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The Gm Bailout Essay

1. Introduction

The moon is an orbital albino, and it gets tons of sunlight, so I propose Operation Sunscreen, where astronauts coat the surface of the moon with a protective layer of sunscreen. If you care about albinos and the environment, you’ll see this is a good idea. And hey, it’s a better use of taxpayer funds than bailing out private banks.
 ― Jarod Kintz

Bailing out people who made ill-advised mortgages makes no more sense that bailing out people who lost their life savings in Las Vegas casinos.” ― Thomas Sowell

Those two, rather cynical, quotes on bail outs reflect how most American economists think of those. It’s not a bail out from prison they mean, it is the consciously directed spending of tax money to save a company that is about to go bankrupt because of reasons as bad governance or economic-misplaning. It is easy to judge, it always was, but how ethical is the judgment? How ethical is the action itself? What moral right and justification does a company have to ask for money from the Government? And how should the Government reply? We would like to discuss this issue in the following case – at the Example of the Bail out of General Motors by the US Government.

2. The Phenomenon

A bailout is a colloquial pejorative term for giving a loan to a company or country which faces serious financial difficulty or bankruptcy. It may also be used to allow a failing entity to fail gracefully without spreading contagion. A bailout could be done for mere profit, as when a predatory investor resurrects a floundering company by buying its shares at fire-sale prices, for social improvement, as when, a wealthy philanthropist reinvents an unprofitable fast food company into a non-profit food distribution network. The bailout of a company might be seen as a necessity in order to prevent greater, socioeconomic failures. Bankruptcy is a legal status of an insolvent person or an organisation, that is, one who cannot repay the debts they owe to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor.

It is not the only legal status that an insolvent person or organisation may have. The principal focus of modern insolvency legislation and business debt restructuring practices no longer rests on the elimination of insolvent entities but on the remodelling of the financial and organisational structure of debtors experiencing financial distress so as to permit the rehabilitation and continuation of their business. It is important to assess the underlying problems and to minimise the risk of financial distress to re-occur.

Financial crisis of 2007 / 2008

The financial crisis of 2007–2008 is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. It resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market also suffered, resulting in evictions, foreclosures and prolonged unemployment. The crisis played a significant role in the failure of key businesses, declines in consumer wealth estimated in trillions of US dollars, and a downturn in economic activity leading to the 2008–2012 global recession and contributing to the European sovereign-debt crisis. The active phase of the crisis, which manifested as a liquidity crisis, can be dated from August 7, 2007 when BNP Paribas terminated withdrawals from three hedge funds citing “a complete evaporation of liquidity”. The recent market instability was caused by many factors, chief among them a dramatic change in the ability to create new lines of credit, which dried up the flow of money and slowed new economic growth and the buying and selling of assets.

This hurt individuals, businesses, and financial institutions hard, and many financial institutions were left holding mortgage backed assets that had dropped precipitously in value and weren’t bringing in the amount of money needed to pay for the loans. This dried up their reserve cash and restricted their credit and ability to make new loans. There were other factors as well, including the cheap credit which made it too easy for people to buy houses or make other investments based on pure speculation. Cheap credit created more money in the system and people wanted to spend that money. Unfortunately, people wanted to buy the same thing, which increased demand and caused inflation. Private equity firms leveraged billions of dollars of debt to purchase companies and created hundreds of billions of dollars in wealth by simply shuffling paper, but not creating anything of value. In more recent months speculation on oil prices and higher unemployment further increased inflation.

The American economy is built on credit. Credit is a great tool when used wisely. For instance, credit can be used to start or expand a business, which can create jobs. It can also be used to purchase large ticket items such as houses or cars. Again, more jobs are created and people’s needs are satisfied. But in the last decade, credit went unchecked in our country, and it got out of control. Mortgage brokers, acting only as middle men, determined who got loans, then passed on the responsibility for those loans on to others in the form of mortgage backed assets. Exotic and risky mortgages became commonplace and the brokers who approved these loans absolved themselves of responsibility by packaging these bad mortgages with other mortgages and reselling them as “investments.”

Thousands of people took out loans larger than they could afford in the hopes that they could either flip the house for profit or refinance later at a lower rate and with more equity in their home, which they would then leverage to purchase another “investment” house. A lot of people got rich quickly and people wanted more. Before long, all you needed to buy a house was a pulse and your word that you could afford the mortgage. Brokers had no reason not to sell you a home. They made a cut on the sale, then packaged the mortgage with a group of other mortgages and erased all personal responsibility of the loan. But many of these mortgage backed assets were ticking time bombs.

