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The Auto Bailout: Too Risky an Investment

General Motors’ bonds are currently yielding a whopping 56 percent. But with the interest rate on U.S. government bonds paying close to 0 percent, are people rushing out to buy these General Motors’ bonds? Do people really think that this is a great way to make a killing? Hardly.

General Motors’ high interest rate means one thing: investors who have their money on the line don’t believe that these bonds will get paid off. In fact, this interest rate is so high that investors don’t even believe that General Motors will make it to Christmas two years from now without declaring bankruptcy -- a bankruptcy where bondholders would get little or nothing back.

The extraordinarily high interest rate shows that a bailout obviously won’t fix the problem. This 56 percent was the rate at the market close on Friday. But by Friday morning, President Bush already indicated that he was reversing course and would use the money for the financial market bailout to help out the auto companies. President-elect Obama and the Democratic congressional leaders have promised that they aren’t going to let the car companies go under.

If these guarantees come true and a bankruptcy is avoided, people who bought bonds today would make a lot of money. Where else could you get this type of return?

The irony is that General Motors will probably be better off going bankrupt and it is probably better to do so sooner than later. For example, while Toyota has fewer than 1,500 dealers, GM has almost 7,000, but it can’t terminate dealers because of state regulations. Bankruptcy would also allow GM to get out of many contractual obligations to unions, such as the notorious “jobs bank” program where laid-off union workers are paid not to work.

Letting the government run GM or Ford and Chrysler with the proposed "car czar" seems guaranteed to ensure that these companies will not return to profitability. Just take the recent debate over micromanaging the companies in Congress. Automobile executive wages will be regulated, but the notion that GM workers get paid the same amount as workers employed by Toyota and Nissan is deemed unacceptable and rejected out of hand.

In the past, when governments around the world have bought an ownership stake in companies, the desire to run firms efficiently goes out the window. Studies consistently find that even partial government ownership reduces firm profitability.

An all too typical example involves Airbus, the giant European aircraft maker. Germany, France, and the U.K. all-own shares in the company. That means that manufacturing plants and jobs are not distributed in ways that make the most sense economically, but so as to ensure that each country gets its “fair” share of the high-paid jobs, subsidized with taxpayer money.

Take a newspaper article describing Airbus’ production process:

"The contribution of the United Kingdom taxpayer alone towards the A380 program is 530 million [British pounds]. In return for that, Broughton [in England]...got to make the wings. But it also means that each completed set of wings has to make a remarkable journey to the final assembly site in France by way of container ship, river barge and specially adapted road trailer. With the main fuselage having to travel from Germany and the tailfin from Spain, no wonder Christian Streiff, the man who was drafted in to head Airbus in July [2006], commented that there must be a simpler way."

Putting the wing factory next door to where the fuselage was made would have saved a lot of money -- money that could have paid higher wages or encouraged more investments and expanded production. Governments could even have taxed away those savings and used them for everything from education to medical care. But politically it was more important that certain constituencies get particular jobs.

The notion that American politicians are going to be able to divorce their decisions from political considerations is romantic. Democratic Rep. Steve Kagen of Wisconsin voted “no” on the bailout because he wanted Cerberus Capital, the majority owner of Chrysler, to sell two paper mills that it owned in his congressional district. It is common practice for politicians to push for military projects that are built in their congressional district regardless of whether the projects make sense.

Democratic Congressman Barney Frank of Massachusetts, chairman of the House Financial Services Committee, when questioned about the auto company bailout during a 60 Minutes interview on Sunday with CBS, was quite clear what the bailout really amounts to: "Yeah, I’m for welfare. You’re not? Are you for letting people starve?"

The notion in Europe, and now apparently the United States, is that there are so many jobs out there that must be preserved. Fortunately, this wasn’t the policy during the horse and buggy days. What is forgotten is how much wealthier a country can be if people are producing products that consumers value, and that they are being produced as efficiently as possible.

Here is one question to ask Bush, Obama, and Democratic members of Congress who overwhelmingly support the bailout: how much of their own money are they investing in buying General Motors’ bonds? Presumably, the answer is: nothing. It is just too risky an investment.


John Lott is the author of Freedomnomics and a senior research scientist at the University of Maryland.

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