Saving the Auto Industry: A Radical Solution

I plan to write a series of posts on the issue of bailing out the Big Three. Let me cut to the chase on a couple of points.

First, yes, I do think we need to save the car companies. The primary reason: if they fail, the U.S. would be looking at a near-term loss of up to 3 million jobs, mainly in Midwestern states that are already beaten down economically. Given the fragile state of the economy, the consequences of this would be nothing short of catastrophic.

Second, I don’t think a bailout of the form the government is currently considering would be much help. Yes, it would buy the car companies some time. However, given that the Big Three are collectively burning through about $6 billion per month, “bridge financing” bailouts in the $25 billion range would buy them only four months. Nothing in the economy is going to change in the next four, or even six to ten months that will suddenly propel car sales and again secure the finances of the car companies. And I don’t think our country can realistically afford yet another bailout in the $100+ billion range.

So, what can be done? I have two radical suggestions. The two are not mutually exclusive.

Option 1 is for the government to buy a controlling stake in the three companies. The combined market caps of three car companies is now only about $10 billion (Chrysler is privately held; I’m guessing its value is $3.7 billion, which may be high). If the government were to buy a controlling 51% stake in these companies for all of $5.1 billion (or less), it would be able to select Board members and directly influence corporate policy and finances in whatever direction it sees fit. In fact, it might be able to do the same with much less than a 51% investment. When the economy recovers, the government would simply sell its shares on the open market and make a nice profit, which it could return to taxpayers in the form of a tax refund.

There already is precedent for this. Unless you missed it, the government now owns (or soon will) pieces of several financial institutions. And one could argue that the government also effectively owns “corporations” like Amtrak and the Post Office through tight regulations and by controlling their funding sources.

Option 2 is to offer Americans a $10,000 refund on their purchase of a new car. Instead of taxpayers footing a $25 billion tab to help the automakers—which has no direct benefit for the average Joe—I’d rather the government take $25 billion and give it back in the form of a discount to car buyers. 2.5 million people could get a dirt cheap car this year. Why would this help? Because, by keeping U.S. car factories running at full capacity for months, no one would be losing their job.

I would add a few stipulations. First, the car or truck must be assembled in a U.S. factory—but it can be a foreign nameplate. This specifically keeps U.S. manufacturing jobs intact, but keeps the playing field level. Honda will still be rewarded for making Accords in Ohio, Toyota for making the Camry in Kentucky, and so on. Remember, this is about American jobs, not GM, Ford or Chrysler jobs.

Second, optionally, we can add fuel economy sticks and carrots to the size of the refund amount. More fuel-efficient vehicles or those with key technologies (hybrids and electrics, namely) could get a bigger refund, and certain gas guzzlers could be exempted from a refund altogether.

Third, to avoid price gouging, I would add a requirement that manufacturers cannot suddenly raise their cars’ prices above list.

The beauty of this approach is that everyone benefits. Consumers get a new car at a bargain price, and still have the freedom to purchase a foreign nameplate. The car companies get their much-needed cash infusion. Manufacturing jobs are preserved. The government can provide a viable incentive for consumers to choose more fuel-efficient vehicles, thus helping to advance a sensible environmental agenda. States will get a boom in sales tax revenue. And I would expect that the stock prices of the car companies, their parts suppliers, and all the companies that support the auto industry will rise, as well, thus helping drive the broader U.S. (and world) economy.

Obviously, Option 2 is a one-shot deal, good for 2009 only. Which is why I like Option 1 in conjunction with this plan. My biggest objection to bailing out the car companies is my fear that even if they cross the chasm until the economy recovers, they still won’t be any better managed and will be doomed to repeat the mistakes they’ve made over the last three decades. Can the government do a better job by controlling their Boards? I’m not sure, but I think it’s time to try something new.

Please share your thoughts by adding a comment.

Advertisements

17 responses to “Saving the Auto Industry: A Radical Solution

  1. I like your idea about government buying a stake in each of the Big Three car companies. One issue that I believe needs to be addressed are the Unions. The UAW should either be fired or make huge concessions for this to work. Because of them an average vehicle brings GM a loss of 1200 per unit vs Toyota 2000 profit. They also would not be able to carry the employee pension burden and burn through the money quickly which even with government control would bring the company down.

  2. I’ve seen a number of people propose the idea of the government taking a major equity stake in the auto industry, with an eye toward making major decisions such as appointing board members or management, and I think it is a terrible idea. Let me explain.