And they just went off. Many financial institutions that are saddled with risky mortgage backed securities can no longer afford to extend new credit. Unfortunately, making loans is how banks stay in business. If their current loans are not bringing in a positive cash flow and they cannot loan new money to individuals and businesses, that financial institution is not long for this world. The idea behind the economic bailout is to buy these risky mortgage backed securities from financial institutions, giving these banks the opportunity to lend more money to individuals and businesses, hopefully spurring on the economy.

General Motors (GM) is the second largest automobile manufacturer in the world. Since the year 2000 Rick Wagoner is the youngest CEO of GM. However, the last years GM had several problems. To be more accurate, Wagoner blames the following aspects as reasons of the misfortune of GM. First of all, the Great Recession in 2008 is a big reason for the failure. Due to this recession the whole sales, especially the ones of the automobile industry, decreased. Secondly, the labour costs, are blamed for the misfortune of GM. The company is paying 70 US$ per working hour. 30 US$ are received by the workers, the other 40 US$ are paid due to other labour costs. It involves the health care, worker’s benefits and the pensions of about 432,000 GM retirees. Compared to other automobile manufacturers, the number of retirees and the labour costs for these are too large.

Thirdly, the most important aspect is that GM concentrated on the SUV (sport utility vehicles) sector. Not only because of the expensive production costs, but also due to the fact, that the demand of SUV`s had decreased in the last years (due to rising gasoline prices), it was a matter of time to fail. The whole strategy, the plants and the research and development programs are laid out to SUV’s. Last but not least, GM underestimated hybrid and electric technology in the last years. Even though they had first mass-produced electric car, GM cancelled the production in 2002 due to a lack of demand. These and other aspects lead to a loss of 80 billion US$ in total and placed GM in a difficult situation. Without external money, GM would become bankrupt.

3. The theories / the literature

3.1 Different economic theories

Adam Smith – The Wealth of Nations

Markets should be free of governmental interventions and be based on mutual self interest. Markets are driven to the public good by the ‘invisible hand’. The invisible hand is a metaphor that suggests, that if there is a market error, the market will heal itself and find the way back to equilibrium itself. In a free market demand and supply are always ideal; there are no monopolies or oligopolies. The state only creates a regulatory frame for the market, it does not intervene or control.

John Locke

Governments should play only a limited role in markets. Human beings have “natural rights” that only a free market system can protect. Natural rights are the Right of Freedom and Right of Private Property. The Government only serves to protect citizens’ natural rights which are endangered in the state of nature.

K. Marx & F. Engels – The Communist Manifesto

Capitalism promotes unjust inequality; workers are not paid the full value of their labor, only what they need to subsist. Private ownership of the means of production is the source of the worker’s loss of control over work, products, relationships and self. Productive property should serve the needs of all and should not be privately owned.

The state of the Proletariat will gradually worsen as the Bourgeois will exploit them. This will lead to a clash, the Proletarians of the world will unite overcome capitalism through socialism and finally reach communism, which is the final state of the world.

3.2 How would Locke, Smith and Marx evaluate the various events in this case?

Event 1: GM applying for money out of the TARP funds

* Locke: The owners of GM have a right of property, but at the same time they are responsible for this property. If the company is suffering from huge losses because the owners didn’t act responsibly, they have no right to ask for the government’s help. * Smith: Smith would totally disagree with the fact that GM asks for money from the U.S. Government. Smith believes in the idea of a free-market with no governmental interference.

* Marx: Karl Marx would disagree with the fact that GM (investors) asks for money from the U.S. Government (citizens). The fact that the investors already spend the money on shares, lost the money and now asks for new money to cover up their losses is totally against the idea of a fair distribution of wealth. In this case the bourgeoisie suppresses the proletarians and Marx wants to free the proletarians. He was against the idea of social hierarchy. Event 2: The U.S government approves the loan money out of the TARP funds

* Locke: The right of freedom and property is violated, because the tax payers did not agree with GM borrowing money from the government. The bill didn’t pass the senate, so it’s indeed a violation of both rights. * Smith: Smith would disagree with the fact that the U.S. government approves the loan out of the TARP funds. This is because of the reason given above and besides that, it is conflicting with the whole idea of the American economic system which he supports. Smith believes in the invisible hand theory which states that markets will heal itself. Companies fall while others are rising and this is part of a well functioning economy.

* Marx: On the one hand the U.S. Government uses tax money to save the bourgeois company. On the other hand proletarian workers are saved from unemployment. In socialism government is obliged to provide a job for each citizen. There is no unemployment.

