homework help 30838

By mid-December 2008, GM, the world’s second largest

auto manufacturer, was losing $2 billion a month. Rick

Wagoner, CEO since 2000, knew that GM did not have

enough money to survive much longer. The year 2008,

GM’s 100th anniversary, was turning out to be its worse

ever. 1 Wagoner already knew GM would end the year

with losses of about $31 billion. But that was an improvement

from 2007 when the company lost $38.7 billion, the

fourth-biggest corporate loss in history. Those losses, and

losses of $1 billion in 2006 and $10 billion in 2005, meant

that the company Wagoner led lost an astonishing $80 billion

in four years.

Wagoner was a dedicated, affable, and likable man.

In high school, he had excelled in all sports but his height

of six feet four made him a star in basketball and upon

graduation, he was secretly hoping to be a professional

basketball player. But as a freshman basketball player at

Duke University, it became clear to Wagoner that he did

not have the talent and drive to be a professional athlete.

Instead, he majored in economics and also began dating

Kathleen Kaylor whom he eventually married. After graduating

from Duke University and getting an MBA from

Harvard University, Wagoner went to work for GM. He

rapidly worked his way up through the company’s ranks

and in 2000, he was named CEO, the youngest person to

ever hold that position in the company’s history.

Wagoner blamed GM’s misfortune on a number of

factors. One of the most significant factors, he felt, was the

“Great Recession” of 2008 that had hurt the sales of all

the auto companies, particularly when the troubled banks

stopped lending money so customers could no longer

get car loans. Unfortunately, GM did not anticipate the

“credit crunch,” and by 2006, it had sold off a controlling

interest in GMAC, the previously wholly-owned finance

company that had provided cheap loans to its car buyers.

After GM sold 51 percent of GMAC to Cerberus for $7.4

billion, Cerberus refused to let GMAC continue providing

the same easy credit to GM’s customers, which turned out

to be a significant blow to GM’s sales.

Yet another problem was GM’s labor costs. In 2008,

GM was paying an average of about $70 per hour for

labor. That $70 included $30 that the worker actually

received in wages, and $40 that went to fund other labor

costs including the worker’s benefits and pension, plus

the cost of providing health care and pensions to about

432,000 GM retirees. Because GM had been operating for

100 years, the number of its retirees was much larger than

those of new car companies. Toyota, for example, was paying

about $53 per hour for labor in its U.S. manufacturing

plants, of which $30 went to the worker as wages, and $23

went to pay for the worker’s benefits and pension, but very

little for retirees since the number was relatively low. In

some of its plants, a Toyota spokesman said, it was paying

as little as $48 per hour for labor.

But perhaps the major cause of GM’s difficulties was

its self-inflicted dependence on large SUVs (sport utility

vehicles). Japanese car makers could make small and midsized

cars for less than it cost GM to make comparable

cars. To compete, GM had to lower its prices until the

profit margins on its small and mid-sized cars were vanishingly

thin. But during the 1980s, when gas was cheap,

GM discovered that large SUVs were big hits with male

customers and with couples with growing families. Moreover,

unlike its smaller car models, profit margins on its

large SUVs were hefty, as much as $10,000 to $15,000

per vehicle. As its SUV sales boomed during the 1990s,

GM expanded its line and eagerly converted many of its

plants over to the production of the lucrative big vehicles.

By 2003, the bulk of its profits were coming from SUV

sales. But when the price of gasoline gradually crept upward,

the costs of owning an SUV also increased causing

the SUV market to slow and then to decline. In 2004,

unsold SUVs started piling up at car dealerships. When

Hurricane Katrina made gasoline prices soar in 2005,

sales of SUVs eventually collapsed. Thus, GM ended

2005 with a loss of $10.4 billion. Things improved somewhat

in 2006, but then losses climbed to record levels:

$38.7 billion in 2007, and $30.9 billion in 2008. Unfortunately,

by now GM’s plants, strategic plans, research and

development programs, and its mindset, were all locked

into the production of SUVs, and it would take years to

change them.

