Auto Industry Bailout
A report by:
BBUS 461: Winter 2011
March 15, 2011
The automobile industry of the United States produces millions of cars each year, also a big player for the U.S. economy. The industry is led by Detroit, Michigan??™s ???Big Three???, Ford Motors, General Motors (GM), and Daimler Chrysler. The aforementioned automobile makers have specialized in developing trucks and sport utility vehicles such as the Ford Explorer, Chevy Suburban, and Dodge Ram. During the 90??™s and early 2000??™s, these specific vehicles were very popular and the big three were fortunate enough to receive very high margin from them compared to smaller vehicles. Ford, GM and Chrysler relied heavily on truck and SUV sales in order to gain substantial profits. However despite big gains from consumers purchasing millions of these types of vehicles, manufacturers did not slow down production on these trucks and SUVs during the shift in demand due to global warming and rising petroleum rates.
Cost structures of these organizations are also a key role into why the big three have been facing economic hardship. For example, GM??™s extremely high employee compensation, healthcare, and other benefits programs have led to difficulty overcoming costs in order to make profits. ???GM, for instance, at one time picked up the entire cost of funding health insurance premiums of its employees, their survivors and GM retirees, as the US did not have a universal health care system??? (fill in later). Most of these plans were chronically underfunded and GM made arrangements with the United Auto Workers union (UAW) to transfer pension obligations to an independent trust. Not to mention the ridiculous amount of the executive bonus payouts. Nonetheless, non-unionized Japanese automakers, with their younger American workforces (and far fewer American retirees) will continue to enjoy a cost advantage.
So why do we care Why should we as American citizens be concerned of such a poorly managed automobile industry If you would like your hard earned money to be mailed directly to Ford, GM, or Chrysler, you need not to read further. However for those who are curious as to why our tax dollars are being used to bail these bad business practicing car makers out, then join me into digging in as to why we paid billions of dollars to the American auto industry.
During the financial crisis of the mid to late 2000??™s, jobs were lost, houses were at risk for foreclosure, banks were failing, and the auto industry was facing bankruptcy. 2007 was a tough time for the United States??™ big three auto manufacturers. Gas prices were at record high and we have been receiving tons of media regarding global warming. Now for those of you who are unfamiliar with the term, global warming is caused by the increasing amount of carbon dioxide (Co2) emissions released from vehicles, factories and other fossil fuel burning machines. These are greenhouse gases that are starting to clog up our atmosphere and therefore trapping the warmer air within our environment. The side effects from global warming include a marginal but consistent increase in average global temperature, melting polar icecaps, and strange weather behavior. Former vice president Al Gore, an environmental activist and founder of the Alliance for Climate Protection, was very passionate about the global warming phenomenon. He wrote a book titled An Inconvenient Truth which explains the origins of global warming which include the overabundance in heavy duty trucks and SUVs. Gore quotes, ??????They keep trying to sell large, inefficient gas-guzzlers even though fewer and fewer people are buying them??? (Gore). This quote was true, and very inconvenient, for the automakers producing them. This was the ultimatum for the big three as to whether they were going to adjust to these changes and begin research and development for alternative fuel sources.
As gas prices surged and a panic was within us, Ford GM and Chrysler were beginning to face trouble. They all had a lot full of SUVs and trucks that weren??™t going anywhere. Interestingly enough, we started to see a lot more Toyota Prius??™ on the roads. Through incentives such as employee pricing and zero percent interest financing, American car companies were looking for any way to liquidate these burden vehicles for they have little value to price and fuel conscious consumers. This was the point where the big three needed to seek additional help, where did they look first The government.
Origins of the auto bailout are defined by the ???Big Three???: Ford, GM and Chrysler. The Big Three had gained a huge market share of 70% in 1998. Only 20 years later, in 2008, their market share took a fall to 53%. Through facing this financial crisis, the Big Three was forced to idle many factories, drastically reduce employment levels, and had to decrease their production levels substantially.
There were many reasons that caused US automakers to fail. Environmental expectations and the changing product demands affected the auto bailout. Environmental politics regarding carbon emissions have heightened sensitivity to gas mileage standards and environmental protection worldwide. An example of this is the Chevrolet Suburban. Its miles per gallon are 12/17 and it is retailed at -$58,990.
Another reason why US automaker failed was the effect of the 2008 oil price shock and economic crisis. There were very high labor costs including salaries, benefits, healthcare, and pensions. In 2008 the gas prices were above $4 per gallon. The Big Three??™s sales and profitability plummeted when Americans stopped buying the larger vehicles. The falling sales resulted in the Big Threes plants operating below capacity. The financial crisis played a huge role in the auto bailout. One of the major events was that GM was unable to obtain credit to buy Chrysler. During 2007, nearly 2 million new U.S. cars were purchased with funds from home equity loans. Subprime mortgage crises and high oil prices of 2008 caused the popularity of once best-selling trucks and SUVs to plummet.
There are many companies that can be blamed for the auto bailout. Many note that the crisis occurred mainly as a result of bad business practices of the Big Three US automakers. Companies did not restructure product line to tend to global crisis. Chrysler filed for chapter 11 bankruptcy protection on May 1, 2009 followed by General Motors a month later due to poor management and business practices.
