GM: General Mess

Time for bit of a rant on General Motors since they are all over the news this week. The issue at hand is whether the government ought to save GM by providing at least $25 billion in low cost loans to the automaker. As expected, there is vigorous debate on the subject and it is rife with emotional arguments.Today Pelosi was on the tape saying that the lame duck session of Congress should take up the issue. Apparently Obama is in favor of taxpayer support as well. It was just recently that I declared we would shed light on bad economic ideas regardless of ideology. That chance came a bit too quickly for my liking.

The argument for a General Bailout is that the auto industry is so large, that the job losses of a bankrupt GM would be tremendous, rippling through the entire industry and affecting suppliers, dealers and the economy as a whole. Bailout proponents argue that this time is different insofar as there is no credit available for people to buy cars and that the Big 3 are a victim of the crisis. Other arguments include that it isn't the workers fault and that this is an essential part of American industry. Powerful arguments indeed.

Let's cut to the chase: the US auto manufacturers are in serious trouble, no argument there. The proposal is to provide loans so that they can continue in business. This is where the logic breaks down. If the goal is to keep GM in business, will the loans accomplish this goal? If not, then it would be a bad idea right?

GM's third quarter results are very telling. They burned through $6.9 billion of cash in the past three months. (Yes I know- you didn't think we would hear the term "burn rate" again after the dot com bust). At this rate, GM will be technically insolvent in about three months. A $25B loan might float the company for about one year. Then what?

It is the "then what?" question that is the problem. GM (and Ford, Chrysler) have tremendous over capacity, high fixed costs, high labor costs and underfunded pensions, but perhaps most important is the fact that they aren't building the vehicles people want. I remember a Rick Wagoner and Bob Lutz presentation when they took the helm back in 2001. These acclaimed "car guys" were going to retool GM into producing cars that people wanted and were profitable. What a novel idea. Unfortunately, the cornerstone of their plan was to extend the Hummer brand and reposition Cadillac to the younger crowd by emphasizing the Escalade- little about the cost structure or fuel efficiency. (The energy boom had already started and the price of oil had doubled in two years).

I mention this anecdote because these two still run the business and can't seem to run it into the ground fast enough. Not a single problem (sans the credit crisis) is new. Not the labor issue, not the mix of vehicles, not the cost structure- nothing here just suddenly appeared. Even the credit crunch- a harder time to get loans for consumers- has been in the making for over a year. This isn't to say it is entirely Rick and Bob's fault. No, we can blame the Board for lacking the will to change; we can blame Bush/Congress for providing tax incentives on Hummers during an energy shortage; we can blame Congress for failing to drag Detroit away from gas guzzling SUVs; we can blame the inflexible unions; and we can blame the Japanese too. Yet none of this matters- what matters is that GM is hardly capable of staying in business long enough to not need loans.

While the tendancy is to place blame somewhere in deciding whether the bailout is ok or not, it doesn't matter why it happened. It only matters that this is the situation today. Would the situation be different if the union took a $1/hr pay cut or if Cadillac sales grew 5% more than they did? No. The fact remains that in its present form, GM participates in an industry with far too much capacity, lackluster products, a high cost structure and way too much debt. The answer is not more debt, the answer is bankruptcy.

Yes, bankruptcy. Do you remember United Airlines going bankrupt in 2002? Probably not, because customers hardly noticed. United was able to renegotiate many of its contracts with not just labor, but also suppliers. Bankruptcy enabled United to discharge a significant amount of debt, recapitalize the company, lower its costs and reemerge a stronger, competitive company. The biggest losers were the ones who enabled it to carry on so long- the lenders and stockholders. If GM goes bankrupt, it will not result in millions of job losses. Instead it will result in some lost jobs and lower wages, but also realign its costs so as to be competitive. GM will not turn off the lights ala Enron, but rather restructure like United.

Consider the plight of the Big 3 from a 40,000ft level. The world's auto market is extemely competitive, not growing and is likely to stagnate for some time. Detroit has high costs, poor product and massive debt (think of debt as a fixed cost). Taking market share can't happen unless you sell every vehicle at a loss. How long can you sell every unit at a loss? If the government gives you cash to do that for a while longer, how will the companies begin to make money again? The products are still poor, they are now even more indebted and costs are no lower.

Put another way, the industry is building more cars than it can sell. Keeping excess production going doesn't solve the problem, it only hurts the profits of the whole industry. When the strong companies find they need to cut costs to stay competitive with dumping (vehicles sold below cost), they will lay off workers and cut production. We end up with the crappy companies taking market share unprofitably (in units) from companies with better product- the net result is still lost jobs, a poorer product mix and deflation in selling prices. A company can't pay off debt when it loses money on every sale. Things are not supposed to work this way, folks. The weakest players are supposed to disappear. Keeping the entire industry depressed is not going to help anyone in the long run.