The Agenda

Further Note on the Auto Bailout

R,M. at The Economist’s Democracy in America blog writes the following:

The purpose of Mr Romney’s op-ed is to clarify his position on the auto bail-out ahead of Michigan’s primary on February 28th. And the piece rivals Cirque du Soleil in its display of contortions. Mr Romney seems loth to gush about the success of the bail-out, noting only the good news that “Chrysler and General Motors are still in business”. He certainly doesn’t mention that 2011 was the best year for America’s carmakers since the financial crisis, with each of the big three turning a solid profit. But he does imply that this achievement is a result of his own advice. “The course I recommended was eventually followed”, Mr Romney writes.

As with much of Mr Romney’s excessive rhetoric, there is some truth to this statement. Following the bail-outs, the president eventually forced Chrysler and GM into bankruptcy, a step Mr Romney thought should occur naturally. And the government oversaw painful restructurings at both companies, which were largely in line with Mr Romney’s broad suggestions. But the course Mr Romney recommended in 2008 began with the government stepping back, and it is unlikely things would’ve turned out so well had this happened.

I read Romney’s 2008 op-ed rather differently. In it, the former Massachusetts governor advocated a managed bankruptcy. That is, the government would take an active role to make sure that the bankruptcy proceeded in an orderly fashion in what was at the time a chaotic economic environment. The following is from Romney’s op-ed:

It is not wrong to ask for government help, but the automakers should come up with a win-win proposition. I believe the federal government should invest substantially more in basic research — on new energy sources, fuel-economy technology, materials science and the like — that will ultimately benefit the automotive industry, along with many others. I believe Washington should raise energy research spending to $20 billion a year, from the $4 billion that is spent today. The research could be done at universities, at research labs and even through public-private collaboration. The federal government should also rectify the imbedded tax penalties that favor foreign carmakers.

But don’t ask Washington to give shareholders and bondholders a free pass — they bet on management and they lost.

The American auto industry is vital to our national interest as an employer and as a hub for manufacturing. A managed bankruptcy may be the only path to the fundamental restructuring the industry needs. It would permit the companies to shed excess labor, pension and real estate costs. The federal government should provide guarantees for post-bankruptcy financing and assure car buyers that their warranties are not at risk.

In a managed bankruptcy, the federal government would propel newly competitive and viable automakers, rather than seal their fate with a bailout check. [Emphasis added]

Does this sound like the federal government stepping back? I don’t think it does. Rather, it sounds like the federal government responsibly managing downside risks facing taxpayers. Some, including Bush administration veteran Tony Fratto, claim that this wasn’t a realistic outcome, because private investors weren’t willing to step in. It’s not clear to me that Romney was ruling out the possibility of a federal loan. Recall that loan financing was only a small portion of the federal cash infusion. One of the ironies of the bailouts is that they’ve arguably put GM on a stronger footing than Ford, which is now at a considerable disadvantage. That is because the terms of the cash infusion, which went well beyond loan financing, were so generous. Another way of putting this is that taxpayers should have driven a much harder bargain on taxpayers’ behalf. 

To return to R.M.:

Free-marketeers that we are, The Economist agreed with Mr Romney at the time. But we later apologised for that position. ”Had the government not stepped in, GM might have restructured under normal bankruptcy procedures, without putting public money at risk”, we said.

Again, Romney never said that the government should not have stepped in. A “managed bankruptcy” is not the same as “normal bankruptcy procedures.” R.M. continues:

But “given the panic that gripped private purse-strings…it is more likely that GM would have been liquidated, sending a cascade of destruction through the supply chain on which its rivals, too, depended.” Even Ford, which avoided bankruptcy, feared the industry would collapse if GM went down. At the time that seemed like a real possibility. The credit markets were bone-dry, making the privately financed bankruptcy that Mr Romney favoured improbable. He conveniently ignores this bit of history in claiming to have been right all along.

It could be that R.M. is correct and David Skeel on Penn Law School, one of the nation’s leading experts on bankruptcy law, is incorrect. Skeel suggests that private financing may well have been available, yet that option wasn’t seriously pursued, in part because the federal government imposed a number of conditions on the transaction that represented significant departures from traditional bankruptcy practice. But it is important to note that Romney did not insist that the bankruptcy be privately financed. Providing guarantees for post-bankruptcy financing is a significant subsidy. 

In other areas of his op-ed Mr Romney is more accurate. Unions did win some special favours in the bail-out deals, though they are not as egregious as the candidate claims. For example, a health fund for retired workers was unfairly favoured over secured bondholders at Chrysler. But an issue like that is unlikely to resonate in Detroit. So Mr Romney must find a way to re-write history, lest he fall further behind Rick Santorum in his state of birth. Mr Santorum didn’t support the auto bail-out either, but he evinces a genuine compassion for blue-collar workers. And he didn’t pen an op-ed predicting, ”If General Motors, Ford and Chrysler get the bailout that their chief executives asked for yesterday, you can kiss the American automotive industry goodbye.” That’s a difficult statement to walk back.

This passages seems to muddle the issue: are we making substantive arguments or offering political analysis? To the extent that we’re talking about the substantive question, let’s think through the “special favors” (not a term I’d use) in question. Consider the following from Shikha Dalmia’s testimony before the House Subcommittee devoted to stimulus oversight:

Normally, secured creditors, meaning creditors to whom a company has offered a piece of its assets in exchange for a loan, are paid back on a priority basis in bankruptcy proceedings. But under the government bailout, Chrysler’s secured creditors received 29 cents on the dollar. By contrast, its unions were paid 40 cents on the dollar even though their claims against the company are equivalent to those of low-priority, unsecured creditors.

The argument that Obama administration’s departures from traditional practice were “not as egregious as the candidate claims” fails to reckon with the larger question of how these departures and “special favors” might impact future investments in politically-sensitive industries. If we believe that secured bondholders at Chrysler were indeed treated unfairly, how might future investors evaluate “national champions” in the future? As Skeel writes:

The indirect costs may be the worst problem here. The car bailouts have sent the message that, if a politically important industry is in trouble, the government may step in, rearrange the existing creditors’ normal priorities, and dictate the result it wants. Lenders will be very hesitant to extend credit under these conditions.

This will make it much harder, and much more costly, for a company in a politically sensitive industry to borrow money when it is in trouble. As a result, the government will face even more pressure to step in with a bailout in the future. In effect, the government is crowding out the ordinary credit markets. [Emphasis added]

That the The Economist has advocated pro-market policies is certainly very interesting and important. But it is important to understand that state interventions set precedents that shape the economic environment in the future. This is an iterative game, in which each round shapes successive rounds. Failing to reckon with that fact undermines the credibility of any analyst, regardless of ideological coloration. 

If Ford fares poorly in the years to come, if GM and Chrysler flounder, rest assured that no will blame the auto industry bailout. This is despite the fact that the bailout may have (a) badly undermined Ford’s prospects, (b) propped up excess capacity as consumers shift to driving less and buying fewer automobiles, and (c) deterred private investors in a politicized sector.

For a clearer understanding of the auto industry bailouts, I recommend reading Dalmia’s take.


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