Politics/Intel
Automakers: Let Them Fail
This past week has seen an acceleration in the claims of impending doom by the big three US auto makers and the consequent need for the federal government to provide them with significant liquidity to remain afloat. Our take on this: now is not the time.Unlike the various financial companies which the government has provided liquidity through its TARP and other programs, the failure of the auto makers will not have an immediate, calamitous effect on the broader economy. Wide spread failure in the financial industry could have resulted (and in some cases nearly did) in the knock on failure of many companies who depend on the financial markets and those companies for day to day liquidity for continuing operations. The same applies to the consumer seeking auto and home loans and short term financing for purchases via bank credit cards. Were the big three to fail, the primary pain would be inflicted on workers and shareholders of those firms and potential lost business by their parts suppliers (and perhaps the supplier of raw materials to them). Certainly, this would be very unpleasant for those involved. But would it be short term or long term pain?
Unlike failed financial institutions, which as a general rule disappear and leave little behind, more traditional 'hard' product companies can and do emerge from Chapter 11 bankruptcy. The airline industry, undoubtedly still troubled, has seen many failures the past three decades. While true that some airlines disappeared, many were able to restructure their operations sufficiently that they could exit bankruptcy a new and leaner company with the chance for longer term survival. The auto industry suffers many of the same problems which inflicted the airline industry and should be allowed to follow a similar path.
Detroit has two main hurdles to overcome: legacy labor costs and product choice. Labor costs are by far the largest single drain of liquidity for the car makers. Recently negotiated contracts have resulted in a tiered system whereby new employees are paid far less in hourly wages and far less when the full benefits package is considered - current workers can expect to see a total pay package of order $30/hour while older workers are pushing $80/hour. Were all employees under the same structure Detroit would not be on Capitol hill hat in hand. Detroit is also saddled with huge health care costs for retired workers who are now benefiting from the auto makers past largesse (this should be a wake up call to the Congress on the need to reform Medicare/Medicaid before its too late).
All the blame, however, can't be placed on workers pay packages. The US auto industry has consistently lost market share - even during the SUV boom years - to foreign producers. This is a function of poor management, one unable to correctly gauge what kind of vehicles the public really wants. There are some signs now they have seen the light and are making cars more inline with the Japanese and Korean imports. But the damage has been done and it will be up to the domestic producers to show their products are superior (more features, better quality, more efficient), better value (lower cost of ownership for similar features/quality) or both.
So where does bankruptcy fit in all this? First, it is not 100% certain all three will go into Chapter 11. Private capital may still be raised and costs further cut to allow operations to continue until spring 2009. At that point the consumer will hold the key to Detroit's future. If sales remain at depressed levels, chapter 11 will follow quickly. As we noted earlier, when an industry is suffering some firms will be liquidated while others will restructure. Chrysler will be the one to disappear - it has the smallest market share and the only unique product they have is the traditional 'Jeep'. Rights to that model (and perhaps a handful of others) could be sold in the liquidation to another automaker. Ford and GM, however, still have significant market share and were the cost structure altered, should be able to remain viable entities under new management. Chapter 11 will allow Ford and GM to change the terms of labor agreements and obligations, close redundant plants and otherwise restructure their operations (i.e. get better managers) to emerge as leaner companies able to make a consistent profit while developing and producing future cars which consumers desire.
We began by saying 'now is not the time.' Were federal taxpayer aid offered now, prior to any Chapter 11 filings, the government would be throwing good money into a hole. Money alone does not solve the fundamental problems of the auto industry. It is true that the current recessionary environment has hurt and hastened their demise (some would argue they should have been better prepared for it), but a capital infusion will only delay the day of ultimate reckoning. It is far better, in our eyes, to allow this process to run its course. Once they have officially filed for Chapter 11 protection, then the government can step in to provide interim financing while restructuring is underway in exchange for some percentage of the 'new' companies. We do not however, favor terms such as those placed on AIG which amounted to a defacto nationalization. Any loans should carry an appropriate interest rate and term with the expectation they be paid in full. The equity stake should be small, say 15%, and offer the company the right to buy back the government stake based on a prearranged price or metric. This will give the taxpayer some upside return but keep the government out of the nationalization business and encourage private capital investment in the survivors.
By following this course the disruption to the economy will be minimized while allowing for the best possible future outcome. The majority of plants will still operate and suppliers will be paid while Ford and GM work through restructuring. Chrysler will fail, but being the smallest producer will limit the damages to the near term as the removal of excess capacity will improve the long term prospects for the larger two. This course will be politically difficult for president-elect Obama and the new Congress but coming at the start of the term gives greater flexibility. And outside of the auto industry, most Americans have said they do not want to see a large scale bail out of the car makers. By letting them fail first and then assisting the restructuring process, Obama can limit the damage from labor voters while increasing his standing with the majority of the electorate. Reagan faced a similar thorny early decision with PATCO (air traffic controllers) but ultimately took the action which resulted in the best long term outcome. Hopefully Obama will do the same.
