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The Auto Bailout and Mental Accounting

Source: Flickr by Cobalt at www.flickr.com/photos/cobalt/1422157740/
Source: Flickr by Cobalt

Last night the $14 billion bailout for the auto industry failed in the Senate primarily because the United Auto Workers union refused to accept a pay cut for its members. This likely spells big trouble for the Big 3 as collectively they are asking for funds in excess of $30 billion. General Motors (GM) alone, which employs a quarter of one million workers, needs $8 billion over the next two months to stay afloat according to its CEO Rick Wagoner.

Supporters of the bailout are now looking to the White House and the Treasury to step in. To date the Bush administration has resisted dipping into the remaining balance of the $700 billion TARP earmarked for the banking industry to help the Big 3. The Bush administration’s position in this regard is well understood. It wants to reserve the remaining TARP funds for the banking industry “just in case”. But there is also no denying reluctance to use the TARP funds to assist the auto industry is really grand scale mental accounting.

Mental accounting, as studied by Richard H. Thaler, is the way we attribute a monetary value or utility to an economic transaction, situation or expectation. It tends to separate those values in different accounts according to their origins and purposes. Mental accounting can also be seen as the failure to see the entire financial picture and how one decision affects another. To understand this concept on a personal level it is best to consider a couple of examples.

  • A divorced mother holds a grudge against her ex-husband and father to her children on whom she depends for child support. In an effort to exact revenge against the ex, the mother makes crank calls to the father’s place of employment causing him to loose his job. This in effect decreases the mother’s income in the form of child support. The mother failed to connect that her income was dependent upon his. In her mind they were separate.

  • A consultant on a temporary project wants a file cabinet to store just a few papers. The local office supply store has small, medium and large size cabinets which cost $200, $250 and $300 respectively. Being analytically minded the consultant buys the largest cabinet as he calculated it would allow him to get the most space per cubic inch for his money. However, he failed to consider he had only enough files to fill half of the smallest cabinet. In essence, he wasted $100 dollars. When something sells for below the mental price we have assigned it, the deal takes precedence over the actual utility of the item.

Whether the government uses the TARP money, some other funds or does nothing at all, we as Americans will collectively “pay” for the automakers woes. Perhaps it will be in funds going directly to the companies. Or perhaps it will be in increasing the welfare and unemployment rolls. It may come in increasing bankruptcies and foreclosures among former workers of the industry. At this point, we, Americans, the government, cannot avoid expending these dollars either directly or indirectly.

In the interest of full disclosure, I wrote an earlier post suggesting giving money to the automakers amounted to a very bad investment decision. I stick by that position. In 2007, GM lost $38 billion in 2007 and Ford (F) lost $2.7 billion. However, in no way was I suggesting nothing be done. As an investor, I am against the bailout. As an American, I can see the government giving the Big 3 the billions they are asking for – I will just close my eyes and hold my nose when and if they do.

Disclosure: I do not, nor do the clients of Brick Financial Management, LLC, own any securities mentioned in this article. But positions may change at any time.

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