There’s a word for a loan made to a company whose ability to repay is contingent on its success.  That word is “investment.”  Companies that are just starting out, or companies that have hit a rough patch and need money to turn their business around, solicit money with the understanding that if the company succeeds, the investors will get their money back, and more.  If it fails, their investment may be lost.

Strings are attached to such investments.  Investors require a plan that describes in plausible detail the path to the success that will enable the investor to receive a return on its investment.  If the investment represents a large enough share of the company’s equity, the investor may be able to dictate conditions to be included in the plan.  It may receive a seat or two on the company’s board of directors, so it can influence the company’s practices, the better to ensure success.

We have coined, in recent years, another word for loans to recipients who may or may not be able to repay them: sub-prime mortgage loans.  This kind of financing involves no plan for success, no financier involvement to ensure that the money will be used wisely.  I assume we’re all agreed that that is a practice we would not want to see gain further traction.

And yet just a few weeks ago, Detroit’s Big Three applied for just such a loan.  They were turned down, but given a chance to develop a plan and re-apply.  Their new plan should be carefully scrutinized.  How likely are such lumbering giants—Ross Perot once said that making GM more nimble was like trying to teach an elephant to tap-dance—to develop a workable recovery plan from scratch in such a short time?  And if we accept the industry’s claims that it is too big and too interconnected to fail—car owners, parts manufacturers and auto workers would be left in the lurch—what happens when the credit card companies apply for a loan?  Think of how retail commerce will come grinding to a halt without them.  What will we say to the oil companies when the price of oil plummets and they demand no-strings loans?

Loans go to entities that can repay them; indeed an old joke says that in order to get a loan you have to prove to the bank that you’re so well-off that you don’t need one.

What the auto industry is asking is, in effect, an investment.  It’s an investment worth considering, as long as we approach it as we would any other investment, the way venture capitalists approach the investments they consider.

First, demand a plan, and a guarantee.  What are the automakers’ plans for success?  If they say their plan is to use the cash to buy breathing room so they can continue their development of energy-stingy cars, demand a guarantee that they won’t make a u-turn when the sinking price of gas lessens consumer pressure.  Get a seat on the Board of Directors, so we know if the automakers start backsliding.

Remember, we’ve been down this road before.  After the last oil price shock, the one that followed the Arab oil boycotts of the late ‘seventies, Detroit begged the Reagan administration for breathing room to develop fuel-efficient cars to counter the stampede of American car buyers to Japanese imports.  The ostensibly free-trading Reagan administration responded by getting the Japanese auto industry to limit the number of cars they sent to the US.  The result:  The industry’s promise lasted about as long as a used-car warranty, after which they concentrated their efforts on developing high-gas-mileage minivans and SUVs, and on thirty years of opposition to lowering federal fuel efficiency mandates.

The problem is not only that the industry will say it is going to change its ways and then renege on its pledge.  It may not know how to make meaningful change.  Or it may know how, but be unable to do what it knows it must do.  So a plan is proof not just against perfidy, but against inability.

Second, define objectives.  Every investor has objectives.  Corporate raiders like Carl Icahn want complex companies broken up, believing that a conglomerate’s units may yield more if sold separately than as a whole.  Silicon Valley venture capitalists wanted the startups they funded to move toward an initial public offering, so they could get their investment back.

What should the government’s objectives be?  It has to be more than repayment or a return on investment.  If that’s what we were investing in, we’d invest in companies that weren’t on the verge of bankruptcy.  In fact, there is a whole new class of investors, many of them investing wealth realized from early technology success.  They’re often known as venture philanthropists, because their objectives tend to be directed at the public weal, like improving the quality of education.  They invest money in ideas that they believe are on the right track, and they pride themselves on relying on data and keeping track not only of inputs—how much money was spent on improving schools?—but on outcomes: how many children finished high school prepared for college?

But the auto industry, investment bankers, commercial bankers—these aren’t the objects of philanthropy.  They’re for-profit businesses, only they’re not making any profits, and they want the government’s help—which is to say our help—to keep from collapsing.  So the effort to shore up these sectors of the economy is a species of investment that lies between regular investment, which seeks a cash return, and philanthropy.  Call it social venture capitalism, or social investment banking.

As with any investors, our investment objectives should be directed at the reasons supporting the investment.  Chief among them is surely the maintenance of an American auto industry.  One of the reasons we’re in energy trouble is that we need the oil produced by other countries, not all of which wish us well, and many of which may, under pressure, line up against us, refuse to give us oil unless we meet their objectives.  We don’t want to be totally dependent on somebody else for cars either.  What happens when we let the American auto industry go as a result of its inability to make a profit, and we need to produce armored humvees for a conflict that Germany—or South Korea, or China, or France—opposes?

But maintaining an industry doesn’t necessarily mean propping up particular companies indefinitely, especially in their present forms.  For example, General Motors didn’t spring full-formed from the brow of its founder, William Durant.  It began as what is now known as a roll-up, a company formed by rolling up other companies—Buick, Chevrolet, Oldsmobile, Pontiac and Cadillac, among others.  It has endured, not because its constituent parts offered car buyers real choices, but by presenting a range of fundamentally similar cars sporting different designs.*  Oldsmobile was phased out in the first part of this decade.  Maybe we don’t need some of the others.  Maybe one of them should be spun off to an innovative group of entrepreneurs as part of a strategy to diversify the industry.

Its current configuration may suit GM’s corporate strategy.  But it may not suit the objectives of GM’s new major stockholder—us.

