TOPICS > Economy

White House Considers Extending Bailout to Auto Industry

October 28, 2008 at 6:40 PM EDT
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Deepening financial crisis among the nation's biggest auto makers prompted talks to allow corporations to apply for aid under the $700 billion bailout plan. Reporters and analysts weigh the controversy around the access to money for Detroit's Chrysler, G.M. and Ford.
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JEFFREY BROWN: As the federal government’s financial rescue plan develops and expands, one of the nation’s most important industries is now asking, “What about us?”

Detroit’s Big Three, hemorrhaging money for years, have seen conditions spiral downward quickly in recent weeks. And now General Motors is in merger talks with Chrysler, but says it needs federal help to complete a deal.

We look at the situation with David Cole, chairman of the Center for Automotive Research, a not-for-profit institute in Ann Arbor, Mich., that studies the industry.

And Peter Morici, an economist at the University of Maryland’s School of Business, who writes frequently on the state of the auto industry.

Well, David Cole, G.M. is the immediate focus right now. How serious are its problems? And how did they grow so quickly?

DAVID COLE, Center for Automotive Research: I think it’s really sort of a double-barrel shotgun blast to the gut that they’ve received as well as others in the industry.

First of all, it was the rapid run-up in energy prices and the huge transition that we saw in the market in the spring and early summer. And, of course, since the meltdown on Wall Street, the credit crisis has really impacted, because it impacts the consumer buying cars, impacts the dealer with their floor planning, and it obviously impacts manufacturers and suppliers.

And with the revenue shortfall that we’ve had in the last couple of months, this has been devastating on cash for the entire industry. G.M., Ford, and even the internationals are really under an enormous amount of pressure right now.

Identifying mistakes made

David Cole
Center for Automotive Research
The other thing is that the legacy costs that the domestics had because they'd been around a long time and they had very attractive contracts for labor, defined benefit on health care.

JEFFREY BROWN: Now, staying with you, a lot of the problems of the industry -- and we've talked with you on this program over the years -- a lot of these programs have been there a long time, management problems, not dealing with labor costs, not building cars that Americans, buyers want to buy. Are those -- to what degree are those problems still with us?

DAVID COLE: Well, in many ways, the industry has changed remarkably. If you look at G.M. today, they're globally integrated. Their products are much, much better compared to what they were a few years ago.

And that's true of many in the industry today. The product execution is really outstanding.

The market, however, can shift dramatically more quickly than any manufacturer can change. And, of course, one of the really underlying factors in this has been we've had a very narrow product range that was quite profitable, and that was the trucks and SUVs.

And one of the key factors in that was the unintended consequences of the Corporate Average Fuel Economy standards back in the '70s. And when we hit 1980, we had a collapse in petroleum prices.

Customers walked in and they said a car now that had to achieve 27.5 miles per gallon really didn't fit them, and that truck or SUV really did. And so we had this explosion for 20-plus years in the truck business, but the car business was really terrible.

The other thing is that the legacy costs that the domestics had because they'd been around a long time and they had very attractive contracts for labor, defined benefit on health care.

For example, at one point, G.M. was covering over a million people on health care costs, which led to, for the whole industry, a couple of thousand dollar cost disadvantage vis-a-vis the new internationals, particularly the Japanese and Koreans that came here to build.

So, in a sense, there were a lot of mistakes all over the place, the government, certainly management, labor, but this is an enormously productive industry. And it was an industry that could afford rich labor contracts until it became much more globalized.

Arguing against federal aid

Peter Morici
University of Md. School of Business
If we were to give General Motors some money to acquire Chrysler, this would just put off for 18 months, two years the inevitable reckoning. One way or another, one or all three of these companies is going through Chapter 11.

JEFFREY BROWN: All right, let me bring in Peter Morici. I know we were having some technical difficulty. I hope you were able to hear a lot of that.

PETER MORICI, University of Maryland: I did.

JEFFREY BROWN: OK, good. The question now, is the industry coming to the government and suggesting that it needs some cash fast? Now, I don't know how you see the particulars of the situation now. What do you think about this request for cash? Should the government help?

PETER MORICI: Oh, I don't think the government should give them any cash. The Detroit three were in a lot of trouble before gas prices recently rose. They were in a lot of trouble before the credit crisis. G.M. has been bleeding cash for several -- many quarters now, as has Ford and Chrysler.

Daimler got rid of Chrysler because it couldn't make any money with the company and saw no prospects of doing so.

