Thursday, November 13, 2008

Open Hands

Now that Bush has started handing out money to any corporation that says they are about to fail, lots more companies are looking to spread the wealth from the American tax payer to their personal shareholders. Now it's the car manufacturers putting their hands out. Some questions that should be answered before we do anything are: how did they get there, how will (or just "will") a bail out help them and how should a bailout be structured?

GM has been on the path to this point for years now. At least since 2004 (I don't have data that goes back further) GM has steadily been posting decreasing net profits (2006 being an exception). The sudden spike in oil prices over the past couple years has exasperated the problem, which is reflected in 2007's $42,000,000,000 net loss. Over the same time period, Toyota has moved more strongly into the American market (exceeding GM for net sales this year). Toyota has done this through a reputation of quality (which GM and Ford have both lost over the past couple decades), a wide selection of low priced cars, and especially the past couple years a record of fuel efficiency. Only in the past year have the American automakers refocused their message on fuel efficiency, often still falling short (due to their focus on SUVs, all of the hybrids from GM, et al have been SUVs, which still barely break the 20 mpg mark vs. 40-50 mpg Prius, etc.). Just this month we learned that the automakers are still bleeding millions of dollars a month, even as they attempt to retool their factories and cut their workforce.

This brings us to what the companies are asking for the money for. One of the biggest costs facing automakers is changing their plants from building SUVs and Hummers to more fuel efficient hybrids and Volts. This is key to these companies being viable in the near and long term future, but it is a huge cost. Due to the credit crisis of the past few months, lending that could have financed such changes has dried up. What the automakers believe is that if they can get the money to make the cars people want, people will start buying again and they will return to solvency.

Sadly, I'm not completely sure this will be the case. The credit slow down has affected more than just banks and corporations. Buyers also are unable to get credit. Also, much of the purchasing power of American consumers in the past few years has been due to increasing home values and decreasing costs of borrowing on those houses. Now, with both of those reversing, the consumer just can't afford to buy a new car. This is reflected in the fact that even Toyota's sales are negative this past quarter. Also, because GM, Ford and Chrysler have been so slow to get into the hybrid market, it will take time to convince consumers that they are comparable to the Priuses and Civic hybrids of foreign automakers.

Because of this, I don't think we should or even can do a bail out similar to the one proposed for the bad mortgages. NPR's All Things Considered last night did a segment on the Chrysler bail out from 1979. Then, instead of directly giving Chrysler the nearly $2 billion, the government only insured the loans banks gave to the companies. In return, the government got preferred stock, required detailed plans on Chrysler's restructuring, and ensured that if Chrysler went bankrupt that it would get repaid first. Because of this action, Chrysler returned to profitability quickly and wound up paying off the loans seven years early and the government made money on the deal.

I believe a similar set up would be even easier to achieve now. The government, through the TARP law, has much more leverage over banks that could finance such loans. After the buyout of AIG, the government controls roughly 70% of the country's largest insurer. Through these two entities, we could potentially help both the auto industry and, depending on the success of the automakers, ensure long term solvency to the banking industry. This will also keep the government from being on the line for yet another $50 billion that we just simply can't afford right now.

The biggest problem right now is that the banks still aren't lending though. In the past couple weeks since the TARP package was passed, the rate banks lend to each other has dropped more than 4%, yet the rate banks lend to borrowers and to corporations has still remained high. Loosening that up, with targeted goals in mind, is going to be one of the best ways to get the economy moving again. There are two ways to loosen that up, and I think both should be taken: 1) Get money flowing to the middle class, which is where most of the consumer debt is held. You can do this through tools such as the stimulus checks of earlier this year, increased unemployment benefits during this slow down, and tax incentives for job creation. 2) Get loans moving to corporations again. The best ways of doing this are through insuring loans to targeted industries (green energy, infrastructure, automotive to name a few) and tax incentives for targeted initiatives (hiring and green energy again). The problem all along has been a trust issue, so if we can increase the trust, we may be able to pull out of this tailspin and not leave our children with $20 trillion in bad debts to collect.


JessiTRON said...

Use AIG? I don't think we want to got there. People are nervous about the gov't stakes in the banks it has bailed out because we _don't_ want the government to run the industry.

That's the only part I disagree with though.

John J. said...

