Saving Detroit: An Investment in Future Failure

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It is highly unlikely that the government will refrain from bailing out Detroit at this point; on Monday, Congress is going to debate rescue legislation for the Big Three that

[C]ontain[s] strict conditions for the beleaguered companies, including management and salary changes, concessions from their powerful unions, and a commitment to making more fuel-efficient vehicles.   .    .one option under consideration was a smaller, more targeted amount of funding “that would get the companies through to March.”

If the government does not bail out the automakers now, the new Congress and administration will almost certainly do so early next year.

But what are the three automakers going to do in the next one hundred days that they have not done over the past decade? Can they restructure, innovate, and operate in a way that creates lasting economic effects worthy of the taxpayers’ investment? And should the American taxpayers risk billions of dollars on the Big Three in the hope that they can become profitable again?

My answers to these questions are “Not too much”,  followed by a bunch of “no’s”.

Chrysler, General Motors, and Ford have failed to meet the primary social responsiblity of corporations in a capitalist system: they are unprofitable. It is not merely stagnant economic conditions that have led to their decline; their competitors, for the most part, produce superior  automobiles, and have a more effective business model. Most of the rival automakers produce cars more economically due to lower labor inputs and a more streamlined production system.

Certainly there are thousands of jobs tied to the automobile industry, and the effects of plant closures cascade through local economies. But these corporations already face hard choices, and need to close plants, renegotiate labor contracts, and most importantly of all, innovate so that they can compete in a global economy, in a highly competitive industry. An investment in these industries may soften and prolong the downward spiral, but it will not likely turn it around.

The government should resist the siren’s call to bail out these corporations, and let the businesses use existing bankruptcy protection laws to turn themselves around, or succumb to market forces. A $52 billion investment to get the Big Three through March is likely a $104 billion investment on March 2nd.

And as for the state and local governments of Michigan, Ohio, and other states that are impacted by the declining auto industry, as well as the unions representing the workers? Be prepared to cut state/local government spending to match the likely tax revenue decline, offer concessions to the corporations, and get some of these startup automobile companies on speed dial so that they locate in an area with an experienced, motivated work force, and a government ready to do business.

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35 thoughts on “Saving Detroit: An Investment in Future Failure

  1. Nice, informative post. There are also some rules that were implemented by Washington that were meant to protect either the Big Three or their workers that are now crippling the industry. If they do bailout the industry, they should tie some sort of de-regulation of these laws to help them compete in the 21st Century.

  2. What could be more of an investment in future failure than federally backed flood or earthquake insurance? What could be more stupid than rebuilding sub-sea level New Orleans?

    When you lose your job at Cray, Dell, Cisco, Autodesk and Microsoft because GM doesn’t exist and isn’t buying computers and related software & hardware, when you can’t get parts for your company machined because hundreds, maybe thousands of automotive related businesses went belly up, well you can say I told you so.

    It’s not “thousands of jobs” that are at stake, it’s millions of jobs and the health of what remains of our manufacturing base.

    There already have been weapons projects delayed because machine tool companies making critical tools folded. We ignore the poor health of our industrial base at our own risk.

    I’m a free market guy, but some industries are strategically vital, let alone economically vital, to our country. At the least we need an industrial policy that allows those companies to thrive.

    BTW, before you complain about high union wages at the Big 2.8, what is more of a drain on the economy, an autoworker with a fat benefit package, or the 288,888 Federal employees who make more than $77,000 a year? At least the UAW guys build stuff. Their wages come out of voluntary purchases, not coerced taxes.

  3. “Thousands of jobs…” Please. Try adding some zeros to that number. That alone tells one all you need to know about your level of understanding as to the depth and seriousness of the problem.

    The reality is that a bankruptcy by GM will have profound effects on an economy that is already under severe stress. Comparisons to other industries (such as airlines) who have gone through Chp 11 restructuring wildly miss the mark…autos are different, and you’ll be hard pressed to find any reliable data that suggests they aren’t, and that the entire US auto industry would very likely be taken down by the bankruptcy of even one of the Big 3. So, if we take that as a given…that’s several million jobs up in smoke. Please tell me how an economy that is dependent in large part on consumer spending is likely to recover by adding ANOTHER several million people to the unemployment line? How does that magic happen, exactly?

