Thursday, September 4, 2008

The Logic of Bailing Out the Auto Companies

The three American auto manufacturers--GM, Ford, and Chrysler--are reportedly planning a lobbying campaign to secure $50 billion in loans at favorable interest rates from the federal government. This money will supposedly allow them to shift more rapidly to fuel-efficient models, a laudable goal. The political winds are behind this idea.

As a matter of principle, a taxpayer funded bailout of the auto companies is a bad idea. In a market economy, private enterprise should profit by dint of its own diligence and perspicacity. And it should takes its lumps without looking for government subsidy. If you have to pay for your mistakes, you'll learn to avoid making them. And the American auto companies have made a boatload of mistakes, ranging from decades of mediocre quality and design to betting the ranch on a single factor--the price of oil. They thought that clever marketing could fool consumers into buying inferior products, and competed against each other when the real competition came from overseas. Even now, one wonders whether they'd make wise use of $50 billion of low cost federal loans. Optimism in this respect isn't necessarily warranted.

Nevertheless, there is a good reason to bail out Detroit. The U.S. is too heavily invested in real estate. Since the Great Depression of the 1930s, the federal government has been subsidizing home purchases one way or another, with tax deductions, federal deposit insurance, and the creation of a vast secondary market for mortgages. Things really got out of hand in recent decades, with Fannie Mae and Freddie Mac reaching Brobdingnagian size and the Federal Reserve keeping interest rates lower than a snake's belly. When you do anything to excess, you'll pay the price, and we're paying the price now.

As real estate values sink lower while mortgage defaults spread like a Medieval plague, the financial markets clamor ever more loudly for a federal bailout of defaulting homeowners. Since just about everyone on Wall Street, from big firms to institutional investors to hedge funds, has substantial investments directly or indirectly linked to real estate, the cries for government intervention ring from sea to shining sea. The Bush administration has been unable to resist these demands, recently making explicit the federal government's formerly implicit guarantee of Fannie and Freddie while promising to assist many distressed homeowners.

But the welfare queens on Wall Street still aren't satisfied, as calls are yet made for federal purchases of distressed properties and more subsidies for home loans. With this being an election year and the Bush administration having abandoned all pretense of favoring a market-based economy, surely more hair of the biting dog is headed for the real estate and mortgage markets.

That, however, will only continue America's over-investment in real estate. The heart of any industrial economy is its manufacturing sector. America's manufacturing sector has been suffering through hard times since Richard Nixon scowled from the Oval Office. It has survived, although with many adjustments and major losses. The recent decline of the dollar has improved export business. But American manufacturing is a hollow shell compared to the mighty juggernaut that built vast quantities of aircraft, ships, tanks and trucks for the victorious Allies in World War II.

Subsidized loans for the American auto companies would help protect America's manufacturing base. The auto companies employ hundreds of thousands, and their suppliers employ hundreds of thousands more. The health of the U.S. economy cannot be sustained by yet more government funded bets on real estate. Business enterprises produce more overall wealth than real estate. This is evidenced by stock market prices, which have historically increased about 3% above the rate of inflation, while real estate values have increased about 1% above inflation. If the Bush administration is going to continue its socialization of the economy, it should diversify its focus and give a little to manufacturing. More concentrated bets on real estate will only set the stage for the next bubble and collapse, with even greater losses to be borne by taxpayers.

Boosting America's wealth is the only way to deal with the demographic problem of an aging population. While increased immigration could improve the ratio of workers to retirees, the political landscape precludes relaxing the borders. So emphasizing economic growth is perhaps the only way to keep retirees and workers from being less well-off than their parents.

Do the American auto companies deserve government subsidies? Absolutely not. They're responsible for the problems they now have--Toyota and Honda simply made smarter bets on fuel efficient car and engine designs, while maintaining better overall quality. But America has to diversify away from real estate. Almost all of the federal bailout money for Wall Street and real estate will go to the undeserving. Since the Bush administration is proceeding to socialize much of the economy, it ought to do it in a way that offers long term benefits rather than short term expediency.

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