Yeah, "use" was probably not the right word for me to use. I am letting my frustration at the effectively open, unrestricted line of credit that we have given AIG that they have decided to repeatedly use to send execs to fancy retreats. They should though encourage AIG to insure loans to the car manufacturers. We shouldn't be taking these actions as if they are in a vacuum; everything is tied together and we should make sure we are getting the larger results that are necessary to get out of this recession.

Comrade Kevin said...

I'm not sure we should reward any company whose financial failings are a direct result of poor planning, bad management, and antiquated thinking.

Distributorcap said...

the problem is Paulson is in charge -- there is virtually no oversight or structure to these bailouts. the companies can do what they want

welcome to the world of republican "help"

i am against all these bailouts -- but if we structured it with rules and oversight - like chrysler in the 80s, like sweden did in the 90's - it might have a shot

the way we are doing it now - with smoke and mirrors and marketing -- and with the stench of the bush administration - they dont have a chance -- and these companies are going to get hooked on cheap govt dollars

no_slappz said...

GM has been posting exlosively higher losses for a few years. The company is, by any standard measure, bankrupt.

For the benefit of the company, its employees, its retirees, the industry and the country, GM must reorganize through a Chapter 11 bankruptcy.

If that happens now, then fewer jobs will be lost and a competitive company will emerge at the end of the process.

If the company gets a taxpayer handout, the magnitude of the problems will grow and the ultimate resolution will hurt far more.

GM, Ford and Chrysler are in decline. That will not change as long as Wages & Benefits and Dealer Contracts remain as they are.

Even though Detroit is producing high quality products, quality is not enough.

If Honda and Toyota can operate profitably in the US, so too can the Big Three -- if they are restructured.

John J. said...

I agree, GM has been hemorrhaging money for a couple years now. Part of the reason though is because it is trying to retool, which costs money. This wasn't much of an issue back a year or two ago when banks were still lending, but now that loans have dried up, GM can't get the money it needs.

I don't think that bankruptcy is the right answer. It has a lot more consequences than people think. The biggest issue is that even if they do start out in chapter 11 (restructuring) bankruptcy, they may still be forced into chapter 7 (liquidation). There is also the direct costs that the government will have to take over should they go into bankruptcy, specifically the current pension plans. This would be a guaranteed loss for the government, while a bridge loan, or what I proposed here of insuring a bank's loan to the automakers, would most likely make money.

The Detroit 3 are in decline for a number of reasons. I don't know the most recent UAW/GM, etc. contracts so I can't speak to those, but one of the biggest reasons for the decline are honestly bad decisions these companies made during the '80s and '90s. Toyota in the meantime planned ahead and built a reputation of reliability and fuel efficiency. GM, et al has improved significantly on these fronts, but they are now coming from behind and need time to fix their image, which I believe they can. Even Toyota and Honda are losing money in the current market.

I think, with a well written bill that protects the tax payer (and actually has oversight, unlike TARP) the Detroit 3 can be forced to restructure without the enormous cost and risk of chapter 11 (or worse, 7) bankruptcy. Do I expect such a bill to come out of Congress in the next two months or be handled properly by Paulson if it were? Not at all. But I do think that something could be done that will cost us less long term and could strengthen our economy better than doing nothing and letting these companies collapse.

no_slappz said...

john j,

GM, Ford and Chrysler are on the slippery slope to failure.

It is a Chapter 11 bankruptcy filing that will SAVE them from failure.

There is no reason a Chapter 11 filing by GM would turn into Chapter 7. The auto business is huge and GM has a big market for its products. Thus, there is no basis for a Chapter 7 filing.

As for who gets stuck with what, well, that's what bankruptcy is for. It sorts out the problems and turns the unworkable into something that works.

Retirees might have to accept reduced pensions. Tough. Payouts for pension plans taken over by the government -- the PBGC -- are capped at $40,000, which is less than a lot of retired GM workers get.

It's amazing that Obama people want fast action on laws that force immediate compliance with respect to Global Warming issues, but are willing to commit taxpayers' money to failing enterprises as a way of postponing their collapse.

Access to government money only keeps bad practices and weak organizations alive, on life support until they shrink to nothing. That strategy maximizes the total bill.

Chrysler will die first. Best bet is for GM to acquire it -- as part of a Chapter 11 reorganization.

John J. said...

The auto business is large, but due to the wider economic issues, it is shrinking, as evidenced by the fact that all the major automakers are posting losses for the past quarter. It would also significantly impact one of the Detroit 3's market share (who wants to buy a car from a bankrupt company?) causing even greater losses for that company. This is why there is a good chance that chapter 11 will lead to chapter 7.