    This blog is hardly alone, but the sheer amount of ignorance on all levels that’s been on display in discussion around this issue has been staggering.

  4. Anon,

    Thanks for reading.

    I may have understated the cascading effects of industry failure, but you most certainly are overstating them.

    The tale is in the stock price. Why buy into a company that almost certainly is not going to turn itself around? A multi-billion dollar investment in General Motors may keep the corporation solvent (through March at least according to the union official quoted in the article), but three to six months from now it is likely to be in the same position once again.

    I would rather see unemployment benefits increased and extended than pass the bailout money through General Motors.

    Boezor, your comments about maintaining strategic industrial capacity were good, thanks. I am actually working on a follow up post right now, on the subject, have a little research left. . .
    But Boezer, if and when the bailout does pass, those autoworkers’ wages are going to come from coerced taxes.

    Cheers.

  5. I think the endless money pit for taxpayers that Ford and GM will become is important. If this is what happens, Congress and Obama will act to make other steps to make this work. One whould be to increase domestic car purchases by tariffs and import restrictions. The democrats will try to pull out all the stops to make it work. Hello trade war and world depression. If the bailout passes, we are screwed.

  6. wilsonrofishing,
    Anyone who follows the automotive industry properly (not just with 20-year old anecdotes about the “crap-Ford” your aunt bought) would have a far, far different story to tell you about whether or not GM and Ford were able to turn themselves around before this crisis.
    That had already started years ago, and was to take an accelerated leap in 2010 when they were to receive long -overdue (and still short) concessions from the UAW.

    Then along came CAFE–the most nonsensical regulations regime we will have till carbon trading comes in courtesy of the Supreme Court.

    That massacred the product plans again, causing these companies to have to scramble and put much-needed products on hold in order to see how they would have to adjust (again) to fit government (not consumer mind you) demands.

    It costs about $2 billion (and about 3 to 5 years) to develop a car from scratch.

  7. And I also want to second the idea that you do not understand the magnitude of what will happen if GM goes down in terms of manufacturing.

    They are already the largest single purchaser of steel in the known world.

    Not to mention what others were saying about supercomputers, battery technology, software, other manufacturers (particularly of military hardware), sensor technology and on and on. It will be bad–and at a time when Russia and Iran are increasingly belligerent.

    As part of your research please do take exra time and read Inside Line’s “AutoObserver”, John MacElroy’s “Autoline”, the Washington Post’s Warren Brown on cars (particularly his weekly chats where he tirelessly battles the “20-year old anecdote status quo”) and Peter DeLorenzo’s “AutoExtremist”.
    Also, Motor Trend’s blogs have serious, serious information on the state of Detroit and what it is capable of. Just looking at stock prices and other market indicators is not very thorough in my humble opinion.

  8. If anything, I’m understating them. Want to ensure a Great Depression II? Go ahead and let an entire industry fail…that’ll do the trick, guaranteed. Stock prices tell me little about anything today. Besides, I’m not arguing that they’re in perfect health today…clearly they’re not…but that’s not really the question, is it? The question is, do they have to be saved and is there any possibility of conditions changing for them down the road? The answer to both of those questions is clearly yes, IMO. The pending shift in 2010 in their labor costs is a necessary part of this story, as others have mentioned.

    As some of the other posters have indicated, I too am a free-market guy. However, there are occasions when ideology has to be squared with reality on the ground. We stand to lose massively as a nation on a host of fronts that go well beyond the job losses (massive in and of themselves).

    Look, I’m all for attaching stringent requirements to this thing. As others have noted, Congress could do them a world of good simply by making overdue changes to CAFE regulations, but fine…let’s add fuel efficiency requirements that make sense, etc. However, to destroy a nation’s industrial base, throw millions out of work in one fell swoop, and eliminate a domestic auto industry from the territory of the world’s largest auto consumer is a very, very serious move…and frankly, very little of the discussion I’ve seen in recent days strikes me as being anything close to “serious,” given the profound lack of knowledge on display.

  9. Dis,

    As always, thanks for reading. Like many American taxpayers being asked to make a substantial investment in these three underperforming corporations, I am reading and learning as much as I can to see how smart a move it would be to put GM and the others in my portfolio. So far I want to balk, and your argument thus far been unconvincing.

