Living Within Our Means: Automotive Edition

by: Diane Rogers October 29, 2008 | about stocks: GM    

Diane Lim Rogers

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If you haven’t heard, the Treasury Department is currently considering a plan to provide $5 billion to $10 billion in aid, ASAP, to General Motors (GM) to help finance its possible merger with Chrysler.  And yesterday, my high school sweetheart was offered $50,000, a car, and 6 months health coverage, to leave Chrysler and his management position at the Detroit-area (Warren) truck assembly plant. 

Liz Wolgemuth on the U.S. News and World Report blog ("The Inside Job”), insightfully asks:  Doesn’t this mean we’re using “tax dollars to fund layoffs?”

Well, being someone who’s constantly got the “fiscal responsibility” angle on things, I’d edit that slightly to say yes, we’re using future taxpayer dollars to fund layoffs–because we’re talking about another deficit-financed rescue, after all.

There’s something quite ironic and sad about “rescuing” an industry by providing it the cash flow that’s needed to shrink it–for the federal government to effectively say they’ll help these companies eliminate jobs, in the name of “fiscal stimulus” and for the cause of keeping the economy “alive.”

This is an auto industry being forced to “live within its means”–with a little help from the government–by consolidating, downsizing, reprioritizing.  Because the industry for too long catered to our entire nation’s living-beyond-our-means mentality, the “transformation” Detroit needs to survive in the longer run (and grow again) will come too late for many thousands of workers who are now losing their jobs.

A Wall Street Journal article by Jeffrey McCracken and John Stoll describes the ironically devastating “human toll” of this ”rescue” and how the auto companies got so cash constrained–leaving the federal government as the only lender willing to fund a merger and the associated layoffs (emphases are mine):

GM and Chrysler estimate that a combined entity would need $10 billion in new equity to lay off workers, close plants, integrate the two companies and provide liquidity, according to several people involved in the talks or briefed on them.

“Without external intervention, from consolidation or government assistance, we expect GM to reach its minimum cash position in under 12 months,” Deutsche Bank (DB) auto analyst Rod Lache wrote last week. In an interview, Mr. Lache added that Chrysler is also running dangerously low on funds. “We believe Chrysler is in the same position. It’s either August 2009 or December 2009 they run out. Both have a limited runway.”…

The human toll of such a move could be high. The companies would slash duplicated functions from engineering to marketing. One internal estimate predicts at least 40,000 jobs could be cut from the roughly 166,000 people employed by the two companies in the U.S., Canada and Mexico.

GM’s cash cushion has been eroding for some time. Each month, the company spends $1 billion more than it brings in. At that burn rate, GM could effectively run short of cash next summer, without even taking into account further sales declines.

The 100-year-old company has about $20 billion on hand today, but needs at least $11 billion to $14 billion of working capital at all times so it can keep paying its bills, GM has said. The company has been trying for months, without success, to raise at least $5 billion by selling assets, such as its Hummer brand, and by pledging unencumbered assets…

But lenders are reluctant to invest. GM debt, once considered the highest investment grade, has tumbled to low-rated, junk status. Many lenders approached to invest in a combined GM-Chrysler have also balked…

When Cerberus purchased Chrysler in the spring of 2007, the capital markets were at full throttle. The firm basically bought Chrysler for free, in exchange for taking on its considerable debt. Cerberus expected that once Chrysler was private, the fund could build a smaller, stronger company with the ready help of debt investors.

It hasn’t turned out that way. In two years, Chrysler has fallen from third to fifth in U.S. auto sales. J.P. Morgan (JPM) estimates it has $11 billion on hand. It uses $3 billion to $5 billion of that as working capital to meet payroll, pay vendors and pay other bills. Its monthly cash burn is estimated at $300 million to $400 million. That figure may grow as vehicle sales slow, suggesting that it could run out of money by late 2009. To conserve cash, Chrysler has halted certain new-product plans, a sign that it sees a deal with GM as the only path out.

The auto makers’ huge obligations, meanwhile, are only growing as revenues and profits shrink. For decades, Detroit’s Big Three have funded generous programs to take care of former workers and surviving spouses…

Obligations growing and revenues shrinking, needs rising and means falling…In this way the auto industry’s woes are just another manifestation of the overextension of the entire U.S. economy.

And thus it is “depressing” (pun inadvertent) to think that if the federal government goes through with this “rescue,” that it will immediately result in more lost jobs, not saved jobs (contrary to what we think short-term “fiscal stimulus” ought to do), and that at the same time being deficit financed, it will also shrink national saving (contrary as well to what we think we should do to encourage longer-term economic growth).

And how will we stimulate the economy in the short term this time around?  More “depressing” news yesterday: consumer sentiment is at an “all-time” (in 41-year history) low.  We’re no longer talking about encouraging folks to shop; that sounds almost ridiculous.  We’re now talking about keeping folks from drowning by helping them hold onto their jobs. 

How to keep up that short-term economic activity is a lot tougher to figure out, now juxtaposed with the longer-term economic forces that seem to be telling us–all over the place in our economy–to downsize rather than up-size.

