The Auto Bailout 10 Years Later: Was It the Right Call?

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Wharton's John Paul MacDuffie and The Detroit Bureau's Paul Eisenstein discuss how the auto bailout looks 10 years later.

The auto industry has occupied an almost mythical place in the American mind. From the time Henry Ford created the first Model T in 1908 and the first moving assembly line, cars were suddenly affordable for the middle class. That transformed not just transportation but the urban — and suburban — landscape.

And like no other industry except housing, at least until recently, carmakers were a perennial key driver of the U.S. economy. In what has become almost a cliché, Charles Wilson, the former CEO of General Motors and U.S. Defense Secretary just after World War II, was asked how he might handle a decision involving a conflict between U.S. and GM interests. He could not imagine a conflict: “For years I thought what was good for our country was good for General Motors, and vice versa.”

By 2009, in the depths of the financial crisis, that bond had disintegrated. As sales cratered and losses piled up, serious questions were being raised about whether GM and Chrysler would — or even should — survive as access to credit markets froze up. Public and official attitudes had hardened in the wake of the collapse of the financial industry. There was a real question about whether the two carmakers deserved the $80 billion needed to bail them out. Despite a 40% nosedive in sales and some 3 million jobs at risk, officials were balking after they had approved unparalleled bailouts of top financial firms.

The ‘Free Market’

Many objections to domestic carmaker bailouts centered on economic philosophy. Critics asked: In the “free” market, shouldn’t companies stand or fail on their own?

Like the banks, the domestic auto industry was widely viewed as having brought a lot of the catastrophe upon itself. The Big Three still had poor reputations for quality and had long been pushing sales of high-gasoline-consuming SUVs and pickup trucks. As such, they were unprepared with smaller, more fuel-efficient models when gas prices spiked in the 2000s and demand for their products — versus those of foreign manufacturers — fell.

“In the run-up to the 2009 bailout, the Big Three manufacturers recorded some of the worst corporate performances in American history,” wrote Austan D. Goolsbee and Alan B. Krueger in 2015. Both were top Obama-administration officials involved in the auto-bailout decision — Goolsbee had been a member of the Council of Economic Advisors and Krueger was chief economist at the Treasury Department. GM lost $40 billion in 2007 and another $31 billion in 2008, they pointed out. What’s more, the Big Three’s market share had shrunk from 71% in 1998 to 47% in 2008.

“You can only ask ‘Where are we now?’ The auto factories are still working. We’re producing products.” –Morris A. Cohen

In the end, the officials decided the nation could not afford another big economic hit, and that if measures were imposed to change leadership, business models and labor costs, then the costs would be worth it. Still, Goolsbee and Krueger noted that most of the bailout decision-makers “did not know if it would work.” They wrote that “… we are both thrilled and relieved with the result: The automakers got back on their feet, which helped the recovery of the U.S. economy. Indeed, the auto industry’s outsized contribution to the economic recovery has been one of the unexpected consequences of the government intervention.”

There may be endless debate about how much bailout measures led to the strong industry recovery versus how much came simply from the general recovery of the economy. But 10 years later, it is worth revisiting what the bailout has meant to the industry, and where it is heading.

For Wharton management professor John Paul MacDuffie, the idea of letting GM and Chrysler wither on the vine made no sense. “It could have been a domino-effect collapse of the domestic auto industry.” He adds that the bailout decision made sense partly to avoid a much deeper crisis, but also to make GM and Chrysler more competitive in the future. It was true that U.S. auto companies were “badly managed for a long time. GM lost market share for 30 years. There were these energy crises and there were no fuel-efficient vehicles being made by the Big Three, over and over again.” (MacDuffie, who is also director of the Program on Vehicle and Mobility Innovation at Wharton’s Mack Institute for Innovation Management, recently spoke about the bailout on the Knowledge@Wharton radio show on SiriusXM. Listen to the podcast at the top of this page.)

The 40% Hit

Yet, that poor record had largely been reversed by the time the crisis hit. When it came to manufacturing capability, product development and supply chain management, the U.S. automakers were close to the levels of “any global manufacturer” in most areas by 2009. They were already in the middle of a large and successful improvement process when the financial crisis hit and they were among the victims, MacDuffie adds. The auto companies were not involved in causing the financial crisis. But then, he asks, what business dealing in expensive, capital-intensive durable goods takes a hit of 40% and isn’t in a crisis?

Put another way, despite public perceptions, the Big Three were finally getting it right by the time the downturn arrived, but they were saddled with debt when they, their dealers and consumers were all cut off from credit overnight. That was potentially a death knell. MacDuffie thinks of the government action not so much as a bailout of an uncompetitive industry that was behaving badly, but more of an investment in a “super-important” part of the economy already on an “impressive improvement trajectory.”

