Detroit's Hail Mary: Saving the Automakers

There has been much ado lately about the very sick state of our domestic auto industry. As you may know, Rick Wagoner, CEO of GM, has been lobbying the Treasury and the White House for approximately $10 billion in funds, which is supposedly needed to push through a merger between General Motors and Chrysler (majority owner by Cerberus Capital, which acquired 80.1% of Chrysler from Daimler AG (DAI) for $7.4 billion last year). It seems that no one has the want or the ability to lend GM the money in the private sector, their creditors included. So apparently Mr. Wagoner goes to Washington can be seen as sort of a last ditch effort. The trouble is, the Treasury announced on Halloween that there would be no treats awarded to Wagoner and his lobbying efforts and that GM would not receive a loan to bail out Chrysler.

Was this the right move? Let's start with the business position of the two companies: General Motors is burning through over a billion in cash every month like a pyromaniac. With about $20 billion dollars in cash, analysts estimate that GM needs at least $14 billion to maintain operations. Analysts expect that, with 14 million units in industry sales next year, GM will be down to the wire by the end of the summer. That outlook is awfully rosy, as some analysts have estimated 12 million units or worse (outlays for all durable goods items year-over-year for the third quarter were down by double-digit figures and will almost certainly get worse).

The final blow, in my humble opinion, is that given this rash of news, very few are going to want to purchase an automobile from a company that may not be around long enough before the warranty on it runs out, much less be able to provide replacement costs for the life of the vehicle. This leaves GM in a dire position in which, without any outside assistance, it is surely to file for Chapter 11 bankruptcy within a year.

Then there is Chrysler and Cerberus. The private equity firm took control of the company last year, promising to make the automaker leaner, although not necessarily greener. Chrysler is saddled with, by a wide margin, the most unfavorable product lineup of any major automaker marketing in the United States. Chrysler's fleet consists of fuel-gulping trucks and SUVs as their bread and butter, with inferior small and mid-size models with dismal sales sales figures (their minivans and the Jeep line being their only clearly distinguished products). This product line had no chance of withstanding the onslaught of increased fuel costs that led consumers to more efficient automobiles, a trend that is not likely to reverse even with the recent large decrease in fuel costs.

Chrysler does have one thing going for it: cash. Chrysler has about $11 billion in cash that GM can get their hands on if the deal can be consummated, which is quite attractive for GM, given that they are hemorrhaging the green stuff. Cerberus also has an approximate 50% stake in GM's finance arm, GMAC, which Cerberus would love to get their hands on a majority stake of, as it would allow them access to the Treasury's TARP recapitalization funds. The proposed combination of General Motors and Chrysler would thus have the potential of salvaging some of Cerberus's inherently poor decision to purchase Chrysler, and General Motors would have access to cash, which could stave off bankruptcy, and everything will be hunky-dory.

Unfortunately, GM would have to close the vast majority of Chrysler's plants, close their dealership network (the costs of doing this alone would be over $1 billion, and would seem counter-intuitive as automakers such as India's Tata (TTM) and China's Chery would love to have an established dealer network to peddle their inexpensive autos in the United States and abort contracts with suppliers. The costs of this rape and pillaging would devour most of the $11 billion booty the pirates at GM want so badly and walk about 35,000 directly-affected jobs off the proverbial plank. These actions would tarnish GM's reputation severely, and would put Washington in the politically suicidal business of downsizing automakers.

It is not surprising then, that Paulson and Bush pooh-poohed providing funds for a merger. Their alternative seems to be the same as many cynical Americans: to hell with Detroit. That option initially looks interesting, just like I stated a GM-Chrysler merger initially does. The conventional logic states that Detroit cannot compete with the imports. The cost differential between, for instance, a Toyota (TM) and a GM vehicle, had been about $1,400 (half of that alone is due to GM's health care liabilities for their employees). It seems rational that Detroit's 'bloated' structure should go the way of the dodo, based on a central tenet of capitalism: uncompetitive industries must die. However, I believe this logic to be not only flawed in this circumstance, but horribly reckless.

There are two main flaws with this argument. The first of which being that Detroit is in fact becoming competitive;  last year's UAW deal will for all intents and purposes close the labor cost gap (although not the health care gap, as Detroit isn't wholeheartedly funding the Health Care VEBA it established, but I'll get to that point later). Also, the product quality gap has been significantly reduced (and with many automobiles, completely eliminated or bested).

