Stock Market Leads the Way

As I write this the stock market is up nearly 200 points, and it has risen in each of the last three months.  Commodity prices are rising based on encouraging manufacturing data from abroad.  Personal incomes rose 0.5% in April.  Chrysler could exit bankruptcy as soon as Monday.  Citigroup and GM are removed from the Dow Jones Industrial Average, replaced by powerhouse Cisco and Travelers.  Ford motor’s shares rose 4.9% on news that it plans to expand production in the third quarter to try to gain market share from its rivals, and without government money.

The Stimulus Flop

Less than 10% of the $780 billion stimulus package has been spent.  President Obama told us we desperately needed or we may be mired in this recession/depression for years .  The free marketers said that this economy is strong enough to recover on its own, which the statists sneered at.  Government created this mess by their meddling in the housing market and how they mishandled interest rates and the money supply but we were told that “only government” can get us out of it.  More recently President Obama, who has been trying to spend every dime Congress will let him get his hands on has said we are out of money. Here’s a thought:  repeal the rest of the stimulus and get out of the way of the strongest economy on earth.

Things to Ponder

• Obama opposed bankruptcy for GM and Chrysler.  Free marketers said it should be allowed to happen.  That’s how the free market works.  After pouring billions of taxpayer dollars into these two, where are we?  Both are in bankruptcy.
• Bankruptcy for GM and Chrysler would be an extraordinarily long and drawn out process costing millions of jobs and killing the auto industry in the U.S.  Where are we?  Chrysler may emerge from bankruptcy as early as Monday, Ford is ramping up for the third quarter.
• Without the stimulus package, we were told the unemployment rate could hit 9% by 2Q2010, whereas with the stimulus it will peak at 8% at the 3Q2009.  Where are we?  It is now at 8.6% and we are in 2Q2009.  The stimulus passed, little has been spent and the administration has been wrong again.  The free marketers say that unemployment will likely rise quickly and if left alone, the recovery will happen more quickly.  If the government meddles and tinkers, we will likely see what happened in the 1930s where this drags on for years.
• President Obama says we’re out of money.  So stop spending.  Repeal the stimulus that is accomplishing nothing because the bulk of the spending isn’t due to happen for another year or more.
• Watching the Information Technology job boards, I see a big rise in the job postings for sales people.  When companies are confident that the economy is turning, they step on the gas for sales to beat the competition.  The operational folks will soon follow.

If the Obama administration is not careful and doesn’t reverse course before he bankrupts us, we may be faced with accelerating inflation and sky high interest rates.  Shall we get nostalgic for the days of Jimmy Carter?

Our once proud automobile industry

The government institutes regulations such as CAFE that force the automobile companies to build many cars they can’t sell at a profit for each car they can.  The unions negotiate contracts that pay people who have been let go 90% of their salary and give retirees extremely generous packages.  The automobile companies stagger under this load to the brink of bankruptcy and what happens?  The CEO of GM gets booted out and the government and the unions end up owning the car companies.  In the case of Chrysler the UAW will end up owning 55% of the company if the government’s plan is approved.

Had the automobile companies gone into bankruptcy before the bailout, as this author advocated, the union contracts could have been voided and a new workable deal struck.  But the government said bankruptcy was bad. The government said we had to give the car companies billions of our tax dollars.  The government said, if you automobiles companies don’t accept our deal, you will be forced into bankruptcy.  Huh?

So tell us again, Mr. Obama, how this is not socialism.

The battle lines are being drawn and the factions are jockeying for position.

