirect and spinoff jobs would be replaced, so that the longer-term job losses would be more like 1.8 million. These projections assume the Big 3 and all international auto manufacturers (because of the collapse of suppliers) literally cease all U.S. operations for a period of time. They also assume that over time only about 20% of the cars that otherwise would have been sold by Detroit manufacturers would be produced by international manufacturers (or, implicitly, by any other buyer of Detroit’s assets) in the U.S., and the rest would presumably be imported forever.
This study doesn’t make crazy assumptions, but it’s surely about as bad as a rational worst-case scenario can get. If this is the worst-case, here are some simple questions:
1. The U.S. civilian labor force is about 150 million people. 3 million jobs is about 2% of this. The current unemployment rate is 6.7%. Adding three million unemployed would spike the unemployment rate to around 8.6%. In the 81 – 82 recession, unemployment peaked at about 10.8%. So, this would mean getting about halfway between the current unemployment rate and a bad recession. How is this Armageddon?
2. Thought of another way, the U.S. economy shed 533,000 net jobs in November. So, 3 million job losses is the equivalent of 5 – 6 more months like the one we just had. How is this Armageddon?
3. The money used for this purpose is money that is not used somewhere else. The amount that would ultimately be loaned to the Big 3 is unclear, but most observers believe that when all is said and done, it will be much, much more than the $34 billion that the Big 3 have requested. Let’s assume $100 billion. As a pure thought exercise, how many jobs could we create with an extra $100 billion of venture capital? How much more sustainable would these be than jobs in companies that need to come to Washington to beg for capital?
Government by worst-case scenario is unsustainable in any case. No one in the world, including ourselves, is rich enough to pay for every rational contingency.
— Adam Greenwood · Dec 10, 11:50 PM · #
I usually agree with you, but you’re ignoring the fact that this is geographically concentrated. Michigan as a whole currently has only 4 million jobs: http://www.milmi.org/
What on earth happens to the state government’s budget if the Big 3 go bankrupt?
— Chris · Dec 11, 12:52 AM · #
In the short to medium term it may be a lot cheaper to generate jobs directly through stimulus than indirectly through supporting the auto companies; but people are right to be very afraid of what this would mean for the region in the long run. That doesn’t mean that we should support nonviable companies, but the desire to find (or believe we’ve found) some sort of managed bankruptcy that will leave Michigan with a viable economy in a few years is strong.
— peter · Dec 11, 01:28 AM · #
I can understand the argument for the bailout because the job losses are “geographically concentrated” but I don’t see why we can’t take that into account when designing a longer-term strategy to deal with the looming insolvency of big auto manufacturers. What if we took that $100 billion and invested at least some part of it proportionally to where job losses and/or lost tax revenue are going to be most acute?
I’m a terrible economist, so somebody tell me why that’s a bad idea.
— Benjamin · Dec 11, 01:56 AM · #
I think a person’s view on this is influenced by where they live. Theoretically, I’m against the bail-out. At a gut level, I’m for it. A looming bankruptcy gives me the feeling an economic Hurricane Katrina is headed south toward us.
I know someone who has recently lost a job, a friend who had four in her office laid off last week, and a couple friends whose husbands would not be surprised to find out tomorrow they’re being laid off.
— Julana · Dec 11, 03:24 AM · #
The main argument for the bailout is the assertion that “bankruptcy = Armageddon” for the Big 3. But it isn’t — almost any non-financial business keeps operating during a bankruptcy case, particularly industrial companies like GM et al. Just look at Tribune (not even an industrial) — the first thing they’ll tell anybody is that they are still in business. Does today’s Trib (or LA Times etc) look any different? Did all the journalists get all axed Monday, or did the dwindling readership stop buying papers entirely? Or take the airlines, serial bankruptcy filers they are. Do you even notice if your carrier is in fact operating under Chapter 11?
GM and Chrysler (not Ford) play up the bogeyman to scare Congress, but leave out the reality that they will still be making cars and make payroll even after they file Chapter 11. The only reason they’d stop is if the UAW ordered a strike. But they’ve struck before, with the only consequence being further weakening of the Big 3 OEMs.
As with the steel and coal industries a decade ago, bankruptcy is in fact the only opportunity for insolvent companies to reorganize and fix themselves — shed a ton of unused capacity and fixed overhead, fix the union contracts, and discharge debt — by forcing all parties to the table.