You should be more honest about what you really want from these companies filing for bankruptcy. It is a very good way to tear apart the current union structure, the one that built the middle class for the past fifty years. That is the only thing these companies gain from filing as opposed to working out a restructuring deal for a loan as I and others have proposed.

I don't know why you find it amazing that proponents of mandates for environmental issues would want to support companies attempting to make such advances.

As for your last statement about government money, it's simply false. Chrysler was a perfect example of government money being used successfully in the '80s as I described in the post.

no_slappz said...

john j,

You, as usual, have bought into the public rhetoric about the Chrysler loans made many years ago. Current reporting is wildly inaccurate. It does not capture the state of things when the government assisted Chrysler.

As I said, Chrysler, which was always the smallest of the Big Three, received loans that enabled it to update its operations and get back in the game.

That's not today's problem.

All the car companies make some good models that have strong appeal to specific market segments. They also have other models that are losers.

In a competitive world, a company would stop making the loser vehicles. But Detroit is not interested in maintaining competitiveness on all fronts.

Why? Because doing so means changing things dramatically and painfully. But why bother when Washington is handing out billions?

Here's another point. The US car makers built around 17 million vehicles last year. That's more vehicles than the market demands.

The domestic automakers are plagued with over-capacity. Demand is somewhere around 13-14 million. But Detroit is forced to pay thousands of workers whether they work or collect their paychecks through the Job Bank.

In short, if GM, Ford and Chrysler are allowed to maintain their current practices, which the requested funding will enable, their obligations will multiply at rates far exceeding their ability to repay the money.

I guess you can't see this. Like a lot of people, you have a binary view -- either GM, Ford and Chrysler will operate profitably OR they will disappear.

It seems the idea of bankruptcy has not gotten through. In situations like this, bankruptcy is the process that keeps a bad situation from turning into a huge disaster.

Furthermore, there's no reason to think buyers will avoid a car company working its way through Chapter 11. The sudden conventional wisdom goes against reality.

First, warranties on used cars vary. Sometimes there are none. But this country has tens of millions of un-warrantied cars on the road.

Second, houses, which are far more costly than cars, are bought with comparatively little protection. And they sell and resell for generations.

Moreover, home-owners buy homes on California hillsides that go up in flames every few years, and they buy homes near water that occasionally floods them.

As for environmental advances, well, every design mandate that leads to higher vehicle costs is another reason buyers will chose a Honda, Toyota, Suburu, Hyundai, Nissan, etc.

Meanwhile, GM and Ford, which build cars for international markets, are not allowed to count their foreign-market high mpg cars in their CAFE statistics. That's nuts.

If the real goal is reducing Global production of various gases, then it does not matter where the car is built or where it operates. Unless, of course, we are looking at things from the point of view of a UAW member. All he knows is that the cars built in GM and Ford plants serving foreign markets do not employ UAW workers. Hence, those cars do not exist in his view.

Anyway, reorganizing the car industry through Chapter 11 is the solution, not the end.

The union structure has accomplished much less than you believe over the last 50 years. Perhaps you do not understand that unions PREVENT many people from working and lead to the hoarding of compensation by those who are permitted to work.

Union membership has shrunk dramatically since its peak in the 1950s. If it were delivering measurable benefits to the economy, unions and union membership would increase rather than decrease.

As I have said, the UAW should buy GM. At $3 a share, all of its stock can be purchased for $1.8 billion. Small potatoes for many. Then, if the UAW really knows what it's doing, it can take charge of everything and bring back the Glory Days of GM.

John J. said...

The Chrysler comparison is a very apt one, IMO. The current problem is the cost of updating production models at these factories. Employee pay is down in the range of 5-10% of their operating costs, retooling their factories from the single SUV to a more dynamic system (similar to what Toyota is already using) costs millions.

Can you show me where you are getting your production/sales numbers? From the little I am able to find, the manufacturers keep roughly a 60 day supply on hand and, at least in early '07, had trouble keeping production to that level even with weakening sales.

It appears more that you have the binary view on the rescue plan. It isn't a choice of hand them money and let them keep doing whatever they want vs. let them go into bankruptcy and restructure. The only bail out proposal I will support is one that requires restructuring and a clear plan for future success. As I was against TARP previously, I would be against any unrestricted hand out of money.