Event 3: The U.S. Government owning 61% of the shares of GM

* Locke: The fact that the U.S. Government owns 61% of GM shares violates Locke’s theory. Locke would state that the right of property is violated because the government took it away from the investors. The right of property is important in his theory. * Smith: Smith would again disagree with the fact that the U.S. government owns 61% of GM’s shares. Governments should not interfere in economic systems and should not own any part of a company. * Marx: He would approve this but he would prefer to see that the government owns 100% of the shares. Marx believes that property should be owned by the people and not by the private few. Since 10% of the shares are still left with the old shareholders, Marx would see this as an oppression of the proletarians by the bourgeoisie.

4. The Reality

Due to the above mentioned difficult situation Wagoner, the CEO of GM, asked for loans of the Troubled Asset Relief Program (TARP), which are used for banks normally. Even though government bailouts were not popular, especially in the automobile industry, hundred leading economics wrote a letter to the U.S. congress. In addition the three CEOs of GM, Chrysler and Ford have asked for loans and argued with the potentially decreasing GDP. Due to no particular plans concerning neither the use of these funds nor the strategic improvements, the U.S. rejected the requests first. GM had to improve their plans before receiving funds. In December 2008 the Bush administration decided that the U.S. Treasury can use the TARP fund to help GM and other automobile manufacturer. GM received consequently funds of about 13.4 US$. Before receiving the money, the U.S. Treasury wanted GM to present a detailed plan on how to use the money and how to achieve “financial viability”.

Barack Obama cancelled the bailout and wanted GM to reduce its labour costs, the models and numbers of cars to be competitive worldwide. The automobile manufacturer could not fulfil these claims but wanted to cut 37,000 blue-collar and 10,000 white-collar jobs, close 14 plants within three years, cut manager salaries by 10 % and other salaries by 3-7 %.

However, GM still needed 22.5 billion US$ to survive the year 2011. Due to the current situation, Obama put together the so-called “Team Auto” which studied the plans and assumptions of GM within a month. The result was that GM had to file for bankruptcy in 2009. The U.S. Treasury created a new brand “General Motors Company”, which belongs to 61 % to the U.S. government, 12 % to Canada, 17 % to a trust and to10 % to the old creditors. The new “General Motors Company” has bought the most profitable brands and plants of the “old” GM by using 30 billion US$ of the government.

5. Conclusions/Decisions

We believe that the bailout should have been done, because the costs to society are likely to be higher without the bailout than with the bailout. Without the bailout GM would not have been able to borrow money from the banks and it would have gone bankrupt. GM employs more than 200,000 workers and finances more than 400,000 retirees. As such its bankruptcy would directly harm millions of people. It may also seriously distress the stock market and economy as a whole. Moreover, GM has been a largely profitable company for many years. If the company can reorganize itself the government may start earning a profit in the future. Was the bailout ethical in terms of …?

* …Utilitarianism: probably, because the costs to society of not rescuing GM are probably higher than the costs of the bailout (see my opinion). * …Justice (looks how benefits and burdens are distributed among people): not ethical from a distributive justice viewpoint because the managers of GM were allowed to enjoy its profits during its healthy years while the taxpayers have to bear the losses. As Nobel prize-winning economist Joseph Stiglitz puts it: “the profits are privatized and losses are socialized.” Also not ethical from a retributive justice viewpoint because the managers are not held responsible for the wrong decisions they have made, for example the choice to lock GM into the SUV market. * …Rights (looks at individual entitlements to freedom of choice and well-being): because government money is the citizens’ money, their right of freedom of choice may be violated here because the citizens cannot choose whether to bailout GM or not. In this sense the bailout is not ethical in terms of rights.

However, the bailout may defend GM’s employee’s right of well-being as they can maintain their salary. * …Caring: when caring about the employees or people who are otherwise dependent on GM the bailout seem ethical. However, when caring about citizens in general it may not be ethical because the profits of GM were not redistributed to citizens either. We scrutinize the situation when a big company is going bankrupt. There are mostly two opportunities for the government. The first one, as we see in this case, is to rescue the company with money from the state and so from its citizens. This happened also in other cases like the bankruptcy of the banks Bank of America Corporation, Citigroup Inc. or the investment banking group Goldman Sachs. Which are all avoid the insolvency by funds of the state.

The pros and cons of this way of rescue is mentioned above. The other opportunity is to let go the tarnished firms bankrupt. This happened when the Italian dairy and food corporation Parmalat. The cost of this bankruptcy have been bear by the stakeholders and the lenders. After his bankruptcy the company set up again. Therefore the most employees didn’t lose his job and the financial loss had mostly the group of people which have earned interests for years.

In our opinion it is very critical when companies are growing that high, that they are to big to fail. Which happens when companies esp. financial institutions that are so large and so interconnected that their failure will be disastrous to the economy, and which therefore must be supported by government when they face difficulty. So they can lend money on favourite terms because the state have to guarantee for this institution and give them money as a lender of last resort.

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