Noting that the auto industry has “so many multiplier effects, there are so many jobs related to it,” he adds that many also believed it was simply “important for a country to have its own car companies.” Losing so much of the domestic auto industry would have reduced competition and taken away a lot of manufacturing capability.

Paul Eisenstein, publisher of online trade publication The Detroit Bureau, notes that some “people were screaming about bailouts for Detroit and yet they seemed to accept as just inevitable that we should be bailing out the banks and Wall Street.”

MacDuffie also points out that a lot of political anger was in fact directed at first at the financial institutions “that did contribute a lot” to the financial crisis and “took little penalty.” The backlash bled over to autos, where it focused more on “the parts of the country that were left behind in boom times.” Imagine, he suggests, how bad the negative fallout would have been in some regions “if those who said, ‘let GM and Chrysler go bankrupt’ had gotten their way.” There would have been a deep sense of abandonment while “the coastal elites, the big banks” were getting bailed out more quickly.

Moral Hazard

Government bailouts often create a moral hazard problem. Big companies can take bigger risks if they assume that a bailout will be available if needed, notes Kent Smetters, Wharton professor of business economics and public policy, and faculty director of the Penn Wharton Budget Model. When the Big Three continue to produce high-margin trucks, making them “more vulnerable” to recessions and oil-price spikes even though smaller, fuel-efficient cars are in demand, it’s possible they are factoring in an “implicit government backstop” if things turn south, he says.

“Some people were screaming about bailouts for Detroit and yet they seemed to accept as just inevitable that we should be bailing out the banks and Wall Street.” –Paul Eisenstein

Though GM and Chrysler eventually did get a bailout — Ford did not need help because it had fortuitously secured a large amount of financing shortly before the crisis — it was not all sweetness and light. GM shareholders were forced to take a big hit, and CEO Rick Wagoner had to resign as a condition for government help, Smetters explains.

If government aid is accompanied by “punitive effects on existing shareholders and executives, I am a bit less concerned about moral hazard. Going forward, however, I would make sure that creditors of too-big-to-fail firms take a larger hit. It would send a signal that counter-parties need to monitor risk as well and remove the credit-rate advantage of too-big-to-fail firms,” Smetters adds.

Morris A. Cohen, Wharton professor of operations, information and decisions, and co-director of the Fishman-Davidson Center for Service and Operations Management, thinks ultimately it’s impossible to know if the auto bailout was the correct decision. “We don’t know what would have happened if they had made the other choice.”

Some argue that limiting competition is bad — it’s better to let the market decide. Yet governments intervene all the time in their national economies, Cohen notes, producing winners and losers even though the distribution can be uneven. The bailout means some jobs were saved, but maybe consumers all pay more for our cars as a result. “It doesn’t affect my life if I have to pay another $100 for a car.” But without a bailout “if I lost my job and I’m 45 years old, that could be devastating. So the cost at the individual level … is much greater.”

Cohen suggests there are two ways to look at the question — from a company and a country point of view. Countries, ideally, try to maximize the welfare of their citizens. They do all sorts of things to accomplish that, he notes. They impose tariffs and quotas. They have restrictions on content and repatriation of profits, and various other tax policies. Companies, on the other hand, have to “optimize their global supply chain subject to the constraints and incentives imposed upon them by governments.”

The Bottom Line

But the bottom line, in his view, is that every country is trying to maximize benefits for their citizens, even if sometimes that involves helping companies. “You could argue that we are in a period of economic warfare — countries fighting against each other.” On balance, Cohen thinks it was the right decision for the U.S. government to save GM and Chrysler. “Countries feel threatened, especially high-wage countries.”

“Vehicles like the Chevy Bolt got a jump start from the policy changes that accompanied the bankruptcy.” –John Paul MacDuffie

Noting he has visited factories in Germany and Japan, Cohen asks, “How could a company survive in Germany with the highest labor costs in the world, producing a very expensive product? And they do, they thrive.” A lot of it has to do with culture, he adds, but “a lot has to do with government incentives. They do whatever needs to be done, and it is the same thing in Japan. They are fighting back. They want to preserve their economy. They want to preserve these activities for their citizens.” Both Germany and Japan have been more effective at it than the U.S. “because we have all of these debates,” such as the one over bailouts suggesting that “maybe we should do nothing?”

So while it’s impossible to know whether the bailout was the best alternative, Cohen says “you can only ask ‘where are we now?’ The auto factories are still working. We’re producing products.”

A sometimes overlooked potential consequence of taking no action was how hard that might have hit survivors — Ford and foreign firms operating in the U.S. While they may have sold more cars — although just how many is questionable if we had slipped into a real Depression — many of their suppliers would have been wiped out, potentially causing untold challenges with supply chains and competition for resources.

