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Will Henry Paulson Sink Detroit?

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Dean Baker
Talking Points Memo, November 20, 2008

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Henry Paulson's main claim to fame is getting just about everything wrong in his tenure as Treasury secretary. However, he now stands to gain lasting notoriety as the person who destroyed the domestic U.S. auto industry, and the economies of the Michigan, Ohio, and Indiana along with them.

The story is that the big three automakers are struggling with record sales declines. This collapse in car sales in turn is the fallout from the collapse of the Greenspan-Bernanke housing bubble. While the domestic automakers have been hit hardest, all manufacturers have seen sharp drops in sales. Toyota's sales were down 23.0 percent compared with its year ago levels. Honda's sales were down 25.2 percent, and Nissan's sales fell 33.0 percent.

These huge plunges in year over year sales by the world's top car manufacturers can't be blamed on the industry. Responsibility for this plunge lies with Mr. Paulson and other economic policy makers, and their Wall Street friends.

The basic arithmetic is simple. General Motors saw its sales fall by 45 percent compared to its year ago levels. That means its revenue has been cut nearly in half. While it has made some reductions in employment and can ease back its production, there is no way it can reduce its expenses by the same amount. Many of its expenses, like interest costs, property taxes, and health insurance for retirees are largely fixed independent of short-term fluctuations in output.

As a result, General Motors is now losing close to $2 billion a month. At this rate, it will burn through its capital in around 2 months and be forced into bankruptcy. Chrysler and Ford are in somewhat better shape, but the basic story is the same. Furthermore, the fallout from a GM bankruptcy could sink Chrysler and Ford as well, as common suppliers shut down and credit for the industry vanishes and customers flee to manufacturers with longer life expectancies.

There have been analysts, presumably including Henry Paulson, who think that bankruptcy is a reasonable solution for the auto industry. This is yet another of Mr. Paulson's famous mistakes. (Remember, this guy missed the housing bubble completely, thought its impact would be small when it burst, didn't see a problem with letting Lehman Brothers fail, and thought the TARP [RIP] was a good idea.)

Bankruptcy would allow GM, Ford, and Chrysler to more quickly cut back their bloated dealer networks and adjust their car lines with current market demand, as its proponents claim. Bankruptcy would also void union contracts, which will thrill the millionaire bankers by forcing workers earning $57,000 a year to take pay cuts. And all those lazy retirees will see the health care benefits that they worked for taken away.

That's the good part. Realistically, bankruptcy is likely to kill all three manufacturers, taking down much of the region's economy with them.

First, some folks may recall the credit crunch. Lenders are extremely reluctant to take risks. In the absence of government guarantees, it is unlikely that any banks will step forward to provide GM and the others the money they need to keep operating in bankruptcy. In other words, bankruptcy is very likely to mean a complete shutdown of the Big Three.

Let's say that the anti-bailout crowd suddenly gets a soft spot and decides to guarantee loans to the firms operating under bankruptcy protection. There is still the problem of selling cars. Customers will be very reluctant to buy cars produced by a manufacturer in bankruptcy, since they won't know if a dealer and supplier network will exist in 3 or 4 years so that they can get their car serviced and buy replacement parts.

While people don't mind flying an airline in bankruptcy, buying a car is to some extent an investment in the company. Many fewer customers will be willing to invest in a bankrupt car company.

But let's assume that the investment financing is arranged and that customers are still willing to come through the doors. The bankruptcy itself is still likely to be devastating to the economies of Michigan, Ohio, and Indiana, the three states where Big Three employment is concentrated.

Bankruptcy protects the firm from its creditors. The creditors of these firms are thousands of suppliers who are heavily concentrated in the same states. In most cases, the Big Three manufacturers were their major customers. These suppliers have already been squeezed by falling demand and lower product prices. If they cannot collect the money owed them by the Big Three, there will be a whole chain of secondary bankruptcies.

The impact in these states is potentially huge. According to the Center for Automotive Research, auto related employment accounts for almost 7 percent of total employment in Michigan, 6 percent in Indiana, and 5 percent in Ohio. Losing 7 percent of total employment in Michigan would be equivalent to losing more than 9 million jobs nationwide.

That is Mr. Paulson's latest plan for the auto industry and these three states. This will be quite a legacy.

There is one last point that should really gall just about everyone. Mr. Paulson has argued that he does not have the legal authority to use the money appropriated for TARP for bailing out the auto industry.

This claim is outrageous for two reasons. As many of us who opposed the TARP argued, it gave Paulson a virtual blank check, and that is pretty much how he has interpreted it, using the money to bail out a wide range of non-bank institutions.

The other reason why this is so galling is that this is an administration that has taken pride in claiming virtually unlimited powers in a wide range of areas, including the conduct of war and holding of prisoners without charges or trial. It would be incredible if they allow Detroit to sink because they claim that they don't have the legal authority to save it.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer. He also has a blog on the American Prospect, "Beat the Press," where he discusses the media's coverage of economic issues.