Monday, December 29, 2008

ECONOMY- The Auto Bailout

I had a talk the other day with a good friend and it started me thinking about some things that hadn’t occurred to me about the state of the economy and the auto bailout.

I’m going to refer to my friend as Bob, although that isn’t his real name. Not that I actually think he’d care for me to use his real name but simply out of respect of the fact that I haven’t asked him. Like many successful and thoughtful people I’ve known, Bob finds himself drawn to Libertarian principles. His thoughts on the auto bailout can be capsulated as (a) the government has no business bailing out failed companies and (b) the Big Three automakers are doomed to fail anyway so any money the government spends to prolong the inevitable is wasted.

As I told him, from a philosophical point of view I agree with both viewpoints. I don’t think it’s the business of government to decide who is “too big to fail”. A free market is only free if failure is an option for anyone. At this point it’s looking more and more like the bank bailout was a terrible waste. Not because the government might not have needed to do something to save the banking system but because, like virtually everything the Bush administration has done, it was poorly planned and terribly managed. What they have done seems to amount to pouring obscene amounts of money into the banking system and having absolutely nothing to show for it. Likewise, if the taxpayers give the automakers a loan that no bank would touch and they default, we have thrown away money and have nothing to show for it.

But Bob repeated a “fact” that I hear over and over again and don’t believe. He says that Detroit’s problems are the fault of the unions. I’m sorry, but this is patently absurd for a couple of reasons. To take GM as an example, the cost of their union pension responsibilities is immense. I read estimates between $1300 and $1800 PER CAR SOLD. But while this is a competitive disadvantage that the foreign companies don’t share, it isn’t the reason GM is bankrupt. Those pensions are a cost of doing business just like the cost of steel or interest on bank loans. You wouldn’t blame the banks for GM’s debts so why blame the pension plan? Those workers had contracts that entitled them to a pension and health care in retirement. They are no more responsible for GM’s predicament than any other creditor.

Another thing people say to blame the unions for Detroit’s trouble is that their workers make too much money. True, US auto companies pay slightly more to domestic workers than foreign companies. That’s why US car makers have been closing plants and moving them to Mexico where they pay significantly less. But the real Pay inequality is among executives. Ford CEO and President Alan Mulally makes about 100 million dollars a year, or about 557 times what that theoretical $75/hr. autoworker makes. To compare, Toyota CEO Katsuaki Watanabe makes under one million a year, or under 6 times as much as the same auto worker. Still think all the money is going to the people actually building the cars?

GM’s problem isn’t new. It’s the same problem they have had for a long time- every year fewer people want to buy their cars. PERIOD. While the Japanese and other foreign carmakers have expanded their market share, American companies’ sales have contracted. If you think the pension plan or labor cost is the problem then ask yourself- would making GM cars $1500 cheaper cause someone buying a Toyota to change their mind? According to Kelley Blue Book a base model Chevy Malibu invoices for $21,395.00 while a base Toyota Camry costs $26,210. The Toyota already costs over $4800 more! Obviously cost is not hindering Toyota who equaled GM in new car sales worldwide for the first time over a year ago.

There are lots of reasons for GM (and as GM goes, so America goes apparently) to have consistently lost customers to Toyota but they aren’t the unions, they’re the cars.

(1) American cars are inferior in quality (many will protest “Not any more” which simply proves that they have been for so long that claiming equality is now considered a selling point). Not only do they break down more often but their build quality and “fit and finish” is inferior. Their technology is often inferior. And they just aren’t as nice. Go to a Chevy showroom and sit inside one of their cars. The interior is laden with cheap plastics, inferior finishes and textures, knobs that feel cheap when you turn them, and seats covered with fabrics that you wouldn’t use to line your dog house. Now go to a Toyota or Honda dealership and sit in one of their cars. The differences aren’t subtle. Do the same thing and look at the seams between body panels or test the ride quality while you’re at it. And the inferiority isn’t just skin deep. The 2009 Corvette, considered one of the best cars made by the General, still uses an engine technology that’s over 60 years old and is suspended on LEAF SPRINGS. For those of you that don’t know, this is the same kind of suspension technology used by stage coaches. And it wasn’t new then. Is it any wonder that almost every review of this “world beating sports car” comments on how bad the ride quality is? Simply put, the foreign brands have made such sales gains because they build better cars.
(2) The resale values for American cars are abysmal. This is mostly because of the program car sales that allow American auto makers to claim sales commensurate with Japanese brands. When you see sales figures from GM, Ford, or Chrysler they include significant sales of cars to rental fleets and other corporate buyers at substantial discounts. These sales assure that there are always plenty of used American cars available at heavy discounts within 12 months of the release of a new model. A friend of mine looked up the loan value on a 2007 Dodge Magnum the other day and found that the car, which had been purchased for close to $40,000 was now eligible for a loan of $15,000!
(3) American car companies make too many versions of the same car. If you walk into a Japanese dealership you will find that the option list is less than a dozen items and often there are only 2 or 3 factory options. Domestic auto option lists contain dozens of items and checking every one can almost double the cost of the car. In addition to that, American car companies make too many kinds of the same car- a marketing ploy called “badge engineering” It is common to find the same basic automobile sold by several different dealerships with only cosmetic changes. For GM to supply autos to GM, Chevy, Pontiac, Cadillac, Hummer, Buick, and Saturn they wind up making the same basic vehicle in several ways, gutting the economies of scale they would otherwise enjoy.
(4) Their management is incompetent and overpaid. True this isn’t exclusive to car manufacturers; it’s epidemic in American business. But American higher management seems to be a kind of “good ol’ boys” club where the ultra rich move from one company to another without demonstrating any real talent. Take the case of Bob Nardelli, who moved from being CEO of GE to being CEO of Home Depot in spite of the fact that he had absolutely no retail experience. True, during his tenure profits for the chain increased, but not at the rate they had been increasing prior to his taking charge. He also managed to keep Home Depot’s stock price steady while their main competitor, Lowes, watched their stock double. For this lackluster performance Nardelli was awarded with a salary of 240 million dollars a year until stockholders had finally had enough and ousted him with a 210 million dollar bonus for his trouble. His next job was to head Chrysler, since running an appliance manufacturer and a retailer was perfect experience for him to run a car maker (NOT). At Chrysler he has presided over it’s slide into bankruptcy, cut back on new model development, and basically continued to exhibit the kind of management excellence that makes one wonder why he isn’t flipping burgers somewhere rather than begging congress to give him some of my money even though he hasn’t earned my business.

Blaming the workers for the problems the Big Three are having is attractive if you are uninformed or have an ulterior motive for wanting to blame the unions. But truthfully, saying that the unions are the cause of the US auto industry’s problems is like driving your car into a tree and saying you shouldn’t have filled the tank with premium gas.

So, should we bail out the auto industry? I honestly don’t know. But I can’t help worry more about the workers for the industry and their ancillary suppliers. And all the industries that will be affected by their loss of purchasing power. And all the other ripple effects. But surely the almost $100,000 per employee that Ford, GM, and Chrysler are asking for would allow the government to keep those people from starving until the industry gets through Chapter 11. (Because if they go on the dole we’re still going to have to pay for them.) It’s only going to last the current management a couple of months. Then it will be time for the taxpayers to make their next payment.

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