Faux Americana

For those less worried about what might happen to foreign carmakers in the U.S., it’s a complicated world out there. Many of those “foreign” cars made in the U.S. actually have more domestically produced parts than those made by the Big Three, according to the Chicago Tribune.

The Tribune article references a report from Cars.com noting that four of the top 10 “most American-made vehicles of 2018 are made by Japanese brand Honda.” A fifth brand in the top 10 was also Japanese. The article goes on to note that the Honda Odyssey is built in Lincoln, Ala. with 75% domestic parts. But the Buick Envision crossover is made in China, with only 2% of the parts being American. Meantime, the largest exporter of U.S.-made cars is not a U.S. company. It’s BMW of Germany, which exported nearly three-quarters of the 371,000 sport utility vehicles it made in the U.S. in 2017.

Here is another little understood notion: The preservation of GM and Chrysler has helped sustain Detroit (and nearby parts of Canada) as a highly significant center of innovation. As a source of patents and other innovations, that region now greatly exceeds many other parts of the country, even in areas of high tech, MacDuffie points out. The patents are either within that region, or they are “co-authored patents with other auto hubs in Stuttgart or Tokyo, or other parts of the world,” he says.

And while not long ago there was black humor about the last person in Detroit turning out the lights, a quiet but dramatic reversal has been underway. Detroit is now “a home for the global auto industry,” says MacDuffie. It has the headquarters of some kind from almost every big automaker and big supplier all over the world. “And there’s a tremendous amount of the next phase of technological advance that’s being propelled both from there, and of course from Silicon Valley.”

Adds Eisenstein: Even Chinese companies that may never set up shop in Detroit “have some form of operation here because of the technology.” True, they also have technology design studios in the Los Angeles or San Francisco areas. But it’s flipping around. Some Silicon Valley operations are partnering with the Detroit manufacturers and others, and setting up high-tech ventures there as self-driving cars and electric cars advance. Toyota, for example, “operates some of its biggest R&D facilities” and a huge test track in the region.

So are today’s domestic auto companies more prepared for having received the bailouts? According to MacDuffie, yes. One straw in the wind: The old guard, notably former CEO Rick Wagoner who was fired during the bailout, had been continuing the long-standing GM strategy of emphasizing market share and “pushing production at all costs, even if it meant a lot of cars put into rental fleets.” Current CEO and chairwoman Mary Barra has brought key changes that should help GM in the next recession. “She allowed GM to get smaller,” MacDuffie says. Barra is more focused on profitability and “not just volume,” and she has led the company to a lot of product innovation.

“Automakers will see more disruption in the next 10 years than in the last 50 years”  –McKinsey

The future for automakers is anything but a straight line. There are unprecedented new competitive challenges to the Big Three from upstarts like Tesla and high-tech companies dedicated to becoming self-driving car leaders. There are also structural and lifestyle challenges. Car share programs and disruptors, like Uber and Lyft, are allowing more city dwellers and others to avoid car ownership altogether, or to have one-car households versus two cars. And while 91% of adults with full or part-time jobs used their car for work or commuted to work with someone back in 2007, 10 years later the number had dropped to 83%. Working at home, mass transit use, walking and biking seemed to be taking up most of the difference.

According to a recent report by McKinsey, automakers will see more disruption in the next 10 years than in the last 50 years, driven by four factors: autonomous cars, connectivity, electrification and ridesharing. “Connectivity and autonomous-driving functionalities are creating a multitude of new business models and monetization opportunities, especially as consumers prioritize driving-related applications, such as connected navigation and networked parking, above those unrelated to driving, such as email and music streaming,” notes another McKinsey report.

Endless Disruption

So if there is one constant for the auto industry’s future, it is likely to be continual disruption. Who would have predicted, for instance, that Ford would announce in April that it would stop making most of its car models to concentrate solely on SUVs, including so-called crossovers, and also pickup trucks. It is scrapping almost all of its sedans — the Fiesta, Focus, Fusion and Taurus. Only the Mustang will survive. Ford CEO Jim Hackett announced the company “will not invest in next generations of traditional Ford sedans for North America,” all part of a $22.5 billion cost-cutting plan.

That brings back the question of whether the bailout recipients are better prepared for the future now. MacDuffie believes that some of the steps forward are impressive. “Vehicles like the Chevy Bolt out of GM — which really is a cut above pretty much any of the electric vehicles that have come out of companies other than Tesla — I think got a jump start from the policy changes … that accompanied the bankruptcy.” So part of the result of the bailout was getting out of a crisis, he adds, but there was a piece “seen as opportunity to nudge these companies towards some new kinds of behavior.”

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