    The problems of the auto industry stem from three separate factors. First, there are long-term consequences stemming from poor management decisions made years or even decades ago. In an industry where a 48 month lead time on a new product is seen as quick, the course for the next year or two at each company is already broadly charted and essentially impossible to change in any big-picture way.

    Second, there are systemic problems that have plagued the industry for decades; these are well-known (health care, pensions) but worth repeating. GM’s problems with pension costs are a microcosm of the larger Social Security issue–it is a small(er) company trying to pay the obligations of the retired workforce of a much, much larger company.

    Third, and perhaps most urgent, there are short-term factors associated with the current credit crisis. The developing meme that GM should die because it doesn’t make cars that anyone wants is tremendously annoying–in fact, GM continues to sell hundreds of thousands of vehicles. But the credit crisis has made it difficult or impossible for GM to lease cars, and GMAC now won’t write loans to anyone with a credit score under 700. A mass market company whose goods must be financed simply cannot survive if it cannot give financing to the vast majority of its potential customers. You see the effects of this in the slow-down at Lordstown; GM is building fewer Cobalts not because people don’t want Cobalts, but because the people that want Cobalts cannot buy them.

    The thing is, nationalizing the Big Three and bringing in new managers would fix none of these problems. New product decisions cannot be implemented quickly enough (even if we trust that a government appointed board would make better decisions about the management team than the current board). The systemic problems with healthcare and pensions would still exist. And until the credit markets thaw, a government controlled industry would be just as unable to move metal as current companies are.

    To riff for a second on one point above–why do we think that a government “car czar” could do a better job in picking management (or making product decisions) than Waggoner, Mullaly, Lutz, et al.?

    My proposal is actually far more sweeping: Guaranteed bridge financing for 12 months. Further government intervention in the credit markets to unfreeze auto loans. And nationalized health care, to level the playing field for ALL American manufacturers against their foreign competitors.

  3. Patrick Bateman

    Filbert, I agree with the second of your two general causes of the industry’s woes. Nationalizing the auto companies wouldn’t fix those. But I think you understate the importance of the first factor you identified, and I do think putting some fresh blood on the Boards could go a long way to addressing it.

    Bad product management at the auto companies isn’t a recent event. We’ve had over thirty years of it. Granted, GM and Ford (not so much Chrysler) have made tremendous advances in the last few years, but there have been some egregious, inexcusable disasters of vehicle planning and general management that I fear will not end anytime soon unless there is a serious shake-up of the management teams. The kind of person I’d like to see the government put on the Board is not an auto industry insider or a politician — I’m thinking someone like Steve Jobs. Someone who by nature always changes the norm and has innovation in his blood. (Credit goes to Thomas Friedman for this idea.) Such a person won’t fix the companies’ problems overnight, but he or she could certainly put the companies on a better track. After all, GM’s current CEO, Rick Wagoner, is the guy who made the decision to kill the EV-1 electric car program, decided that investments in hybrids weren’t worth it, decided to buy Hummer, and to invest heavily in large SUV product development. With a visionary track record like that, why would we want to keep him in place? If GM’s Board won’t oust him, the government should take a controlling interest and do so. I don’t know about you, but I’d feel a lot more comfortable if someone like Steve Jobs got on board.

    As for your alternate proposals, I again agree with the last two pieces of it (further government intervention in the credit markets and national health care). But guaranteed bridge financing for 12 months? Look, the industry’s current burn rate is about $6 billion per month, and I expect that will increase into 2009. So 12 months of support would be a government bailout to the tune of $80, maybe $100 billion. Frankly, I don’t think our country can afford this, nor should. Politically, I doubt this would ever fly.

    At this point, we’re looking at a spectrum of bad options to save the auto industry. It’s a lesser of all evils question at this point. Under my plan, the government spends $5 billion to buy a controlling stake in the Big Three and puts some dynamite leaders on the Board to help secure its future, plus gives vouchers worth up to $25 billion to Americans to buy U.S. made cars to keep the factories humming and everyone employed. I think my $30 billion plan would better accomplish the desired results than just handing the companies $100 billion.

  4. I do not mean to understate the importance of good product–it is critical. My point, though, is that the product picture is the one area where things look kind of good for the industry. GM has released a slew of vehicles that have received critical acclaim recently (and, more importantly, are selling reasonably well). Others are in the pipeline. Ford has a solid plan to bring its well-received European products to the US, though whether that will be successful in light of the recent crash in oil prices remains to be seen.

