Bailout 101

A few months ago we were told that a financial industry bailout was required to avert a repeat of the Great Depression. While some government intervention was probably necessary, the blank check that Congress passed and President Bush signed is the best definition of a “slippery slope” I’ve seen in a long time. $700 billion dollars later, we hear that the credit markets are still frozen and more bailouts are necessary to save the economy from catastrophe. The bailout du jour is the U.S. auto industry. President Bush recently announced $17.4 billion ostensibly designed to get GM and Chrysler through early 2008. The Bush band-aid is not a long term solution. It looks like Obama and the incoming Congress to decide what to do long term.


How GM, Chrysler, and (to a lesser extent) Ford got to brink of bankruptcy has been well documented. Poor management decisions, heavy government regulation, high labor/union costs, fuel prices, and the poor economy all contributed to the malaise. The bottom line, however, is that the Big Three have not produced enough cars and trucks that consumers want to purchase.


In a capitalist society, companies come and go. The strong survive and must constantly improve to stay on top, while the weak must retool or drop out altogether. Economist Joseph Schumpeter referred to this as “creative destruction,” and it is the very process that drives economic growth. In other words, the economy improves because less efficient firms are replaced by more efficient ones. Stated yet another way, the departure of noncompetitive companies is good for the economy because it enables new competitors to enter the market and provide better products and services.  Following this logic, the real question we should be asking about the prospective auto bailout is simple. “Why should the federal government interfere with the market by providing emergency funding to automakers that investors are not willing to provide?” 


Those in the “mainstream” media have posed another question, however: “Should we allow the carmakers to fail?” Perhaps some frame the question this way because they simply don’t understand how the economy grows. However, such a question also puts the onus on society, not the auto companies. Think about it this way. If you and your friends choose to eat at Dave’s Drive-In instead of Harry’s Hamburger Hut, you are forcing Harry to offer better food, improve service, or cut prices to lure in customers. If he doesn’t, Harry’s business will fail, not because you “allowed it to fail,” but because he couldn’t figure out how to run a successful restaurant. When he closes, someone else would probably move in and give it a try. This is the market in action, and this process gives us the best choices in restaurants, dry cleaners, service stations, and yes, automobile manufacturers.


Preventing capitalism from running its course lessens some short term pain but creates greater long term problems. Specifically, I am fascinated with three arguments I heard in favor of the bailout.


“If we can give the banks $700 billion, then why not give something to the Big Three?” If you don’t see the flaw here, look up “slippery slope” in the dictionary.


“If the carmakers go under, then hundreds of thousands of Americans will lose their jobs.” There are two problems with this argument. First, if GM and Chrysler file for Chapter 11 bankruptcy, they won’t go under, at least not now. Chapter 11 can bring about leadership changes and allow these companies to renegotiate unfavorable contracts that weigh them down. These companies could emerge from Chapter 11 stronger than ever. Second, even if the Big Three eventually file for Chapter 7 bankruptcy and liquidate, they would leave a production gap in the market. Foreign carmakers like Toyota and Honda might expand their manufacturing presence in the U.S. American entrepreneurs might purchase the auto plants at fire sale prices and produce their own cars. In other words, the industry collectively would fill the gap left by the departing competitors. In the end, the net effect would likely be a loss of jobs (which is already occurring), but certainly not the catastrophe proponents of the bailout forecast.


“Under a bailout, government watchdogs will make sure that these companies make the changes necessary to succeed.” Are politicians and bureaucrats capable of running a company successfully when seasoned business leaders have failed? Have you been to the Post Office recently? Do you really want American companies to be “accountable” to politicians?


The economic reality is clear. If the government must intervene to save jobs that would otherwise be lost, then taxpayer money is being spent so that inefficient carmakers can continue to produce vehicles that a sufficient number of Americans are not willing to buy. Chapter 11 bankruptcy exists to allow struggling companies to reorganize before they go under, and this could be a good option for the carmakers. On the other hand, a government bailout allows politicians to play Santa Claus, save the union contracts, and push the production of “green” cars like never before. Unfortunately, a bailout squanders both billions of taxpayer dollars and an opportunity for the Big Three to make the kind of serious changes that are sorely needed. The same is true for the others waiting in the bailout line, from insurance companies to state governments.

3 thoughts on “Bailout 101

  1. You’re 100% correct! Now they’re telling us about the $30 million golf resort the UAW runs for its cronies. It’s bad enough that workers have to pay for it, but the taxpayers should be left out altogether. If we pay them anything, then I think the union should give up the resort as part of the deal.

  2. It is all politics. The TARP was rushed through so that administration could leave feeling good. This “payback package” is no better. The taxpayers monies are being used to pay back the constituent groups that elected Obama. The monies going to ACORN is a example. The big 3 bailout is really for the labor unions and the fair choice act will follow as a payback for the SEIU and thier sizable contributions.

  3. No Surprise that GM had to sink like the Titanic.. Just the pain and hard work of 300 Million Taxpayers going down the drain.. Whose responsible for that?

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