• The UAW is standing firm that they are not contributing anything more (but the taxpayers should)
• Rick Wagoner, CEO of GM, says they are not even planning for bankruptcy (but recently news has come out that the board is now considering it, if they can’t get the taxpayers to step up)
• Congress wants a plan from the automakers before showing the money (they want to make sure that the auto companies adopt a green agenda and build a lot more cars that they can’t sell at a profit, and palm it off on the taxpayers)
• Some pundits are claiming that 3 million jobs will be lost if we don’t bail them out (but fail to finish the thought and tell us who is going to build the cars that the market demands but GM, Ford, and Chrysler won’t be building if they completely shut down as some predict)

The louder the hue and cry against bankruptcy and the need to empty my wallet, the more confident I feel that bankruptcy is the right thing to do.  Without fundamental management change, union change, and structural change, no amount of taxpayer funding and bailout upon bailout, will enable the Big Three to crawl off their death bed and once again be giants of American Industry.  Bankruptcy is bitter medicine, but without wrenching change that bankruptcy protection can provide, with a trustee making hard decisions and getting concessions from all sides, this patient on life support will die.

A Sad but True Parody

I came across this excellent joke on Evolving Excellence that was making the rounds a few years ago, but seems sadly relevant today.  As I said it is a few years old, so don’t look too closely at the financials:

A Modern Parable.

A Japanese company ( Toyota ) and an American company (Ford Motors) decided to have a canoe race on the Missouri River Both teams practiced long and hard to reach their peak performance before the race.

On the big day, the Japanese won by a mile.

The Americans, very discouraged and depressed, decided to investigate the reason for the crushing defeat. A management team made up of senior management was formed to investigate and recommend appropriate action.

Their conclusion was the Japanese had 8 people rowing and 1 person steering, while the American team had 7 people steering and 2 people rowing.

Feeling a deeper study was in order; American management hired a consulting company and paid them a large amount of money for a second opinion.

They advised, of course, that too many people were steering the boat, while not enough people were rowing.

Not sure of how to utilize that information, but wanting to prevent another loss to the Japanese, the rowing team’s management structure was totally reorganized to 4 steering supervisors, 2 area steering superintendents and 1 assistant superintendent steering manager.

They also implemented a new performance system that would give the 2 people rowing the boat greater incentive to work harder. It was called the ‘Rowing Team Quality First Program,’ with meetings, dinners and free pens for the rowers. There was discussion of getting new paddles, canoes and other equipment, extra vacation days for practices and bonuses. The pension program was trimmed to ‘equal the competition’ and some of the resultant savings were channeled into morale boosting programs and teamwork posters.

The next year the Japanese won by two miles.

Humiliated, the American management laid-off one rower, halted development of a new canoe, sold all the paddles, and canceled all capital investments for new equipment. The money saved was distributed to the Senior Executives as bonuses.

The next year, try as he might, the lone designated rower was unable to even finish the race (having no paddles,) so he was laid off for unacceptable performance, all canoe equipment was sold and the next year’s racing team was out-sourced to India.

Sadly, the End.

Here’s something else to think about: Ford has spent the last thirty years moving all its factories out of the US , claiming they can’t make money paying American wages. TOYOTA has spent the last thirty years building more than a dozen plants inside the US. The last quarter’s results:

TOYOTA makes 4 billion in profits while Ford racked up 9 billion in losses.

Ford folks are still scratching their heads, and collecting bonuses…

IF THIS WEREN’T SO TRUE IT MIGHT BE FUNNY

It will be interesting to see when the auto executives go back to Washington, will they fly in three separate corporate jets? will they “jetpool”? will they fly first class?  will they fly coach? or will they drive one of their excellent products to ask for a bailout?  How much trunk space do you need to carry $25 billion?  Remember that’s 25,000 million.

A Modest Proposal

About every three years when the labor contracts between the unions and the auto companies come up for renewal, a target company, Ford, GM or Chrysler is typically chosen.  The purpose is to threaten a strike on that company while allowing UAW members to keep working at the other two (and still pay union dues), rather than striking against all three.

Here’s my proposal.  Since GM seems to be in the worst shape, they should go Chapter 11 right away.  Let Ford and Chrysler stand back and watch the result.  If it works and GM successfully restructures, you can bet Ford and Chrysler will be scrambling to go Chapter 11 to get their houses in order.  If it is a bust, then one of three things can happen.  One, they can learn what GM did wrong in the process and perhaps craft a better and maybe even “prepackaged” Chapter 11 filing.  Two, they can go back to Washington and try again, but at least they would have a stronger case for why bankruptcy is a bad idea.  Three, they can wake up and get all the parties together including management, unions, retirees, suppliers, banks, bondholders, local governments, Congress and make the changes voluntarily that would otherwise be made under a bankruptcy.

