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Unnecessary Moral Hazards: the Auto Bailout

CEOs of the Big Three meet with Congress.Only time will tell if the US government will extend the evidently loose financial hand to aid the Big Three, but should it decide to, America will have cemented the moral hazard (the idea that risk or losses are protected due to the assumption that an outside party will step in to help) economists have nightmares about.

CEOs of the Big Three meet with Congress.“Failure is simply the opportunity to begin again, this time more intelligently.”

Mr. Ford could not have said it better. I want to start by saying that I was born in Detroit, Michigan, in a hospital coincidently named after Henry Ford himself. Yet is it crazy if I am vehemently against the proposed automotive bailout of the Big Three (Ford, General Motors, and Chrysler) that could potentially save Detroit from becoming a ghost town? Will the Detroit faithful tattoo “traitor” on my forehead for what I am about to say?

Only time will tell if the US government will extend the evidently loose financial hand to aid the Big Three, but should it decide to, America will have cemented the moral hazard (the idea that risk or losses are protected due to the assumption that an outside party will step in to help) economists have nightmares about.

Starting in September, we saw what many say was the spark to the financial crisis of 2008. The investment bank no longer exists, crude prices went on a rollercoaster ride, and the government went to town bailing out business after business in hopes of jump-starting the economy. Could you ever imagine in a hundred years that the US government would hold financial stakes in an insurance company (AIG) or take over a mortgage purchaser (Freddie Mac and Fannie Mae)?

Fast forward to present day. The Dow Jones Industrial has lost approximately 2700 points or dropped 24% of its value since September, all while the US government passed the $700 billion bailout plan, a plan that was supposed to prevent or slow down the aforementioned outcome. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke made us believe that this money would help stabilize the markets. The only thing that we know about the $700 billion is that the Office of Financial Stability, assigned to manage the $700 billion, has no idea what to do with all that cash. I liken the passing of the $700 billion bailout to a band-aid applied to a gunshot wound. It is a quick and idiotic solution to the problem, but definitely not the right way to solve it. Hank and Ben convinced the United States that this money would create an immediate impact to the financial markets but unfortunately, we have yet to see this impact. Improvement looks to be far away, judging from the record unemployment rates, quarterly declines in GDP, and declines in consumer spending.

Now we arrive to the present. A scene that looks far too familiar, the Big Three have approached the government in hopes of obtaining a lifeline in the form of cash to prevent an “economic crisis”. Unfortunately, this is a lifeline that Detroit may get. Initially, a separate 14 billion dollar bailout was proposed for the automotive industry, but given that the bill died in the Senate, talks are now in the works to use the $700 billion bailout money to help save Detroit, yet another instance proving that the money has no clear purpose but to be used when and how Hank and Ben see fit.

What is most problematic is that the Big Three have returned to Washington in less than a month since their last visit with a slightly different tune. Ford is now claiming it will not need the cash, yet initially Ford claimed it was in desperate need of some support. GM and Chrysler have agreed to accept less cash ($14 billion versus the $30 billion initially requested), yet all three argued that anything less than originally requested would be of no benefit. People say politicians are know to flip flop, but the Big Three CEOs seem to be quick learners. While all the details of the current automotive bailout are beyond the scope of this article, there are a few noteworthy reasons why a bailout – should it pass – is not the solution to help the ailing Big Three.

The automotive industry in America became flat out lazy pursuing the easy short-term profit and deserves to face the consequences. Innovation, quality, and price were compromised, all for the bottom dollar. SUVs were pushed on a nation when gas was adequately priced, yet we all know what happened to the sales of SUVs once gas prices started to rise. The American public was given the choice between an American automobile versus a reliable Japanese automobile not only comparable in price but consistently rated higher in quality. Judging from the performance of the Japanese automotive companies, the American Public has spoken.  The Big Three’s lack of long-term planning and efficiency is a dagger in the heart of a group fighting to survive in the jungle we call the free market.

Speaking of efficiency, the United Auto Workers union hindered the competitiveness of the Big Three by pushing for crippling labor agreements through generous pensions, hourly wages, and benefits that forced the auto companies to compete at a major disadvantage. How can a company compete when it has to pay its employees two to three times the amount its competitor pays? Not all blame can be placed on the Big Three, but ultimately it was the management that agreed to enter into these labor agreements.

Lastly, as Henry Ford beautifully put it, failure allows for a more intelligent restructuring in a true free-market economy. This allows the Big Three to return to the market humbled and places the fate of their legacy in their hands versus the taxpayer’s hand. For years, the companies have been reporting losses during times of relative economic stability. The brightest CEOs have come and gone trying to fix the Detroit problem. Yet they expect to magically return to profitability with this bailout? What makes us, the American public, believe that during a recession these same companies can fix their problems with extra cash when financially strong and well-managed companies are also struggling?

It cannot be neglected that there are obviously very serious economic, social, and political repercussions should the Big Three fail. However, we can also not neglect the fact that if we are to help these companies, we need to provide aid through means other than a simple handout. Give a man a fish, and you feed him for a day. Teach him how to fish, and you feed him for a lifetime. This old proverb applies beautifully to Detroit’s Big Three. Rather than feed Detroit for a few months, let us work on ways to teach Detroit and the American automotive industry to become more efficient. Let them fail, face the consequences of the aftermath, and work towards reconstruction. This is what the free market is all about, and by creating unnecessary moral hazards, we are tampering with a system that has worked effectively and efficiently for so long.

Should the bill pass, we will most probably be reading in June of next year about one of the Big Three filing for bankruptcy and starting over. That money we lent…well, we can kiss it goodbye, because the only thing the automotive industry has proven to us is that it can burn things very well, first our gas through its SUVs and now our taxpayer money.

