Editorial: Bailout Watch 395: Complexity Sucks
Ever heard a movie hero say, “It sounds simple, but it just might work!”? Humans have a natural tendency to over-complicate problems and, thus, devise inherently delicate solutions. Have a look at Operation Eagle Claw, the 1980 Iranian hostage rescue attempt. Or, consider the upcoming Presidential Task Force on Autos. The PTFA will waste countless hours with Chrysler and GM auto execs, union reps, dealer council chiefs, supplier supremos, investment bankers, outside analysts and not a single average car buyer. They will devise a clever plan that will please no one and fix nothing. What a waste. In this case, all the Obama administration need do is nothing whatsoever.
Chrysler and GM are trussed-up with ropes made of Gordian knots. Their brands are a disaster, but they can’t kill brands without violating 50 states worth of franchise laws. Their debt is mountainous, but they can’t get the paper holders to swap obligations for equity. They can’t shut excess to capacity factories, but they can’t afford not to shut factories. They can’t work with United Auto Workers (UAW) work rules, but they can’t get rid of them. The need to improve their products STAT, but they can’t afford to and, even if they could, the market sucks.
The best way to sort this out: bankruptcy. But since we’re paying people to over-analyze the situation, let’s drill down.
Debt
Assuming GM can eliminate $18B of unsecured bond debt, they’ll still need at least $18B of new debt ($9.4B already advanced so far by Uncle Sam and the need for an equal amount more a certainty than not) thus netting a debt reduction of zero. Nothing to see here folks, move on.
And Chrysler? There’s zero chance of its bank lenders ($7B owed) of swapping anything. The parts are worth more than the whole and they’ll get (most of) their money back after selling off the minivan plant, Jeep, and anything else which they’ve got covered by security agreements. But Chrysler took on $4B from the government and is looking for $3B more. That’s a total of $7B—exactly the same amount as the existing bank debt. So eliminating existing bank debt and taking on IOUs to Uncle Sam places the company back where it started.
Union obligations
Bringing union wages and work rules into parity with transplants’ might be helpful in the long run, but labor costs represent under 10 percent percent of Chrysler and GM’s total running expenses. And we’re only talking about US labor—not for the rest of GM’s (crumbling) global empire. At best, a new deal with the UAW might save GM North America a billion dollars. Not enough to right a ship that’s losing $2B+ a month in cash flow. Chrysler’s rapidly shrinking workforce and increasingly undesirably product portfolio render any union cost discussion irrelevant. Period.
In terms of the automakers’ obligations to stuff their union’s health care superfund with cash, the UAW won’t go there. Unless they can get the US government (that’s you and me) to guarantee the proposed paper. If that happens, his retiree flock will realize Barack Obama’s dreams: guaranteed health care above and beyond existing Medicare/Medicaid coverage. Obama can’t be that stupid, right?
But even if he gets this guarantee, GM and Chrysler both have to still come up with billions of dollars before January 1, 2010, to fund the new VEBA anyways. And where is that money supposed to come from? Profits and positive cash flow in 2009? Not a chance.
So the take so far—assuming even these companies can hit the targets outlined by the government for the loans—is that it’s still not enough to keep these companies afloat. Existing debt swapped for new paper plus new government debt nets nothing. No savings. A zero change in the debt balances. The new VEBA still will require a cash down payment—a non-trivial amount too. And labor savings that might provide value later but are relatively meaningless in the depressed car market of 2009.
Brand, model and dealer reductions
How much will this cost without a bankruptcy? Dealers won’t go away quietly in the night. They’ve got an army of state attorney generals to protect them. And while Saturn might be a “new kind of car company” with operating agreements, not franchises, among its dealers, it won’t prevent lawsuits. GM can’t give away Saab or Hummer at any price so no easy out there. And it’s not clear that Chrysler could even kill one brand amongst its troika without inflicting a mortal wound. (Assuming it’s worth saving Chrysler.)