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This article has 9 comments:

  •  
    Oct 29 04:24 AM
    i would think there is no economic dynamic in combining two sick automakers. seems like a waste of money because both will fail because their are weak at the worst possible time.
    Reply | Link to Comment
  •  
    Oct 29 09:26 AM
    I guess Ford will be the next domino.
    Reply | Link to Comment
  •  
    Oct 29 10:14 AM
    Author,

    I believe you've recounted the situation our domestic automakers now find themselves in very well. So let me ask you, do you have any suggestions on how to FIX this mess, or is yours just one more lament?
    Reply | Link to Comment
  •  
    Oct 29 10:28 AM
    It costs money to make money. Unless, that is, you are an automaker. In that case, it costs money to lose more money.

    These companies have all been managed with an extremely short-term perspective by a revolving door of executives only interested in making their quarterly bonuses. That explains a lot about why they mortgaged their future years ago to prevent a few strikes. They have vaporized the money of countless investors over the years. Now the govt. can't wait to get in line. This proposed merger will not fix the core problem - which is their product line.
    Reply | Link to Comment
  •  
    Oct 29 10:37 AM
    paulk8756,

    I don't think the govt. could impose a solution unless they completely nationalized these companies. Management is just buying time (perhaps months) before they go bankrupt. That time might be enough for another bonus.

    If someone was interested in resurrecting these dead companies, they would have to:

    -Declare bankruptcy and shed their pension and healthcare liabilities.
    -Abandon most U.S. union production capacity and set up shop in Asia and Latin America.
    -Pay executives a flat salary, rather than stock options and ban golden parachutes. Make executive's interests long term.
    -Concentrate on building a small handful of products with top-notch quality, durability, and reliability. 250,000 mile, low maintanence cars are now the norm.
    -Invest in fuel and insurance efficiency. Reduce total cost of ownership for their vehicles.
    -Makeover the brand, logos, marketing, etc. Stamping "Chevy" or "Ford" on a vehicle actually reduces its value!

    Reply | Link to Comment
  •  
    Oct 29 12:30 PM
    wow.capitalism at its best? is it possible some problems cant be fixed. some co's & enterprises cant be saved.dont be concered.the chinese built car if the quality is good will put the final nail in the american car when it arrives here.globalization is changing capitalism & the big corps.will rule the world.
    Reply | Link to Comment
  •  
    Oct 29 01:54 PM
    The sad part of it is that the government bailout does not help anything. You still have a great many job losses and the combined companies will still be weak. You have also taken $10 billion from people who would have used it to buy cars or other things that would have helped the economy. Furthermore, these are industry-defining companies, especially GM. While GM has made many public relation announcements about changing, we have not seen it yet. We have to expect, given the record, that the $10 billion would go to preserve the current state. Given the rate at which GM uses cash, $10 billion probably would not last long.
    Reply | Link to Comment
  •  
    Oct 29 05:09 PM
    paulK - you can't fix a problem caused by decades of dead wrong reckoning. The American auto makers excel at things that no longer matter - bigger, fancier, thirstier - and a culture of total warfare between management and labor.

    GM, Chrysler and Ford could ALL survive,, perhaps even thrive, if management took a voluntary 2/3 pay cut and labor took a 50% pay cut. They won't. They'd rather not work.

    Make no mistake, the Big 3's problem is salaries and wages at an unsustainable level. They can be counted on to sustain the pay levels at the expense of their future employment. And all those benefit packages that retirees used to think would last forever won't.

    They got a reprieve from Alan "Bubbles" Greenspin's credit tsunami. Now, unless they radically change the pay levels, they're looking at the end of one of the most lucrative chapters of economic history.

    But look on the bright side - museums will have cars with 40 Gig hard drives. That get 16 mpg.
    Reply | Link to Comment
  •  
    Oct 30 08:51 PM
    Maybe the short term product line should focus on improving what we've got--internal combustion. Better fuel efficiency will help. But America imports $300-400 billion of oil a year and much of it goes to fuel transportation, so fuel efficiency still leaves the trade deficit untouched.

    I think the best thing the US auto industry could do right now, with or without government help, is to push fast forward on electric cars and clean coal electricity to charge them. Clean coal technology is ready for industrial scale applications and America is sitting on mountains of readily accessible and cheap-to-produce coal.

    Internal combustion is a century old technology. Did they even have typewriters when internal combustion was invented? It's complicated (which makes for lots of jobs building and fixing engines) and thirsty.

    I like cars that go fast and handle well. If I could buy an electric car that would do that for a reasonable price, I'd buy electric over gas any day. No more gas stations for me. I'll fuel up at home.

    GM and Chrysler are both working on electrics. I can't remember the details, but there's an electric carmaker in Canada called Zenn who made a deal with an American who invented a new form of electricity storage system which would make batteries obsolete. According to what I read these systems could power a car for 250 miles and take 5 minutes to recharge. If this technology actually exists then an automotive revolution is about to happen and US automakers should grab it and run with it.
    Reply | Link to Comment
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