Tuesday, December 09, 2008

The Auto Bailout - Again

The proposed bailout for the auto industry is still not a done deal. This is good. It maybe that our elected representatives have decided to take more time and not react to emotion, but instead use common sense to look at the issue (we can only hope).

Can the auto industry under its current business plan survive with $34 billion from the taxpayers? I say categorically no! The basis for this is to look at the past ten years. What has been the trend in auto sales, jobs and profits during this period of time? The root cause of the auto industry demise is its business plan. The unions have negotiated very good benefits and wages for is members. The Auto Companies instead of accruing the cost for these good benefits each year they were earned decided to pay future liabilities out of future company revenues. By doing this, they made the earlier years look better than what they actually were.

For example if the contract calls for paying 95% of a worker’s wage for one year for each laid off worker, then the company needs to plan for this circumstance. What would the cost be to a company if 100% of the work force were laid off? This is an extreme case, but it now looks like it could very well be a reality. The sum total of workers at GM if they number 1000,000 workers making $50,000 a year would require $5 billion just to pay this contractural contingency. Did they set these funds aside, no? Did the auto industry routinely set aside the cost of healthcare and pensions, as they came due, no? Did they make up delayed payments when missed, no? Had they, they would not be in this mess.

In simple terms their business model for running a car company does not work. The only way business model that will work competing with other car companies for market share is to build a car with equal or better quality, selling at the same price or cheaper and making a profit. From what I have read and heard, the Big three Auto Companies healthcare costs, benefits and wages are so high, that they cannot cover these costs with the cars they sell. This means their business models will not work and any taxpayer funding of their current business model is a waste of money and a very bad deal for taxpayers. No matter how many other industries are affected, a bad business plan only deceives the taxpayer, consumes valuable capital and over the long run is worse for the country.

The best thing that can happen is for the unions to renegotiate contracts, which make a long-term business plan successful. First off, the unions do not have time to renegotiate these contracts before the company’s burn through their cash. Second, retirees are unlikely to renegotiate their benefits. Since neither of these two conditions can be met voluntarily, the only way for them to be met is for the companies to file chapter 11. This will void all contracts and create a clean slate from which companies to negotiate, keeping in mind the market price of cars, the quality premium if any for their product and the material cost. Labor costs have a ceiling above which the company cannot survive.

Inevitably, these auto companies will eventually file chapter 11. The sooner they do so; the sooner workers will have more secure jobs.

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