Because of its reliance on SUVs, GM had put off investing

in the small fuel-efficient cars a gas-conscious public

had turned to in 2005. In the 1990s, GM had developed

the technology for an all-electric car, the EV1. The EV1

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THE BUSINESS SYSTEM: GOVERNMENT, MARKETS, AND INTERNATIONAL TRADE 191

was, in fact, the first mass-produced modern electric car

made by a major car company. By 1999, GM had spent

$500 million producing the EV1 and $400 million marketing

it, yet had leased only 800 vehicles. Convinced that

the car would never match the profitability of its SUVs,

the company stopped making the cars and in 2002, it repossessed

all the EV1s it had leased and phased out the

project. At the same time, both Toyota and Honda were

introducing their small hybrid electric-gas engine cars into

the United States. The hybrids turned out to be a commercial

success and, more importantly, production of the

cars allowed both Toyota and Honda to gain almost a decade

of experience in hybrid technology, while GM continued

focusing on its gas-guzzling SUVs. In a June 2006

interview published in Motor Trend, Rick Wagoner confessed

that his worst decision during his tenure at GM was

“axing the EV1 electric-car program and not putting the

right resources into hybrids.”

All of these problems had culminated in the $80 billion

loss that placed GM in the difficult situation Wagoner

knew he had to deal with in the closing weeks of 2008.

With many analysts predicting that GM would go bankrupt,

banks—which themselves were barely surviving the

worse financial crisis in decades—refused to loan the company

more money. At the rate it was running through its

cash reserves, Wagoner knew the risk of bankruptcy was

growing daily. Given the company’s dire straits, he decided

that only a government bailout could save it.

Government bailouts were not popular. In September,

2008, the George W. Bush administration asked the

U.S. Congress to pass legislation creating a $700 billion

fund called the Troubled Asset Relief Program (TARP).

A reluctant U.S. Congress approved the TARP bill which

authorized the U.S. Treasury Department to use the funds

“to purchase . . . troubled assets from any financial institution.”

The “troubled assets” were millions of mortgage

loans that banks had extended to home buyers who were

now unable to make their monthly mortgage payments,

and whose homes were worth less than their mortgages

because home prices had collapsed in early 2007. Since

the homes were worth less than their mortgage loans, the

mortgages could not be repaid in full when delinquent

homeowners sold their homes or when banks confiscated

them. Suffering huge losses, many U.S. banks were on the

verge of failing as were European banks that earlier had

taken over thousands of the now “troubled” U.S mortgages.

Many economists predicted that these widespread

bank failures would turn the deepening recession into a

global depression worse than the worldwide Great Depression

of the 1930s.

In spite of the looming financial crisis, many had

opposed the plan to bail out the banks. A hundred leading

economists signed a letter to the U.S. Congress that

said lack of “fairness” was a “fatal pitfall” of the plan

because it was “a subsidy to investors at taxpayers’ expense.

Investors who took risks to earn profits must also

bear the losses.” 2 Calling the bank bailouts “socialism

for the rich,” the Nobel prize-winning economist Joseph

Stiglitz wrote “this new form of ersatz capitalism, in

which losses are socialized and profits privatized, is

doomed to failure. Incentives are distorted [and] there

is no market discipline.” 3

Nevertheless, if U.S. banks were able to get bailout

money from Washington, perhaps GM could do the same.

So Rick Wagoner and two GM board members flew to

Washington on October 13, 2008 to meet with officials of

President George W. Bush’s administration. During the

meeting, Wagoner summarized the precarious position of

the company and asked for a loan from the TARP fund.

Bush’s people balked at the request, saying the legislation

explicitly said TARP funds were for financial institutions

so they could not be used to provide loans to car manufacturers.

Turned down by the administration, a desperate

Wagoner turned to the U.S. Congress. On November

18 and 19, he and the CEOs of Chrysler and Ford—the

two other U.S. auto companies were also going through

difficult times—came before Congressional committees

and asked for legislation authorizing government funds to

aid the auto industry. Committee members, however, became

angry, particularly when the auto executives admitted

they had not prepared plans detailing how they would

use the funds nor what changes they intended to make to

ensure they could return to profitability. In the end, the

three CEOs were told to come back in December with

detailed financial plans for their companies. In early December,

the CEOs dutifully returned to the U.S. Congress

with plans in hand and repeated their requests for financial

assistance. A few days later, both the U.S. House and

the Senate proposed legislation to aid the auto companies.