    So, Ford and GM have decent products on the way (let’s leave Chrysler to one side, because in many ways it is just a basket case). After years of ignoring the automotive segment, each has a very competitive mid-size sedan and appealing small cars one to two years away. Each is transitioning away from truck-based SUVs toward lighter crossovers, which seem popular. Given that it takes at least two years to bring a new product to market, what could someone like Jobs do in the short term to improve that situation? And, if we think that fresh ideas from outside the auto industry are needed, why not give Alan Mulally time to implement the plans he’s put in place?

    Moreover, I come back to my fundamental belief that the shareholders and board of GM and Ford are acting rationally. In this case, as in many others, I have no reason to think that the government could do a better job of picking or attracting top management talent to either Ford or GM than could the private shareholders that already control the company. To my mind, it’s far MORE likely that a government-selected leader of either Ford or GM would be a dreary bureaucrat whose ideas about which cars to build were driven far more by political pressure (more hybrids!) than by what could profitably sell (i.e., maybe trucks and other socially unacceptable vehicles). Remember British Leyland? Government control of the auto industry in the name of “saving” it doesn’t necessarily work.

    Finally, on your point about costs, I agree that if we had a plan that could save the industry for $30b as opposed to $100b, that would be better. I’m just not sure that $25b is enough. That’s, what, 2.5m $10,000 vouchers? In the grand scheme of things, 2.5m vehicles isn’t that many, and whether the vouchers would actually get used is another question given the tight credit market and looming unemployment figures (especially since many of the vouchers–perhaps the majority of them–would be spent on Honda Accords, Civics and Toyota Camrys). Even if that gets you through 2009, that isn’t long enough for ANY new products that aren’t already in the final stages of development to hit the road.

    Besides, once the taxpayers control the auto companies, you’ve opened the taps completely. The financial black hole at that point becomes limitless–not that it wouldn’t be with a direct cash bailout (because, really, once you’ve started spending it’s impossible to stop; who is going to be the politician that kills GM by cutting off its aid)–but I don’t think you can count on a takeover costing less than a bailout.

  5. Oh, one other thing occurred to me on the voucher plan: it would have an utterly disastrous effect on the resale value of newer used cars. It would, actually, probably collapse that market.

    That’s bad for the ordinary consumer who just bought a car, but it’s even worse for the captive finance arms of the auto companies who have any number of lease returns due back over the coming year. Those companies have already taken a merciless beating on truck/SUV leases this year; subsidizing new cars would just worsen this problem and make it even harder for the lending arms to provide credit.

  6. Filbert: Nice one on the collapse of the used vehicle market. I was going to make the same point. It would leave me with a $400/month asset that I would have to sell at a hefty loss in order to redeem my $10,000 coupon. It could make my coupon really worth only $5000 or less, and in order to redeem it, I’d need to assume two car payments because the sale of my current car wouldn’t come close to covering the note.

  7. That is, “$400/month payment on an asset” of course.

  8. I spoke just yesterday with my very close friend who is in management at the a GM truck plant.

    He told me that Deutche Bank just gave an quote for the market cap of GM …… $1.5 Billion.

  9. There’s a word for the government taking over industry. That word is “socialism.” It may just be my right-wing paranoia kicking in here, but, once acquired, do you think Pelosi/Reid/Obama are going to give up their controlling interest willingly?

    Instead, we’d get a whole slew of mandated PC cars (as pointed out above), maximum protection and additional favors for unions (a key Democrat constituency), and trade barriers to protect our New State Industry’s market share from those nasty foreign countries who can make a quality product at a reasonable price and still turn a profit.

    In this scenario, if the Big Three continue to lose money, the State keeps them because they can’t survive on their own and we can’t have job loss, especially not union job loss. If the Big Three start turning a profit, the State keeps them because they are a crucial source of revenue to the Treasury and we need the money to fund entitlements and schools and stuff. The campaign against selling off the controlling stake would closely resemble the campaign against President Bush’s modest proposal to allow some choice in Social Security plans. A vote for this is a vote for lousy schools and starving senior citizens! And really, what kind of heartless cretin wants that?

    Throw in socialized health care, which we are unfortunately very likely to get soon, and we are well down the Road to Serfdom. Maybe the oil and gas companies are next.

    As to Maciek’s comment that the unions need to be busted: Great idea; fat chance. In order to do that, we’d need Zombie Reagan as president with a 70% Republican Congress and even then I wouldn’t like the odds.