The other flaw is the current state of the capital markets. Detroit does have a viable future, but has little chance of getting private funds to see them through (seems providers of capital have more to lose than the United States if Detroit fails, no surprise there). Without Washington's help, Detroit's potential will thus never be realized.

The argument that the failure of automakers do not pose a systemic risk is completely laughable. The negative feedback loop caused by big three bankruptcies (historically, bankrupt automakers haven't been able to emerge from bankruptcy and have ceased operation) would include the failure of suppliers. This could also mean that healthy automakers with American operations would be forced to close their domestic works as well (maybe a bit of a slippery slope, but this is certainly plausible). In total, it is estimated that up to five million American jobs are dependent upon Detroit. Not to mention, the decimation of our industrial base is a national security risk. Suddenly, "death to Detroit" rings a little hollow.

Here's what I think should be done: Give Ford (F) and General Motors capital injections with the caveat that they cannot be allowed to buy Chrysler, for the very simple reasons that a) Ford has a future, b) GM is too big to fail, and c) Chrysler's business is arguably being dismantled by Cerberus already (Chrysler CEO Bob Nardelli has been doing this since the day he set up shop in Auburn Hills). I am confident that giving Ford and GM capital would allow them to weather this dreadful auto market and will result in their comebacks, if and only if, the United States guarantees health care for all Americans (see Senator Wyden's Healthy American Act, which is somewhat similar to the Massachusetts model, one that has significant bi-partisan support and one I wholeheartedly support as well).

Guaranteeing health care would allow Detroit to almost eliminate their health care liabilities, providing the domestic industry with a strong future. So let Cerberus have their just desserts for rolling the dice with Chrysler (bailing out a private equity firm and a German automaker is not America's business). Unfortunately, Paulson can't call a time out and just let the next administration deal with the problem because it will by then be too late.

A bit of a digression, but I watched the Michigan State Spartans emerge as the victor over my beloved Badgers Saturday afternoon after clueless coach Bret Bielema tried to take a time out when the Spartans had twelve seconds to scramble for a field goal kick. Bielema's time out didn't work and Paulson's will certainly not either. Furthermore, GM's Hail Mary didn't work out last week, but with the action steps I have highlighted here, hopefully there will still be at least one play left in this wild game.

Disclosure: none

Comments

[ButWhy:]

I am over-simplifying, for the sake of argument.

In a free market, wouldn't the 'jobs' that are lost get taken up by the business created by Chrysler going bankrupt? Wouldn't Jiffy-lube, or Mom and Pop, send a notice to all Chrysler owners that stating they will take care of the car? Wouldn't the parts suppliers then sell to Jiffy-lube? (Just using them as an example.) Wouldn't the mechanics who work in the Chrysler dealership move on to these stores? Ford and GM now have less competition, as such, their dealers will become more profitable. Isn't the biggest problem we have more cars than consumers to buy them?

Who buys film for their cameras today? Again, over-simplifying things, but should the American taxpayer have bailed all of the companies who had become outdated? Why is it the poor Union worker, and his family, or his widow, that becomes the reason we MUST do this? They rolled the dice, we all do. I can't wait for the personal tragedy stories, the kind a liberal news network will trot out. "Look at this poor widow, her husband worked at Chrysler for 42 years, he died of cancer, she is looking forward to the generous health benefits, blah, blah, and look at yourselves, greedy taxpayers, why aren't you willing to help her out?"

Because taxpayers shouldn't have to. The "government" is the taxpayer. Innovation will create jobs for those who lost the old one. Should we have bailed out vinyl record manufacturers? TV box makers? What about their families?

The Unions broke the car industry. Eventually, a parasite destroys the host. The socialist agenda does not work.

I vote no bail out.

2008 Nov 02 11:07 AM

[Master Blaster:]

