By January 2009, American and Canadian taxpayers had pledged about $21B to help a small part of the auto sector; in mid-February 2009, GM and Chrysler wanted another $19B from American taxpayers plus funds from Canada. By March 2009, GM and Chrysler wanted even more money, with no assurance of the maximum cost to taxpayers. A bailout costing at least $40B will not safeguard the industry’s employment and it does not avoid contagion of economic collapse to the wider industry. But, a well-designed flow through assistance program can largely deliver greater assurance of employment and avoidance of contagion, and it would minimize a transfer of taxpayer wealth to wastrels. This article deals with distressed, toxic manufacturers but the principles apply to banks, airlines and diverse, other industries.
- No company is too big to fail.
- Some entities are too toxic to fix (Enron and now AIG and ...).
- The end of a toxic entity reallocates capital to productive use.
- Executives of toxic entities should never profit from their creation of toxic waste.
- Shareholders of toxic waste should never be bailed out.
- The demise of a large toxic entity creates risks of contagion for society.
- Government should limit itself to containment of contagion.
Flow Through Industry Assistance
Industrial sectors often are composed by a small group of major manufacturers, which are supplied by a much larger group of smaller manufacturers that in turn are supplied by a still larger group of still smaller manufacturers. Using the American Congressional Report from 2005 on automotive manufacturing, about 23% of total employment was at the motor vehicle level, 62% was at the parts supplier level and 15% was at the bodies, trailers level.
An ‘average’ primary manufacturer, assuming five primary players, may represent 5% of total employment in the industry cluster. Bailouts to a couple of primary manufacturers may at best help preserve or maybe postpone the loss of 10% of total industry employment. The other 90% of employment will not be safeguarded and the risk of contagion to suppliers may not be reduced.
In a liquidity crunch and a recession, bailout cash to a primary manufacturer or bank will be hoarded in rational self-interest. When the primary manufacturers hoard cash, their Tier One suppliers have restricted cash and are forced to hoard cash and restrict payments to Tier Two suppliers, which in turn are forced to hoard cash and restrict payments to Tier Three suppliers. Limited cash resources restrain the entire industry. The result is an industry with wobbly participants.
Parts manufacturers represent 62% of auto sector employment. A single parts manufacturer may be largely dependent on a single motor vehicle manufacturer (MVM) but sell significant production to other vehicle manufacturers. An insolvency of a MVM will leave hundreds of its Tier One suppliers with bad debts and the prospect of insolvency; this will put at risk the solvency and survival of their many more, much smaller Tier Two and Tier Three suppliers.
Under just-in-time production and delivery, manufacturers and parts suppliers are tightly linked. So, a disruption at Tier One, Two and Three suppliers (due to bad debts arising from a MVM’s insolvency) will disrupt production at solvent MVMs, wounding allied suppliers and the downstream retailers.
Flow through assistance to an entire industry (autos, steel, commercial real estate or any other whining industry) helps the entire industry. Every primary industry player (the equivalent of General Motors, Ford (NYSE:F), Toyota (NYSE:TM), Honda (NYSE:HMC)) must accept assistance and all of the assistance must cascade to Tier One, Two and Three suppliers in the payment of accounts payable, excluding remuneration arrears greater than $2,500 and principal payments. Funds must be disbursed to accounts payable within 29 days of receipt.
Government advances to the primary industry players must bear covenants and interest rates that increase in severity with time and have priority security. The funds must be not subject to seizure as the funds pass through bank accounts or by creditors pursuant to bankruptcy. Loan conditions could include prohibitions on executive bonuses, share dividends and redemptions. After using the funds as directed, solvent MVMs could repay the loans at any time.
To illustrate, using the auto industry as an example, the US and Canada would commit $50B, proportionate to their respective auto production. Governments would disburse by, say, March 31, 2009 to MVMs proportionate to their respective 2008 production. The MVMs would be obligated to disburse all funds to their accounts payable within 29 days. Tier One suppliers would be obligated to disburse the funds to Tier Two suppliers within the next 29 days. Tier Two suppliers would be required to disburse the funds to their suppliers within the following 29 days.
In this manner $50B would flow through MVMs, Tier One and Tier Two suppliers to thousands of small and large suppliers to create an accumulated liquidity flow of $200B. Flow through assistance would improve the working capital position of each player, strengthen the resiliency of the entire industry in the event of a default of one or two ailing MVMs and help (but not guarantee) up to 100% of industry employment. The governmental exposure would rapidly decrease from a peak of $50B to $20 – 25B as stronger MVMs repay the government loans.
Bailouts and flow through assistance do not address too much supply chasing too little demand. With bailouts, governments pick candidates for life support. With flow through assistance, consumers vote with their purchasing decisions. And, the weak MVMs? Any business that could not survive after a massive conversion of short-term accounts payable to a long-tern government loan would be allowed to pass into bankruptcy and liquidation which would reallocate consumer demand within an industry already strengthened by flow through assistance.