Unfortunately, while the House approved the auto aid bill

on December 10, the Senate voted it down. Without the

support of both the House and the Senate, the proposed

legislation was dead.

Wagoner was stunned and despaired for the future

of the company he had served for over thirty years. But

his despair turned to elation when he got a telephone

call from the Bush administration. The administration

had decided the U.S. Treasury could, after all, use

the TARP funds to provide loans to GM as well as to

Chrysler. (Ford had decided it could survive without government

money.) On December 19, 2008, President Bush

announced that the U.S. Treasury would provide GM with

a $13.4 billion loan from the TARP fund, while Chrysler

would get a $4 billion loan. In announcing the assistance

to the auto companies, the Bush administration said “the

direct costs of American automakers failing and laying

off their workers . . . would result in a more than one percent

reduction in real GDP growth and about 1.1 million

192 THE MARKET AND BUSINESS

workers losing their jobs.” 4 To get the money, Wagoner

had to agree that by February 17, 2009, GM would hand

over a detailed plan specifying how it would achieve

“financial viability” and the plan had to be acceptable to

U.S. Treasury officials. With his back to the wall, Wagoner

agreed to the terms and on December 31, 2008,

GM got a first installment of $4 billion from its allotted

loan amount; it received another $5.4 billion on January

16, 2009, and a final installment of $4 billion on February

17, 2009.

Many objected that bailouts violated the free market

philosophy embraced by many Americans and replaced it

with a kind of socialism. Republican Senator Bob Corker

said the GM bailout “should send a chill through all

Americans who believe in free enterprise.” 5 Several Republican

members of Congress submitted a resolution on

the bailouts that said they were “moving our free-market

based economy another dangerous step closer toward

socialism.” 6

By February 17, 2009, newly-elected President

Barack Obama had taken office so his administration

would end up finishing the auto bail-out that the previous

administration had set in motion. As part of the

“viability plan,” that he had agreed to submit by February

17, Wagoner was to renegotiate GM’s union contracts to

make its labor costs competitive with foreign car makers in

the U.S., reduce the number and models of cars it made,

shrink its unsecured debt of $27.5 billion down to $9.2

billion by getting creditors to cancel part of their debt in

exchange for GM stock, and invest in fuel-efficient hybrid

and electric vehicles. 7

Wagoner had quickly entered negotiations with

the United Auto Workers (UAW), GM’s major union,

and with creditors. But GM’s creditors had stubbornly

refused to reduce their debt by the amount the government

wanted. In the end, GM did not reach the debt reduction

targets the U.S. Treasury wanted it to reach by

February 17. Nevertheless, in the final “plan for viability”

it submitted to the U.S. Treasury on February 17,

GM said it would cut 37,000 blue-collar jobs and 10,000

white-collar jobs, close 14 plants over three years, eliminate

four of its eight car brands, cut manager salaries by

10 per cent and all other salaries by 3 to 7 percent, and

shift the costs of retiree health insurance to an independent

trust funded in part with GM stock and in part with

debt. However, the plan added, GM would need an additional

$22.5 billion from the government to continue

operating to 2011. 8

The Auto Task Force Obama had put together to review

GM’s proposed plan was not happy with it. Steven

Ratner, who headed up the task force said:

It was clear to us from the “viability plans” that

the companies had submitted on Feb. 17 that

GM and Chrysler were in a state of denial. Both

companies needed gigantic reductions in their

costs and liabilities. They had way too many

plants and workers for expected car volumes.

And their labor costs were out of line with those

of their most direct competitors . . . I was shocked

by the stunningly poor management that we

found, particularly at GM, where we encountered,

among other things, perhaps the weakest

finance operation any of us had ever seen in a

major company. 9

“Team Auto,” as the Obama task force called itself,

spent over a month studying the plan and concluded

that GM’s optimistic assumptions that its market share

would grow in the future, its costs would decline, and in

a few years it would have positive cash flows, were out

of touch with reality. On March 30, 2009, the Obama

administration told the company that its plan was not acceptable

and did “not warrant the substantial additional

investments . . . requested.” Nevertheless, GM was given

60 days, until June 1, to try to extract deeper concessions

from its creditors and was also given another loan

of $6.36 billion to carry it through the next two months.