Another of Uncle Sam’s investment objectives might be an irrevocable commitment to environmental sustainability.  Detroit has dabbled in environmentally-friendly technology for years, but has always backed off when gas prices fell or when drivers got used to high gas prices.   What might they accomplish if their major investor held their feet to the fire?  What about focusing the talents of the marketing geniuses who convinced American drivers that they needed SUVs on convincing buyers that they should buy and drive green?  Detroit has always been good at structuring the auto market to conform to its corporate interests.   I’m confident in its ability to adapt—even if only to please an important investor.

And let’s not forget the industry’s employees.  No plea for an auto industry bailout leaves them out.  If their welfare is important enough to justify a $25 billion loan to a sub-prime borrower like GM, it certainly ought to be among the government’s investment objectives.  Right now, the conventional wisdom is that we ought to respond to the economic threat that bankruptcy would pose to industry workers by reducing their wages—in a recession; reducing their health insurance—at a time when the new president pledges to increase, not decrease, the number of people with health care coverage; and cutting off their pensions—just when we’re getting ready to phase out the jobs of millions of assembly-line lifers at an age when they’ll find getting a good job at 55 more than a little difficult.

The remedy doesn’t have to be guaranteeing an auto industry job to everyone who works there today, but it might be cheaper, and more productive, to help them bridge the interval between their auto industry jobs and wages and their next job, or retirement, than to give no-strings to unreconstructed auto companies.  This isn’t only about doing what’s right for workers as a matter of equity.  Workers with salaries cut in half will not be buyers in the resurgent economy of six months or a year from now.  Unemployed workers without health care coverage will flood publicly-supported emergency rooms with ailments that will be more expensive to treat there than in a doctor’s office, and might have been prevented.

Let’s not be led astray, by the way, by the myth of the $70 per hour American auto worker.  As is explained in the piece linked to below**, the average auto worker makes about $28 per hour—about $56,000 a year.  That worker’s health and pension benefits add about $10 per hour.  The $70 figure comes from dividing among current workers the cost of providing pensions and health insurance to retired workers.  Why, then, are the average wages and benefits attributed to American employees of Japanese auto workers so much lower?  Because Toyota, Honda and the rest have only been making cars in the US since the ‘eighties.  They are simply responsible for many fewer retirees than GM, Ford and Chrysler.  The pension and health care overhang are a real problem for the Big Three, but (a) They agreed to them, and they certainly wouldn’t want to weasel out of a contractual obligation, would they?  And (b) Those costs are not fairly attributable to current employees.

Whatever conditions the government imposes on mendicant auto makers, we will be told, the government will be entering the marketplace, picking winners and losers, a task it is supposed is outside their competence.

First, the government won’t need to pick losers.  We know who the losers are.  They’re the ones with their hands out, asking to be saved from the consequences of their decades of bad choices.  If all the government has to do in its economic decision making is improve on their record, it’ll be a short contest.

Second, despite the myth of the government as a bad maker of economic decisions, its record isn’t so bad.  Limited-liability corporations, to take just one example, are not part of the state of nature.  They represent a government judgment on how best to encourage economic activity.  So does the compulsory education that gives future workers the preparation they need for the job market.  So do publicly-supported airports, the interstate highway system, and legal protection from being held accountable for advertising claims.

In fact, I’m suggesting only that the government follow the good example of private-sector investors, risking its money only on condition of a business plan that is compatible with the investor’s interests.  For this investor, that would be the public interest.


  1. John Austin
    December 8th, 2008 | 7:08 pm

    “There’s a word for a loan made to a company whose ability to repay is contingent on its success. That word is ‘investment,’’’ says Mr. Barbash. I would take exception to this definition.

    A “loan” is almost always secured by some sort of collateral, something of equal or greater value that the loaner can repossess if the loan is defaulted on. In the case of General Motors, the amount of the loan sought far exceeds the value of GM’s assets after subtracting its liabilities.

    An “investment” is wholly different from a loan and, again regarding GM, investors have spoken on what they see. GM’s stock price has plunged in the last year from about $30 per share to $4.08 at the closing today, December 5, 2008. Buying GM stock now is the same sort of investment as would be the purchase of junk bonds—except without the upside of exhorbitant returns that junk bonds always pay.

    No, the word Mr. Barbash should have used for a “loan made to a company whose ability to repay is contingent on its success” is a “speculation,” or better, a “bet.”

    This does not necessarily mean that a bet should not be made; obviously the possibility of something worse than losing money would occur if millions of jobs are lost, something that cannot be measured in dollars and cents—the cost in damaged lives of those thrown out of work.

    I suggest that if Congress makes this bet it should be totally honest with the American people: it should call it a bet, or what it is: a bailout—a bailout that has very good chance of not paying off with an industry and jobs that survive, a bailout that has very little chance of ever benefitting taxpayers, but one that should be made nonetheless for humanitarian reasons.

    The money should come from either the Troubled Assets Relief Program (TARP), the $700 billion already authorized for bailing out financial institutions, or from a fund already set aside by the Bush administration to aid U.S. automakers to produce vehicles friendlier to the environment. However the funding is derived, the legislation should be written in such a way as to ensure that the Big Three auto companies are restructured to give them at least a fighting chance to survive and compete with foreign auto manufacturers. It also should give the taxpayers a fighting chance to recover the funds by establishing very clear rules for monitoring their use, perhaps modeled on those established for the Chrysler bailout some two-plus decades ago.

    The problem with what Mr. Barbash calls for in the way of “demands” is that they come after the fact, after the money is put out the door. What sort of demand can Congress make stick at that point? Any demand should be structural in nature and made BEFORE the money is given.

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