With the fallout from the credit crisis now spreading from the banking sector to the cash starved industrial sector, pressure is now building to provide bailout funding to the domestic auto sector as a way to help secure their economic viability.

The auto industry is clearly on the front lines of the credit crisis with GM effectively borrowing money above 40% interest and their cash reserves expected run dry as early as next summer. While many would argue that these problems were of their own making and we should just let things take their proper course, the fact that up to 3 million domestic jobs may be at stake from a full scale collapse of the sector should give us pause. Given the circumstances, we should at least look to explore all of the available options before allowing Chrysler, GM and their suppliers to be added to the growing list of credit casualties.

In order to honestly explore whether we as taxpayers should play a role in helping to revive our domestic auto companies, we must first look at the problems these companies are faced with. In addition to the overwhelming burden that high financing costs are having on investment in their businesses, the immediate problems faced by the autos are three-fold; 1) they don't supply vehicles their consumers want, 2) they are perceived to be less innovative and have lower quality standards than their competitors, and most worrying from a public funds perspective 3) the market for autos in the US is expected to contract over the coming years due to the economic downturn.

While the first two concerns appear extremely challenging though solvable given the proper incentives, if the third point is correct and the industry as a whole starts to contract, it will be very difficult if not impossible to successfully execute a business as usual bailout for the industry.   

In a recent research report, Goldman Sachs cut their 2010 US vehicle sales forecast by 2mln cars from 16mln units to 14mln units, citing weaker consumer credit conditions and a slowing US economy. The report notes that access to cheaper and better consumer credit has been fundamental to making automobiles more affordable in the US over time. In fact, the study points out that cheap credit explains in many ways how auto sales in the US have managed to grow faster than population or even driver's license registration growth over the past several decades.

The Goldman report concludes that with consumer credit rates starting to tighten, there is now a growing risk of this trend reversing. Consumer credit costs will start to rise, autos will become less affordable as a percentage of a person's income, and auto sales will begin to contract.

From the taxpayers perspective, a low to no growth scenario such as this would prove disastrous for investment in the business as usual recovery strategies being floated by the domestic automakers. What is needed for a recovery of the domestic auto industry is a completely transformational approach to their businesses. One that is based on best in market technologies that, when deployed to scale, would allow them to compete head to head with their more progressive competitors.

The best way to ensure that this goal of being first in class is achieved is by linking any public financing agreements to the production of dramatically cleaner, higher mileage cars. Cars with a corporate average fuel economy (CAFÉ) that matches or exceeds the goal set by President-elect Obama of 39mpg by 2020. 

How higher CAFE or greenhouse gas performance standards can work to reward consumers is quite straightforward. In broad terms, every mile per gallon of higher average fuel economy translates into roughly $5bln of lower fuel costs for the American consumer on an annual basis. This is a significant dividend to the American consumer and if a decision is ultimately made to rescue the domestic auto industry, higher CAFÉ standards should play an important part to ensure a reasonable return on our taxpayer equity. 

For example, an agreement to accelerate CAFE standards from 35mpg, scheduled to take effect in 2020, to 40mpg would allow the American public to receive $5bln per mile in fuel savings or $25bln annually from their investment. This fuel savings dividend would be additional to the number of jobs saved and created by the innovations needed to bring these more efficient cars to market. 

Indeed, the use of higher CAFE standards is also a critical way to motivating the kind of transformational re-tooling investment needed to vault our domestic auto industry back into a leadership position in the global auto market. Short-term bailout packages could be coupled with longer-term re-tooling incentives in a cap and trade bill, that could be brought forward once the bill is passed, and provide the investment capital needed to make the transition to a first in class, efficiency driven automotive sector that America needs.

Blank checks are not the answer. We have a choice to help GM and others invest in projects like the Volt and become a world leader in the production of dramatically cleaner, higher mileage cars or simply let them carry on with business as usual until they run out of gas. If we choose to use CAFE standards as a way to enhance our investment in a bailout, the American taxpayer could be well rewarded for their efforts.