    You are making the assumption that this is a zero sum game, that either the government is going to shovel cash into the corporations and save every single job and the U.S. economy, or its not, and the entire global economy is going to collapse due to unbreakable linkages to the economic nerve center of Detroit.

    If any of these companies go bankrupt, is every single subsidiary or automotive-connected manufacturing plant going to disappear? Will some still manufacture parts for existing autos, or retool to make something else?

    And would the American economy decline forever if one or more of these automakers were defunct, or would demand for automobiles eventually reach a level that would have to be met with either increased production from other automakers or new competitors?

    Why not let the companies use bankruptcy laws to renegotiate contracts and retool their entire business enterprises? They can start from scratch on contracts and become competitive again. And they could do so without the interference of the U.S. government, who are going to argue about CEO compensation, maintaining labor contracts, environmental standards, et al., and a whole bunch of other stuff that will probably not put these companies on the road to wellville as stand alone, privately held corporations. I honestly doubt that the United States Government could operate a brothel and stay in the black.

    I read one or two of the blogs you wrote about occasionally, Inside Line AO is in my Reader. Today’s top story is about the millions of dollars that Chrysler, likely to receive billions of dollars in taxpayer money soon, are planning to pay out $30 million to executives in the form of bonuses in February 2009! It also mentions that a Ford executive received a $15.7 million dollar bonus last year as well. I wonder if $25 billion will really be enough to get the Big Three through March?

    The story about how nearly all of the MG Rover were able to find employment after the company went under (albeit with significant paycuts) was also interesting as well.

    Thanks for taking the time to read, and the references you provided me. I would suggest back to you that take time to read Capitalism and Freedom, by Milton Friedman, and The Road to Serfdom by F.A. Hayek; both books are a good reference to some of the issues you and I are discussing here.

    Cheers.

  10. A few erroneous assumptions are being made in regards to the possible bankruptcy of the Big Three. The biggest one is that bankruptcy means they will fold, closing all their plants, laying off all of their employees, and canceling all of their contracts with their suppliers. Instead it gives the automakers the chance to reorganize, shed themselves of onerous and unrealistic labor contracts, and streamline their operations.

    Will there be pain? Absolutely, there’s no way around it. But better some pain now rather than major pain and suffering when they fail later, with little or no hope of staying in business. Either the Big Three make major changes or they will fail regardless of how much taxpayer money is thrown at them.

  11. I am from Detroit and have seen how the big three’s place in my community has diminish. Along with it’s disappearance has been the disappearance of opportunity for many Michiganders.

    What the automakers did was give false hope. They told us and told us that they were doing fine. No one could ever make a car or take over the big three. They lied and that was an error.

    My city is paying for listening. Now I am learning that this is bigger than Detroit. What happens to these companies will affect the country. The country can become like Detroit is now. It’s bad.

    The bail out is necessary, but so is great innovation. We cannot do what we have been doing.

    I think of MAC Computers and how the PC made them non-existence for years. MAC reinvented itself and created a new genre of product.

    This is what our auto industry needs to do. It is sorrowful that the government waited until it was necessary to do. We are not proactive, but hope this will change in the next administration.

  12. The point about bankruptcy is important; the big three are trying to avoid going bankrupt through this infusion of government funds. Why? The bankruptcy protections will allow them some space to reorganize, renegotiate contracts (or cancel them altogether), and try to become profitable once again.

    There were no “crap ford” anecdotes, either, in the valuation of these companies; I have owned AMerican trucks and SUVs for most of my adult life and been pretty happy with them, anecdotally.

    But when you look at the company’s stock price trends, its estimates (what is the current estimate of GM’s future price, I think it’s around $0 right now, correct?), its product line, and the fact that it needs a government bailout just to make it to the spring, it paints a pretty clear picture of what kind of investment this one is, right?

    And if I am uninformed, what about the big investors? If GM is such an undervalued company right now, why isn’t someone like Buffett jumping in to buy it?

  13. wilsonrofishing ,
    Thanks for the reply. This is close to my heart in that I have been following the “Big 3” since I was about nine years old!

    I should indeed read up on Milton Friedman and the like. I am committed to the free market as well, but…

    As far as I understand, if one of the “Big 3” goes down, all go down. That is how bad things have been for automotive suppliers. Delco and Continental have filed for bankruptcy recently, and they are two of the largest (and this was way before the crisis hit). In my humble opinion, I would not have bailed out AIG or GE and instead used the money to help the “Big 3”.

