The Unknown Costs of Saving the Auto Industry

By Jun 6, 2011, 8:42 AM Author's Blog  

This past Friday’s unemployment report was beyond disappointing. With non-farm payrolls increasing by a token 54, 000 and the prior month’s report indicating a downward revision of 12, 000 our ‘walking pneumonia’ economy continues to languish under the weight of excessive debts and grave uncertainties. What is an administration to do when faced with such a challenge? Spin, baby, spin.

Where do I witness this spin cycle working in overdrive? The Obama administration’s touting of success in saving our automotive industry. There is little doubt that the Obama team will be ‘driving’ this ‘saving’ of the automotive industry hard as part of his 2012 reelection platform.

Obama is entitled to deliver whatever message he may care to gain reelection but the American public is equally entitled to know the lengths and costs to which the administration went on this front. Trampling of capitalism and the Constitution, perhaps? Twisting of arms like never before? Playing hardball politics with basic market principles in an unprecedented fashion? Yes, yes, yes.

If we were to listen to the Obama team define the situation, we would not be making any autos in our nation if not for his efforts. Wow. Is that right? Talk about chutzpah. The fact of the matter is the ‘saving ‘ of the auto industry was nothing short of a massive trampling of basic rules of bankruptcy with the administration picking the winners and losers in the process. If you think that these abuses do not come with real long term costs then let’s open up the dictionary and review the definition of ‘naive’.

David Skeel, professor of law at the University of Pensylvania, writes in today’s Wall Street Journal about The Real Costs of the Auto Bailout,

President Obama’s visit to a Chrysler plant in Toledo, Ohio, on Friday was the culmination of a campaign to portray the auto bailouts as a brilliant success with no unpleasant side effects. “The industry is back on its feet,” the president said, “repaying its debt, gaining ground.”

If the government hadn’t stepped in and dictated the terms of the restructuring, the story goes, General Motors and Chrysler would have collapsed, and at least a million jobs would have been lost. The bailouts averted disaster, and they did so at remarkably little cost.

The problem with this happy story is that neither of its parts is accurate. Commandeering the bankruptcy process was not, as apologists for the bailouts claim, the only hope for GM and Chrysler. And the long-term costs of the bailouts will be enormous.

No unpleasant side effects? What planet is he on? Remarkably little cost? Get serious.

The claim that the bailouts were done at little cost is even more dubious. This side of the story rests on the observation that GM’s success in selling a significant amount of stock, reducing the government’s stake, and Chrysler’s repayment of its loans, show that the direct costs to taxpayers may be lower than many originally feared. But this doesn’t mean that taxpayers are off the hook. They are still likely to end up with a multibillion dollar bill—nearly $14 billion, according to current White House estimates.

But the $14 billion figure omits the cost of the previously accumulated tax losses GM can apply against future profits, thanks to a special post-bailout government gift. The ordinary rule is that these losses can only be preserved after bankruptcy if the company is restructured—not if it’s sold. By waiving this rule, the government saved GM at least $12 billion to $13 billion in future taxes, a large chunk of which (not all, because taxpayers also own GM stock) came straight out of taxpayers’ pockets.

The indirect costs may be the worst problem here. The car bailouts have sent the message that, if a politically important industry is in trouble, the government may step in, rearrange the existing creditors’ normal priorities, and dictate the result it wants. Lenders will be very hesitant to extend credit under these conditions.

Why will lenders be very hesitant to extend credit under these conditions? Well, let’s revisit just how creditors were treated by the Obama administration in the midst of the Chrysler restructuring. I highlighted this treatment on May 2, 2009 when I wrote, Is Barack Obama Going Tony Soprano?

“One of my clients was directly threatened by the White House.”

That’s a quote, folks, from a lawyer representing firms which lent Chrysler money on behalf of their clients, including pension funds, teachers, labor unions, college endowments, et al.

Threatening creditors may be common practice in the underworld. In the world of business and politics, commonly accepted rules of law, business practices and ethics are widely accepted and adjudicated by the courts to prevent abuse. Did the White House just abuse the Constitution in the process of engaging Chrysler’s non-TARP creditors? Tom Lauria, an attorney with White & Case representing a few non-TARP Chrysler creditors, believes the White House did exactly that.

I strongly recommend that you listen to the audio recording of Frank Beckmann’s interview with Tom Lauria (special thanks to Daisyjane for the link).

Obama and team are certainly entitled to their own opinions but the fact of the matter is the costs of bailing out not only the automotive industry but also Wall Street are far greater than we may ever know.

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