If we were to give General Motors some money to acquire Chrysler, this would just put off for 18 months, two years the inevitable reckoning. One way or another, one or all three of these companies is going through Chapter 11. One way or another, the pensions are going to fall back on the Pension Guaranty Corporation the federal government runs.

And that's going to be a crisis for the federal government, because it doesn't really have adequate assets for all the pensions throughout the country that it's guaranteeing, because that wasn't set up properly.

But the bottom line is, we've heard over and over again from General Motors remorse and repentance in how they were going to finally upgrade themselves and be truly competitive with Toyota and the other transplant automakers that very successfully make high-quality cars here in North America for some 20 or more years. And they just haven't been able to deliver on that.

The bottom line is that General Motors just doesn't make cars people want to buy and neither does Chrysler. Chrysler has a couple of good brands that would be very attractive to a Japanese manufacturer after it went through Chapter 11 and was rid of the UAW contract because it would nicely complement their lines. And one of those Japanese manufacturers could fix what is wrong with Chrysler in those lines.

Industry failures affect economy

David Cole
Center for Automotive Research
And if you look at the functionality, the capability of this industry, it's dramatically improved from where it is. I'm not sure people outside understand that.

JEFFREY BROWN: All right, let me ask David Cole. What's the argument for the government stepping in to help?

DAVID COLE: Well, first of all, I don't think Peter is very up to date on what's going on in the industry. He does not have deep knowledge on the industry. And if you understand this industry and what it's gone through and where it is today, it's dramatically improved from where it has been in the past.

You look at the products. Three of the last four cars of the year at the International Auto Show were G.M. products. It's producing very well, but it has a very difficult time.

Now, the bottom line here is that the cost of a failure and the clean-up of that mess is a whole lot more expensive than the prevention of that problem.

JEFFREY BROWN: You mean the cost to the broader economy, is that right?

DAVID COLE: Oh, the cost to the broader economy -- you look at a cascading impact, in terms of tens of thousands, over a million jobs. You look -- and I am basically a free-market guy. And in principle, I would agree with Peter.

But when you look at the impact of this industry, the multiplier on jobs in this business, which are higher than any other industrial sector, we're talking about a shock that this economy really cannot afford to take versus the cost of prevention, which is nominal.

And I think what we have seen now is that the government does understand that. They are moving forward, I think, with -- we don't know exactly how this is going to be shaped yet, whether it's the DOE money related to the fuel economy standards or the bailout of Wall Street.

We're not sure how that's going to occur, but I think the government basically recognizes that, if they let this thing get away, we have a real problem.

And the future close by is really quite bright. If you look at capacity reduction, the cost reduction, particularly next year, with the new labor contract, and then, third, the pent-up demand, this is a very difficult period, but the near-term future is really very bright.

And if you look at the functionality, the capability of this industry, it's dramatically improved from where it is. I'm not sure people outside understand that.

Catastrophe may be inevitable

Peter Morici
University of Md. School of Business
I mean, General Motors certainly has some winners. It just never has enough of them. Its products have an old shelf life, because it costs too much to develop cars inside of General Motors. And that's quite apart from its UAW contract problems.

JEFFREY BROWN: Well, let me let Peter Morici respond, particularly on the issue of, if you let these companies fail, then the cascading impact on the broader economy are just too hard to contemplate, so it's worth stepping in now. What do you think?

PETER MORICI: Well, it's worth stepping in now, if you accept that argument, if giving them the money would keep the catastrophe from happening.

But in my mind, putting Chrysler and General Motors together and then subsidizing them, the only way you're going to keep the catastrophe from happening two and three and four years from now is if you're prepared to write them a check every year from now and forever, because General Motors, even with its new labor contract, is still going to have higher labor costs than, for example, Honda will have at its new Indiana plant.

It's still going to have a more bureaucratic management structure, more difficulty, and higher costs in developing new products.

I mean, General Motors certainly has some winners. It just never has enough of them. Its products have an old shelf life, because it costs too much to develop cars inside of General Motors. And that's quite apart from its UAW contract problems.

My feeling is this is going to happen one way or another, so we shouldn't throw good money after bad.

JEFFREY BROWN: All right, gentlemen, I'm very sorry, but we're at the end of the program. So I have...

DAVID COLE: Peter, you just don't know this industry at all.

JEFFREY BROWN: OK, we'll have to leave it there. Peter Morici and David Cole, thanks very much.