— Eric · Dec 11, 07:33 AM · #
Also, as currently structured, the bailout plan is in fact manna from heaven for Wall Street, or more specifically, anybody who bought into GM or Chrysler bank debt at 30-40 cents on the dollar. How? Congress wants its money to have first repayment priority over existing debt. Very fine and noble, but this expressly violates the existing bank loan agreements (and other debt instruments) in place. Breaking that is an event of default, which means the creditors can put GM/Chrysler into an involuntary bankruptcy.
So how do you play it? Wait until the government puts its billions in and takes its super-priority lien. Then you as the hedge fund owning the bank debt claim those new liens create an event of default, thus requiring the company to repay you in full (at 100 cents, or 2.5x-3x your money) immediately. If they don’t repay you, you immediately put them Chapter 11. Once there, the bankruptcy court will trap the government’s cash in the debtor estate (so the govt can’t yank it) and will disallow the government’s repayment priority (in laymans terms, they just can’t jump in front of you in line). Now there’s far more cash in the company than bank debt, and guess what? It’s a hop skip and a jump to repaying the “bank lenders” (i.e. hedge funds) out just to make them go away.
This construction fails if the government manages to circumvent the bankruptcy laws — i.e., break the laws govt is supposed to enforce.
BTW there is a way for the government to get its super-priority repayment status, but only as a “DIP lender” in a Chapter 11 bankruptcy.
— Eric · Dec 11, 07:59 AM · #
I dislike the big 3 as much as the next guy, ossified union structures, short-term focussed management, quality issues, SUVs, the list goes on.
I imagine that a bailout may turn them into “zombie companies” that will be on the dole for years.
Yet I can’t bring myself to seriously support an action that might result in the loss of all these jobs. So far lots of layoffs have been in the financial sector – folks who are educated, mobile, and if they’re not total idiots then they probably have nice survival nest-eggs. Letting the big 3 go would be hitting the worst-suffering demographic slice of America when its already down.
Its an ugly corner we’ve painted ourselves into.
— Mike F. · Dec 11, 12:54 PM · #
Jim, I have to agree with some of the comments above: you’re right that randomly removing 3 million jobs from the economy wouldn’t be catastrophic; the problem is the concentration of these jobs in one state. Losing 3 million cells at random, not so bad; losing 3 million cells in your pancreas, much much worse.
You call this bailout an “inefficient jobs program”, which is certainly a legitimate way to see it. But no matter how inefficient it proves to be, it must be more efficient than providing emergency funds to Michigan’s state government and people. If the latter, we get no return at all. At least with the former we’re still making and selling cars.
Of course, I’m outside my wheelhouse on this, so I’m probably not seeing it as clearly as you are. I also have tons of family in Detroit, which colors my judgment somewhat.
— JA · Dec 11, 03:54 PM · #
Jim,
The number getting played in the stimulus plan news reports is that each $1 Billion in gov’t. infrastructure spending will create 40 – 60K jobs. So the current stop-gap bailout of $14 Bn could create from 560,000 to 840,000 jobs in its own right. A $34 Bn full bailout would create up to 2 Million jobs.
If those numbers are right….
Let Detroit burn. Use the Bailout money to rebuild it.
I live in Central Ohio and the prospect of the collapse of the Big 3 scares me quite a bit. But I have no respect for these companies. They were confronted by Japanese competition over 30 years ago and have yet to display even the slightest hint that they might be able to compete effectively.
You made excellent points about whether or not this is really Armageddon. Thank you for putting it into a little better perspective.
— Tom L. · Dec 11, 04:14 PM · #
Another thought…
Entrust the bailout money to Warren Buffett to loan out as venture capital or otherwise invest with the goal of job creation and economic growth. Let him keep a cut of any returns and the government is no longer in bed with the economically non-viable.
— Tom L. · Dec 11, 04:23 PM · #
Bankruptcy would be an event that would trigger all the CDS bets out there on the Big 3, would it not? Like with Lehman, right?
But I guess Treasury already knows the person at AIG who receives and cashes the government checks, so once say, GM files, Paulson can just call up that dude and say, “(Another) check is in the mail.”
— keatssycamore · Dec 11, 07:26 PM · #
<i>Yet I can’t bring myself to seriously support an action that might result in the loss of all these jobs. </i>
You don’t have to support an action. Do nothing. Let events take their course.
— Adam Greenwood · Dec 12, 05:31 PM · #