Objects in Mirror Are Closer Than They Appear

Visual acuity improves with hindsight. Still, it's hard to understand how American automobile manufacturers let their situation deteriorate to the point of crisis. The auto industry's woes are a replay of the collapse of the domestic steel industry in the 1980's. As John Hoeer documented in And the Wolf Finally Came – The Decline of the American Steel Industry, self-serving, short-sighted behavior by management and the union is bad for business. Both parties functionally ignored the obvious challenge that foreign steel manufacturers presented. By the time the steel industry and the United Steelworkers were done fighting over concessionary contracts, the game had changed.

More than 350,000 steel industry jobs have disappeared since 1977. Since the 1980's, most of the losses have been due to automated manufacturing processes that have multiplied productivity.

Profits for steel makers are closely tied to the numbers of autos sold. Automobile production costs reflect the price of steel. As domestic steel companies endured bankruptcy, reorganization, and fought for trade regulation, the Big 3 was there, watching from a front row seat.

Many Americans, including the Republican side of the U.S. Senate, believe that a $14 billion loan is not the best avenue to avoid a Detroit debacle. Some analysts believe otherwise. Parallels between the decline of domestic steel and auto companies don't necessarily translate into the same prescription for survival. Comparing the auto industry's plight to steel, the Pittsburgh Post-Gazette's Len Boselovic recently wrote:

Even when the steel industry hit bottom, a few stable producers remained standing that had enough staying power to acquire their fallen foes, such as U.S. Steel's $1.3 billion acquisition of National Steel. Also, a major financial buyer emerged: financier Wilbur Ross, who lined up credit to purchase Bethlehem, LTV Steel and Weirton Steel.

The Big 3 have attracted some private capital in recent years, with Cerberus Capital Management acquiring a controlling stake in Chrysler last year for $7 billion. But there is no private source of capital to fund their way out of the recession now.

Boselovic interviewed Scott Paul, of the Alliance for American Manufacturing, who warned of far-reaching effects if General Motors, Chrysler, or Ford goes under:

The Washington, D.C.-based policy analyst said the auto industry has a much larger economic footprint than steel. Including dealers and parts suppliers, it employs more than 1.5 million workers, spends $156 billion annually on parts, materials and services and supports as many as one in 10 U.S. jobs. Car manufacturers are the biggest customers for steel, plastics, electronics and computer chips.

Today, the House of Representatives passed a bill to aid GM and Chrysler. Ford Motor Company does not face short-term liquidity problems, but supports loans to the other car companies.

The Senate will take up the issue on Thursday. Although President Bush favors the loan legislation, it's not likely to get to his desk in it's present form.

TARP Reaches From Pittsburgh to Cleveland

The Troubled Asset Relief Program (TARP)-funded acquisition of Cleveland based National City Corporation by PNC Financial Services Group, Inc., of Pittsburgh, will be a template for government intervention in the credit crisis. Len Boselovic of the Pittsburgh Post-Gazette and Thomas Breckenridge of The Plain Dealer reported on the $5.6 billion deal in Sunday's P-G. The U.S. Treasury is supplying PNC with $7.7 billion to support the National City bailout. From the article:

Cleveland's economy is suffering because National City and other banks have restricted credit, said Raj Aggarwal, dean of the University of Akron's business school. He was stunned by the number of businesses who said they couldn't get credit.

"To me, that's exactly the kind of thing we don't want, as a nation and as a banking system," Mr. Aggarwal said.

In an interview with the business staff at The Plain Dealer, National City CEO Peter Raskind was clear that agreeing to the acquisition was a difficult, but necessary decision:

A National City doing business at less than full octane, you've got to question how helpful is that to the community? How helpful is that to employees? That's the frame of reference that I'm thinking about versus a strong and healthy and a perceived to be strong and healthy institution.

Reasonable people could disagree on this. That's why I made the comment that I did. And let me be clear about this, because I haven't actually said this, so I will: I feel terrible about this.

I mean, let's be clear. There's no ambiguity about that. I feel terrible about this. That's why I couldn't get through the employee meeting this morning without stopping every sentence or two. There's no debate about that.

Mr. Raskind isn't the only one that feels terrible about the deal. Quoting again from the Post-Gazette:

"Without regard to the economic and psychological impact on our community, Treasury made a coldly calculated decision to push National City off the cliff and use our tax dollars to help another bank scrape up the remains," said U.S. Rep. Dennis Kucinich, a Cleveland Democrat who voted against the bailout.

U.S. Rep. Steve LaTourette, R-Cleveland, said Congress should have given Mr. Paulson and other regulators a blueprint on how to use the $700 billion instead of letting the Treasury secretary "play God."

"He has picked winners and losers," Mr. LaTourette said. The first winner he picked was Goldman Sachs, where he came from. ... The chickens have come home to roost in Cleveland in a horrible way."

The addition of National City offices will expand PNC operations into the Midwest, and make it the fifth largest bank in the U.S.

The Lady or the Tiger, 2008

In a televised address on Wednesday evening, President Bush explained why the $700 billion bailout of major financial institutions had to be implemented quickly to preserve "America's overall economy." The President said that:

The government's top economic experts warn that, without immediate action by Congress, America could slip into a financial panic and a distressing scenario would unfold.

He explained the administration's plan:

It would remove the risk posed by the troubled assets, including mortgage-backed securities, now clogging the financial system. This would free banks to resume the flow of credit to American families and businesses.

Any rescue plan should also be designed to ensure that taxpayers are protected. It should welcome the participation of financial institutions, large and small. It should make certain that failed executives do not receive a windfall from your tax dollars.

[…]

First, the plan is big enough to solve a serious problem. Under our proposal, the federal government would put up to $700 billion taxpayer dollars on the line to purchase troubled assets that are clogging the financial system.

In the short term, this will free up banks to resume the flow of credit to American families and businesses, and this will help our economy grow.

Second, as markets have lost confidence in mortgage-backed securities, their prices have dropped sharply, yet the value of many of these assets will likely be higher than their current price, because the vast majority of Americans will ultimately pay off their mortgages.

The government is the one institution with the patience and resources to buy these assets at their current low prices and hold them until markets return to normal.

And when that happens, money will flow back to the Treasury as these assets are sold, and we expect that much, if not all, of the tax dollars we invest will be paid back.

The final question is, what does this mean for your economic future? Well, the primary steps -- purpose of the steps I've outlined tonight is to safeguard the financial security of American workers, and families, and small businesses. The federal government also continues to enforce laws and regulations protecting your money.

Earlier Wednesday, a letter signed by 166 economists was sent to the Speaker of the House of Representatives and the President pro tempore of the Senate. The economists, who represent nearly every political viewpoint in the country, are urging hearings and contemplation. The text of their letter:

As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come.

The Lady or the Tiger? Which door would you choose?