My mom asked me to write a post on what to do about the fact that GM is now bankrupt. Oh, you might not have heard about that. According to the Detroit Free Press, the Wall Street Journal, and (my favorite source) The Truth About Cars, General Motors is running out of operating capital and will not be able to continue operating factories and paying workers through the end of this year. If their sales went up dramatically or they could get big loans then this would not be a problem, but nobody expects a jump in new car sales and nobody wants to lend money to GM.
Without intervention, this means that GM will be forced to file Chapter 11 bankruptcy, in which case the company would be placed under court supervision. A judge (and a team of other government people) would then be responsible for figuring out which creditors get paid back with what, which contracts can be modified, and how the company should be structured.
It’s maybe worth mentioning what the problem is. All the automakers have seen a sharp fall in sales during the last three months, but most are expected to survive without incident. GM, however, is in a particularly bad position for three reasons: their vehicles are not competitive, their labor contracts are very expensive, and they have way too many dealers.
GM has spent the past 15 years focused on expensive, inefficient “SUVs” (really passenger trucks). When gas prices were low, this was a great strategy, with enormous per-vehicle profits achieved by selling Suburbans to suburbans on credit. Unfortunately, GM didn’t invest this money in designs for smaller cars, which were not profitable. As gas prices have risen over the past few years, GM has found themselves with an enormous variety of great trucks, but very few competitive cars. GM does make a few cars, like the Chevy Malibu and Cadillac CTS, that are as good as their competition, but the great majority are too large, too heavy, and too inefficient, as if they were made by a truck company. GM’s subcompact that is perfect for the economic moment is the Saturn Astra, which is imported from Europe, and is thus so expensive that it can hardly be sold at a profit. Their other small cars like the Chevy Aveo have received so little attention that they are distinctly subpar, next to foreign competitors like the Honda Fit, and Scion xD.
A big part of GM’s problem is that they cannot produce small cars profitably (or at least they don’t think they can). Small cars sell for lower prices, and require less material, but need a similar amount of labor to build, and GM’s labor costs are very high. This may seem an inevitable result of producing cars in the United States instead of in a third-world country, but it’s important to remember that the Toyota Prius, BMW X5, Honda Civic, Nissan Altima, and many other “foreign” cars are actually produced in the United States. The principle difference between these plants and GM’s is that they do not pay their employees quite so well. In particular, GM in the 1970s and 1980s guaranteed their workers excellent pension plans, but did not fund those plans immediately. As a result, they are now paying for top-notch health insurance for thousands of retired employees and their families. These costs are called “legacy costs”, and in 2005 they added $1600 to the cost of every GM vehicle. GM’s employees are still virtually all union members, and GM’s union contracts prevent them from cutting wages or benefits, even if it drives the company into bankruptcy.
The final issue is the dealer network. Toyota has about 1200 dealers in the US. Chevrolet alone has over 4000, and GM also has the Cadillac, Buick, Pontiac, GMC, Saab, and Hummer brands, with thousands more dealers. Toyota sells more vehicles than GM, through a fraction of the number of dealerships. This means each dealership has to be supported by selling a much lower volume of cars, so there must be a wider profit margin on each vehicle, which again makes GM less competitive. Franchise laws prevent GM from simply closing these dealerships or otherwise deliberately putting them out of business.
Without intervention, GM will fall into Chapter 11 bankruptcy within the next month or so. Chapter 11 would place the company under the supervision of a judge, together with a large team of government bureaucrats, who will be given responsibility for determining which of GM’s contracts and obligations can be honored and which must be modified. The bankruptcy proceedings would provide an opportunity to solve these fundamental problems by replacing the company’s management and renegotiating contracts with unions, retirees, creditors, and dealerships. Thousands of dealerships would be closed, wages would fall, benefits would be restricted, and brands like GMC might cease to exist… but the company could survive, and hundreds of thousands of workers would keep their jobs. This is the plan that The Truth About Cars has largely endorsed. Moreover, if the government wishes to “bail out” GM to ensure that as many people as possible remain employed, then the logical time to do this is after bankruptcy proceedings have stripped the company of its impossible obligations and bad managers.
This sort of reorganization is not uncommon in bankruptcy proceedings, but it’s hard to do well. It’s even harder for a company as deeply in debt as GM; many creditors will surely be calling for the company to be shut down and its assets liquidated. Bankruptcy has also been seen as a major public relations problem for GM. Nobody wants to buy cars from a bankrupt company, so it’s expected that sale prices on existing GM vehicles would fall way below cost, creating huge downward pressure on the rest of the automobile market and damaging Ford and Chrysler’s similarly iffy finances.
To avoid bankruptcy, GM leaders met this week with Nancy Pelosi in search of a bailout. If Congress authorizes $50 billion in low-interest loans for GM, it might provide them with enough cash to continue operations for another year or two, and this is what they were asking for. The fundamental problem here is: why should we expect them to do any better next year than they did last year? They’ve been losing billions of dollars a year for a long time, and it’s hard to see why the trend should break now. Without addressing the three critical problems, GM is never going to become profitable. That doesn’t mean that this bailout won’t happen, though, since the Democrats want to keep winning elections in Michigan. It just means that it’ll be more taxpayer money being handed out to incompetent GM leadership (their CEO, by the way, is paid about $40k a day) with little chance for repayment.
I don’t have a lot of insight into this problem, but it seems to me that, given the inevitability of a GM bankruptcy, if the government is intent on preventing the resultant bad PR, they should create a special status for GM. Call it the Federal Program to Ensure Success. GM, recognizing its imminent Chapter 11 status, would instead apply for admission to the FPES, which would accept them. The FPES would create the moral equivalent of a bankruptcy court, coupled with the understanding that the government will provide additional credit as necessary to ensure that the resulting reorganized company is capable of meeting certain requirements. With a Federal guarantee that warranties would continue to be honored and parts would continue to be sold, prices for GM products should not fall so far. The government must ensure that the leadership of GM is replaced, and their contracts adjusted for minimal compensation, to ensure that the process does not create a moral hazard for future corporate bankruptcies.
Barack Obama has made carefully vague statements about the automakers, stating that they are “critical”, but not indicating which approach he would take to maintain them. Bush has been very nearly silent. We shall see.
EDIT: Hilarious Businessweek article from 2005. Choice quotes:
Wagoner is pegging his turnaround largely to a rebound in large pickups and SUVs. That’s highly problematic. GM should get some pop just from replacing its aging truck lineup, which is six years old and staggering as buyers turn to smaller SUVs and newer vehicles such as Toyota’s Sequoia full-sized SUV and Ford Motor Co.’s (F ) rejuvenated F-150 pickup line. GM’s Kowaleski says: “Even if those markets don’t grow, there is a lot of opportunity for volume and profit.” But first-quarter sales of full-size SUVs nosedived 21.5% from a year earlier, according to Autodata Inc., thanks to rising gas prices and competition from crossovers,
Merrill analyst John A. Casesa estimates GM can last five years before it hits a liquidity crisis. “We believe that 25% market share is the threshold,” Casesa says. “If GM falls below that, things get ugly fast.” But that assumes overall U.S. car sales remain at their current high level. If rising interest rates, high gas prices, or other factors hammer the economy, the picture darkens further. At 15.4 million vehicles and a market share of 24%, GM would burn through $3.6 billion of cash annually, says Merrill; a 20% share would leak a catastrophic $5.7 billion. “The next blow comes if there is a recession,” says longtime industry analyst Maryann N. Keller. “We just got through an [economic] expansion, and the balance sheet is in worse shape than it was before.”
In other words, this is not exactly a surprise.