    You are correct in that the government does not need to get more involved with them on the regulatory side, and that the bailout is prime for this to happen but I am not sure Gm could survive bankruptcy. The many people left with a useless warranty would likely never buy from them again.

    We cannot lose our manufacturing base,and this is a ruthless business to fail in. Look at Tesla. You’d think with all their “Silicon Valley expertise” that they’d be sailing ahead of Detroit.
    Turns out it’s much harder than that.

  14. The bankruptcy argument is one that you’re seeing being made and it’s another example of the utter failure to understand reality on the part of those who offer it up. Disappointed nails it…this is not the airlines, not even close. Why do you think they’re trying to avoid bankruptcy? Perhaps it’s because they understand that an auto company is extremely unlikely to come out the other side. This is a VERY different deal than other industries where Chapter 11 has been beneficial.

  15. At a minimum, these companies need to renegotiate contracts with unions and dealerships, unless we are going to add a line item to the fed budget for them.Are they going to get that kind of tough love from a federal bailout? At least not during the FIRST bailout!

  16. Well, according to John McElroy, the labor situation is better than we think. Deals have been renegotiated.

    http://www.autoblog.com/2008/11/14/autoline-on-autoblog-with-john-mcelroy/

    Here is the relevant quote:

    “Last year’s UAW contract was truly historic in that it will completely remove the health care cost burden off the Big Three. Though they have to give the union the money to assume this burden, they’re paying 40% less than it would otherwise cost them. After 2010 they stop paying billions in health care every year and start dropping that money to the bottom line.

    Moreover, there will no longer be any pensions for new hires. They’ll get 401k’s instead. Again, massive cost savings going forward.

    On top of that the UAW workforce takes big pay cuts, and new hires come in at a wage rate that is roughly the same that Toyota, Honda, Nissan, et al, are paying their American workers. In other words, the Big Three can finally compete with the transplants from a labor cost standpoint. That means they can now make small cars in America without losing money on every one they make.”

    If there were not credit crisis we would not even be discussing this.
    In fact, we would be discussing how GM increased market share (for that is exactly where their sales were headed).
    GM did not create the credit crisis, and should not be punished for it.

  17. This country NEEDS a nice deep recession or depression. Then people who have been frugal and careful and paid attention to how they managed their lives can buy up all the good stuff for cheap, which is the way things ought to run.

    I have houses near me priced at $800,000 that I wouldn’t give $400,000 for. But I would give $300,000.

  18. Interesting post. I agree that you’ve understated the potential impact of failure for the D3…but even if the impact is everything that the CAR report indicates, I’m not sure a bailout at this point is better than restructuring under Chapter 11.

    There would certainly be leverage for negotiation with UAW under bankruptcy courts.

  19. What makes everyone think that if GM folds the “cascading” effects will not just be a realignment of those workers and manufacturers into industries that have a sustainable level of demand? I can’t understand why people would want to prop up an industry when it is incapable of producing a profit. If it can’t produce a profit then it has no business being in operation. If no one wants to buy cars from Detroit, why should Detroit be propped up to sell cars?

    Also, if GM was really worth saving and could be saved with a simple influx of capital … private investors would be the first to line up and produce the loans needed; as they would see the potential for a struggling company to turn itself around and create a successful business. That hasn’t happened.

    Could GM turn around? Maybe. But morally it is wrong to force disinterested investors (the tax payer) to invest. Has anyone on this blog in support of the bailout bought GM stocks recently? Probably not … but it’s ok to force everyone else to?

    Hyundai, a recent success with plants in the U.S., is having trouble now expanding into oversees markets amid fears of the U.S. propping up Chrysler. We should welcome these foreign manufacturers and allow the U.S. manufacturing and labor force to shift into their favor.

    Just take a look at Hyundai’s manufacturing plant in Alabama which was recently opened.

    Or Honda, Toyota, etc.

    http://www.hmmausa.com/

    And compare that to the Detroit dinosaurs.

  20. calicolyst,
    They already do.
    They have the largest market share in the country.
    In case you did not know even Toyota is experiencing 20% drops in sales (more actually). It’s bad for everyone, Toyota just has more cash right now.

