If You Thought the Auto Bailout Was Ridiculous Before...

To be honest, I figured General Motors (GM) would be in bankruptcy by now. With a monthly burn rate of estimated to be between $2 billion and $6 billion (depending on source) it would seem this money hole would have imploded sooner rather than later.

But with the stimulus package signed and the goal of creating or saving 3.5 million jobs (on a side note, if anyone knows how you calculate “saved” jobs please let me know – it seems if 3.5 million people are still working by the time the next election rolls around, this will be a “success”) and hundreds of billions of dollars ready to be handed out to anyone who earns a prevailing wage, the government may have revealed their plan to save GM and Chrysler.

This time, they’re actually addressing the real issue at hand. After all, it’s basic economics. It’s all about supply and demand.

The Supply Side

In a week when GM’s market cap fell to below its 1938 valuation (yes, lowest since the Great Depression) and announce 47,000 layoffs, it still felt it’s somehow deserves more taxpayer money to stay afloat, GM and Chrysler handed in their recovery plans.

The plans called for layoffs, restructuring, and more cash – much more cash. GM and Chrysler asked for an additional $7 billion in “loans” immediately and more than $21 billion down the road. This was on top of the $17.4 billion the companies received last year.

But this cash won’t address the real problems GM and Chrysler are facing we identified when they got their first round of handouts:

At the end of October, GM North America reported it has 799,000 vehicles in stock – consisting of both cars and light trucks. That’s about five months worth of inventory (when measured against the 166,000 sold in October), which is 15% below last year’s inventory, but it’s only getting worse.

At current sales rates, inventory will start to grow. GM expects to produce an additional 567,000 (875,000 total for Q4 minus 318,000 October production) over the next two months. If the October sales rate holds up, despite rising unemployment and falling consumer disposable incomes, GM’s total inventory will increase to 1,234,000 vehicles.

Since then sales have only gotten worse and thanks to government life support they’re still making more and more cars. But here’s where the government is making its most ridiculous move yet to address the overcapacity problem and cover more of the automakers cost.

The Demand Side

This is the big question I had a few months ago. During an interview with BNN, we identified there were a total of 250 million cars, trucks and motorcycles registered in the United States. But there are only 203 million drivers. That’s an average of 1.23 vehicles for every driver.

At the time it seemed everyone was focusing on debating the morality, but there were much, much bigger questions at hand whether it was right to bail out these companies or not. For instance, where would all the demand come from? Does everyone who wants a car already have one? How many people would choose to upgrade to a new model in the middle of an economic downturn?

So the government devised a solution: they’ll create demand.

One big part of the stimulus package is for the government to purchase $300 million worth of new cars. Sure, it’s for hybrid cars (which I guess makes it a bit more marketable to the public – who wants to say hybrid cars are bad?), but it’s clearly aimed at making a dent in the overcapacity problem.

So now the government is not just subsidizing supply, it’s also creating artificial and unsustainable demand.

Ballooning Backdoor Bailouts

On top of that, there are plenty more “backdoor bailouts” for the auto industry. The Detroit Free Press reports there is:

• A tax deduction on auto loan interest which consulting firm R.L. Polk says works out to about a $1,250 subsidy per car purchased (good idea! Especially since the tax policies and implicit Freddie and Fannie guarantees which help create a “house for everyone” bubble worked so well…).
• An income tax deduction for purchase of hybrid vehicle worth about $330 per vehicle.
• A $2 billion grant for manufacture of batteries for hybrid cars (read: government pays for a big portion of the cost of production).
• $4,500 vouchers for new cars given only to people who drive cars which get less than 18 miles per gallon (a nice “thank you” for being part of the problem).

In the end, this whole situation seems eerily similar to a story a friend of mine once told. I lived in Germany a few years ago and worked with quite a few Germans who showed me firsthand how socialism can destroy an economy.

One of them was from East Germany and who used to work in a nail factory before Berlin Wall came down. He told me one side of the factory made nails. The other side of the factory melted them down. It seemed inconceivable to me at first, but it was a way to create “jobs” for everyone.

Hopefully we’re not going that way here, but the way it’s all shaping up, more questions remain.

What happens after we have a new government department (Car Czar and staff) to oversee the production of cars nobody wants? Do we get a new department to hire people to drive them around?