I grew up in Detroit during the 50's, 60's and 70's. Moved to Florida in 1982 to work on the Space Shuttle. I returned to the Detroit area for the first time in 2002 and was TOTALLY amazed at the amount of US auto manufacturing plants that had been shut down. Many were vacant and some were converted to computer hardware manufacturing.
What many don't realize is that many of the GM, Ford and Chrysler autos are no longer made in the US. The Big 3 found out that they could have their vehicles made in countries like Mexico (and others) for a much cheaper labor price. I was disheartened to find out that my first Chrysler product, a 1985 Dodge 600 Turbo Convertible, was made in Mexico. My ex-wife bought a new PT Cruiser when they first came out and paid over sticker for it. It was also made in Mexico. Some Fords are made in Romania! All of this was done to save a buck. The plants had all been built decades ago and were totally depreciated with any upgrades costing millions. The labor prices in the non-US countries is extremely lower than in the US. The Big 3 can blame the UAW all they want, but the vehicle prices continued to rise with the benefit packages provided by new contracts. Prices became about unreachable for most blue collar workers, cutting out a large percentage of their market base.
I'm willing to bet that the UAW workers would gladly renegotiate contracts and take some cutbacks if it would save thousands of jobs, but in these hard economic times, that's a hard decision. Rising medical costs are a result of the AMA, resulting in higher health insurance costs for, in most cases, reduced coverage. When the UAW contracts are so affected by health care costs for current and retired employees, there's not much the Big 3 can do.
In my opinion, the biggest factor in most of the economic problems of US industry in general is the AMA. When a new 1978 full size Ford cost about $10,000, the health insurance was based on $70/day/room hospitilization (worked for Met Life during that period) and cost about $35-$40/month. Now the cost of the room, if you happen to be able to stay overnight, is over $1000. That's somewhere in the neighborhood of a 1400% increase, with the monthly premium being about $1400-$2000/month! The same products, the same medical care.
Who's to blame?
In my deluded opinion, unless the U.S. Government gets the AMA (who's the biggest lobby in D.C.) to do something about their profit structure and attack alternative fuels with vigor, the U.S. Big 3 don't stand much of a chance staying with U.S based assembly plants. Detroit is a ghost town with unemployment lines going forever. Bad enough that they are advertising on TV trying to get new manufacturing companies to come. But Detroit also has an extremely expensive tax structure, not only for manufacturers, but also residents. And for what?

2008 Nov 02 11:47 AM

[Jackson Cash:]

Paulson to Detroit, "You are not rich, nor white collar -- game over."

2008 Nov 02 12:40 PM

[ButWhy:]

When did health care become a 'right'?

I didn't have the advantage of being employed by GM or Chrysler. I built my own business, and I pay my own health insurance. It is very expensive. However, if I didn't have health insurance, and I had an injury, or illness, the hospital and doctors would sue me if I didn't pay. As I have a net worth, I could lose everything.

However, if I was lazy, and didn't have a job, and collected welfare, my medical needs become a burden on the taxpayers. What a great system you espouse! If I choose to smoke crack, or get drunk and crash my car into a pole, good old American taxpayer will be there to fix me.

Sure, the health care system in the USA is in need of an overhaul. The reality is, when people pay for things, they tend to take care of them. Making health care a right will result in substandard health care services. We (the taxpayers) simply do not have the money. There is no Santa Clause, life sometimes sucks, and actions have consequences.

Mortgage backed securities were like gold when backed up by homeowners who had a lot to lose if their home went into foreclosure. Then the socialist agenda took over; if we could just 'give' someone a home, they would magically turn into a 'responsible' person. (Thanks Acorn!) In today's skewed system, the responsible ones are being punished.

I don't run to the doctor every time a sneeze. I don't smoke. I take care of my health. I pay. Why shouldn't my neighbor? I understand charity, I am not unfeeling. However, shouldn't personal responsibility be rewarded, somehow?

I have been to Russia. They stand in 4 hour lines just to pay the electric bill. They wait a week to see the doctor, sometimes more. Sure, the easy strep throat cases get taken care of. The complicated cases? Stand in line. Russians are used to standing in lines.

2008 Nov 02 01:22 PM

[Convexity123:]

GM has been on the road to bankruptcy for years. It is just now getting close to the end. Injecting $20 Billion of taxpayer money into GM won't accomplish anything other than delay the inevitable. Has GM laid out their plan to return to prosperity?

GM's gameplan to prosperity seems to be to destroy $10+ Billion in capital investment (via the shutdown of factories and layoff of thousands of employees). I guess GM figures that if it reduced auto supply (i.e., effectively shut down Chrysler) will help raise prices, and all the Chrysler buyers will turn to purchase GM products. Hmmm? Somehow I don't think this will work ...

I seriously doubt the above strategy will work.

