Money Matters - Simplified

Why We Shouldn't Bail Out Detroit

General Motors (NYSE: GM) fell 23% yesterday. Shares hit levels not seen since 1946 -- a mere 38 years after Ford 's (NYSE: F) Model T was introduced. Ford itself is less than a buck away from penny-stock territory. Chrysler's minority shareholder, Daimler, has written its stake down to ... drumroll, please ... zero.

"As GM goes, so goes the nation," the old saying went. Let's hope they weren't being serious.

Why We Shouldn't Bail Out DetroitGet original file (17KB)

Detroit's auto giants are running out of gas. Without a bailout, they're likely in big trouble. Before the gauge hits empty, auto execs, politicians, and investors are lining up to beg for help. And why not? Even strong banks like JPMorgan Chase (NYSE: JPM) and Wells Fargo (NYSE: WFC) have received 11-figure injections from the Treasury. Why not include beleaguered auto giants, too? Too big to fail! Right?                                                                                                           

Uh, no
Comparing a Detroit bailout to a financial-system bailout is, quite frankly, stupid. When auto manufacturers go out of business, we lose jobs. When the financial system goes out of business, we lose the economy. If GM fails, Chevy trucks won't simultaneously explode. If AIG (NYSE: AIG) fails, financial markets will simultaneously explode.

But that isn't the point. To justify a bailout, you'd have to make the case that doing so would get the industry back on a sustainable track. There's no logic in bailing out companies if they're simply going to blow through the cash and come back begging for more.

The long downward spiral
Detroit's hemorrhaging, you see, isn't caused by a one-off event that will be contained with a blank check from Uncle Sam. It's driven by factors that have been brewing for decades. Mainly:

  • Uncompetitive labor and legacy costs.
  • Reliance on vehicles nobody wants anymore.

The first issue could probably dropkick auto giants into oblivion all by itself. GM's health-care costs tack on $1,500 per vehicle. Toyota (NYSE: TM) and Honda (NYSE: HMC) spend a mere $400 per vehicle at their U.S. production plants -- in Japan, it's as low as $150 per vehicle. In recent years, GM had a staggering 2.5 retirees per current employee. The rough reality of globalization is that the country with higher labor costs -- us -- gets the shaft when it comes to manufacturing. Unless a bailout entails permanently subsidizing labor costs, Detroit will probably never be competitive.

The second issue -- a reliance on SUVs and trucks -- is really the 800-pound gorilla here. The profits Detroit gushed in years past didn't come from selling small, fuel-efficient cars, but from SUVs with downright stupendous profit margins.

In some cases, Detroit could pull down five-figure profits per SUV sold, while accepting slight losses on small cars. Selling small cars at a loss probably didn't seem like a bad idea, because it built a stable customer base and enabled manufacturers to meet fleetwide gas-mileage requirements. Ford, for example, made as much as $18,000 profit on every Excursion SUV, while losing money on its Focus compact car. For years, that balance worked beautifully. But as soon as energy prices soared and the green movement took off, demand for those profitable SUVs drove right off a cliff.

In other words, the only avenue Detroit could rely on to remain profitable has been thoroughly roadblocked. And unless we discover another Saudi Arabia, it probably won't reopen. 

Cruisin' down a dead-end road
Taxpayers funding a bailout deserve the answer to a serious question: "Is this worth it?" I sincerely don't think it is. Think about it: When the economy picks up, energy prices will spike, and the fate of SUVs will continue hurtling earthward. How about selling cheap, fuel-efficient cars? Detroit can't compete there, simply because its labor and legacy costs are leaps and bounds higher than foreign competitors'.

Heads, you lose. Tails, you lose.

The brutal reality is that Detroit doesn't need a bailout so it can reorganize and compete with foreign manufacturers; it needs the money to salvage a business model that's been proven horribly hopeless. After all, Chrysler was bailed out in 1979 ... and three decades later, here we are again. Detroit isn't suffering a cyclical downturn that'll bounce back and reward taxpayers for their benevolence. It's suffering an inevitable day of reckoning decades in the making.

True, perhaps hundreds of thousands of workers will lose their jobs if an auto giant goes belly-up. That's terrible. But in the long term, those workers will find jobs in companies with better than a snowflake's chance in hell of surviving. In the short term, it's miserable. In the long term, it's for the best. That's how free markets work.

Copyright © 2008 Universal Press Syndicate.