What do you think?

He looked nervous.  He curled up the corners of his two hole cards, aces.  He eased them back down on the table and scanned the other players.  Nancy Pelosi had a stack of chips totaling $25 billion and he wanted all of them.  No, he needed all of them.  Desperately.  The other three, all Japanese, sat expressionless behind their dark glasses.  At every hand all they said was “Call”.   No raise.  No drama.  Very cool.  Very dangerous.

He looks again at the four cards on the table.  Nothing to help him there.  He needs another ace. He needs the ace he calls the Volt. Pelosi turns to him. “So, what’s your plan?”  He swallows hard, trying hard not to show it and says, “All in,” and pushes his remaining chips into the center of the table.  The dealer burns another card and then peels off the “river.” And we’ll be right back for the final outcome of tonight’s game.

GM on the Precipice

That must be how Rick Wagoner feels.  It seems he’s betting everything on the Chevy Volt. If he draws that ace, he’s a hero.  If not, he’s history.  So what are his chances?

If that’s all he’s got, they’re pretty long odds.  The Volt is not due to hit the showroom floor until 2010, and at a whopping $40,000 per copy.  Not a bad price for a Cadillac, but for an untested electric car with a 40 mile range?  That’s a tough sell.  Even at that, the $40,000 might not be profitable, just break even.  But, there will be a tax credit of $7,500 to help take the sting out of it.

Without Bankruptcy

Without a major revamping of their cost structure that can probably only be achieved through the bankruptcy courts, GM is still carrying $2,000 per vehicle in labor costs that its competition doesn’t have.  And what about those three players to his right in the dark glasses, do you think they are standing pat?  Although very low key, it is reported that Toyota, Nissan and Mitsubishi are all planning to introduce electric cars in the same time frame.  If they do that and they also have the $2,000 per vehicle edge, it will be very bad for GM and any bailout will go down the drain.

The other factor is the way the Japanese do strategic planning.  They typically do not look to just the next quarter.  They are known for developing 50 and 100 year plans.  That is not a typo.  So if they introduce a vehicle they will do it for the long haul.  Believe it or not the Toyota Prius has been on the market for seven years already.  The Japanese are not afraid to introduce a pretty good model and then continuously improve it and if they believe the direction is right, they are willing to wait for the results.  The Big Three, on the other hand tend to have a shorter planning horizon.  Witness Ford’s announcement that it intended to build 250,000 hybrids and then did a market survey when gasoline was about $2.30 per gallon, and decided that they should not go forward.  When gas prices took off they were caught flatfooted while Toyota was selling Priuses at a premium and they couldn’t make them fast enough.

New Administration, New Congress, New Energy Policy

Then there is the energy issue.  Putting more and more electric cars on the road is a good idea and a way toward energy independence.  However, the new administration and the incoming Democratic Congress want to kill the coal industry.  Coal currently generates 49% of our country’s electricity and when it comes to coal reserves, the U.S. is to coal what Saudi Arabia is to oil.  But the new incoming chairman of the House Energy committee, Henry Waxman of Beverly Hills, California, is more determined than ever to implement a green agenda and kill coal.

So what do you replace the coal with?  Oil? Gas? Nuclear?  On the campaign trail, I heard Barack Obama and Joe Biden mumble some things about nuclear being okay, but it was hardly a ringing endorsement.  Do they think for a minute that wind or solar are anywhere near replacing coal?  So, they actually plan to reduce our electric generating capacity by 49% and then not only replace it but grow it to be able to handle all these electric cars.  Where’s that plan?

If you don’t have enough electricity, you can’t charge up your electric cars.  If good old supply and demand does its usual thing, the price of electricity should skyrocket and I can tell you first hand that in New York, it’s not cheap right now.  If electricity skyrockets, whatever manufacturing is left in New York and other rust belt areas will be pulling up stakes left and right and heading south.  If that population follows the jobs, does that mean more votes for the red states and a shift in Congressional seats as well?

