Is the Bankruptcy of the AmericanAuto Industry Unavoidable?

Congress will decide on December 8th whether it will allocate an emergency fund to struggling American automobile manufacturers.

With a $70 billion accumulated loss since 2005 and very pessimistic prospects, General Motors’ future seems more than compromised. Its CEO, Rick Wagoner, expects the company to run out of cash before the new president of the United States, Barack Obama, takes office on January 20th. And the situation is equally compromised for the two other important American manufacturers Ford and Chrysler. All of them are asking for a federal government bail-out–for now, without success.

What is the American manufacturers situation?

The Big Three leaders – General Motors, Ford and Chrysler – sent out an SOS before the American Senate on Monday, November 17th. They are asking for a 25 billion dollar bail-out.

Excluding exceptional items, General Motors registered a $4.2 billion loss in the third quarter. Ford’s [losses] exceed $2.7 billion. But the real issue is liquidity: manufacturers are burning cash and banks outright refuse to finance them.

Rick Wagoner admits that his company, which consumes $1 billion a month, will soon be out of cash. Ford has just sold 20% of its shares in Japanese automaker Mazda. And Chrysler, who is not quoted anymore, doesn’t communicate any longer. But its situation is without a doubt the most difficult after its buyout by investment funds.

How did it happen?

Several elements explain this fast deterioration.

First, new car sales have been plummeting for 18 months. They went from an annual rhythm of a bit more than 16 million units at the end of the second quarter of 2007 to 10.5 million in October of this year. Americans have suffered a lot from the fuel bill increase, before being caught up by the credit crunch and the economic recession. These problems affect all manufacturers, as shown by Toyota’s decision this week to stop its factories in the United States for two days in December.

But the Big Three also present specific weaknesses. First, their offering is largely inadequate for the present situation. While Japanese manufacturers favored compact vehicles, the three American manufacturers still made between 60 and 75% of their profit with 4WD and pick-up sales, that is to say more expensive and more fuel hungry vehicles. Still, these companies only partially acknowledged their increasing difficulties. Even before the current crisis, their factories showed very modest utilization rates. Finally, they carry the burden of their promises to pay the retirements and health related costs for their former employees, which must be unbearable for foreign manufacturers.

By the end of 2007, General Motors liabilities reached $45 billion. For Ford it was $27 billion. Measures were taken these last months, but they have been insufficient considering the extent of the market’s deterioration. As proof, General Motors’ results have been negative since 2005, when the global economic situation was much more positive than it is today. The situation for the three big American manufacturers has but little chance to improve in short or long term.

Will the government intervene?

Manufacturers are asking for money. Barack Obama, who hasn’t taken office yet, declared that they should be helped. Democrats would like to see a part of Paulson’s plan, intended for the financial sector, allocated to the automotive industry. Of the $700 billion dollars, $25 billion could be diverted from their original destination.

Republicans are opposed to this, as is Treasury Secretary Henry Paulson who initiated the plan. They explain that the manufacturers’ situation is so difficult that their medium term viability remains questionable. These uncertainties also explain why the financial institutions refuse any credit to these companies. In the event of bankruptcy, they would lose the loaned funds. However, it is difficult to contemplate the end of the crisis without support from the banks.

The three big manufacturers find themselves in a vicious circle from which only a bankruptcy could rescue them. That is the Republican reasoning anyway.

What would be the consequences of the bankruptcy of one or more of them?

Rick Wagoner refutes the reasoning that Chapter 11 bankruptcy represents a solution to the current crisis of the sector. His opinion is that the bankruptcy of General Motors would mean its disappearance, pure and simple. A Chapter 11 filing would allow to solve the social liabilities, the financial debts and remodel the industrial tool at a low financial cost, but doesn’t guarantee a permanent solution. The equipment supplier Delphi has been under Chapter 11 for two years, and its situation is still as desperate as before.

The social and financial cost of bankruptcy would be astronomical. The manufacturers employ 820,000 people in the United States directly and 4.5 million indirectly, according to a study by the Center for Automotive Research. The same advisers think that the disappearance of 50% of the Big Three’s production capacity over the next three years would represent 1 million jobs lost. In three years, revenue loss would reach $275 billion. And the lost income from taxes would exceed $100 billion–much more* than what manufacturers are demanding today.

*The last sentence, when translated from the original text, used a word meaning “less”/”inferior”. The translator felt that the sentence made more sense with te above proposed changes.