Thursday, February 16, 2012

Auto "Bailout" Redux: Sen. Romney was Bush who bailed out GM -- Obama forced it into bankruptcy...
Mitt Romney now thinks the bailout bad. At first I assumed that he'd used clever phrasing that could be given that spin, because as a former investment banker he should be familiar with more than just the basics of bankruptcy and restructuring. That is, it was a case of journalist sensationalism. But in fact he was clear, saying:
"The president tells us that without his intervention things in Detroit would be worse. I believe that without his intervention things there would be better." (Bloomberg of Feb 16)
Furthermore, this contrasts with his calls for more Federal assistance to the industry during his unsuccessful 2008 campaign.
Now there was a bailout of the industry under Pres. Bush, loans with no strings attached (or rather, "here's money to give you time to come up with a plan"). Pres. Obama was then faced with a choice of providing another bailout, or allowing General Motors and Chrysler to file for bankruptcy. We know his decision.
Back to Romney. Given how he made his hundreds of millions, he clearly is knowledgeable about corporate finance. So he should have no illusions – or maybe delusions – that at the time of the bankruptcy filings financial markets were not operating normally. To keep operating, however, a company needs to be able to borrow, to pay suppliers and workers, what is called DIP (debtor-in-possession) financing. Such financing was not available in private markets. Absent financing from the government, Chapter 11 bankruptcy would not have been possible.* Instead, what we would have seen was Chapter 7, an "orderly" dissolution of GM and Chrysler. Workers – both blue- and white-collar – would have lost their jobs immediately, along with their health care. Of course dealerships would have had no product to sell, and no ability to obtain continued financing – banks were nervous, and many large ones were themselves in trouble; car loans were already hard to find. Good luck, too, repairing a car. You'd be able to find brake pads, but not replacement body panels or computer chips or anything else that required "genuine" parts.
Suppliers were trying to stay afloat in the face of a 40% drop in sales; many were themselves in dire financial straits. (In fact, the final financing package made allowance that, authorizing GM to on-lend to suppliers.) They too would have been thrust into bankruptcy. This would have affected not just GM. First, over the past decade European and North American headquartered suppliers have done a fairly good job at penetrating the "transplant" makers, including Toyota. Had even a few mid-sized suppliers abruptly closed their doors, in all likelihood so too would have Toyota, Honda and BMW. While they may not have been thrust into bankruptcy, they would have put their workforce on unpaid leave, and left their suppliers without business. Indeed, as we saw with the March 2011 Tohoku Earthquake in Japan, the impact have stopped at our borders. Today's supply chain is interlinked on a global basis; in many segments in the parts business, US suppliers are the technological leaders, not Japanese ones. In the normal course of events plants in the US ship vehicle components and specialized materials around the globe (even if most production takes place nearer to their final customers in Germany, China and Brazil). We would have seen plants throughout the world facing temporary shutdowns.
As a result not just GM but also Toyota dealerships would have had no new vehicles coming their way. Furthermore, in 2009 banks themselves needed rescue; many had simply pink-slipped their entire auto finance operations. But many of Toyota's dealers also operate GM and Chrysler franchises. That Toyota technically was still in business would have been scant consolation as they watched their cars be (re)possessed** by their banks.
So to put it bluntly, all automotive-related production in the US, Canada and Mexico would have squealed to a halt in a matter of days, and most of the new car dealerships and portions of the vehicle repair business would likewise have shut down. Not just for GM, but for Toyota as well – with collateral damage to Canada (where banks were not up to their reserves in bad real estate loans) and manufacturing throughout the world. In January 2008 auto-related manufacturing in the US employed 950,000 workers; by April 2009 some 275,000 of those people had lost their jobs; the dealership sector shed 245,000 jobs. Had GM collapsed, another 500,000 manufacturing jobs and another 500,000 dealership jobs would have vanished overnight.
Conservatively – it doesn't attempt to measure jobs in steel and aluminum and paint, in trucking, and other sectors directly dependent upon the industry, much less local businesses that depend on such workers – this would mean 1 million jobs from the already depressed levels of Spring 2009. Of course losses by lenders to the industry would have amplified the "hits" to the banking sector coming from the mortgage sector and related derivatives.
Would Michigan be better off today? Let's assume that the above did not lead to a full-fledged recession on a national basis, and that we are seeing the tepid recovery of today (Feb 2012). Without GM and Chrysler, Toyota and Honda and BMW and Hyundai would be booming. Other than the Honda plants north of Columbus, however, none of these firms have plants within 3 hours of the metro Detroit area. In contrast, we would have seen virtually no jobs created in Michigan. And remember (well, none of us are that old…) that in the Great Depression the car companies didn't shut down – even if Ford and GM were employing fewer workers than in 1929. Unemployment in Michigan wouldn't just be percentage points higher than it is now, it would be higher than in the darkest days of the 1930s.
Back to Romney. That he thinks the State of Michigan would be better off without the so-called "bailout" is, well, inexcusable. His wealth suggests competence in the realms of high finance, of which bankruptcy is a piece. He knows enough of the auto industry to know that it is interconnected.
I wish he had the courage to stand by the truth. Instead he's turned his back on healthcare reforms that worked, and that the main part of Republican party supported not all that long ago. Yet attacking the ills of healthcare is one of two long-term issues facing our nation – our budget deficit can't be tackled without doing so, it is consequence not cause. He shows no boundaries on his willingness to pander. No, I take that back: he's not (yet?) renounced his Mormon heritage to become a Baptist.