Although GM continued trying to work with its creditors,

the Obama task force soon realized that the only

way GM would force its creditors to forgive GM’s debt

was by filing for bankruptcy. 10 This would give a federal

judge the authority to cancel as much debt as was needed

for the company to become a viable business again. On

March 31, the U.S. Treasury informed the company’s

board of directors that if it filed for bankruptcy, the government

would provide the funding it would need to

emerge as a viable company.

By this time, Rick Wagoner’s fate had been sealed.

In mid-March, Steven Ratner asked Wagoner about his

plans and he replied, “I’m not planning to stay until I’m

65 but I think I’ve got at least a few years left in me . . . , but

I told the [Bush] administration that if my leaving would

be helpful to saving General Motors, I’m prepared to do

it.” 11 On Friday, March 27, Wagoner attended a meeting

with the Auto Task Force to discuss GM’s restructuring

plans. Before the meeting Steven Ratner pulled him aside

and said, “In our last meeting you very graciously offered

to step aside if it would be helpful. Unfortunately our conclusion

is that it would be best if you did that.” Wagoner

agreed to step down, and on March 30 he submitted his

resignation from GM.

On June 1, 2009, GM entered bankruptcy. The U.S.

Treasury created a new company named “General Motors

Company,” and the now bankrupt “Old GM” sold

its most profitable brands and most efficient manufacturing

facilities to the new “General Motors Company”

who used $30 billion of the government’s money to buy

THE BUSINESS SYSTEM: GOVERNMENT, MARKETS, AND INTERNATIONAL TRADE 193

them. The creditors of “Old GM” received a 10 percent

share of the new company plus proceeds from the sale of

the assets of “Old GM.” A 17 percent share of the “New

GM” was put into a trust to pay for union retiree health

care benefits; the union trust also received a $2.5 billion

note from “New GM” and $6.5 billion of its preferred

stock. The government of Canada, which had contributed

$10 billion to bail out several GM plants in Ottawa and

Ontario, got 12 percent of the new company. The remaining

61 percent share of the company became the property

of the U.S. government in return for a total of $50 billion

it pumped into GM. The U.S. government also retained

the right to elect 10 of the 12 members of the board of

directors of the “New GM”; it was now the major owner

of a car company. 12

GM was not the only firm that became a (partially)

state-owned company during the financial crisis. On February

27, 2009, it was announced that in exchange for $25

billion the U.S. Treasury was taking 36 percent ownership

of Citigroup, Inc., a large banking company driven to the

brink of failure by the financial crisis. On September 16,

2008, American International Group, an insurance company

also brought to its knees by the financial crisis, announced

that the government, through its Federal Reserve

Bank, was taking ownership of 80 percent of the company

in exchange for $85 billion.

Many observers claimed that government ownership

of companies is the kind of government ownership

of the “means of production” that Marx and other socialists

advocate. For example, Robert Higgs, editor of The

Independent Review , wrote that “the government is resorting

to outright socialism by taking ownership positions

in rescued firms.” 13 And the Mackinac Center, a conservative

research institute focused on promoting “the free

market,” published an article by Michael Winther that

stated:

There are only two economic systems in the

world . . . These two economic systems are generally

described as “the free market” and “socialism.”

. . . Socialism is characterized and defined

by either of two qualities: Government ownership

or control of capital, or forced pooling and

redistribution of wealth. . . . [T]he current bailout

could be described as “super-socialism” because

it involves every possible component of

socialism: the forced redistribution of wealth,

increased government control of capital, and

even the extreme of socialism, which is government

ownership of capital. Our federal government

is not content to just regulate the markets

(capital), but is also taking the next step of purchasing

ownership interest in previously private

companies. 14

Questions

1. How would Locke, Smith, and Marx evaluate the various

events in this case?

2. Explain the ideologies implied by the statements of:

the letter to the U.S. Congress signed by 100 leading

economists, Joseph Stiglitz, Bob Corker, the Republican

resolution on the bailouts, Robert Higgs, and

Michael Winther.

3. In your view should the GM bailout have been done?

Explain why or why not. Was the bailout ethical in

terms of utilitarianism, justice, rights, and caring?

4. In your judgment, was it good or bad for the government

to take ownership of 61 percent of GM? Explain

why or why not in terms of the theories of Lock,

Smith, and Marx.