American carmakers on the edge - ECO

IF NOTHING else, the revelation by General Motors (GM) on November 7th that it is in danger of running out of cash before the end of the year has concentrated minds. The reaction within the embattled car industry, and in Washington, DC, has been the same: we knew it was bad, but we did not know it was that bad. Ford is in a similar position, although its cash should hold out for a few months longer. As for Chrysler, the smallest and weakest of Detroit’s Big Three, the precise state of its finances are harder to gauge because it is privately held. But the increasingly desperate attempts by Cerberus Capital Management, the private-equity firm that owns 80% of Chrysler, to offload some or all of it to another carmaker (GM said on November 7th that it had walked away from such a deal) suggest that its future as an independent entity is all but over. What will happen next? The shareholders have been more or less wiped out, the credit markets are closed and neither GM nor Ford has any non-core assets that anyone wants to buy, with the possible exception of Ford’s 33% stake in Mazda, a profitable Japanese carmaker. The North American car market should come back strongly in 2010 or 2011, but for all practical purposes, that is light-years away: North American sales are running at their lowest levels since the early 1980s, when the population was 50m smaller. There are just two broad options: either the federal government steps in to save Ford and GM (Chrysler is probably unsalvageable) or America’s two biggest car firms must seek Chapter 11 bankruptcy protection. In many ways, Chapter 11 was designed for just such a contingency. For all their present agonies, both Ford and GM have good long-term prospects. They have relatively healthy businesses in Europe and have been doing well in emerging markets, such as China, where there is vast potential. They are also nearing the final stage of a lengthy and painful restructuring of their North American operations. Two million units of capacity have been stripped out; factories are being converted to produce more fuel-efficient cars; and a landmark deal with the United Auto Workers union in 2007 paved the way to cutting $1,000 of costs on every car they make from next year. “The river they are swimming across has been getting wider and deeper, but the pot of gold on the other side has been getting bigger as well,” says David Cole of the Center for Automotive Research. However, there is considerable scepticism both within the industry and among analysts as to whether Chapter 11 is a way forward for GM and Ford (though it may, some concede, be more appropriate for Chrysler). Mr Cole says that “it would kill them in the market”. The fear is that rather than give the firms a breathing space in which they could complete the restructuring of their operations and extract further concessions from the union, Chapter 11 would set off a downward spiral. Consumer surveys that suggest that 80-90% of prospective customers would abandon the products of a carmaker that had filed for bankruptcy protection. When airlines went into Chapter 11, most of their passengers stuck with them, reasoning they would be at least be in business long enough for tickets bought for trips just a few weeks away to be honoured. Cars are different. A car is the most expensive purchase many consumers make, and by buying a car they also enter into a long-term contract. Buyers expect their 60,000-mile warranties to be honoured, parts to be kept supplied and their dealers not to have disappeared. Used-car values are also a critical part of the deal. If the firm that made the car has gone bust, it becomes virtually unsellable secondhand. A further reason why Chapter 11 might not work for the carmakers, says Mark Oline, an analyst at Fitch Ratings, is that they have very little scope for further cost-cutting. “They’re not being crushed by wage and benefit costs—it’s about revenue and products now,” he says. Bankruptcy would do nothing to speed up the introduction of vital new models. Those arguments may have weighed heavily with both Barack Obama, the president-elect, and the Democrats in Congress, who are moving towards sanctioning a bail-out package. They have gained added force from estimates of the economic fallout that could follow bankruptcy. Rod Lache, an analyst at Deutsche Bank, believes it would imperil many of the component-makers in North America, which in turn would hit the foreign-owned “transplant” factories that make up the rest of America’s car industry. Mr Cole’s firm has modelled a scenario in which Detroit’s production falls by 50%. He estimates that in the first year that would cost 2.5m jobs: 240,000 from the carmakers themselves; 795,000 from suppliers and 1.4m from other firms indirectly affected. The cost in transfer payments and lost taxes would exceed $100 billion over three years. Some of Mr Cole’s assumptions are likely to be too pessimistic, but his blood-curdling forecast and others like it have helped to convince legislators that the $50 billion of help that the carmakers are asking for would be cheap at the price. How and when the rescue funds will arrive is less certain. Nancy Pelosi, the House speaker, has called for a bill giving the carmakers access to the $700 billion Troubled Asset Relief Programme (TARP) established to shore up failing banks. But Hank Paulson, the treasury secretary, said on November 12th that this was not what the TARP had been intended for. Some are calling for a repeat of the scheme used to bail out Chrysler in 1979. On that occasion, in exchange for a loan of $1.5 billion, the government received warrants that it eventually sold for a profit. A “lame duck” session of Congress could be convened as early as next week to pass the necessary legislation. President Bush might still veto it, but is less likely to do so if Mr Obama backs the plan. His recent victory is at least one piece of luck to have come the carmakers’ way.