More trouble coming for the automakers

We’re starting to hear rumblings about the impending bankruptcy of GM.

Detroit has known for 30 years that America needs more fuel efficient cars. Japan built them, and Detroit didn’t. Now it’s too late: although GM, for example, has closed the factory-efficiency gap somewhat with Toyota, and the timeline for taking a car from drawing board to showroom has dropped from about six years to two, they just cannot catch up. The Chevy Volt isn’t ready, and even when it hits the streets it will be more expensive than the Prius. It’s not enough to finally start making the cars of the future – they need to do it as well as Japan does.

Ford is doing the best of the three companies; they have some cash set aside and are moving forward on fuel efficiency (they may sell Volvo to raise cash). They said they might be able to do without bailout money. Chrysler is broke and may need a merger; they had been talking to GM about it. GM, whose stock dropped from 75 dollars to 3 in eight years despite some painful restructuring efforts, may dump some of its brands, at the very least; they would have to sell rather than liquidating, which costs money – if they even survive. Some of its more drastic options include cutting U.S. operations, taking Saturns away from Saturn-only dealers, and delaying payment to the retiree health care fund.

The Democrats told the Big Three to have a detailed plan: their demands included accountability for the loan structure (to include recalling the loan if benchmarks are not met), for the taxpayers (who must be paid back first and must share in the profits as things improve), for the employees and retirees (health care and pensions), for the shareholders (in the form of blocking excessive executive packages), and for the consumer (in the form of building fuel efficient cars and backing warranties). If they don’t meet the benchmarks, call in the loans. Somehow it isn’t happening.

The bailout will do little to change the ugly facts. The Detroit business model is unsustainable: it’s too big, with too many, factories, employees, dealers. The over-paid corporate leaders still show no signs of credible leadership: they still tend to blame everything on labor or on the fiscal crisis. Demand is down and likely to stay that way, with credit so tight. U.S. auto plants have high fixed costs and way too much capacity. Joint ventures are problematic: Chrysler was working on a project with a Chinese firm to build small cars, but they couldn’t figure out how to manage the safety and environmental issues.

The big issue is the gigantic cost of labor contracts. The UAW leadership can see the trouble coming: the union chief gave so much away in the last contract that the rank and file almost rebelled – it’s not their fault that management failed for decades to design good cars -- and management is already chipping away at benefits. The unions were willing to give ground on the jobs bank, delay payments to the retiree health fund, and alter old contracts. They refused to approve wage cuts for 2009.

Also, pension costs are brutal: GM’s pensions, for example, are insured by a quasi-governmental agency, the Pension Benefit Guarantee Corp. With a million participants, that hit alone could cost taxpayers more than $100 billion, with another $100 billion in lost tax revenues and $10 billion in increased Medicaid annually. Health care, same thing – that issue alone drove a big chunk of the Detroit auto business across the border into Ontario, and Canada’s health care system isn’t even all that good.

Obama, the Democrats, management and labor have criticized the Chapter-11 restructuring option proposed by people like Romney, but it would be less drastic than a Chapter-7 liquidation, which could still happen (although we must not let the companies frighten us with that prospect, and stampede us into a bad bailout). Under Chapter 11, firms would dump excess brands and factories, and possibly the government would take direct control over the pensions. Perhaps we use bridge loans to get the firms through the worst of the recession, and then phase out the firms in favour of the new structural model. A critical issue would be finding or creating jobs for millions of factory workers, dealers, suppliers and everyone else – another reason to do it gradually. Another: until consumers see who the new companies are and really understand what they’re selling – both cars and warranties – how do you get the auto sector back on track, selling cars?

It’s not just management, labor and taxpayers with skin in the game. The automakers have creditors who will take a hit. Then look out for the shareholders (who already are receiving no dividends), suppliers, and anyone involved in car loans. Dealers will take a heavy hit: there are too many of them and they are protected by state franchising laws (GM has four times as many dealers as Toyota).

U.S. automakers aren’t the only ones in trouble. Even Toyota is reeling: they posted their first loss in 71 years. European firms, suffering from sagging sales, are asking their governments for bailout money, and subsidiaries, partners and suppliers are shaking in their boots too. The scary thing is that the Europeans, unusually for them, are working smoothly together to craft a continental strategy rather than a dozen national plans, cutting capacity and focusing on building the right cars; if the Europeans can come up with a good tough-love plan while America babies its firms and its unions, then what little competitive advantage we have goes down the drain. Firms in China and Australia are looking for help too – although a Chinese firm could buy into the U.S. market once things settle down next year.

New plants are still being built, which will make the capacity glut even worse: automakers and governments are starting to grumble of a subsidy race, which could preserve a lot of excess capacity, and cause a lot of other problems which will distort an already-wobbly market.

Rust Belt lawmakers wanted to help the automakers, but western pro-environmental Democrats and Blue-Dog deficit hawks have suspicions about helping them out. The Republicans, who hope that a drastic restructuring will kill the UAW and please their big business allies, can filibuster, but if they foul things up and then massive layoffs ensue, Obama’s reelection is a giant step closer.

But big, big trouble is still coming, on jobs and pensions.