Vertical Issues in the Auto Industry

The Financial Times reports that France is poised to bail out Peugeot; meanwhile Ford will close its Belgian plant. This will impact suppliers, particularly Lear, which has a seating plant in Belgium dedicated to producing for Ford. [To my knowledge, no car company makes its own seats, which are the single most expensive item they purchase — at one company I’ve visited where the engine is purchased, the seats cost more than the engine.]
More generally, with sales in the EU at a 17 year low, it’s not just the OEMs [original equipment manufacturers, aka car companies] that are hurting but also suppliers, who account for 3/4ths of employment. In Europe (as in Japan) suppliers use contract and temporary workers; Lear has already given 300 the axe, and Federal Mogul and JCI [Johnson Controls, in this case its seating division] have also announced cuts.
An Automotive News story [Ford’s Belgium plant closing could impact U.S. suppliers] reports that 20-25% of BorgWarner’s European workforce is comprised of such contingent workers. [It and Honeywell dominate the market for turbochargers.] But in contrast to 2009, they now have $189.5 million in free cash flow [2012Q2]. In general, suppliers are not in crisis mode.
This is important. In 2009, it was not just GM that teetered on the edge of the abyss, it was also its core suppliers. But those same firms supply Toyota, Honda, Ford and BMW — in other words, everyone in the industry. If one of those large suppliers had collapsed, all auto manufacturing in the US would have ceased, and most suppliers would have shut their doors. Of course without new cars (or replacement parts) dealerships would have also closed their doors. While they might have been able to sell a few used cars, they would have lost the warranty work business (and in fact been unable to get parts, not just get payment). Most would also have gone straight into bankruptcy, because their loans would have become due, cross-bankruptcy clauses in their agreements.
Now Mitt Romney has quietly changed his stance on the bankruptcy of General Motors and Chrysler (it was not a “bailout” since everyone lost). He initially maintained — the primaries — that GM should have been allowed to fail. That would have set off the chain reaction noted above, which my calculations suggest would have led to 3 million job losses, half in the first 2 weeks. That would have turned our current Great Recession into a second, full-fledged Second Great Depression.
His new stance is that we should have merely guaranteed loans to GM and Chrysler. This fails on several grounds. First, as he should well know, in a big restructuring (we’re talking $30 billion-plus) you have to rely on big firms such as Lehman Bros and Bank of America. Whoops! — in 2009 Lehman was gone, Bank of America was itself being rescued, no large financial institution was lending, all had capital impaired [banks are required to maintain a specific capital/asset ratio, if you have bad loans that eat into your capital, you have to shrink your loan portfolio]. In short, even coming up $1 billion would have been a real feat of arm-twisting by the Treasury, government guarantees or no. So there would have been bankruptcy, but it would have been Chapter 7 liquidation (close everything down and hold a fire sale) not a Chapter 11 restructuring, which is what government loans enabled.
There’s another problem with guarantees: there’s no upside for the taxpayer, only downside. If the restructuring didn’t work, we’d be out a lot of money. If it worked, investment banks would make a killing, in the way that Romney did with Delphi through his investments (which, claims to the contrary, are not in a blind trust as defined under US law). Instead, by allowing loans to be turned into equity, we have a potential upside. However much he may be worthy of derision for other things, Paulson [a Bush appointee, continued under Obama] used his Wall Street savvy to restructure deals in the taxpayer’s favor. Romney hasn’t shed his mindset that deals should be structured to let him make money.
Romney may have been born into a car industry family (his father was CEO of American Motors, which Chrysler purchased to get its Jeep brand, made in Toledo Ohio then and now). But he doesn’t actually seem to know anything about the industry, or if so he doesn’t let that affect what he says. He has legitimate claim to understanding finance. He’s still willing to twist things to match what his audience wants to hear — a normal Chapter 11 was possible in 2009?! — when he surely knows that was not the case. Finally, he has been unable to reorient his mindset to think in terms of the welfare of the American people, rather than Wall Street, despite spending 7 years on the campaign trail. That does not bode well for the nation if he should become president.

2 thoughts on “Vertical Issues in the Auto Industry

  1. The auto bailouts are certainly a politically divisive issue right now. It seems candidates are trying to juggle their need to be supportive of manufacturing, particularly automotive in the midwest (which just so happen to be swing states). Given the current deficit our government is running and has been over the last decade, more spending and taxpayer-funded guarantees to corporations don’t seem to ring well in the ears of voters. However, no candidate would find it prudent to completely denounce support for these manufacturers who employ large chunks of swing-state voters, so heavy rhetoric without any guarantees seems to be the best strategy in dealing with this issue. Hopefully whoever wins the election will show their full support of the auto industry, but not without overburdening taxpayers.

    • To echo what Trey said, it is clear that the bailouts of the auto industry and the current state of the automotive market are key points of contention. It’s unfortunate for Romney that the auto industry is such a key industry in some swing states, because even some of his own supporters believe Obama’s handling of the auto industry crisis preserved one of our country’s core industries and is an example of effective national policy. Biden is famously quoted that Obama should be re-elected because “GM is alive, and Bin Laden is dead.”

      While there are certainly many other important issues in this election, the effectiveness of the auto bailout and the current state of the auto industry are great signs for Obama and his supporters. The data shows that the auto industry is better off now than prior to the bailout, but the Right argues that a “traditional bankruptcy,” one that didn’t use taxpayer money, may have been the more effective method to handle the crisis.

      The most recent controversy stems from a 30 second ad by Romney in which he claims Obama is pushing American jobs in the automotive industry to China through his policies. Many different groups (The Washington Post, PolitiFact.com, etc.) claimed that the commercial was misleading to say the least. What do you think?

      See the commercial and discussion on the state of the auto industry here: http://www.washingtonpost.com/politics/decision2012/in-critical-ohio-obama-rips-romney-ads-on-auto-industry-as-scare-tactic/2012/11/02/bd324602-2500-11e2-9313-3c7f59038d93_story.html

      …and here: http://www.bloomberg.com/news/2012-11-02/obama-s-u-s-auto-industry-better-off-than-four-years-ago-cars.html

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