Federal Loans for U.S. Automakers are a Bad Idea

The three U.S. automakers are pushing this month for Congressional approval of $25 billion in federal loans.

They shouldn’t get them.

As this article in Industry Week notes, the loans are gaining support because of fear at least one of the three might go into bankruptcy, which “could have an enormous economic impact.”

I’ll get back to that in a moment. But first, consider how they got into this situation. For too many years, the U.S. companies made vehicles of poor quality using inefficient production methods – creating a situation that smart competitors (read Toyota, Honda and Nissan) were able to exploit.

Quality has improved, and the American companies are becoming leaner (though they still lag far behind the Asian companies).

But now the problem – so we are told – is technology. A law approved last December requires automakers to boost average fuel economy of their vehicles to 35 miles per gallon. The article notes that “The Bush administration has estimated that retooling for the new standards would cost the automakers $100 billion.”

So the automakers need the money to pay for retooling to meet fuel economy standards? They why doesn’t Toyota need loans?

Because technology and fuel economy are not the real issues. Detroit misjudged where the market would go, investing too heavily in big trucks and SUVs, and its failure to become lean means it lacks the flexibility today to respond quickly to market shifts.

Jerry Flint, automotive columnist for Forbes, notes an interesting fact in a recent column. While the U.S. companies in July held a 43 percent share of the U.S. market for vehicles (a big drop from the past), if you factor out the trucks and SUVS and look just at cars, the U.S. share drops to 32 percent.

Flint comments, “Regaining a reasonable share of the car market will not be easy – not against today's foreign competition.”

If the U.S. companies get their $25 billion, what are they going to do with it? Will that amount of money make it possible for them to change how they operate in some radical way that will suddenly make them more competitive? I doubt it.

Yes, I know Chrysler received loan guarantees in 1979 – and emerged from that experience as a better, more competitive company (at least for a while). But today’s market is different from 29 years ago. Toyota was not the powerhouse it is today. Chrysler was competing primarily with GM and Ford.

In the Industry Week article, Peter Morici, an economist at the University of Maryland, accurately points out that “any loan program even if it is called a research plan would be a ‘fig leaf for a subsidy’ that distorts the market.” Unfortunately, Morici then goes on to say, "Our trading partners give us no choice. Every other major auto manufacturing country protects their industry so we may have to do the same."

Wrong. I’m not saying other countries don’t engage in protectionism or subsidies. But this is the same tired argument that implies foreign protectionism is the cause of the U.S. auto companies’ problems. Market miscalculations and poor manufacturing processes have a lot more to do with it.

There is one final argument in support of the loan guarantees – the idea that some companies are so big and important they cannot be allowed to fail.

I see two problems with that idea. First, as big as the U.S. auto companies are, I don’t believe a bankruptcy of any one of them would be that devastating to the economy – not with the way the market has shifted. Second, any bankruptcy filing would almost certainly be under Chapter 11, so that the company would continue to operate and seek to recover. As such, it would not "fail." And I believe bankruptcy would do more to force an auto company to change its ways than a government bailout.

The loans are politically popular and may be approved. I hope they aren’t.