I sure hope not. But if it does, I can’t wait to see Rick Santelli’s next rant.

Comments

[Mad Hedge F...:]

I’ll tell you what GM’s problem is. My dad was a religious lifetime GM customer, buying a new Oldsmobile every five years. Once he even flew to Detroit for a factory tour and drove his new prize home. Thirty years ago I told him he was doing GM no favors by buying their cars, and the only way to force them to improve a deteriorating product was to buy better made German and Japanese vehicles. This was right after the State of California had forced auto makers to install seatbelts on new cars. Airbags and ABS brake systems were still years away. His response, “I didn’t fight the Japs for four years so I could buy their cars.” (He was a Marine). GM’s problem is that my Dad passed away seven years ago. Of the original 17 million WWII veterans, 1,500 a day are dying, and there are only 1.5 million left. All of them loved Detroit because it built great Jeeps, Sherman tanks, and half tracks. Their kids prefer German, Japanese, Italian, Korean, and soon, Chinese, and Indian vehicles. It is no coincidence that GM’s problems really accelerated with the passing of the “greatest generation.”

Feb 23 07:07 AM

[John D:]

Hedge Trader .... I take it you also prefer to give away the 100's of 1000's of jobs so you can drive those foreign cars as well, your dad wasn't doing anyone other than you and your generation a favor by buying those cars - it helped put meals on many tables for many years including yours indirectly BUT what your saying is we will take all that you grew up with and jeopardize your childrens future here in North America so you can drive an import .... would it have not been a lot easier for you to move to Japan or Germany so you could drive them on their HOME LAND !!!


On Feb 23 07:07 AM The Mad Hedge Fund Trader wrote:

> I’ll tell you what GM’s problem is. My dad was a religious lifetime
> GM customer, buying a new Oldsmobile every five years. Once he even
> flew to Detroit for a factory tour and drove his new prize home.
> Thirty years ago I told him he was doing GM no favors by buying their
> cars, and the only way to force them to improve a deteriorating product
> was to buy better made German and Japanese vehicles. This was right
> after the State of California had forced auto makers to install seatbelts
> on new cars. Airbags and ABS brake systems were still years away.
> His response, “I didn’t fight the Japs for four years so I could
> buy their cars.” (He was a Marine). GM’s problem is that my Dad passed
> away seven years ago. Of the original 17 million WWII veterans, 1,500
> a day are dying, and there are only 1.5 million left. All of them
> loved Detroit because it built great Jeeps, Sherman tanks, and half
> tracks. Their kids prefer German, Japanese, Italian, Korean, and
> soon, Chinese, and Indian vehicles. It is no coincidence that GM’s
> problems really accelerated with the passing of the “greatest generation.”
>

Feb 23 08:18 AM

[User 362439:]

Hedge Fund Trader . Is that a job ? if it is please explain how that benefits your country and your community , also explain how this contributes to the advancement and intellect of the human race.
If you know any history you would understand how US automobiles contributed to the greatness of this nation.

Feb 23 08:49 AM

[TB3:]

All I can say is it's a good thing that being a good hedge fund trader doesn't also require being a good writer of the Engish language. Based on your writing skills, the next government bailout should go to writing classes for hedge fund traders.

Feb 23 09:34 AM

[ctj:]

Either way, the truth is that GM vehicles today are not only competitive but leading in some categories. Further, their product development and design has all but taken almost every big award over the last 3 years (2009 euro car of the year the most recent). Many hold perceptions that are as old as the oldmobiles referred to earlier and just as out of date. The data tells a different story....

Feb 23 09:39 AM

[Shadrach:]

Why is it that it now seems to be the attitude of many (in favor of bailing the big three) that Americans should have to buy over priced, lower quality vehicles so that a few can sustain their lifestyles. The big three cut their own throats and everyone knows it.

Feb 23 09:42 AM

[kelm:]

Good article. Detroit auto is a failing industry and needs to be allowed to fail or forced to consolidate massively. We have a large non-big 3 auto industry in this country and they also are a significant component of our manufacturing base but the government doesn't seem to like to talk about that.

