As I write, the United States has seen two major
developments. First, the US Treasury bailed out
Citigroup: a handout of $20 billion plus government
guarantees to cover $306 billion of toxic assets.
Second, the Detroit automakers — General Motors,
Ford and Chrysler — have been camping at Washington
DC to lobby Capitol Hill for a $25 billion dole
without which, they claim, there will be bankruptcy
and mass unemployment.
By the time you read this, President George Bush may
have caved in to Detroit’s demands. So, too, may the
US Congress. The automakers certainly have history
on their side. Some 29 years ago, when Jimmy Carter
was the President and the US was reeling under the
second oil price shock, Lee Iacocca of Chrysler went
to Washington with a begging bowl. On 21 December
1979, after putting tough conditions, the Congress
passed The Chrysler Corporation Loan Guarantee Act.
It was a government guarantee worth $3.5 billion to
allow Chrysler to borrow from the market with the
backing of the Federal government. The economy
recovered thereafter; Iacocca introduced two small
cars that took the US by storm; Chrysler returned
the money in 1983; and the US government earned $350
million profit on this transaction. Detroit will
certainly refer to the honourable repayment of 1983
to make their case.
The more important reason why Detroit may get the
cash is that US lawmakers care more for the plight
of blue collared workers and the regular Joes than
the Zegna suited-Salvatore Ferragamo tied-Tod shoe
wearing fat cat bankers of Manhattan. If those guys
can get billions of dollars of government money
because their banks are too important to fail, then
why not save the livelihood of 500,000 auto workers?
They are the Main Street of real America; they have
more voting power; and they will feel the effects of
job loss much more deeply than a laid off investment
bankers. It is indeed a powerful emotive and
political economy argument.
However, it is wrong economics. I have no sympathy
for Manhattan’s bankers whose greed and imprudence
have got us into the God forsaken mess. Left to
myself, I’d love to see a large number of them truly
suffer the pains of unemployment, instead of
forsaking their next Porsche. But, there is a clear
logic for bailing out large banks and financial
institutions; just as there isn’t one for the
automakers.
Banks have what economists call externalities. It
means that the ripple effects of a major bank
failure are too large to countenance. These
externalities are truly massive. If a bank is feared
to fail, it will immediately cause a run on
deposits; completely freeze all counter-party
transactions; shut corporate lending; and, like
dominos, affect a slew of other banks and financial
institutions as well. If Citigroup tanked, it would
be the mother of all financial So, much as one
dislikes the avarice of well heeled bankers, we must
accept that big banks have to be bailed out. The
alternative will be devastating for the global
economy.
Automakers or airlines are different. The US has an
efficient and quick corporate bankruptcy
reorganisation process under Chapter 11. Companies
facing bankruptcy seek protection from the court
which orders an immediate stay on the creditors’
dues; creates a committee comprising of creditors
and management to prepare a financial, operation and
business reorganisation plan; induces all claimants
to take appropriate write-downs; forces
restructuring and downsizing; and then gets everyone
to sign on to the plan. More often than not Chapter
11 works. It forces reduced pay; lower workforce;
greater efficiency; right-sizing; and makes equity
take the maximum hit, as all risk capital must in
bad states. Most companies that exit Chapter 11 do
so stronger than before.
Chapter 11 is the logical place for the automakers.
However, having seen the bank bailouts, the Detroit
trio think they have a fair chance of garnering
taxpayers’ goodies. It will be wrong to bail them
out. It will open the floodgates for other
industries; and will signal to the world if times
are bad enough, even systematically poor management
can get rewarded by dole. The US government should
force the three to go to Chapter 11. It can help
with some guarantees at the time of Chapter 11
restructuring, if needed. But it can’t give a cheque
for $25 billion and let equity off the hook.
What kind of logic is this? Bankers escaping while
autoworkers are punished? The answer: many bankers
should have been fired when the doles were handed
out, and their bonuses eliminated. It hasn’t
occurred — maybe due to the US Treasury Secretary’s
own pedigree. But yet another wrong can’t make a
right. Fire the most errant bankers; freeze the
salaries of others; but draw the line somewhere. Let
Detroit go to Chapter 11.
Published: Business Standard, November 2008