The Democrats better re-think that plan if they want to stay in power.

It’s not over yet folks, although your voice is being heard.  The big sticking point seems to be whether the bailout money should be taken out of our left pocket ($700 billion TARP bailout package) or our right pocket ($25 billion fund to provide re-tooling for green production).  The only people talking about going Chapter 11 are people on the right such as Mitt Romney, who actually knows something about it having watched his father, George Romney, try to save American Motors, as CEO.

Politics Trumps Problem Solving

Barney Frank has weighed in to make sure the class warfare card is played.  He compared the bailout of AIG with the bailout of the auto companies as White Collar (AIG) vs. Blue Collar (GM). A blog by dbeale points this out very well.  This begs the question:  where does it all end?  Where do you draw the line?  If you bail out AIG, you have to bail out GM because they have blue collar workers.  If you bail out GM you have to bail out (fill in the company name) because they have (fill in special interest group).

But if you read the post carefully you can see the true political objectives of the Democrats and their supporters:

1. Give the auto companies a bailout
2. Fire most of senior management for mismanagement
3. Threaten bankruptcy but don’t do it
4. If the auto companies don’t reinvent themselves (which they can’t do without bankruptcy), nationalize them.  Don’t call it nationalization, call it a “quasi government takeover”
5. Make sure the focus is on building high mileage cars, and whatever else the green program demands.  Anyone who gets in the way of that goal should be fired. To quote dbeale, “every one involved in undermining gas efficiency standards must go.”
6. Appoint a automobile czar (don’t call it nationalization) to oversee the companies to make sure that the management isn’t paid too much, that union contracts are reinforced, the “right” kind of cars are built.
7. Bailout with more government money every 3 years, because the root cause the problem is never addressed.

A Workable Solution

The root of the problem is that the auto companies as they are today, are not competitive.  Here is my proposal

1. Eliminate the CAFE standards.  The CAFE standards were introduced 1975 in response to the energy crisis.  At least that was the stated objective.  The real objective was to curtail the importation of foreign cars, particularly Japanese cars, which could already meet the standards.  If you wanted to buy a car that got good gas mileage, you could.  This was a attempt by government to force U.S. car companies to make cars of similar economy.  However, their cost structure would not allow them to compete with the imports at the low end of the market.  G.M., Ford, and Chrysler don’t seem to have a problem making a profit on the luxury end of the market, on SUVs, and light trucks.  But if, for example the standard is 27 MPG, and your Cadillac only got 20 MPG.  You would have to sell eight compact cars that get 28 MPG for each Cadillac to comply with the standard.  However, it is estimated that GM is at a cost disadvantage of $2000 per vehicle.  At the luxury end there is enough margin to cover that.  At the low end there isn’t.  So, GM as a direct result of government policy has to sell eight cars at a loss to allow them to sell one car at a profit.  Why not let them sell as many cars at a profit as they can, sell no cars at a loss and let the market decide?  If need a high mileage car to save on gas for your long commute, buy a foreign car.
2. File bankruptcy.  Reorganize and get rid of those things that are killing you.  That’s what the bankruptcy laws are for.  Yes, shareholders may get wiped out, union contracts will have to be renegotiated, commitments to continue paying revenue bonds for plants that are no longer needed can be renegotiated or voided, pension commitments revisited, etc.
3. Slim down, come out of bankruptcy, and get competitive again.  The Big three made about 17 million vehicles in 2007.  Does any rational person believe that if the Big Three go into bankruptcy that the people and companies that bought that many vehicles will no longer need cars?  If they still need cars, someone has to build them.  That can either be the foreign makes, the slimmed down Lean Three, or new companies that are formed to take advantage of this huge demand for 17 million vehicles that no one, or not enough are stepping up to the plate to meet it.  People will be re-hired, sub-contractors will have new subcontracts, and the auto industry can actually thrive and not just limp along from bailout to bailout.

