Funny Cartoon
Many people believe we should let the markets go its course and get rid of the American Automakers. They state that the automakers produce inefficient cars, have bad management, and have made the wrong decisions. As a result, they should be wiped out. I believe that there is a consensus on the fact that these companies have made wrong decisions; however, if we follow that thought, we should have also let Freddie Mac, Fannie Mae, and AIG go bankrupt without government intervention (for over-leveraging themselves and also making bad decisions in their investments). It also follows that we should have let Goldman Sachs’ and Morgan Stanley’s stock prices be wiped out in the week that Lehman Brothers went bankrupt instead of rushing their process to become bank holding companies.
Therefore, we will only look at the effects of letting the automakers be wiped out.
The first factor complicating the situation is the current state of the U.S. economy. If this was mid 2006 when everything seemed to be going great, the bankruptcy of the automakers would probably be less disastrous. However, we’re probably in the worst economic downturn since the Great Depression. This means that negative events tend to be amplified and also create panic.
The second factor is the uncertainty about what would happen if they went bankrupt. When Lehman Brothers filed for bankruptcy, most investors did not expect some the events that followed:
*Credit Markets came to a halt.
*There was a flight to quality (making 3 month T-Bills hit a negative yield).
*There was an extended sell-off in equities worldwide.
*Companies started hoarding cash.
*There were massive capital outflows from Emerging Markets.
*The Fed had to pump trillions of dollars into the market.
*And the markets went into panic.
So, we have to be careful not to underestimate the effect of letting the automakers going bust.
Now, the third factor is the concern regarding a chain reaction. If the automakers go bankrupt, given the current economic conditions, it is likely that many small suppliers and those who rely heavily on the American automakers will also go bankrupt. This means that the negative outcomes will extend to suppliers of parts and commodities that are used to manufacture cars.
The fourth factor is unemployment. It has been estimated that a combined 3 million jobs would be lost from the automakers and its suppliers. A noteworthy comment is the negative effect this would have on the housing market. How would these 3 million families be affected in regard to paying the mortgages on their houses? Therefore, this could mean another spike in foreclosure rates which would create more problems in the housing and mortgage markets.
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Putting it all together, the grim economic conditions and the uncertainty of the effect of filing for bankruptcy, combined with massive unemployment and a chain reaction. makes helping the automakers a reasonable path to take.
Therefore, the same way that letting AIG go bust may not be a good option, it could be the same for the Detroit Automakers.
However, many analysts have given a target price of $0 to GM stock. I believe that GM’s stock will probably lose another 50% or so from its current $3.01 price. The bailout may still pass, yet it seems that they don’t have the time or ability to make a comeback with the current conditions. Therefore, I would probably liquidate any positions on GM or the other two American automakers.
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