  10. I appreciate your concern and you are right, three million jobs lost is not going to not be digestible for anybody.

    However, the Federal Government buying the auto industry is not acceptable either.

    Renault and Peugot are examples of what a government run car company can become. Pretty much like GM, but instead of going out of business, it becomes a public subsidized business – like our postal system. The difference being with the postal service, everybody benefits. The government run auto industry only benefits those employed by the company and it’s partners at the expense of all taxpayers. Even if you gave a tax credit for purchasing an American car, the taxpayers still have to pay the bill – that would be 60% of the people in this country who pay taxes.

    If you want to be radical, here’s a thought;

    1) Shut down the Union or make them 100% responsible for all retirement benefits and pension – with reduced member numbers, wages, benefits and dues – which is not feasible.
    2) Pensions and Benefits are reduced immediately vs. being lost forever.
    3) The Federal Government secures and takes over a portion of the pensions and retirement benefits. The Federal Government receives dividends that come off the top of any and all profits from the automakers as payment on the loan they’ve made to free up the chunk of benefits they have taken on.
    4. Consolidate the three automakers into one and cut 1M jobs over a two year period. Which is better than 3M jobs in a six month period.

    In economics there is a principle called Loss Minimization – If price is greater than average variable cost but less than average total cost the firm tries to increase asking price for its product (which isn’t feasible) or reduce fixed costs to move the company to break-even or better. If this cannot be achieved, or if price falls below average varible cost the company must shutdown because it is in the position of paying to a produce a product that cost it more to sell than it can make.

    The auto industry variable costs can be managed on the open market. The fixed costs – labor contracts, pensions and benefits have creeped up to the level where variable costs at any price cannot be purchased and repurposed at a profit.

    When the Government attempts to control a market, as they would through ownership of the auto industry, you get something like our current Medical System. Medicare and Medicade consume the majority of healthcare in this country, but the government pays substantially below the market price for those services. This leaves those who can afford to be insured holding the bill which is further stressed by those who cannot afford insurance and do not qualify for medicare or medicade. It’s a lope-sided market that eventually breaks.

    So – Consolidate the three to one, remove the unions, reduce current pensions and benefits, the government takes over a portion of the pension and benefits, assume 1/4 of the benefits, in exchange for dividends paid first on all profits and cut the work force by 1/3 over two years.

    Sadly, it would be better to cut labor immediately, but it’s feasible to make the cut over two years, if all other changes are made immediately.

  11. I agree on the consolidation point, though I don’t think we need to see 3:1 consolidation; Chrysler is the obvious candidate for closure, though the Cerberus ownership is a bit of a wildcard, there.

    The fact that there needs to be consolidation but that consolidation is politically impossible is yet another reason to avoid direct government ownership in the Big Three. As Gordon Winslow observes, it’s impossible to imagine the government, having taking control, allowing any of the companies that it controls to go under. And you pretty clearly couldn’t nationalize just one or two of the companies, given the competitive imbalance that would create.

    On the radio tonight, they mentioned government assistance in the form of paying for the UAW pension plans. That kind of “soft” assistance, assuming its sufficient, makes a lot more sense than nationalizing the companies; it allows them to continue to compete as private entities, and (hopefully) allows the stronger of the three to fight their way back to profitability.

  12. Greetings! I know this is kind of off topic but I was wondering which blog platform are you using
    for this site? I’m getting sick and tired of WordPress because I’ve had issues with hackers
    and I’m looking at options for another platform. I would be fantastic if you could point me in the direction of a good platform.

  13. Hello There. I found your blog using msn.
    This is an extremely well written article. I will be sure to
    bookmark it and return to read more of your useful information.
    Thanks for the post. I’ll definitely comeback.

  14. This blog was… how do you say it? Relevant!! Finally I’ve found something that helped me. Cheers!

  15. My brother suggested I may like this blog.
    He used to be totally right. This put up truly made my day.
    You cann’t consider simply how a lot time I had spent for this info! Thanks!

  16. Private Detectives London have been about for longer than thirty-five a number of
    for this reason longevity they have already gained much experience in handling different cases for example matrimonial and
    corporate investigations. It is also important that an organisation’s
    Board include people with utmost integrity who does engage themselves while using management.
    It has become the opinion that they may be better at subtle persuasion than men.

  17. Thanks for posting this awesome article. I’m a long time reader but I’ve never been compelled to leave a comment.
    I subscribed to your blog and shared this on my Facebook.
    Thanks again for a great article!

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s