• As in a standard bankruptcy, taxpayers and other large creditors took the equity stake when GM and Chrysler emerged from Chapter 11, rather than handing it to managers and bankers. Some apparently think we should have simply handed those shares to the banking system – apparently thinking they deserve additional lucre at our expense.
** Banks don't hold title, so they would be exercising a lien to take initial possession. The "repo" men hauling away cars wouldn't care.

Friday, February 10, 2012

Mock Convention Economics

Sen. Huckabee gave a speech at Washington and Lee on Friday, 10 February as part of W&L's quadrennial Mock Convention. I caught only a portion, in which he spoke of the role of values, that if all followed the Golden Rule, we would need no of government. What he said was thoughtful, at times eloquent, and certainly commensurate with my understanding of Scripture. But as a theory of government it is incomplete.
Certainly our brokenness is central for criminal law and the like; if sin were only skin deep rather than reaching to the core of our beings, the world would be a different place. But that represents but a small part of what a modern government does. In a modern economy, government is about our finite nature rather than our sinful nature.
Leviathan is above all local, not Federal. Government is first and foremost dominated by educating our children, and then by attending to the needs of our cars, providing us with water and taking care of our, uh, sewage, and with the exigencies of accidents. At the Federal level the largest function is addressing the side effects of aging, in particular the poor ability of markets to allocate resources over long time horizons in the face of high levels of uncertainty.
Trying to address these in a purely private manner presents insuperable challenges. Society benefits from a citizenry who are literate, numerate and engaged. Should a parent teach their child to read? send them to high school? – if it is left up to a market system, then the financial constraints that families face (after all, children come early in life, incomes peak later in life) and the uncertainties of the gains from education (does buying a college education really pay off?) would mean that we would regress to the 19th century, when illiteracy was pervasive.* And remember that education is not "bankable" – absent loan guarantees, who would lend money up front on the chance that years later Johnny or Julie would get a good enough job to repay with interest? This isn't a matter of sin – the issue persists even with an underlying willingness to pay.
Then there are simple efficiencies. Sewage treatment is costly, but less so if households can use a common system. Fire protection is hard to run on a pre-paid basis, and impossible on a fee-for-service one, billing a resident and their neighbors after a house burns down. Some of this stems from the challenges of coordinating the whole thing – setting up a membership system, convincing people to join, billing, and so on. Plus (rightly or wrongly) there is wide divergence of how much these services are worth. Government provides a one-stop-shop, while the political process tries to arrive at an acceptable compromise given the diversity of perceptions and preferences among society. But Americans are pretty good at team sports, and at management. All impressions to the contrary, over time we've improved the efficiency of government: despite a more complex world, and a far greater range of government services, it's no greater share of the economy now than it was in the 1950s.
So government does serve as a response to human brokenness. But it is also a response to our finite natures, to the costliness of information, and to the costs of coordination. The more complex a society is – the richer a society is – the greater the number of such issues, and also the greater the (market) value of our time. We simply can't be bothered with each and every issue, we don't have the knowledge, we don't know where we stand – and when we do, we seldom are so concerned as to be willing to spend time to work out our differences.
Of course this also means that government almost never gets things right.** Should we complain? No, we should get involved, while realizing that it's the unusual committee that votes our way all the time. That's what our forefathers did in rebelling against the British. It wasn't over taxes – after all, the first act of the new Congress was to levy one on tea. It wasn't over a failure to provide a legal system and courts, what we did there was pretty much to continue what the British had put in place. It was over voice. The Mock Convention hopefully instills a practical experience with that in Washington and Lee students that they will carry over into decades of active citizenship.
* Footnote: Now with guarantees, banks do lend, but students aren't good judges of whether for them education makes financial sense, plus they may simply prove unlucky, graduating with a degree at a time when no one is hiring. The track record of "manpower planning," of forecasting which skills will be in demand years down the road, is poor. So is any other attempt to predict the future. Would-be students are no more prescient than the experts. Markets don't work very well, can't work very well: without public provision our education levels would be abysmal. [If you never looked at a school or university budget, you may not realize that even private education is highly subsidized, with deductible charitable contributions, property tax and endowment income exemptions. Nor do we tax operating surpluses. (No, no! – "surpluses" are not profit.)]
** Footnote: Arrow's Impossibility Theorem shows this to be a general issue: all voting rules have defects. To rephrase this, no one ever seems to agree with me, and I get overruled in ways that are unfair–or are unfair to others. Arrow in fact has a second Impossibility Theorem, his proof of the existence of Walrasian general equilibrium, which is a necessary foundation for thinking that prices are good signals of scarcity. He in fact showed that the restrictions necessary for markets to work well and deliver the "right" prices are, well, too restrictive for the real world. And that's without factoring in either our finiteness or our sinful nature.