The key to this working is to get government out of the mix.  We are facing a plethora of problems and most of them can be traced to government intervention in the market place.  The financial crisis is a direct result of government programs such as Fannie Mae, Freddie Mac, the Community Reinvestment Act, the strong arm tactics of the Clinton Justice Department and HUD to demand more sub-prime lending, and the resistance of Barney Frank and Chris Dodd for more oversight.

The tragedy is that we have problems created by the government and we think that more government is going to fix them.  Keep up the fight.  Let your representatives and senators know, NO BAILOUT

It’s hard to read the news about the auto industry and not clench your fists at the outrage.  GM and to a lesser extent, Ford and Chrysler, are asking the American taxpayer to bail them out, but what is their position?

• The unions say they are not going to negotiate anything to help the situation
• The CEO of GM says that they are not filing for Chapter 11 and not preparing to file, despite that they may run out of cash by the end of December.  Not even as a contingency, Mr. Wagoner?
• Wagoner refused to consider resigning, even if it would help them get aid
• GM’s board is supportive of Wagoner

This company negotiated an agreement with its union that pays them almost full pay if they are laid off.  Let me get this straight.  You lay people off, as painful as that may be, to cut costs.  GM negotiates an agreement that keeps the costs, but sends the people away.  From their perspective, it’s free labor, they pay for it either way so put them to work!  But no, I’m sure there are union restrictions about what you can put them to work doing.

Remember the Dot.com Bubble?

In 2000 we saw the Dot.com bubble.  What was the fallout?  Millions were lost on Wall Street.  Companies by the bushel basket went out of business.  Thousands were thrown out of work.  How much did taxpayers cough up to bail them out?  Nothing.  The market dealt with it.  The strong companies re-grouped, the weak fell by the wayside.  John Chambers, CEO of Cisco Systems, changed his own salary to $1 per year until he righted his ship.  Today Cisco has $26 billion in the bank and Chambers is still at the helm.  Nice work, John.  It wasn’t done with arrogance and going hat in hand to Washington looking for a hand out.

Deja Vu

In the 1970s and 1980s in the UK, British Leyland, maker of the Triumph, MG, Rover, Jaguar, Austin and five others, was in need of a bailout to keep going.  The British government complied eventually pumping in $16.5 billion in taxpayer money to the company.  It limped along for another few years and then went out of business.  It sold its Jaguar and Land Rover brands to Ford, which then poured $10 billion into Jaguar.  It recently sold both brands to Tata of India, getting back about half of what it paid for the brands.

Did the British economy go under?  Is the British military without tanks?  Let’s not forget that the Jeep was made by American Motors.  Where is American Motors today?  A company named AM General makes the military Hummer.  Guess what the “AM” stands for?  GM, Ford and Chrysler combined made about 17 million vehicles in 2007.  Does anyone think this demand will vanish if GM, Ford and Chrysler vanish?  Of course not.  Either GM, Ford, and Chrysler will re-make themselves, new companies will emerge, or U.S. based foreign companies will grow to take up the slack.  The jobs will move around.  The demand is there, the supply will emerge to satisfy it.

The Way Out

The way out of this mess is to go Chapter 11, reorganize, renegotiate onerous labor contracts, sell off properties no longer needed but tied up in commitments to bonds that were sold to attract a factory, etc.  The government should do their part and dump the CAFE standards.  Americans will still want high mileage cars and companies will build them.  It may not be GM, Ford and Chrysler who build them, but if they trim down, maybe they will.  But they do make a profit on their premium models and light trucks.  Let them.

But keep your hand out of my wallet.

I was having lunch with a colleague the other day and the conversation turned to the economy. He spoke of some recent analysis of the number of jobs that would be lost if the Big Three failed.  He recounted not just the employees of the auto companies themselves, but the employees of their suppliers, advertising firms that produce car ads, and on and on.  His final tally was well over 1 million jobs lost.  He concluded by saying it would make the current financial crisis a walk in the park.

Getting enough exercise?

Does that mean that we are all going to start walking?  Not that that would be a bad idea, we could all stand to lose some pounds, but for someone who has a 23 mile one-way commute with no option for mass transit, it’s just not going to happen.  So what do we do?  Well, one of several scenarios is going to happen.

