Detroit Needs a Selloff, Not a Bailout

Robert W. Crandall and
Robert W. Crandall Adjunct Senior Fellow - Technology Policy Institute
Clifford Winston

November 27, 2008

Congress was decidedly unimpressed by the three domestic auto makers’ plea for a bailout last week and responded by asking them to do the impossible: conjure up plans by Dec. 2 detailing how a bailout would revive them.

After more than three decades of denial about their long-term decline, Detroit’s car companies must now face the facts. A bailout will not revive them. Moreover, the leading alternative that has been proposed by others — bankruptcy — will not re-energize these companies sufficiently to reverse their decline.

In our judgment, based on experience elsewhere in American industry, the most constructive role the government can play at this point is to provide a short-term infusion of capital with strict repayment rules that will essentially require the auto makers to sell off their assets to other, successful companies.

Why is such a dramatic step necessary? For the unavoidable reality that the fundamental problem the auto makers face is not their pension, health-care or other legacy costs. It is that they are not making cars and trucks that enough Americans want to buy. And this has been true to some degree since the first energy shock hit the U.S. in the early 1970s.

In 1970, General Motors, Ford and Chrysler made about 90% of the new cars sold in the U.S. Today their share is closer to 40%. Their market share of light trucks has also declined, but less precipitously thanks to a 25% tariff on many imported light trucks.

How could a federal bailout or a bankruptcy reorganization change that? Pension and health-care liabilities have been a hindrance, but they haven’t blocked product innovation.

Bankruptcy has allowed some industries to turn themselves around. A decade ago more than 40% of the steel industry’s capacity was reorganized in bankruptcy. The result was the rationalization of capacity and new labor agreements that allowed three large players — U.S. Steel, Severstal and Mittal — to create a more efficient steel industry.

But this change occurred only after a dramatic restructuring of the industry in the face of fierce competition from new “minimills.” By the time the larger companies — Bethlehem, LTV, Weirton and others — collapsed into bankruptcy, they had already shed a vast amount of uneconomic capacity and ceded the production of certain types of products to the minimills.

Thus, the operations that Mittal, U.S. Steel and Severstal bought out of bankruptcy were the most efficient remnants and were devoted principally to making products used in motor vehicles, appliances and (to a lesser extent) construction. They did not have to build new blast or steel furnaces or revamp product lines. They simply had to rewrite labor agreements.

Similarly, the airline industry weathered a round of bankruptcies following 9/11. The problem then was overcapacity relative to what the changing market would bear. But economic recovery and lower labor costs negotiated in bankruptcy allowed most airlines to rebound because they did not have to face multiple carriers that offered better service and cheaper fares.

Detroit faces very different problems. It has had a persistent product-line problem that may be even more severe than its labor problems, and in any event will not be solved by getting UAW wage rates in line with those at the U.S. plants of Toyota, Honda, BMW and Nissan by 2010. The gaps between U.S. and foreign competitors simply have become too large to make up by reducing labor costs or rationalizing capacity. Even if the overall economy rebounds and gives Detroit auto makers some breathing room to emerge from bankruptcy, they will likely face similar — if not more severe — problems in the next recession.

In the end, the capital and labor of these companies need to be reallocated into better hands. To this end, we suggest that assistance of some form — short-term financing or government purchase of equity — be granted under the condition that the Detroit Three restructure their labor relations so as to be able to sell some or all of their major assets. 

There are a number of potential buyers for these assets. Toyota’s market cap is $100 billion and Volkswagen’s market cap is $110 billion. Either could bid for these assets. Honda, Nissan and even U.S. companies in related sectors, such as Caterpillar or John Deere, are possible buyers.

Members of Congress need to accept that the best possible outcome is a fundamental change in direction for the American automotive industry — a change that includes making Detroit’s facilities more attractive to successful companies. A joint venture between GM and Renault-Nissan was briefly discussed last year, and Daimler-Benz’s majority ownership of Chrysler was abandoned this year. Both failed because the Detroit-based operations could not improve their labor relations measurably and otherwise restructure sufficiently to be competitive.

By establishing firm mileposts for asset divestitures from which the companies could repay government funds, taxpayers could be reasonably assured that their money is well spent. But if Congress enacts a bailout without our conditions, the U.S. taxpayer will likely be on the line not only for additional support in the next recession, but likely on a regular basis for the foreseeable future.

We do not generally support government assistance to failing companies. But we think that our proposal will cost taxpayers less and, in the long run, be more beneficial to labor and the overall economy than either a straight bailout or