Attempting to pump up the US consumer is not the way out of this crisis. The nation needs to structurally move towards a more balanced economy and not one that is 70% consumer driven. That is what any stimulus should have reached for, instead we are simply trying to prop up consumption.

What next? Maybe they will just mandate that everyone get a new Detroit car. The truck will drop it off at our door and haul away whatever you have to the junk yard. Ridiculous but not very much different from the path the administration is embarking on.

Feb 23 10:40 AM

[PassingBy55:]

The blind patriotism present in these comments hobbled america in our modern war period - 2001 -? and will continue to hobble america.

GM makes cars people don't want for a variety of reasons. We have a capitalist economy, you're not going to do any good trying to ram patriotism down people's throats to buy products they don't want. GM needs to be restructured and start producing cars AMERICANS want.

You'd think being located in AMERICA would give them a number of competitive advantages selling cars to AMERICANS. The american automakers have been lax for years and their fate is going to catch up with them.

I support the view that we should support our domestic economy, but major companies' offerings should mirror the tastes of their target consumer, its just business.

Feb 23 10:45 AM

[Gwailo Joe:]

Our automakers have shot themselves in the collective u-joint by failing to anticipate the needs if their own domestic market and creating too many vehicles that Americans DONT WANT. I love cars. I respect and admire the triumphs (and setbacks) of our automotive history. But it is a pretty poor argument to label someone 'un-American' because they wont buy domestic: and with globalization what the hell is really domestic anymore anyway? Better to buy a Toyota from Tennessee than a Mercury from Mexico, right? I guess it depends if we care more for workers or corporations. . .
I suppose I'm part of the problem: never spent more than $6000 for a car. I'd love to drive one of those new Cadillacs, but for me, owning a working vehicle outright beats GPS, heated seats and a 30K loan anyday. . .
Do feel bad for the country: it's a dark day when GM begs for a taxpayer handout.

Feb 23 11:19 AM

[tricky dick:]

I spent 30 years in the retail auto business....the "bean counters" in Detroit rarely listened to those on the front line, when domestic sales dropped steadily and imports rose. Let the law of supply work, let them survive or fail on their own

Feb 23 11:41 AM

[Pstoneki:]

Competitive? Come on. Every time i sit in a new GM vehicle (minus the CTS and STS, which are awesome) I'm reminded just how far the competition has come. Every one of the plastic interior parts have exposed mold seams. The seats are covered in cheap cloth or leather (although not as bad as that in a Nissan). The Corvette and the Cobalt are the worst. Ever sit in a new VW / Audi / Toyota / etc? Fantastic. Also, current GM powertrains are from the 80's compared to other makers. The Vette still uses 16 valve, pushrod V-8 technology when every one of the real competitors uses modern 32 valve SOHC or DOHC engines. For their halo car? Their foreign competitors have it right. Given they sell at the same price point as the comparable GM vehicle it is atrocious that GM is even considered viable, let alone considered competitve.


On Feb 23 09:39 AM ctj wrote:

> Either way, the truth is that GM vehicles today are not only competitive
> but leading in some categories. Further, their product development
> and design has all but taken almost every big award over the last
> 3 years (2009 euro car of the year the most recent). Many hold perceptions
> that are as old as the oldmobiles referred to earlier and just as
> out of date. The data tells a different story....

Feb 23 12:13 PM

[James H. Wang:]

It looks like the government is competing with GM and Chrysler in how much money it can lose.

Maybe, once we have lot after lot of unsold cars from all this stimulus money (after the government buys a chunk of them), we can just donate them to poor nations like Opera did.

Tongue in cheek, perhaps, but it would be far more reassuring if this didn't seem even somewhat plausible at this point.

Feb 23 01:15 PM

[HBWOW:]

THE FACT IS THAT WE CAN NOT SURVIVE UNLESS WE HAVE A LARGE MANUFACTURING BASE WHATEVER THE MIX OF PRODUCTS. AUTOS SHOULD BE INCLUDED AS THEY ARE A HIGH TICKET ITEM AND AMOUNT TO A LARGE PART OF OUR GNP. Our government is too big, manufacturing base diminishing, and these two negatives are a major reason for our growing deficits. Our FREE TRADE has mostly been returned with protectionism from our trading partners. Japan started the trade war (first electronics, then cars, then trucks) and China has magnified this problem with their cheaper everything.