Conclusion
All that’s filler, of course. The only thing that needs saying, or doing: let both companies go into bankruptcy now, without crafting any governmental solution whatsoever to prevent it. Then we can see what’s worth saving and how much it will cost. Simple, eh?
More by Ken Elias
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We get it, Ken. For the umpteenth time, you like BK as the way out for GM and Chrysler. Let's set Chrysler aside for the now. It's clear now that when Hank Paulson turned his back on Lehman last autumn, he and everyone else then considered "expert" had no idea of the consequences. And now that moment is cited by pundits and economists as the inflection point at which a crisis economy tumbled off a cliff. What if Lehman had been saved? What if, indeed. So it is with General Motors. We're pulling on a thread without having any idea how long is the string. The money intended to bridge GM to a better market and revamped viability will be cheap if it works, and still cheap if it fails but delays GM's demise until after other strands of a safety net can be strung under the economy. NOW is not the time to unravel the domestic auto manufacturing sector if it is in fact headed for entropy; and further there is still an excellent chance to save it. This is far more than just a political matter, but the politics are certainly relevant and real. The benefits of destruction are abstract but as we've proven in the past, can be weathered in a stronger economic context. The consequences of catastrophic collapse are real and immediate to a massive cadre of people cutting a broad swath across, as well as up and down, the US. So for GM to clear that debt, they’d have to post profits of $1.8bn per quarter* and use every penny of that profit to clear their debt for over 6 YEARS. Clearly unattainable. Even the Swiss figured out they had to save watchmaking in response to commodity quartz. It took years but they rebuilt. The D3 are more important than market share figures or comparative advantage theory suggest. Put another way, they are not disposable without fearsome consequence. Losing them will wound the social mobility engine that drives American culture. Transplants will not expand to fully replace them, nor will any presence they retain have equal economic leverage. So, why does the debt have to be paid in six years? The investment we're making as taxpayers is for a vector of far lengthier value and trajectory. Granted, the loaning party -- us -- should impose appropriate governance on the deal. Appropriate, not punitive nor excessive. But make the loan term 15, 18, 24, 30 years. Who cares? Waive interest and principal for three years. Keep the ensuing interest rate low, too. Give the company the option of shifting to a higher market rate for the money at any point they want to be freer of strict oversight. Give them incentives to pay back early. If GM can service the loan on an extended basis, that means they've succeeded and the deal will have been cheap. In fact, I don't *want* them to repay the loan too soon. I'd rather we direct them to invest more heavily in competitive product development and building corporate reserves. Given the recent record of colossal wind-downs, we have no reason to believe BK for automakers will be beneficial creative destruction. Instead we have every reason to fear we'll find ourselves gut-shot. Phil
Phil, I appreciate your comments. Really, a bankruptcy would be a disruptive event. But it would also provide the patient with a real chance to reorganize, break the corporation of its past nasty habits of self-delusion, and mostly restructure its balance sheet, brands, models, labor contracts, and dealers in one fell swoop. The time to do it is now, not later when the market returns to SAARs of 12+MM units. The presentation today shows the desperation of this company, its inability to have addressed known issues years ago, and the requirement of $30 billion of taxpayer money on a balance sheet that won't really support it even with the givebacks/swap by the unsecured bondholders. It just makes no sense. In all reality, GM is insolvent without gov't money. It's auditors will likely issue a "going concern" opinion. What GM is trying to accomplish is an out-of-court restructuring with selected creditors - but not addressing the complete and quick restructuring really needed. Saturn is now a damaged brand - the public now knows it so what's the point of keeping it going? Also, with gov't money, GM can still play the incentive game - a game that it needs to end and only disrupts the pricing in the marketplace. Again, the treadmill of binge/purge at GM will continue indefinitely. It's time to take the company off the dole and let it fend for itself. That means a trip to court. Then, with a deep restructuring, a purging of management, and shedding big chunks of its global operation, the company can emerge as a reborn entity positioned for success. But I don't want to fund forever a company on the dole - especially when Pelosi & Co. start making ridiculous demands on green cars.