I do see chapter 11 as highly likely to lead to chapter 7 though for reasons I have already explained. Your reasons why it won't are completely unrelated to the reality of the situation. Your statement about used car warranties is completely irrelevant, and comparing the sale of an item that (generally) appreciates in value (a home) to one that immediately depreciates (a new car) is a false equivalence.

If GM, etc. are producing cars internationally that would help them meet CAFE standards here, maybe they should produce and sell those cars here. Allowing them to count those products without doing that doesn't help our domestic fuel consumption problems. I expect the countries where these cars are being sold are already giving GM benefits for these cars (say, market access?).

Your last statement about unions is a completely false premise in that it ignores any other possible factors for decreasing membership (hundreds of closed plants for one). The fact is that for the first half of the last 50+ years, the standard of living had been steadily increasing due to an expanding middle class led in part by strong unions. Yet in the past 25 years, due to union busting efforts by Reagan and others and smear campaigns against them, the unions have lost strength and the middle class as seen a decline, especially in the past eight years. Unions aren't the sole cause of a strong middle class, but they do add to it, even in industries and factories that are not unionized.

no_slappz said...

john j,

The current situation in Detroit is NOT about upgrading and modernizing. If that were the real issue the companies would have done it.

Management is fully aware of the reasons modernization has not occurred at a pace that would ensure or maintain competitiveness.

The reason: too many union work rules have prevented it. Management has got to work within the framework that open to it. Unfortunately, management has too little power over its labor. Labor is the biggest hurdle the company must overcome.

If you look at GM's 10-K for 2007, you will see that the company built 9.5 million vehicles that it sold in its global markets. About 3.5 million were sold in the US.

Total revenue was $178 billion. But due to last year's employee buyouts and other cost-cutting actions, the company lost $39 BILLION.

Stockholder's Equity is NEGATIVE $37 BILLION.

When a company is $37 billion in the hole and going deeper, do you think it is bankrupt?

Revenue was $178 billion. Labor costs were at least $53 billion. Probably more, but I don't want to spend a lot time digger deeper into the financial statements to find all the buried labor expenses. Thus, labor is as least 30% of sales and probably more.

As for your figures on Chrysler, putting labor at 5%-10% of sales, well, I have no idea where you get your numbers since Chrysler is a private company that does not file public documents. Chrysler's costs are not reported anywhere. It's that simple.

If you think a Chapter 11 filing will lead to a conversion to a Chapter 7 filing, then you are saying the companies are already beyond repair.

That means people would be fools to buy cars from them since a company in such dire straits that a Chapter 7 filing is in the offing has no business luring in consumers. That's a little like health clubs selling one-year memberships knowing they are on the cusp of shutting down.

However, it is true that the US no longer needs GM, Ford and Chrysler. And Chrysler is the company most likely to disappear. It would have merged with GM if the government would have thrown enough cash at the deal.

Fortunately, the government said NO.

There's a reason the steel business in the US when through a brutal contraction. It's the same reason it happened in England. Union sclerosis.

Countries like Korea saw the opening and went to work. There's still a steel industry in the US, but it is not the industry founded by Andrew Carnegie. As the price of steel rose -- due to factors including union wages for steel workers -- the big buyers, like GM, Ford and Chrysler substituted for it. More aluminum. Better designs that minimized steel. More plastic. More composites.

By the way, Delphi, a major supplier of parts to the auto industry, has been operating in bankruptcy for two years. But the auto companies keep buying from Delphi. The bankruptcy did not end its business with the Big Three.

As for the high mpg cars that GM produces for foreign markets -- the company is not permitted to sell those cars here. Union rules prevent the company from importing its own vehicles. That's another swell tactic of the UAW that GM management foolishly agreed to.

The UAW is interested in staying alive, even if it means taxing Americans. In other words, General Motors is about to become Socialist Motors.

You may think that money from the government will come only with large strings attached. But around Christmas, when GM management cries that the company is at the very edge of collapse, the strings will decrease and the company will receive enough funding to hold off collapse, but not enough to reorganize itself.

Despite claims that the Chevy Volt is big news -- it's not. It's neither fish nor foul. It's not a true electric vehicle and it's not a true hybrid. It's the worst of both -- a short-range Electric Vehicle with an onboard gasoline engine to power a generator that recharges the insufficient lithium-ion battieris. At $40,000, there is simply no way this dog can compete with a Prius or any US hybrid.

