I’ve been predicting a General Motors bankruptcy since 2005. (Actually longer than that, but that was the earliest point at which I mentioned it on this blog space.)
The reasons go far beyond the global economic crisis, or any current or impending recession. Take away those factors and you are still left with a devastating set of facts:
- GM–now 100 years old–is an Old Economy corporation with an Old Economy cost structure. Without a radical reorganization–which almost never happens without a bankruptcy–GM will be stuck with that Old Economy cost structure for at least another generation.
- GM’s competitors are New Economy corporations with New Economy cost structure.
- GM management still operates with an Old Economy mindset.
What do I mean by Old Economy cost structure? I’m talking pensions and retiree health care costs. Pensions are financial obligations to employees that GM must fulfill, even after those employees are no longer with the company.
The competition, on the other hand, uses New Economy retirement packages–401(k) plans–the obligation to which ends when the employee separates from the company. 401(k) plans came to fruition with the Employee Retirement Income Security Act of 1974. With ERISA, companies began shifting to defined contribution plans, as opposed to pensions which are defined benefit plans.
There are a number of reasons why GM could not switch their pensions to 401(k) plans:
- The UAW would have gone for the jugular, and probably would have won. They had far more strength in 1974 than they have today.
- Switching current employees–especially those who had substantial degree of vestment with the company–from pensions to 401(k) plans would have required a large amount of capital.
- GM management was not known for financial creativity or the willingness to take risks and make bold proposals. In fact, their culture–and sheer size–discouraged managerial innovation and rewarded the “play it safe” mentality.
- Even if GM had switched their current employees to 401(k)s, they still would have had their retirees to cover. Switching them would not have been a realistic possibility.
- Defined contribution plans–in the 1970s–were not as thought-out a concept as they are in 2008.
Fast-forward to 2008: the economy is arguably heading into Great Depression II. Even President-elect Barack Obama has had the mother of all “Holy [expletive]!” moments, as his tone has changed remarkably.
(Some of that is politicking, as Obama is trying to reduce expectations. Still, much of that is a case of him coming face-to-face with the reality that the economy is far worse than he ever imagined, and Bernanke and Paulson–who have been successful in their careers because they do not panic easiily–have clearly panicked.)
Now, the entire auto industry–with the probable support of Obama–is seeking a bailout on par with the recent bailout of the banking industry.
The case for the bailout bears some mention, for several reasons:
- Unless handled properly, any bankruptcy filings by GM, Ford, or Chrysler would overwhelm the Pension Benefit Guaranty Corporation.
- Even if the PBGC picked up the pensions, the retirees would only get a fraction of what they are getting now. Many of them would be wiped out en masse. Cities–such as Anderson, Indiana–that depend on GM retirees would be crushed.
- Any Big Three bankruptcies would cascade into other companies–components manufacturers and raw materials corporations.
- No President, Congressman, or Senator wants to have the burden of dealing with an election season–the next of which is 2010–having to explain to voters why the largest industrial bankruptcy in world history happened on his watch.
- Much–but not all–of the current crisis in the automotive industry is the playing out of consequences of government policies that extend back to the 1930s and 1940s.
Wage and price controls–implemented during World War II–prevented employers from offering higher salaries to compete for qualified workers. To find a way to compete, employers began offering health insurance and pension benefits in lieu of higher salaries.
Labor unions–strengthened by government policies during the Great Depression–began including health insurance and pension benefits in their negotiations with management. At the time, companies were more than happy to deal with health and pension matters equitably for several reasons: (a) life expectancies were lower, and therefore the actuarial impact of pensions and retiree health care was a not large one; (b) there were many ways corporations could get out of–or reduce–their pension obligations; (c) health insurance was largely inexpensive at the time; (d) there was little or no foreign competition in the auto industry.
The United States emerged from World War II as the one of the only countries in Western Civilization with an industrial infrastructure unscathed by war. We were literally the only game in town, and GM was the biggest fish in the ocean. What was good for GM was good for America.
Today, the competitive landscape has become an order of magnitude more saturated. Toyota, Honda, Nissan, Hyundai, Volkswagen, Kia have all eroded the market shares of our Big Three. Even in Europe–where GM once was quite formidible–GM is losing a grip on its market share. This in spite of a falling dollar that would otherwise make American cars a good buy for Europeans.
Complicating matters, GM is restrained in its ability to innovate because–due to legacy costs–they must produce vehicles that can provide enough margin to cover those legacy costs. GM employee and retiree health care costs run close to $1,500 per vehicle sold.
That means they cannot produce a low-cost economy car that sells for $10,000, as they will incur a 15% tax for uncontrollable expenses that they will have to pay for the next 40 years. This is why they are relying on larger vehicles–Cadillac, Hummer, their many lines of trucks and SUVs–to bring in the money.
Now, we are left with two secnarios: a government bailout of the auto industry, or one or more bankruptcies of our major industrial giants.
Some pundits–and economists–will insist that a bailout is necessary, as a GM bankruptcy would be an economic WMD that would gravely impact our country.
I am not convinced of this, and Part 2 will be my reason, including an alternate possibility.