President of the United States is a job with no shortage of responsibilities, but last week the Obama administration added another role to the presidential résumé: carmaker-in-chief. That was effectively the result of the administration’s decision to force out General Motors CEO Rick Wagoner and announce that GM will need to shake up or else face unspecified but dire consequences. What this means for the company, and for the country, is a question worth considering.
The story of General Motors is significant because of what it says about American capitalism. If the largest US corporation, as measured by amount of sales, can stumble to the point of failure, then anyone can, and it’s a vindication of one of capitalism’s core principles: succeed or die. It’s worth examining how GM got to that point. No less remarkable is the federal government’s response to GM’s woes – not least because of what it says about the incipient radicalism of the new administration as it seeks to change the landscape of American business.
The US auto business has always been cyclical, with booms and busts following each other on a something close to a seven-year cycle. What happened last October, however, was extraordinary. In the wake of the financial crisis that began the month before, consumer demand in the US suddenly collapsed and has remained very low ever since, with the auto industry especially hard hit. Not just GM but all 11 of the global automakers operating in the US have reported sales declines of anywhere from a third to a half in each of the past six months. Losing half their revenue has hurt all the automakers. But it pushed GM over the edge.
To be sure, GM’s managers have been aware for decades that their operating model is fragile. This is an enterprise that was built for steady long-term growth. Thus GM concentrated on staying large, even at the expense of profitability. They supplemented their capital by selling long-term bonds and now have trouble paying the interest. And they depended heavily on easy consumer credit to finance purchases of their vehicles.
Moreover, GM has never responded adequately to global competition. As they lost market share over the years to imports and “transplants” (foreign makes assembled in the US), they never figured out how to make money selling smaller, fuel-efficient vehicles. But as long as cash flows covered their obligations, they managed to postpone the day of reckoning. Adding to the company’s financial troubles, their labor union, Ron Gettelfinger’s United Auto Workers (UAW), has never been willing to allow GM to close antiquated factories and lay off the affected workers.
At the end of the September financial quarter, GM had about $11 billion left. At the time, they were losing about a billion dollars a month, and were planning to line up new capital or new financing in 2009. Their economists were projecting a strong improvement in demand for their products this year. Then the bottom fell out in October, and GM started losing nearly $5 billion a month. By the end of November, it was clear that GM would be out of cash by year-end. And that’s exactly what happened.
Was there another way out from the financial crisis? For instance, couldn’t GM file a Chapter 11 bankruptcy and continue operating? Now-fired CEO Rick Wagoner consistently said no, asserting that customers would not buy vehicles from a bankrupt company out of fear that spare parts and warranty service would be unavailable. There’s certainly something to this, but it obscures the real reason that GM could not file Chapter 11: No bank would lend them the money to do so.
When you don’t have enough cash to pay your suppliers, they’ll generally force you to file for Chapter 11 bankruptcy. (Long-term debt holders can also force a bankruptcy, but they’re usually better served by cutting a deal to restructure the debt.) To operate in Chapter 11 bankruptcy, you usually will arrange so-called “debtor-in-possession,” or DIP financing. Your bankers will lend you money to stay in business, secured by the hard assets of the business. There was absolutely no way for GM to arrange DIP financing. They were literally staring at a Chapter 7 bankruptcy – that is, the liquidation of the business – starting sometime in January.
It’s impossible to overstate the gravity of this danger. Hundreds of thousands of people would be thrown out of work, and thousands of suppliers and dealers would face their own bankruptcies. At a time of pervasive crisis in the financial world, there wasn’t a penny of private money that could possibly be lent to GM to keep operating. There was also no time (and no financing) to line up a lightning-fast acquisition of GM by another automaker. Toyota Motor? Volkswagen AG? Those companies are in trouble, too. Because no one had any money, there was simply no way to avoid some government intervention.
Government intervention, however, is not a magic cure for the car industry’s troubles. The auto market has suffered from reduced overall demand. As recently as mid-decade, North Americans purchased nearly 17 million new cars and trucks each year. Demand in 2009 will barely reach 10 million units. We have the ability to produce far more vehicles than the market needs, and some of that overcapacity has to be eliminated. (To a small extent, you can mothball idle factories, but you have to stop paying idle workers.) Ordinarily, the free market takes care of this process in swift and brutal fashion. But in the auto business, there’s the UAW to contend with.