2008 Nov 02 03:36 PM

[Steven Hansen:]

this issue is too complex for simple litmus test responses. every comment made has validity, as well as the author's points. i am on the fence on this subject of a bailout for GM. no matter how you cut it, GM has been mismanaged for over 30 years - and the uaw did the rest of the damage in destroying GM. does GM deserve to survive - no. even with the money, i would bet against GM surviviing based on the tract record of the last 30 years.

but then we run into cutting-off-our-nose-t... syndrome. the unintended consequences may include a secondary unemployment cascade, a few more percent off of gdp, lower tax revenues, higher social costs, etc.

now is not the time for GM to fail because the state of the economy. Maybe the key is to provide a loan guarantee to break GM up while it is still worth something.

2008 Nov 02 09:27 PM

[User 290394:]

Rising medical costs are a result of the AMA? Physicians would probably beg to differ. Those that I know have had their compensation fall by nearly 50 percent during the past dozen years.

For what seems to be quite a while, now, medicine and higher education have led the way in pushing up the cost of living. Annual price increases of about 10% - triple the inflation rate - have been the norm for years in these two fields. And what they have in common is that the lion's share of their funding mechanisms is controlled by the federal government - via Medicare and the Department of Education.

To more fully socialize medicine is to more thoroughly empower the politicians who created and control the Medicare leviathan. I think I'll pass.

2008 Nov 02 09:37 PM

[markcostello:]

Rather than buy inferior UAW built autos or bail them out with tax dollars, why don't we just send our savings directly to the DNC, Accorn and/or Michelle and Barack? My next purchase will be an auto built in America by highly dedicated and compensated American workers: a Honda Civic.

2008 Nov 02 11:08 PM

[Pztrick44:]

ButWhy said...
"Sure, the health care system in the USA is in need of an overhaul. The reality is, when people pay for things, they tend to take care of them. Making health care a right will result in substandard health care services. We (the taxpayers) simply do not have the money. There is no Santa Clause, life sometimes sucks, and actions have consequences."

Re: "making health care a right will result in substandard health care services"

Not true. Universal health care can give us something today's system does not; preventative treatment.

When the uninsured feel sick, they don't go to the doctor. They wait... wait.. wait... Sometimes they win out and they get better. Other times they get so sick they need very expensive operations(often where early treatment could have prevented this).

But let's say Joe has a cough. Were he insured, he could visit his doc and possibly get treated with a single round of antibiotics(not too expensive for buddy tax payer)--but no, he is not insured. He does not visit his doctor, and after a motnh, unlike previous colds, this one develops into life-threatening pneumonia.... He goes to the hospital, is hospitalized for a month. When all is said and done, Joe cannot afford the bill, and it's kicked to the tax payer.

Would it not have been cheaper for the tax payer to have simply treated a cold rather than critical pneumonia??

This is a very simple explanation... but the practice of preventative treatment runs much deeper. Insured individuals get physicals all the time when they are not sick--they may be lucky and their physician identifies conditions early(know a friend who was able to nip cancer right in the bud when his doc suspected it from a physical?) Do uninsured individuals ever get physicals? No. But they will show up at an Emergency Room when their entire body system has already metastasized full of cancer.

I don't have a strong opinion on private health care or universal health care, but what NEEDS to happen is this change to preventative health treatment rather than only-go-to-the-doctor-... Whether this is full universal health care coverage, a basic Medicare for each citizen such that wealthier individuals can afford extra plans for their wishes, or just vouchers every year for a physical and one urgent-care visit(I would probably start here)... I don't know. But people need to start visiting docs before theyre sick, to bring the burden of health care costs down.

2008 Nov 02 11:43 PM

[mynine14:]

Great story, though can you please elaborate on "Detroit does have a viable future..". Presumably you are referring to the auto industry. If that is the case, then I would have to disagree... My persepctive is that it will take many, many generations to 'flush' out the attitudes of superioirity and entitlement that may have been applicable many years ago. My frame of reference is validated with the facts that I recently had the opportunity to spend a couple of years with the mighty GM and grew up with several generations of automotive professionals.

2008 Nov 03 09:57 AM

[mynine14:]

Great story, though can you please elaborate on "Detroit does have a viable future..". Presumably you are referring to the auto industry. If that is the case, then I would have to disagree... My persepctive is that it will take many, many generations to 'flush' out the attitudes of superioirity and entitlement that may have been applicable many years ago. My frame of reference is validated with the facts that I recently had the opportunity to spend a couple of years with the mighty GM and grew up with several generations of automotive professionals. Reply |Report abuse

2008 Nov 03 09:58 AM

[Paul Killinger:]

The definition of "insanity" is doing what you have in the past and expecting a different outcome. Now we're embarking on more corporate bailouts of dying industries and even greater socialized medical care. This isn't even insanity, just inanity. As the Rev. Wright would say, America's chickens are going to be coming home to roost. Big ones, too. (Or as Huey Long once put it, A chicken in every pot.) How appropriate!

