Thursday, November 13, 2008

Thoughts on the Detroit bailout (2)

The more I think about it, the more I'm intrigued by something I said on this issue yesterday. In short, the problem with Detroit can't be fixed with a bailout or with loans or with infusions of capital, because Detroit's biggest problem is the UAW and absurdly high labor costs. The unions seem determined to cling to these high costs, even as the Big 3 slide towards irrelevance. But this doesn't mean that the Detroit auto industry has to go down a black hole. They could all declare bankruptcy, sell their assets to some Japanese automaker, and the plants could reopen in days and rehire everyone at a competitive wage.

This is very similar to the housing/subprime crisis. Houses are worth less than their owners owe, so eventually a lot of those owners will stop paying and their homes will be sold in foreclosure, or if they are lucky their banks will reduce the amount they owe so that once again they have an incentive to pay. The painful part of all this is that someone has to eat the losses. In the case of Detroit the auto workers are going to eventually have to accept lower wages. In the case of the housing market, lenders will have to accept losses on the loans they hold (a process that is well underway). But once these losses have been accepted, the assets are effectively redeployed. New owners can buy homes they can afford, while those who get debt relief can continue to live in their house and have hopes of building equity again. Most importantly, life can go on. No homes are destroyed, and no jobs are destroyed. Some wealth is destroyed, but even if the losses on homes with subprime mortgages in the US total $1 trillion, that is a drop in the bucket compared to the $50 trillion or so of households' net worth.

Please leave comments if this piques your interest.


Gene Prescott said...

I would suppose there would be a domino effect as the lower paid jobs ripple through. That is, many of the auto workers have commitments geared to the higher wage level. Thus a job at 2/3 of their current salary will change what they can afford, which for some will include their current home mortgage.

I agree with your premise, just noting that the auto workers will encounter a lot of personal disruption.

Red River said...

The Big 3 automakers are looking a a backlash if they take any bailout money.

I plan to go buy a Toyota or Nissan if this does occur.

Scott Grannis said...

gene: those workers are going to either lose their job entirely or keep working at a lower wage. Either way they will be spending less, so you can't avoid the ripple effect. Better to get it over with quickly in my view. It's like getting into very cold water. You can do it a little bit at a time and suffer for a long time, or jump in and really suffer but only for a minute. Autoworkers can't avoid the inevitable.

Scott Grannis said...

red: If you're right, and I think you are, that would be actually encouraging since it would speak well of the public's ability to understand the reality of the situation. And it would be one more piece of evidence that our politicians shouldn't be trusted with so much power.

The Therapist Is In said...

thinking about buying a big fat suv from a blown out hedge fund trader at 0 percent financing, what do u think? I don't even like suv's.

Mark Gerber said...

I feel a large, cultural problem exists within US Auto makers that has been neglected for decades: sub-par engineering.

I am an engineer and have never been a union member, but I am generally agnostic when it comes to Unions. Based on the data, perhaps the US Auto makers are at a competitive disadvantage because of higher labor costs. However, we also know they are at a huge disadvantage due to legacy costs with medical being a big portion of that. I believe the biggest long term problem, however, has been subpar quality, and that is far less the workers fault than the engineers and management.

In the simplest terms, I believe these companies have a culture that rewards creativity over quality. The diligent american engineer that labors over boring details of long term quality simply does not get as much reward and respect as other engineers. The top engineering students first choice isn't likely to be manufacturing engineering or quality engineering but the more glamorous and lucrative R&D engineering.