The whole point of a labor union is to protect the jobs, the pay, and the benefits of existing workers. (By resisting productivity improvements, they also artificially overprice labor, which has the side effect of increasing unemployment elsewhere in the economy.) In GM’s case, the union’s adamant refusal to give up anything, together with dyspeptic and incompetent management, has made it impossible for the company to adapt to changing market conditions.
That brings us up to the current crisis. GM is the weakest of the large automakers (Chrysler’s case is somewhat different). Parts of GM, such as the overseas operations, are healthy and worth keeping, but a substantial chunk of North American operations really ought to fold. A global recession, however, is no time to allow a messy liquidation of large chunks of a $200-billion company.
However, it’s delusional to suppose that GM can return to full health and profitability. It simply must become much smaller, because America is not buying the vehicles it makes. The proper role of government in this situation is to bridge the company through the process of partial liquidation.
This would have required five steps. First, making a deal to force the holders of GM’s bonds (more than $20 billion) to accept lower payments of interest and principal. Second, buying out and closing down several thousand dealers. Third, closing unneeded factories. Fourth, turning the company’s retiree benefit obligations over to the federal government. Fifth, and most critically, firing tens thousands of employees. The whole process likely would have required between $50 and $100 billion taxpayer dollars over perhaps 18 months. However unfortunate, this would have been the least-bad outcome, and a vast improvement over a rapid, forced liquidation of the company.
At this point, however, two factors come into the picture, one old and one new. The old factor is the protection extended to the UAW by Democrats in Congress, and now in the Obama administration. You can expect that the union will not be required to accept large cuts in pay, benefits, retiree healthcare and work rules. But that will not stop UAW president Ron Gettelfinger, perhaps with Barney Frank or Barack Obama at his side, from telling us, against all evidence, that the union has made deeply painful concessions, for the good of the country.
The new factor is actually quite a surprise, and a very unpleasant one: the Obama administration has decided that it wants to run General Motors in bankruptcy. From their statements so far, they appear actually to believe that they can bring a new management approach that will return GM to a robust profitability. They certainly have expressed little hope that the company’s existing management can do the job.
The right approach, as noted, would have been to bridge the company and to pressure it to downsize aggressively, with a bankruptcy judge imposing harsh concessions on the union as well as the other stakeholders. But the administration has signaled that it wants to do something completely different. They fired Rick Wagoner (for whom I shed no tears) and installed GM veteran and former chief financial officer Fritz Henderson in his place. Henderson immediately stated that he is responsible in significant measure to federal “car czar” Steven Rattner. An independent CEO, of course, is responsible primarily to his common shareholders.
At the same time, no less than President Obama announced the formation of an independent, government-financed entity that would honor the warranties of newly-purchased GM vehicles. That takes care of Wagoner’s original objection to bankruptcy.
But why is the president promising to fix our cars and trucks? Why does he think his people should be significantly contributing to the management of the largest US automaker? Surely, his job is big enough already.
The portents of the government’s new role are troubling. For one thing, government isn’t subject to market discipline. At the very least, a government-run GM will not be efficient. It will probably lose money and will certainly misallocate perfectly good capital. At a time of forced restructuring and smaller markets, nothing could be worse. Congress is intent on protecting the union from taking large cuts in pay or benefits, and the Obama people have made it very clear that they want GM to start making smaller vehicles, ideally with alternative power sources. You can’t operate a business at maximum efficiency if you make your marketing decisions in light of political goals, as opposed to what the market actually wants.
Also worrisome is the potential impact on trade. If the government props up a large failed domestic manufacturer, and preserves its overpriced labor contract, that will make the US less competitive globally, because vehicles produced abroad will be able to deliver better value for less money. Pressure will then rise to protect the domestic industry. The only way to make that work over time is to erect barriers to trade, which will impoverish the emerging world and lead to increased international tension.
But worst of all is the sense, born of hubris, that the federal government can and should undertake the task of manufacturing automobiles, or anything else. The reason the US economy has long been the world’s strongest and most flexible, is that our private sector has always made the decisions. In its attempt to change that model at GM, the Obama administration has lurched into dangerous territory.