2008 Nov 03 10:55 AM

[Boiling Point:]

It is nice to see a journalist who gets it or at least how important the auto industry is to the health of the U.S. economy. It appears that the economy and standard of living in this country has been in decline lock step with our domestic auto industry. How can we expect the Detroit auto makers to compete when the country of Japan and Germany subsidize their industry and have closed markets to U.S. products. Just look at what GM spends on health care. Toyota and Honda have a national health care program along with closed markets. Oh and lets not forget our South Korean friends who also have their markets closed to American products but also ship a million or so vehicles into this country. If you don't believe me take a trip over there and see for yourself. You can bash the domestics all you want but when their competitors have a whole nation supporting them it is hard to win. Unless Americans wake up and connect the dots they will find they have no industries left. They will soon find themselves living their life as every other 3rd world person.

2008 Nov 03 10:58 AM

[jmatson:]

"Universal health care can give us something today's system does not; preventative treatment."

A study done by the AARP found that 25% of visits to the doctor in the US are social calls.

Loneliness can be an expensive proposition.

2008 Nov 03 11:48 AM

[sumosama:]

don't confuse bankruptcy with going out of business as the author does. there are many bankrupt companies still in operation. highly unlikely gm will shutter if it files for bkp.

2008 Nov 03 11:52 AM

[Jeremy Needham:]

You may have a point that GM, Ford or Chrysler could continue to operate through a bankruptcy in some way, shape or form. However, it is highly speculative to imagine how that might pan out. One thing that worries me is that automobiles are a big-ticket durable goods item, which I would imagine requires a little more faith than purchasing an airline ticket. The research on this point is not very encouraging, so forgive me if I may have depicted a bit of a worst-case scenario:

www.trucktrend.com/fea...

On Nov 03 11:52 AM sumosama wrote:

> don't confuse bankruptcy with going out of business as the author
> does. there are many bankrupt companies still in operation. highly
> unlikely gm will shutter if it files for bkp.

2008 Nov 03 12:30 PM

[car_guy:]

This is a good article and summarizes the current situation. The biggest problem is that unlike Japan, Europe, and even Korea, health care and retirement pensions are the responsibity of the company. In the home country of every US 3 manufacturer, government programs cover pensions and health care, especially for retirees. While this also raises taxes, it distributes the cost across the economy. Additionally, US laws force companies to meet ever changing minimum funding requirements for their pension plans. This means that the government will likely force GM to take cash it needs to run its business into its pension plan and retiree health plan because of the huge drop in the market. Ironically this will drive the companies into bankruptcy, chapter 7 not 11, faster which will shift the liability for these penisions to the government. I have seen estimates that for just GM & Chrysler, this will cost the government over $20B.

The UAW contract negotatied last year will make the Detroit 3 cost competitive with Toyota/Honda/etc (that is what GM held out for in the negotiations) once the VEBA to manage retiree health care is established and these liabilities come off the books. Both GM and Chrysler must put $7B in cash into their VEBAs in 2009 (Ford's number should be similar). If the government provided this funding it would take these liabilities off the books, which would give the companies the cash they need to move into 2010 and help offset the competitive disadvantage policies around health car in this country have created.

Also, GM and Ford would likely go into bankruptcy like Delphi did, which was to only declare bankruptcy for their US operations. Their international operations, which have been very healthy and competitive would continue. Chrysler cannot do this because they are US based. .

So either the government provides some aid, preferably by providing funding to the VEBAs, or they accept over $20B in pension and healthcare liability, the loss of over 100,000 jobs, and the relocation to Europe of 1 or 2 historic US companies.

I'm glad to see you understand the dire consquences involved. Too bad most other people do not.

2008 Nov 03 12:47 PM

[Paul Killinger:]

Yes, there are consequences involved in a capitalist society. There are supposed to be. That's the whole point!

2008 Nov 03 08:59 PM

[car_guy:]

paulk8756 - so you are saying that the US is the only capitalist society on the planet? Everyone else is socalist? I thought we won the cold war!

2008 Nov 05 01:21 PM