Below The Beltway

NYU Professor of Finance David Yermack lays out the reasons that the pleas for a federal bailout coming from Detroit should go unanswered.

First, as Yermack notes, all of the so-called Big Three have wasted a tremendous amount of capital over the years investing in a failing business model:

Over the past decade, the capital destruction by GM has been breathtaking, on a greater scale than documented by Mr. Jensen for the 1980s. GM has invested $310 billion in its business between 1998 and 2007. The total depreciation of GM’s physical plant during this period was $128 billion, meaning that a net $182 billion of society’s capital has been pumped into GM over the past decade — a waste of about $1.5 billion per month of national savings. The story at Ford has not been as adverse but is still disheartening, as Ford has invested $155 billion and consumed $8 billion net of depreciation since 1998.

As a society, we have very little to show for this $465 billion. At the end of 1998, GM’s market capitalization was $46 billion and Ford’s was $71 billion. Today both firms have negligible value, with share prices in the low single digits. Both are facing imminent bankruptcy and delisting from the major stock exchanges. Along with management, the companies’ unions and even their regulators in Washington may have their own culpability, a topic that merits its own separate discussion. Yet one can only imagine how the $465 billion could have been used better — for instance, GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan and Volkswagen.

The implications of this story for Washington policy makers are obvious. Investing in the major auto companies today would be throwing good money after bad.

Second, Yermack notes that both of the major arguments in favor of bailing out General Motors, Ford, and/or Chrylser don’t stand up to scrutiny:

Two main arguments are being raised to justify a government rescue of the auto industry. First, large numbers of jobs may be at stake, perhaps as many as three million if one counts all the other firms that supply the Big Three. This greatly overstates the situation. Americans are not going to stop driving cars, and if GM, Ford and Chrysler disappear, other companies will expand to soak up their market share, adding jobs in the process. Many suppliers will also stay in business to satisfy the residual demand for spare parts even if the Detroit manufacturers go under. If the government wants to spend $25 billion to protect auto workers, it would do better to transfer the money to them directly (perhaps by cutting each worker a check for $10,000) rather than by keeping their unproductive employer in business.

In other words, even if all three of the Detroit automakers went out of business tomorrow, there woul still be a tremendous physical plant, distribution network, and parts-supply relationship that someone — be it a Toyota, Honda, or Nissan, or maybe an impudent little company in India or China seeing an opportunity across the Pacific — would be eager to snap up. Americans would still be employed in the auto industry, they’d just be working for someone else — presumably someone who had a better idea of how to run a car company.

Yermack goes on:

Second, it is suggested that the failures of the U.S. financial industry, which have cost us something like $700 billion, justify bailouts of other sectors of the economy. This makes no sense. If the government diverts our national savings into businesses that have long track records of destroying investment capital, eventually we’ll end up with an economy like France’s — or Zimbabwe’s.

Other arguments are on the table as well. Some see the troubles at GM and Ford as opportunities to retool the auto industry to produce environmentally friendly cars. Given their long track records of lobbying against fuel economy standards and producing oversized gas guzzlers, this suggestion seems ridiculous, sort of like asking cigarette companies to help with cancer research.

In the long run, as Yermack points out, the troubles at the Big Three are little more than a reflection of the fact that the American auto industry — at least in terms of the industry personified by Detroit — is a dinosaur that has not been able to retool itself to compete in the modern world.

Propping it up isn’t going to help anyone.