Feb 23 04:01 PM

[babyray:]

Anytime somebody writes about a friend telling him a story ( friend from Germany describing socialism) It is made up!! Just another hedge fund manager that got us into this mess to begin with!! Labor is only 10 % the cost of a vehicle. Its not the UAW's fault this company is falling apart. Its unequal trade agreements, Unfair EPA and cafe standards and competition that have most of their operations in countries that have National health care. Never mind Southern Republican Senators that give foriegn companies 10 years tax free to build a couple of plants in their states so they can employ less than one quarter of the amount of employees of the Big 3 but fool the public into thinking they are a huge American Employer!! If we get areselves in a big war will the transplants let us convert these plants for our millitary Use. I think Not!! Be American!! Buy American!! Drive American!!!

Feb 23 04:51 PM

[Pstoneki:]

Yawn. Labor may be only 10% of the cost of vehicle (which is a lot). However, when that labor builds a poorly built vehicle that has a raft of warrantly claims we have a serious problem. I worked on the line at several GM assembly plants. I saw the junk we built. A lot of the guys and gals did a great job. However, their quality work was overshadowed by the poorly executed, just plain lazy work of others. My father in-law worked in an engine plant at Ford for 46 years. My father was a plant manager at a Chevy assembly plant. Both saw a lot of the same things.

8 years ago I started consulting at a variety of American assembly plants for foreign makes - Honda, Nissan, Toyota, and BMW. What an eye opener. Although my father in-laws blood still runs Ford blue, my dad saw the light. He now drives a Toyota. This from a guy who only drove Chevys and Buicks since his first in 1957.


On Feb 23 04:51 PM babyray wrote:

> Anytime somebody writes about a friend telling him a story ( friend
> from Germany describing socialism) It is made up!! Just another hedge
> fund manager that got us into this mess to begin with!! Labor is
> only 10 % the cost of a vehicle. Its not the UAW's fault this company
> is falling apart. Its unequal trade agreements, Unfair EPA and cafe
> standards and competition that have most of their operations in countries
> that have National health care. Never mind Southern Republican Senators
> that give foriegn companies 10 years tax free to build a couple of
> plants in their states so they can employ less than one quarter of
> the amount of employees of the Big 3 but fool the public into thinking
> they are a huge American Employer!! If we get areselves in a big
> war will the transplants let us convert these plants for our millitary
> Use. I think Not!! Be American!! Buy American!! Drive American!!!

Feb 23 05:31 PM

[fireball:]

how about letting business handle business and make the dumbass lawyers stay in washington. no stipends, tax breaks, or subsidies. hopefully gridlock will paralyze washington so there is a slight hope this great nation can recover.
the banks problems seem to come from govt. pressure to make stupid loans to stupid citizens. the buyers should buy the car they want. the auto industry seems to be caught between ridiculous uaw wages and govt. regulation. then with bipartisan effort we get rearended.
if you want to fix a problem let a capitalist make a buck. if you want it really screwed up give it to a room full of lawyers.
i know what is, is.

Feb 23 07:02 PM

[Ergo:]

Interesting article. It seems the govt has assumed a temporary problem, in which spending can get over a hurdle. This ignores the large market forces at work, and the many changes which have taken place in the auto industry (much more than can be summarized here). IMO, Detroit needs extreme fundamental changes in order to thrive, and they're still moving sluggishly at adapting. Unless this recession has a quick turn-around (unlikely now), there is clearly more trouble ahead.

If given a comparable choice, I'll always buy American. Trouble is the choice is getting less comparable, and cars are much too large an investment to buy frivolously. I won't need another car for several years, but when I do, I have a responsibility to my own family to act responsibly, and I will do so at that time.

Feb 24 12:29 AM

[Motor Head:]

True, but the best of the best only amount to a drop in the bucket. What The root of the problem is that American automakers have wallowed in a non-customer centric business model for decades! The "build it and they will come" way of product development is long dead. The foreign competition recognized this and build what customers have wanted! Good example, the pick-up truck! US automakers told us we needed a pickup in every garage and they sold well until the US consumer found that they did not meet their needs, either economically or practically. Great marketing but poor requirements alignment.

Feb 24 09:37 PM