    As to why investors don’t lend to GM? Well there is this thing they’re calling a “credit crisis”…

  21. Right OTM about the credit crisis, Disappointed…and that’s what those calling for Chapter 11 miss. That’s not a panacea…you have to have the ability to obtain investment even with the “positive” effects of the bk in order to go forward…see United in 2003 as an example. Guess what? That’s not the atmosphere we’re in right now.

    Whenever I see the “make cars that people actually want to buy” stuff, I wonder what year said person is living in. Much easier to stay in a rhetorical box than actually invest some effort in paying attention. That’s OK, though. Let’s wreck Michigan and Ohio…you know, states that historically have contributed mightily to the economic, military and social strength of this nation, all in the service of some short-sighted “point.”

  22. Oh, and NYU…is the banking sector creating a “profit” right now? Should we have let AIG or any of the multitude of financial firms who have received TARP money fade away…because, you know, other industries will just absorb that capacity? C’mon…

    This is such short-sighted stuff. A nation without an industrial base (and believe it…without a domestic auto industry, that’s exactly what the US is) has a host of problems and potential problems that go beyond even the horrific economic impact that would result in the short term.

  23. Disappointed,

    Thanks again for commenting, I appreciate it here.

    Where are you getting your numbers from in terms of market share? Correct me if I am wrong, but I believe that foreign automakers account for 51% of U.S. market share, and that roughly 1 in 3 cars sold in the U.S. were made in U.S. plants owned by foreign automakers.

    Yes, there is a credit crisis, but in the past several two months a major investor has sold his holding company’s stake in Ford (at a loss), and Warren Buffett purchased a $5 billion stake in Goldman Sachs. Interesting, no?

  24. http://blogs.gmhightechperformance.com/6305256/gm-news/gm-had-highest-monthly-market-share-of-2008/index.html

    What was interesting was that at a time when everybody’s sales were falling, GM managed to increase market share slightly.

    But I have said elsewhere that GM’s management had an impossible task: Undo 50 years of damage in 7 years (approx. when Wagoner came in as CEO).
    In that time they had 9/11 and now this.

    But GM did what people were telling them to do for years.

    –They slashed fleet sales so that their cars would have better resale value and thus attract more customers.

    –They closed Oldsmobile one of too-many brands that they carried. This cost them about $2 billion to do as far as I have read.

    –They renegotiated with the UAW more than once (one time they forced the issue before the contract was up); and won whopping concessions (for a union) that take effect in 2010.

    –They revamped their product development and managed to churn out some real winners in the auto press (unheard of for a long time) and in terms of sales.

    –They upped their vehicle quality (according to JD Power) dramatically and offered the longest warranty in the business after Hyundai (5 years/100,000 miles) to back it up.

    –They began to slowly cut dealers as legally as they could (they have way too many).

    All that in 7 years and in a tough market. Expectations were a bit unreal. They’d never be making the $13 billion profit Toyota made (in 2007?) right away, it was too much mess to clean up.

    All indications were that the new model cars they brought out all were selling in numbers far exceeding the old; and they were making slow conquests.

    I think GM moved as fast as they could since 2001 to try to undo 50 years of prior mismanagement. If the government can make money off a loan like they did with Chrysler, both can benefit.

    By the way, Autoblog is a good place in general for car-related news etc.–particularly about sales and market share.

  25. TARP is your answer…or did I forget the $700 mill that preceeded Buffett’s investment? Not really interesting as much as completely understandable.

  26. Disappointed’s post is correct right down the line…again, so much of the criticism one is hearing about the industry in particular simply does not apply to GM…they’ve made the moves necessary, but that doesn’t correct overnight. From the point the latest contract with the UAW was negotiated, it was understood that 2010 was the year the game would change for good. You have to be able to GET to 2010, of course, for any of that to matter, and that’s what this is all about.

  27. Yes, Buffett jumped in after the fact; nonetheless, Kerkorian fled rather than wait for the government to save Ford.

  28. if you read my blog carefully, i didn’t say a bailout was going to transform the companies to profitability and innovation. the bailout will help ensure that the economy does not collapse and they will have to go bankrupt in the future to do as you say…become sustainable for the long term. the money is for the american people and american economy…not the companies.

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