Unnecessary Moral Hazards: the Auto Bailout

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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.

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