Detroit tries to fool them again

By John Gapper

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Having exhausted the search for “rich Arabs” who could prop up his company, having tired of calls for “laissez-faire for ever and other assorted bullshit” and having decided that “bankruptcy would be catastrophic”, the chief executive flew to Washington to beg.

“I think we are doing enough to help ourselves. You just watch us. You will see a lot of action at Chrysler. You will see better cars and you will see better service and better quality,” he promised.

Thus spake Lee Iacocca, chief executive of Chrysler, seeking a federal bail-out in October 1979. Sounds familiar.

Mr Iacocca’s eponymous memoir ends, after fierce tussles with critics who tried to stymie federal loan guarantees, with Chrysler put back on its feet by the US taxpayer.

Twenty-nine years later, Detroit is in trouble again. It faces falling sales, an oil shock and a liquidity crisis, with its Asian competitors selling more fuel-efficient, smaller cars. This time, all three of the Detroit companies are in line for government aid.

Rick Wagoner, chairman and chief executive of General Motors, is repeating Mr Iacocca’s pitch. The US cannot afford a Detroit failure, which would hurt suppliers and cause high unemployment and economic chaos. GM has a good recovery plan; it just has to be tided over.

Another bail-out is practically a fait accompli. Barack Obama, the US president-elect, has signalled that he favours one and is pushing George W. Bush to act quickly. Democratic congressional leaders want some cash from the $700bn bail-out fund to go to the big three, in addition to a $25bn (€20bn, £17bn) loan to make better cars.

After the financial panic that followed the collapse of Lehman Brothers, and with recession looming, there is little appetite for letting GM, Ford and Chrysler go bankrupt. One motor industry-funded study calculates it could cause 3m job losses and cost the US government $160bn.

But, before the cash starts flowing to Detroit, here are three reasons this bail-out is a bad idea.

First, it will reward failure. To read Mr Iacocca’s memoir is to realise that, while Detroit often pledges to change and periodically shows progress, one thing is unchanged in two decades. It is still overpromising and underdelivering against Japanese and South Korean rivals.

GM, Ford and Chrysler are better at talking their own book than making cars, which is a tough business. It is particularly hard when you are stuck with high structural costs, an inflated dealer network and regulations that provide you with incentives to make trucks and sports utility vehicles.

GM can point to some new cars, such as the Chevrolet Malibu, that are of high quality and that 14 of its 15 new vehicles between now and 2010 will be passenger cars or crossovers (lighter SUVs). But when Detroit says things will be different this time, why should we believe it?

Second, it will preserve chronic overcapacity. For years, the Detroit car companies have pumped up US sales to 16m or 17m units a year with financial incentives in order to keep their factories going. They made it so cheap to buy a new car that the average age of cars on the road has steadily fallen.

As a result, when recession looms, customers can stop buying cars because the ones they already have work fine. GM now expects annual US sales to fall to about 12m per year in 2009 and 2010, which amounts to financial catastrophe for Detroit.

The big three want tax breaks and subsidies to inflate US sales again, although the sustainable level is far lower than they have been pretending. “This industry needs to lose capacity. It is obsessed with vehicle renewal and accelerating the replacement cycle, which pushes up fixed costs,” says John Wormald of Autopolis, an industry consultancy.

Third, a Detroit bail-out will harm the US auto industry as a whole because it will benefit the least efficient companies, while the most efficient ones – Asian companies that build vehicles at non-unionised plants in southern states – will face subsidised competition.

We know how this story ends because we have seen it elsewhere. The UK, which struggled for decades to prop up underperforming British car companies, finally conceded defeat to US and Asian companies, only to find it gained a more stable industry that employed more people.

All any government can do is stand in the way of history for a time, and the US is becoming a repeat offender. Perhaps the immediate cost of a Detroit bankruptcy is too high but the long-term effects would be beneficial, a point Margaret Thatcher recognised in the 1980s when, as UK prime minister, she stood up against unions to enforce closures of coal mines.

Having said all of this, a Detroit bail-out is going to happen anyway, so how can the US get the most from its flawed investment?

One condition Washington should insist on is that GM takes over Chrysler and reduces Detroit’s big three to two. It is what GM, and Chrysler’s owner, Cerberus Capital Management, planned before the cash crunch struck and GM started angling for federal money instead.

The GM-Chrysler logic still holds. It might cost $10bn to close plants and dismiss half of Chrysler’s 66,000 employees but the US would get a smaller and stronger industry and Detroit’s competitors would be less crowded out by the US taxpayer. For the struggling economy, it would be painful but bearable.

Besides, Chrysler has already had one bail-out from Washington and promised to do better in future. Congress would need an awfully short memory to be fooled again.

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Comments

  • adam hartung  On November 13, 2008 at 10:19 pm

    GM’s problems are only somewhat the economy. Their biggest problem has been Lock-in to old concepts of their market, and a horribly locked in maanagement, leaving them vulnerable to market shifts that started in the 1980s and are now driving all the profit out of their old business model. Read more at http://www.thephoenixprinciple.com

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