Prior to Congress’s first bail-out of the US auto industry, auto industry management’s presentation to Congress gave us only part of the reason we shouldn’t try to bail out the auto industry – management teams that have not seemed to grasp, over many years, what will enable them to reverse a long-term decline, a decline that has merely been exacerbated by our current credit crisis and recession. Our elected representatives did succumb to pleas and forked over $15 billion to GM and Chrysler, $15 billion which will be wasted as I’ll explain below, and the industry will be back for more money.
Simply bailing out the car industry won’t work because the car companies’ basic business model does not make sense as it stands. Until the financial crisis, they made just enough money to cover the health care and pension obligations to current and previous employees and profits if any came from their financing arms. For example, at present, GM is paying health care benefits for three times as many retired works as current workers and GM states that its health care costs amount to $1500 per car. Without the ability to make money on financing, US automakers can’t and won’t make enough to meet their obligations for health care and pensions, let alone approach the Holy Grail for the auto industry of actually making a profit.
A natural approach to lack of profitability would be to downsize, focusing only on products that the public wants and thus should be profitable. However, this doesn’t work easily for the auto companies and likely makes the fundamental problem worse. When they downsize (as they have tried to do), pension and health care obligations may drop a little but are largely unchanged. Yet, these roughly constant obligations are spread over fewer cars. This means that the car makers would be further in the hole for each car. An average auto worker receives $28 per hour in wages but the average hourly cost including benefits for the worker and retired workers is $70 per hour. The only saving grace of downsizing is that they incur fewer future obligations for pensions and health care. But, even this silver lining is smaller than it should be. GM (and I think other car companies) have had contracts that did not allow them to rapidly cut labor costs as volume fell; employees were paid whether or not they were needed to make cars and, of course, retiree pension and health care benefits were always paid. Because GM would lose more by shutting the plants down than by running them at a loss, GM had an incentive to keep factories open and produce cars that were not economic. This policy is consistent with actual GM behavior. Although GM has introduced a number of very good cars such as the
Until they fix their business model, bailing out today’s
To reach a sustainable profitable future, automakers need to end agreements that pay for less than productive worker effort. But, more importantly, automakers need to transfer pension obligations, health care benefits and other obligations away from the company before any new investment should come from any government entity. With no new investment, the alternative of liquidation over time would likely eliminate all health care obligations going forward. But, such a change in an existing company would not fly in the Obama administration. Transferring the health care obligations would be harder than shedding pension obligations, but the need to make the transfer might provide a great opportunity to jump-start President Obama’s eventual plan for universal health care. Unions, and thus the Obama administration, would have great difficulty agreeing to such a transfer up front. The car makers cannot easily shed these obligations without entering bankruptcy. Labor contracts that block or make costly the company’s flexibility would be voided by the bankruptcy, but the automakers would, in return for the investment, need to develop a plan that maintains a significant
With a plan to ensure that it can sell cars for more than the cost of a) making them; and b) paying for pension and health care obligations if any remain after a bankruptcy, management would be running a company that has a chance of making profits in the future. This puts an onus on the new controlling shareholder to bring in new and capable management, where it has been lacking. [Note: To this non-auto industry expert, it appears that management at Ford has a much better grasp of how to deal with the challenges it faces than do managements at GM and Chrysler. It is entirely possible that their managements actually knows what will really be needed to fix the industry but can't say it for one of a number of reasons, though there is no evidence of this.] As investors going into this, we'd also have to know that there appears to be substantial overcapacity in the global automobile industry and thus not all companies will survive. Perhaps we as investors would invest in the Ford and GM businesses but conclude that Chrysler is not viable even with a big infusion of cash.
As the car makers slip toward bankruptcy, which they inevitably will and sooner more likely than later, the government can take control of restructuring by providing debtor-in-possession financing, a form of investment that makes it senior to all previous equity-holders and other creditors. With this control, the government can induce the changes that are needed for the companies’ survival. Rather than throwing good money after bad, taxpayers would ultimately realize gains from the matching the companies’ obligations to realistic expectations for what they can manufacture and sell. Customers who are now reticent to buy a car from a company that might have to liquidate would know that these companies have, at least for some time period, capital from the government to enable them to survive and restructure.