Scenario 1:  The Big Three Close Their Doors

If this scenario came about, what would we do?  We would go buy Toyotas, Nissans, Hondas, Volkswagens, etc.  Those companies would have to scale up to fill the void caused by the Big Three closing their doors.  That demand would need people.  So a significant number, but by no means all, of the laid off workers from Detroit would move to North Carolina, Alabama, and other points south, and join these auto companies at their U.S. plants.

Likewise the suppliers would form new alliances to supply these car companies, as would all the other ancillary companies that currently support Detroit.  Would jobs be lost?  Yes.  Would it be anywhere near the number of jobs my friend projected?  No.

Scenario 2: The Big Three Reinvent Themselves

The liberty of the car companies to reinvent themselves is constrained by government regulations.  Surprise!  If the Big Three have any hope of reinventing themselves, they have to have the freedom to do so.  Start by eliminating the CAFE standards.  CAFE, which stands for Corporate Average Fuel Economy, is the mileage standards dictated by the government that the auto companies must comply with or face heavy fines, draining more money from the Big Three’s coffers.  So for every car that the Big Three build that may get 20 mpg, they may have to build and sell perhaps 3 that get 30 mpg, in order to meet the standard.  But what if they can make money on the 20 mpg car, but they lose money on every 30 mpg model?  What if the reason they can’t make money is because of their labor costs per vehicle, their pension costs per vehicle, their health care costs per vehicle, when added up are too high compared to their foreign competitors.  They are basically forced by the government to make an unprofitable product.

Why not abandon the CAFE standards?  Let Detroit build the cars and trucks that they can make at a profit.  Let the foreign manufactures make cars that they can make at a profit, including high mileage cars.  Let the American people have the freedom to choose which they want.  As the price of gasoline climbs as it did, and will again, people will want to buy high mileage cars, hybrids, electric cars, but they will also want to buy SUVs, luxury cars and light trucks.  Why does a particular manufacturer have to produce all kinds?  When has government ever made the right call on what products to produce? (Hint:  think of all the five-year plans and Great Leap Forwards from the Communist world).

Scenario 3: The Government Bails Out the Big Three

The government prints up a bundle of cash, $25 billion or more, gives it to the auto companies and hands the IOU to you and me.  The new Democratic Congress and Administration will toe the line for their backers in the environmental movement and demand higher CAFE standards for the auto companies in the interest of addressing: our dependence on foreign oil; green house gases; and helping consumers.  This will put increased pressure on the Big Three to make more unprofitable products and we will find ourselves back in the same place a few years hence.  More liberties will be vaporized as the government appoints a czar to oversee the auto companies to be sure they are building the right products, that management is not getting paid too much money, and well let’s face it, they would basically be nationalizing the auto companies.  Management talent would dry up, and socialism would make greater inroads into the U.S. economy.

The Best Scenario

The Big Three file for bankruptcy, if that is what they need to do.  The stockholders would probably be wiped out, the management team would be replaced, and this will let them re-negotiate their labor agreements.  Congress and the new Administration realize that people will want to purchase cars with higher mileage as the price of gas climbs regardless of any government requirement.  There is no justifiable reason that any particular auto company has to build a particular car because the government says so.  Achieving this state of enlightenment, Congress repeals the CAFE standards.  With the liberty to manage the company to make a profit rather than meet the constraints of a bevy of interest groups, a more energized management team takes the reins, and returns the Big Three to competitiveness.

Drawing a line in the Sand

If we don’t take a stand here and now, every company that wants a cash cushion will be working the halls of Congress to get their hands on your money.  There is not enough to go around.  In addition, many of the problems we are facing were created by government initiatives.  The mortgage mess was not the result of not enough regulation but by government programs that compelled lenders to give loans to people who could not afford them.  Detroit’s problems are a result of CAFE standards and onerous union contracts.  Since government created many of these problems why do we think that government knows how to fix them?  What we need to do is tell them to back off and let the free market work.