As far as growth of the middle class goes, there is no doubt many union workers reached middle-class status. But obviously that was not much of a factor since union membership has been declining for 50 years.

What happened? The sons and daughters of labor union workers went to college. That got them off the shop floor.

Meanwhile, a lot of shop labor has been eliminated by smart engineering. By replacing men with machines and by engineering and designing in ways that minimize the need for labor. That will continue.

Bottom line: your expectation that funding should be contingent on big changes at the car companies leads to the same outcome as a Chapter 11 bankruptcy filing. Thus, you are agreeing to the fact that GM, Ford and Chrysler are relics operating with deeply flawed business models. But you think they are willing to take their medicine even though Ron Gettelfinger, UAW president, told the nation today that UAW workers are finished taking cuts.

John J. said...

The current problem in Detroit, like in the rest of the world, is liquidity. This exacerbates the pre-existing problems that GM, etc. have had adjusting to the new car purchasing patterns. They are in the process of re-tooling, but they can't get financing because credit markets have dried up and they are bleeding money more quickly because car sales across the board have dropped, for Toyota and GM and the rest.

If employee pay were the problem, Toyota would be having more issues right now than GM. Toyota employees at American plants made more than UAW workers for at least part of last year (without links to the numbers you are claiming, this is the data I have to go with). You are also comparing employee costs vs. revenue as opposed to payroll as a percent of total expenses, which leaves payroll as a measly 5%.

As for why chapter 11 will likely lead to chapter 7, since you clearly haven't comprehended what I said the past several times, the reason it could do that is because financing for restructuring isn't available. GE, the largest DIP financier isn't lending. Delphi was able to restructure because it had access to that financing before the credit market freeze. Eventually, if we want to see these companies survive, the government will have to step in with money. Bankruptcy is much more destructive an option than a well managed bail out modeled on the Chrysler '79 deal.

I do believe that any money we give them should be conditional; when we gave AIG unconditional money, they gave their executives bonuses, paid dividends to stock holders, and sent their executives on massively expensive retreats but have not improved lending or any of their business practices. If the Detroit 3 have to lay out specific targets for improvements they won't have the option of blowing the money frivolously.

no_slappz said...

john j,

The government will provide the DIP financing for a Chapter 11 filing if no other lender steps up.

The alternative is government funding for the car companies that rolls on and is never repaid.

Meanwhile, in "pre-packaged" bankruptcies, the financing is in place BEFORE the filing is made. That's an advantage of entering into bankruptcy on a Voluntary basis.

Liquidity is an issue -- at the moment. But GM, Ford and Chrysler have been losing market share for decades. They sell too many models that are uncompetitive and the good models suffer from a pricing disadvantage. Liquidity will not change that.

And like I said, if GM thinks the Volt will save it, then management has lost its collective mind. More likely, management is hoping the half-baked Volt bamboozles Congress long enough for the money to change hands.

John J. said...

So under your plan, the government would still be on the hook for a $25 billion loan to the companies. But instead of loaning it to a still (barely) solvent company, it would be to a bankrupt company. Not only that, but the government would also be on the hook for another couple billion in pension plans that these companies would be able to offload which would be pure loss for the government. And also Medicare would likely become responsible for any retirees that aren't on it's rolls because retiree health plans could be dropped. And then, if GM, etc. still can't pull their acts together, their only option is chapter 7.

How is that a better idea than a well structured loan forcing the reforms that GM would try to enact under bankruptcy without incurring these extra costs to the government?

no_slappz said...

john j, if GM is in such bad shape that a Chapter 7 liquidation is the only option, then it's only a matter of time before it happens.

Meanwhile, the GM pension plan is fully funded for years. It has assets of more than $100 Billion.

If retirees must accept a reduction in benefits, well, then that's the thing that has to happen. However, given the substantial level of assets in the plan, there's no danger of taxpayers getting stuck with the bill. Thus, the sanctity of the GM pension plans have no role in a Chapter 11 filing.

As I've said, if the UAW really believes management is the problem, the union can buy GM for $2 billion and run the entire company.

Of course the union will not. The fact that this issue has never been raised is proof that the union knows its deal is too good to last. Further the UAW knows the only way to keep the party going is to threaten the entire US with claims that a bankruptcy would lead to the collapse of the entire economy. That's extortion.