Thursday, December 18, 2008

What is a disorderly bankruptcy? 

The Bush Administration is saying today that it wants to help provide for an 'orderly' bankruptcy of GM and Chrysler.

President Bush�s spokeswoman, Dana Perino, confirmed growing speculation within legal circles that the president and Treasury Secretary Henry M. Paulson Jr. were considering the step as part of an overall rescue package for the automobile industry.

The action would be unusual, and would require concessions by the United Automobile Workers union, suppliers, investment banks, the federal pension board, bondholders and other stakeholders in the two auto companies.

Under one possibility that has been discussed, the government would give G.M. and Chrysler enough financing to operate for several months. Then a government-selected overseer would bring together company executives and other representatives to map out steps that would be taken once the two companies file for Chapter 11 protection.
The White House is apparently still trying to figure out its strategy here, but for the moment it appears to have landed on a good one. The key to this deal, as an Investors Business Daily editorial stated last week, would be to get government out of the way. Dan Ikenson last month reminded us that these two firms failing would not doom the U.S. auto industry, since they employ roughly a third of all autoworkers.
They employ American workers, pay U.S. taxes, support other U.S. businesses, contribute to local charities, have genuine stakes in their local communities and face the same contracting demand for automobiles as does the Big Three. The difference is that these companies have a better track record of making products Americans want to consume and are not seeking federal assistance.

...If one or two of the Big Three went into bankruptcy and liquidated, people would lose their jobs. But the sky would not fall. In fact, that outcome would ultimately improve prospects for the firms and workers that remain in the industry. That is precisely what happened with the U.S. steel industry, which responded to waning fortunes and dozens of bankruptcies earlier in the decade by finally allowing unproductive, inefficient mills to shut down.
The difference between now and 2001 is the state of the financial sector, not the auto sector; it may be advantageous for government to provide the debtor-in-possession financing that the banks might be loathe to provide now. GDP without autos was positive in the most recent quarter (motor vehicle and parts consumption deducted .6% and .8% from GDP the last two quarters), so there's no doubt some of our difficulties at present could be accounted for by the auto industry. (Graph to the right is growth of GDP ex auto, and then contribution of motor vehicles and parts to GDP, source BEA.)

That graph isn't a reason to bail them out either, however. In 2001 Russ Roberts wrote this about the bankruptcy of Bethlehem Steel:
The underlying explanation for the drop in employment in the steel industry over the last half-century is an increase in productivity�the industry gets more done with fewer people. America is not the only nation with less employment in the steel industry. World steel employment is roughly a third of what it was 25 years ago. Virtually all of the steel producing nations, even the ones who allegedly dump their steel on U.S. markets, have fewer people making steel than they did 25 years ago. But world output of steel is up.

The same thing has been going on in many manufacturing industries. Overall, manufacturing employment is close to the same as it was 25 years ago, while output is up dramatically. The cause: higher productivity. The phenomenon holds in good times and bad. It's not an indication of an economic crisis�it's the result of innovation. Competitive pressure drives manufacturers to find ways to do more with less.

This is good for America overall. It means we get more output from fewer workers while employment expands in health care, entertainment and the other sectors of the economy where the American skills and creativity produce the best products in the world. It allows new industries to be created and others to expand. It means we remain competitive with the rest of the world, using the best techniques available for steel production. It lets us use our highly skilled labor force to focus on what we do best and on the dynamic future rather than a static past.

The Bethlehem bankruptcy was also blamed on "complacency and high labor contracts" that left it less competitive. Its bankruptcy did not kill the U.S. steel industry: US Steel is still in the Fortune 500, just not a top 20 company any more. In 2008 American steel producers will make about 76 million metric tons of crude steel according to Stratfor. That's half of what we produced in 1970, as imports have replaced the use of steel, and as we have found substitutes for the product. (Those CAFE standards could be one reason for that.) Maybe we don't do steel as well as we did in 1970; maybe we don't do cars as well as we did then either. But we do many other things better now than we did then, some things we didn't even see.

But make no mistake: Bethlehem Steel's bankruptcy was only 'orderly' in the sense that it didn't cause riots in the streets of Pittsburgh. A great wailing and gnashing of teeth in the papers happened then. For those in the steel industry, it was very disorderly. Lives were turned upside down. As they will be in the auto industry.

For he who occasionally espouses free markets: Markets are volatile; disorderly only means volatility in the absence of news. There's plenty of news, so lots of volatility. Wear a helmet.