The Big Three Executives flew in to Washington D.C. in their own $36 million private jets to ask for money from the government. Wagoners private jet trip to Washington cost his ailing company an estimated $20,000 roundtrip. In comparison, seats on Northwest Airlines flight 2364 from Detroit to Washington were going online for $288 coach and $837 first class. “This is a slap in the face of taxpayers. To come to Washington on a corporate jet, and asking for a hand out is outrageous??? (Newman), quoted Tom Schatz, President of Citizens Against Government Waste.
There were many political demands involved in the auto bailout. CEOs of the Big Three were asked to present “credible restructuring plan” involving “significant sacrifices and major changes to the way of doing business,” to qualify for further government assistance. This included, situation assessment, forecasts under various assumptions, taxpayer protection, transparent reporting to an oversight body, dividend and executive pay restrictions and approach to covering healthcare and pension obligations.
In the White House, Democrats leaned towards helping the U.S. auto makers. They agreed to fund some of the $700 billion bailout money. Republicans felt that this simply will not fix the issue at hand so they disagreed to loan them billions of dollars of taxpayer money. The White House wanted to use money from a $25 billion loan program aimed at helping automakers convert production to more fuel-efficient vehicles. On December 19, 2008, a $17.4 billion rescue plan was approved by congress along with Bush Administration which was made available from the Troubled Asset Relief Fund. The funds were distributed to GM and Chrysler; $9.4 billion to GM, 4 Billion to Chrysler and Ford said they did not need immediate help. Ford had an extensive line a credit that was able to keep them alive. The senate told automakers to come up with restructuring plans so they would become viable companies.
The Big Three participated in brand reorganization. For GM, nameplates such as Pontiac, Saturn, Hummer, and service brands like Goodwrench were discontinued. Others, such as Saab, were sold. GM then offered 18 ethanol-enabled FlexFuel cars and trucks in the US and produced more than one million new FlexFuel vehicles. GMs goal is to have half of their annual vehicle production be E85 or biodiesel capable by 2012. The Ford Motor Company announced it would accelerate its plans to produce more fuel-efficient cars. Today, they are producing flexible fuel, hybrid, and all electric vehicles worldwide. Chrysler Group LLC emerged from a Chapter 11 reorganization and announced a plan for a partnership with Italian automaker Fiat. They released Dodge Durango, Ram, and Aspen Hybrid line with hemi motors available.
Other options that the Big Three could have consider would include selling assets that include General Motors??™ Hummer, SAAB and even the allegedly untouchable Cadillac brands. Other options would be to conduct rights offering to raise equity, drop some advertising and a Nascar sponsorship or two, cut more costs, including wages and benefits for union members raise more debt on assets, end bad dealer relationships and lastly to simply sell more cars.
As far as the future of the Big Three, new fuel efficient models have boosted sales since the auto bailout. The slowly recovering economy is helping the companies raise their sales. Ford, GM and Chrysler each recorded higher sales in 2010 than in 2009, one of the worst years in decades. Ford has taken full advantage of the recent Toyota safety defaults. For GM, its dominance in China allowed the company to emerge from bankruptcy. Lastly, crossover vehicles and trucks are becoming popular again.
Here we are now in a global environment where hybrid technology has advanced and replicated throughout almost every automaker in the world. Many have discussed whether or not we should have let the automakers fail to let more competent organizations establish their vehicle production. Yes it is true that thousands of jobs would be lost but there would definitely be new jobs available. If Ford, GM, and Chrysler would have foreseen what was to come earlier in the decade, they could have readjusted and transitioned into an efficient company similar to Toyota??™s and Honda??™s business models. However we are moving forward and slowly recovering from difficult times. The Big Three seem to be coming closer to financial stability as sales have increased and they have been making payments back to the government.
Amadeo, K. (2009, December 31). The auto bailout. Retrieved from http://useconomy.about.com/od/criticalssues/a/auto_bailout.htm
Effects of the 2008??“2010 automotive industry crisis on the United States. Wikipedia. Retrieved March 15, 2011, from http://en.wikipedia.org/wiki/Effects_of_the_2008-2009_automotive_industry_crisis_on_the_United_State
Newman, R. (2008, September 4). A $25 billion lifeline for gm, ford, and chrysler. US News: Money, Retrieved from http://money.usnews.com/money/blogs/flowchart/2008/09/24/a-25-billion-lifeline-for-gm-ford-and-chrysler
FedSources, (2008). The bailout review. http://www.fedsources.com/client/libraries/bailout/Federal/Federal%20Weekly%20Bailout%20Review%201119.pdf
Kane, P. (2008, December 12). Auto bailout talks collapse as senate deadlocks over wages. The Washington Post, Retrieved from http://www.washingtonpost.com/wp-dyn/content/article/2008/12/11/AR2008121101578.html
Cloud, J. (2003, Febuary 24). Why the suv is all the rage. Time, Retrieved from http://www.time.com/time/magazine/article/0,9171,1004283-6,00.html