Detroit Doesn't Get It, But Will

Detroit Just Doesn’t Get It, But Will


Two weeks ago the Big Three appeared before Congress, pleading for a bridge loan of $25 billion. The Detroit execs and UAW leaders expected pro forma approval of the loans by a friendly, Democratic Congress.

After all, the victorious Democrats owe much of their success to Big Labor, and the UAW was historically the greatest of the unions. The governors of six states, Michigan, Ohio, Delaware, Kentucky, New York, and South Dakota, sent a letter to Federal Reserve Chair Ben Bernancke and Treasury Secretary Paulson, seeking immediate assistance for the auto industry. Congress had just enacted a $750 billion bailout bill, which included funding of a $25 billion loan to the auto makers to retrofit their assembly plants for fuel efficient vehicles. Under the circumstances, an additional $25-50 billion would seemingly not pose a problem.

Yet, the original bailout bill was politically unpopular, with the backlash leading to the defeat of some Republicans in the November election. It also became clear that a bridge loan would not save Detroit. Detroit wanted a $25 billion bridge to nowhere, right up there with Senator Ted Stevens’ infamous Bridge to Nowhere.

The Big Three is the industrial equivalent of Dead Men Walking. Americans were not buying their vehicles, and the companies lacked financial reserves to ride out the perfect storm: high gas prices and a severe credit crunch. Consumers who do not purchase Detroit products do not favor bailing out the industry.

Thus, the Congressional hearings became a veritable turkey shoot with the Detroit execs providing target practice. The media immediately criticized their performance in running an industry totally out of touch with the market, failing to note the irony that the media is similarly unable to adapt to changing market conditions.

That the execs flew to Washington in private jets gave rise to a chorus of jeers, ignoring the practical reality that for security purposes, business no longer wants its leaders traveling on common carriers.

Congress sternly told Detroit to come back on December 2 with revised plans to reflect the new market conditions.

Detroit will return tomorrow with proper obsequiousness, and Congress will attempt to give Detroit what it needs, or so it will seem, for both President Bush, most of the Republican legislators, and Democrats representing districts and states with imported car manufacturers are opposed to a new bailout. Detroit may have to wait until January 20, 2009 for Congrssional salvation, but enacted it will be.

They will come in vehicle caravans, with execs, union workers, and retirees in solidarity to plea their cases to a compassionate Congress.

GM will sell a few corporate jets, divest itself of Suzuki, and phase out all or part of Pontiac, Saab, Hummer, and Saturn. Ford has already left Aston-Martin, Jaguar, Mazda, and Rover in the rear view mirror, and will divest itself of Volvo. Chrysler will be on a respirator. The UAW will sacrifice what’s left of the Jobs Bank. The companies will impose limits on executive salaries and dividends.

All of which is either symbolic or meaningless unless the public starts buying millions of Detroit vehicles in the near term – not a likely prospect.

Detroit as we know it is dead; it’s had a wonderful, century long run. Most businesses and industries do not last that long. For example, the Route 128 mini-computer industry in Massachusetts barely lasted a decade. Names like DEC, DG, Prime, and Wang rose like a meteor, and collapsed even quicker. Whatever happened in the PC market to Atari, Commodore, Northstar, Osborne, Packard Bell, VisiCalc, or even IBM? Only GE is left from the original Dow Jones index of 12 stocks.

Many are dumping on Detroit for the failure to adjust to a changing market. The reality is that only a year ago Toyota was having difficulty selling the Prius. Dealers were discounting it. Consumer preferences can change on a dime but industrial production lacks that flexibility. GM was selling 1 million SUV’s only a few years ago at a gross profit of $10,000-15,000 per vehicle. That sounds like satisfying the market.

The unspoken truth is that the fate of the UAW and its medical plan are at risk. The union and companies recognized a few years ago that the status quo was no longer viable. Pensions, medical plans, and the job bank could not be sustained by an ever shrinking sale of new vehicles. Thus, the auto makers spent billions buying out existing workers while the UAW agreed to a two tier wage system for new workers.

They had plans to adjust. The sudden balloon in gas prices, followed by the credit crunch today, changed everything. Detroit simply ran out of time.

Just as significantly, the UAW and the Big Three entered into an agreement, effective in 2010, in which the union will assume in a trust fund the medical coverage of the UAW retirees. The Union recognized that while some federal protection exists for pension rights, none exist for medical benefits, especially if the employer enters bankruptcy. The Big Three was on course to fully fund the Voluntary Employee Beneficiary Association when the market collapsed. Thus, the VEBA is currently underfunded and cannot be implemented without additional employer contributions.

The Big Three are due to contribute an additional $12.5 billion to $18.1 billion to the fund, with GM alone owing $7 billion. The companies don’t have the money.

However, the proposed $25 billion bailout includes $10-12 billion for GM, $7-8 billion for Ford, and $7 billion for Chrysler. No one from Detroit, the UAW, or even Congress was going to state the obvious two weeks ago. The bailout funds are destined for VEBA, and that is why it will pass.

In addition, no one, especially in the Democratic Party, wants to put Detroit, the city, the industry, and the state (Michigan), out of business. They have been bleeding to death for four decades, but pulling the plug is not a viable political option.

A bankruptcy of GM or Ford will enter unchartered waters. Any bankruptcy will be on a scale never contemplated before - not even Enron’s.

The fear is that consumers will not buy an “orphan” car, although they have flown bankrupt airlines. Considering the poor reputation in quality, price, style, and fuel efficiency of Detroit branded cars, the fears may not be exaggerated.

An investment of equity funds in Detroit will be as ineffective and money draining as the British investment in British Leyland Motors. Nothing short of $.89 gas and easy credit can revive Detroit.

An argument can be made that all three do not deserve a bailout. Chrysler has already been saved once by federal funds in 1979 with Lee Iacocca leading Chrysler to success with the K-cars and the Minivan. Today’s CEO, Robert Nardelli, was passed over at GE and then led Home Depot for 6 years until he was forced out, albeit with a golden parachute of $210 million. He is a consummate bean cutter, who purportedly has cut all product planning past the next two years. Regardless of its past, Chrysler has no future under these circumstances. By way of contrast, Ford is replacing 60% of its fleet over the next two years and is best positioned for survival.

GM has sold an amazing variety of assets over the years to raise capital, including 51% of GMAC to Cerberus – a hedge fund which also acquired 80.1% of Chrysler from Mercedes last year.

GMAC was established as a means to provide financing to GM purchasers. Just when it is most needed, GM can no longer turn to GMAC for sales assistance. GMAC had diversified into sub- prime mortgages and incurred a $2.5 billion loss last quarter. GMAC sadly can no longer borrow funds to finance GM sales (DiTech should be a four letter word in Detroit).

The bleeding will continue in Detroit. Congress should simply fund VEBA and leave Detroit to the market.