Detroit deserves stern treatment
It may seem like the government is taking a heavy hand with the Big Three automakers, but it's fairer than it looks.
(breakingviews.com) -- The U.S.'s treatment of domestic car makers must leave Motown feeling hard done by.
After all, Bank of America (BAC, Fortune 500) and Citigroup (C, Fortune 500) have each received more than double the amount of direct government aid than Chrysler and General Motors have between them. Yet neither megabank is staring enforced bankruptcy in the face. But in fact, Detroit does call for a more heavy-handed approach from Washington than Wall Street.
Sure, Motown can point to some egregious bailout examples in the financial sector that seem to confirm favoritism, especially the $180 billion handed to American International Group in several installments and apparently with few questions asked - a mountain of taxpayer money that is highly unlikely to be repaid in full. And banks are guilty of excesses that need taming, including pay mechanisms that rewarded excessive risk-taking.
The AIG (AIG, Fortune 500) fiasco shouldn't be seen as a model to follow. And most other financial firms are far from getting away scot-free. Some mostly smaller ones have been allowed to fail. For others, the precipitous drop in the sector's stock prices has slammed shareholders, including employees. And some 430,000 finance jobs have been lost in the last two years, according to outplacement company Challenger, Gray & Christmas.
Of course, stakeholders in Motown's manufacturers can point to similar pain and sacrifice. And both industries can claim that illiquid credit markets are really to blame for their trouble.
But letting a big bank fail can have a bigger and much more immediate effect on the economy, as the collapse of Lehman Brothers proved. GM (GM, Fortune 500) spun the line that its bankruptcy would have similar ramifications - but executives have since dropped that argument. In any event, the government has already taken steps to help alleviate the consequences by guaranteeing warranties and setting up a program to backstop payments to suppliers by Detroit's Big Three.
Fear of the domino effect of a bank collapse isn't the only factor driving the different approach, though. Financial firms have much more flexible cost structures: they can shed staff and office space quickly to help restore profitability. GM's most recent restructuring plan, on the other hand, had a five-year time frame - and the writing has already been on the wall for Detroit's broken business model for at least five years.
Also, as liquidity returns, some financial asset prices should recover, meaning banks might recoup some of their losses. Chrysler and GM cannot pull that trick with car sales - in fact, they usually offer discounts to shift any excess inventory, which increases their pain.
That means GM and Chrysler are less likely to be able to pay back the government than most banks - in fact, a handful of smaller firms already have, while the likes of Goldman Sachs (GS, Fortune 500) and JPMorgan (JPM, Fortune 500) would like to once the Treasury's stress tests are completed.
The government should make sure those tests are tough enough. But overall, the intractability of Detroit's problems justifies the sterner treatment. It might sound harsh, but it's fairer than it looks.