The Big Three seek Big Loans

Monday 25 August 2008

America's Big Three automakers are seeking as much as $50 billion in loans from the US government to help them shoulder the costs of shifting production to more fuel-efficient models. They see it as an exceptional request for exceptional times.

It looks like a bailout and it smells like a bailout. But for Detroit’s Big Three automakers – GM, Ford and Chrysler – the $50 billion in government loans they are seeking from Congress is not, let’s repeat, not, a bailout.

 

The automakers would prefer that we regard their grovelling for Congressional largesse as an exceptional request for exceptional times. They say the emergency cash is crucial as they seek to retool their ageing production models and make the shift to the type of smaller, more fuel-efficient cars that Europeans have been driving for years.

 

Their argument is pretty straightforward: American automakers are the backbone of US industry - just as large Wall Street banks are the backbone of the financial system, and mortgage firms such as Fannie Mae and Freddie Mac are essential to the smooth functioning of the nation’s home loan market.

 

So why, the argument goes, shouldn’t they be privvy to the same type of aid packages that have been bestowed on the darlings of Wall Street?

 

To a point the argument makes perfect sense. After all, few would argue that the auto industry is in distress. As the New York Times points out, they have lost billions of dollars in recent years and the Congressional loans would provide vital cash support as they revamp antiquated business models. GM posted a $15.5 billion loss in the second quarter of this year, while Ford shed almost $9 billion.

 

All three automakers have pressed on the accelerator in their quest to shave costs and prepare for a streamlined future. GM last week announced plans to offer incentives in the form of employee-price discounts to the general public. It’s all part of an attempt to clear out inventory and reverse a trend of rapidly declining sales that has hit the North American market especially hard.

 

The Big Three are also retooling their assembly lines to meet the growing demand among American drivers for cleaner, more fuel-efficient cars. This means partly forsaking their historic stock-in-trade – large, lumbering pick-ups, SUVs and 4x4s.

 

And it’s not just about wise business strategy – it’s also a matter of political exigency. The industry has an ultimatum to shift to cars that can travel an average 35 miles per gallon by 2020. The cost of doing so, some estimate, is roughly $100 billion – a prohibitive price for the automakers to bear alone in a weakening economy.

 

The $50 billion loan figure I mentioned earlier is actually an extension of a previous $25 billion request that was authorized by an energy bill enacted by Congress last year.

 

What Detroit needs now is for US lawmakers to approve the $3.75 billion needed to cover the costs of the risk premium on the $25 billion request. That way they can begin to put the loans to work. But beyond that, they are doubling the initial loan request – which also means doubling the default risk costs.

 

And noone in Detroit is promising that the requests will end there. But they do suggest that the costs of not freeing up the necessary cash will be far greater to the American driver if it undermines the US car industry.

 

Both US presidential candidates have acknowledged the resonance of the issue.

 

Barack Obama, the presumptive Democratic nominee, has said he'd rather see the fuel-efficient cars of tomorrow built “not in Japan, not in China, but right here in the United States of America – right here in the state of Michigan.”

 

His Republican opponent, John McCain, meanwhile, said he preferred an individual tax credit of $5,000 to encourage consumers to buy more fuel-efficient models as well as a $300 million prize to promote studies into battery efficiency. But he’s also thrown his support behind the loans.

 

But in the end, it can also be reasonably argued that the automakers made their bed and they should now be forced to sleep in it. Their decision to build large, gas-guzzling cars, while fueled by strong consumer demand, was nonetheless deliberate, and there are those who might say that their current tribulations are deserved comeuppance for their miscalculation.

 

And then there are other considerations. In Europe, such a request for government aid might be struck down on anti-competitive grounds. We’ve already seen companies like Boeing protest at perceived European subsidies to its arch-rival, Airbus – why should the rules change when applied to American companies?

 

But who knows, if these loans actually hasten the automakers’ transition to a cleaner future, rather than help them perpetuate a discredited model, perhaps they will justify themselves.