About Ahmed Saheb

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  • Huda Jawad

    I agree with most of your points Brother Ahmed, very well written piece. I wrote a piece on the bailout back in September: http://islamicinsights.com/news/opinion/the-bank-was-saved-the-people-ruined.html

    I think one of the questions that needs to be asked regardless of the bailout going through or not for the Big Three, Why was AIG bailed out and not GM? Some will argue it is because AIG is a bunch of suits….however, I believe the Auto industry does need help, the issue is, if the big 3 fail, thousands of small businesses will fail also.

    Before we hand over a dime to the 3, they all need new bosses. We cannot continue the same tired policies and reward them with our money.

    Great insight once more.

    — Huda.

  • otowi

    I do think it is worth examining the consequences of the failure of the auto companies. If they disappear for whatever reason, what are the repercussions to the average citizen of the nation? For one, it would increase the nation’s dependency on foreign countries for cars as for, well, just about everything, which is clearly not healthy from a national economy standpoint. So what is more unhealthy – saving them or not saving them? And do they really need saving as much as they say? I don’t know.
    I come from a family of union members, and so I have a different view about unions. It is an easy thing to ask a middle class work base to take such cuts in pay that they will no longer be able to support their families and pay their bills. There are much bigger problems than union pay and union worker rights – they are not the cause of the financial woes of this nation in the auto industry or elsewhere, and stripping them is by no means the solution, either – that would only further the financial woes. Yes, they get paid more than people in some other countries do for the same work, yet they are not getting rich, they are making living, middle-class wages. But, generally speaking, their cost of living is also much higher than other countries they might be compared to, and they also have a higher standard of living they are trying to maintain – they do not want to move backwards to the standard of living of, say, Mexico – and I don’t blame them – very few people would volunteer themselves to move backwards like that. Every right that workers the world over have was in large part won by the blood of the unions. Before unions, workers had no rights or few rights and found themselves in such situations as being forced to work unlimited hours in absolutely unsafe conditions for pittance wages that they could only spend at the company store where prices were controlled so that they could never, ever, break free of the company and would be forever indebted to them. I do not want to go back to that, so I think unions have their place and their role to play.

  • Ahmed.Saheb

    Sister,

    Thank you for your kind comments. I had a chance to read your piece on the Financial Sector bailout and agree with what you had to say, I also commend your foresight regarding the first bailout as I initially supported the plan on the premise that the money would be used for what it was intended to be used for. How silly and naïve I was to think otherwise.

    With respect to AIG getting the bail out, one can possibly say AIG benefited from the hysteria of a possible financial markets collapse in September that caused Hank and company to act prematurely. Also the fact that AIG’s collapse has a global impact plays a major role in the decision to bail out the insurance company. Alot of pressure was placed on the U.S. Government by other nations to make sure they fixed things ASAP given the ripple effect it would have on the world. While if the Big Three were to fail the States would feel the brunt of the collapse with minimal impact to the world. The world would still have the option of buying Honda, Toyota, BMW, Mercedes, VW, etc…without Ford, GM, and Chrysler around. If anything the collapse of the Big Three internationally would benefit the other automakers position in the industry on a global scale possibly one of the reasons we see less global pressures placed on the US Government regarding this matter.

    Just another way to look at the situation and consider.

    I agree that the industry needs help but I am not a fan of government intervention and the precedent that it sets to other companies. The three companies are sending mixed signals, just look at the message (the pre-mature rough draft) the Automotive CEOs sent in November to Congress and their humble attempt at a true rough draft in the previous weeks. Somewhat different messages, so different that Ford indicated it would go without the bailout money the second time around (although they want to have a backup line in “case”).

    Ford’s risky moves of mortgaging a good portion of their assets paid off. These are the type of moves I support and feel will help fix the problems that plague Detroit. Throwing money at the problem from an entity (the US Government on behalf of the Tax Payer) that will attempt to hold the Big Three accountable will only delay the inevitable, bankruptcy.

    Time will tell as to what will change, but I am optimistic primarily regarding Ford’s direction. They appear to be ready to handle the tough times ahead, should GM and Chrysler bite the dust, fear not, they will come back in some capacity hopefully better managed and leaner to face the new market.

    As for the person discussing Unions and defending them, I am not against unions and I agree they have made some promising moves for worker rights. But the agreements they pushed on management in the earlier years caused GM, Ford, and Chrysler to work under extremely inefficient conditions. The Big Three were able to avoid the consequences of the Union labor agreements in the past due to strong sales basically covering the problem. However now we see the foreign automakers coming in building cars with better quality in America (Toyota makes cars in Kentucky for example with labor costs (non-union) estimated to be $30 dollars an hour versus the estimated $70 dollars an hour the Big Three are paying).

    So to say Unions are completely off the hook because they tried to keep the middle class living a lifestyle better than that of a third world country is commendable but their job is to also ensure they don’t place the employer in a position where the employer will not be able to function in the future. A balance (good pay versus efficiency) was needed to help both sides effectively move forward with their agendas. Again I only brought up unions briefly because they play a small portion in the equation of Detroit’s problems.

    As for the nations dependency on foreign cars, I believe this will only be a short-term result should the Big Three fail. As I mentioned many times before failure will lead to the companies restructuring and returning possibly leaner and ready to compete with their efficient competitors. Besides in this globalized economy there is no such thing as true dependency on manufactured products, automobiles are made in many countries around the world allowing for the field to remain competitive and efficient.

    Thank you both for your comments, I appreciate you taking the time to read the article and look forward to hearing anything else you may have to say.

  • A.Kharoush

    Salams,

    It is the responsibility of the Board of Directors to keep an eye on the management. It is always interesting to read the names/qualifications/affiliation of these members.

    Unfortunately, too many people/countries will be affected if the automakers are not bailed out… Maybe a ripple is what the country needs.

    Kh.