No Runny Eggs

The repository of one hard-boiled egg from the south suburbs of Milwaukee, Wisconsin (and the occassional guest-blogger). The ramblings within may or may not offend, shock and awe you, but they are what I (or my guest-bloggers) think.

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Who’s Doing The Math?

by @ 5:47 on November 17, 2008. Filed under Economy, Politics - National.

Wasn’t it just last week that Barack Obama said there is only one President at a time?

Barack Obama and others are pushing a $50 Billion bail out of the Auto Industry.   Phrases like “too big to fail,” “catastrophic” and “psychological impact” are being used as reasons for urgent and significant action (sound familiar?)

This time, unlike the original “trust me” bailout, we have a pretty good idea of what is causing the problem and how big the problem is.   Let’s take a look.

The  current problem with the automotive industry is that they aren’t selling any cars.   Some claim credit is an issue, some claim that Detroit is designing and making vehicles people don’t want.   I don’t think either of those are more than a small percentage of the problem.   The core problem is that consumers have pulled in their spending, hard.  

The last thing many consumers are doing while jobs are a concern,  is to  make major purchases that are not absolutely essential.   While credit for purchasing autos hasn’t dried up, it has gotten tighter.   Rather than financing more than 100% of the purchase price, most lenders have gone back to the draconian practice of getting a down payment!   Additionally, the value of used cars have dropped drastically in the past few months.   This means that many consumers have a bigger delta that they need to bridge between the value of their  trade in and the car they desire.  

While current sales are certainly a problem, even waving a wand and restoring 2006 level sales won’t save Detroit.   Why?   Detroit has a cost structure that is uncompetitive.

The Carpe Diem blog put together an analysis that shows that the Big 3 pay fully loaded wages that are 50% higher than their competitors levels. Now we can argue about whether this is labor or management’s problem to solve but regardless, even with the Big 3 closing the gap on productivity, they are left with a significant cost disadvantage which isn’t going away.   OK, so that’s one problem.

Another problem is with the pension plans that the Big 3 have.   Over the years, they have made commitments to their union employees to provide certain retirement benefits.   Like a lot of companies and industries, the funding for these retirement programs have not kept up with the expected cost of the benefits.   In the case of the Big 3, the unfunded portion of their health and pension programs is now estimated to be $90.5 billion.  

Not that it’s impossible, but it’s hard to imagine any of the Big 3 returning to a profitability level that could put a serious dent into the $90.5 billion short fall. GM’s last profitable year was in 2004 and it was just shy of $3 billion. GM’s share of the $90.5 Billion is estimated to be about $50B.

Finally, the Big 3 are burning huge amounts of cash. Reports have it that GM and Ford alone, are using $15 Billion per quarter. Chrysler is a private company so it doesn’t report it’s burn rate but you can bet they are feeling pain as well. At the end of September, 2008, GM had $16 Billion of cash. They had burned nearly $9 billion during the quarter. It’s entirely likely that GM’s situation has not improved this quarter. If their cash burn continued as it was in the third quarter, they are reaching a point of no return. With the consumers now sitting on the side lines, especially with major purchases, and many economists saying we won’t see any improvement until at least the second half of 2009 and some saying into 2010, how does $50 billion make much of a dent in an industry that is burning $15+ billion per quarter?

So here are the questions:

  1. Does shoving $50 Billion into a $90.5 billion hole even get you to the point where you can see above the edge of the hole?
  2. Do you believe that $50 Billion can buy enough time for the automakers to keep them alive until consumers buy their product again?
  3. If you answer yes to 1 and 2, how do the Big 3 remain/regain competitiveness with a labor cost structure that is 50% above their competition? Oh, and if you have any notion that the competition is getting easier, read this great article!

Should GM and others get a straight “bail out?”   Nope.   I can’t see how putting money into this without a dramatic change in the underlying cost structures does anymore than delay the inevitable.   Additionally, I don’t want Nancy Pelosi and Barack Obama making decisions on what the Big 3 make, how they make it etc.   Having anyone in Washington dictating Detroit’s marketing plan is a sure way to ensure we’d never get the money back.

Should GM fail?   Probably.   Should it fail now?   Probably not.   While I don’t favor a straight bail out via capital infusion or additional loans, I would favor debtor in possession loans.

I believe GM, and the others if they find themselves there, need to go through a Chapter 11 reorganization.   It appears to be the only way for them carve out profitable business segments and shed costs that they can no longer support…and I’m not talking just union contracts.   The conventional wisdom is that GM and others, can’t file for bankruptcy because they couldn’t get interim financing.   I think the conventional wisdom is accurate.   However, I don’t see the government standing by and watching GM sink under the waves, they will do something.   I would rather see the hard decisions forced via the bankruptcy proceeding than allow “whistling by the graveyard” of getting funding and hoping it will be enough to get by.  

Some may argue that by filing for bankruptcy the US tax payer will end up paying for the unfunded liabilities of the pension and health plan as they are insured by the Pension Benefit Guaranty Corporation.   While that is true, I suspect we’re going to be ultimately responsible for it anyway.   By forcing the issue now we can stop the bleeding.

Some may argue that the example of Chrysler in the ’80’s shows that bankruptcy isn’t needed.   Actually, the Chrysler situation proves the point for bankruptcy.   The Chrysler loans,  a deal at just $1.2 billion, contained language that required Chrysler supplies to provide certain concessions.   The effect was that Chrysler negotiated contracts with suppliers, unions and debt as if they were in bankruptcy.   The populace is already upset about the $700 billion bailout and even more so by Paulson’s nose thumbing on doing what he said he was going to do with it.   If a bail out for Detroit gets shoved down the taxpayer’s throat, it should at least have the appearance of serious consequences for shareholders and those who have been sucking from the teat while the industry fails from a growing cancer.   Even without a bankruptcy filing, Washington is going to find little support for a Detroit bailout.   With a bankruptcy filing, the howls may be muted.

Additionally, there is concern of whether US consumers will purchase from an auto company that is in bankruptcy.   To those folks I say, that folks are more likely to buy from a company that is dealing head on with their issues and forging a plan than with a company whose future is solely tied to a quick spring back in the economy.

In the end, I don’t know if the US auto industry, as we know it, will survive.   Certainly pieces of it will but I doubt it will contain the behemoths we see today.  

It used to be said that “What was good for GM was good for America.”   While I think that phrase may still be fairly true, I don’t believe that the converse is true.   America can’t  continue to write checks with nine zeros at the end of some number.   This is especially true when there are endemic issues that significantly dilute the benefit of any support.   There will likely be support for the Big 3, I hope that Detroit is forced to deal with their issues and Washington resists the temptation to dictate automotive development.

I hope but I’m not hopeful!

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