DUNTOV E O BISCAYNE

O Chevrolet Biscayne das fotos foi alvo de uma restauração de três anos de duração, típica dos americanos, que resulta em carros em condição melhor do que quando saíam de fábrica, conhecidas como over-restoration (sobre-restauração). Muita gente não aprova esse tipo de tratamento, mas antes de condenar a prática, precisamos saber o motivo.

Fazer um Chevrolet aparentemente tão simples e de alta produção ser assim tratado e ficar nessa condição tem um motivo muito especial. É um carro que precisa ser entendido para ser admirado por todos que consideram importantes a história da General Motors e de Zora Arkus-Duntov (1909-1996) em particular. O ex-engenheiro-chefe do Corvette, que chegou a esse cargo por ter sido o responsável pela transformação de um pacato conversível no ícone esportivo americano, é também o mentor desse cupê concebido para uso policial.

O Biscayne, fabricado a partir de 1958, é diferente desse carro de 1959, quando praticamente todas as marcas americanas começaram a fabricar carros mais baixos. O estilo de 1959 é único, o 1960 já sendo diferente novamente.

A traseira é curiosíssima, com a tampa do porta-malas parecendo um par de asas, acima de lanternas de desenho curioso. Um verdadeiro show!

CONTINUE LENDO >>>

China: The Domestic and the Global Industry

In October 2013 sales in China reached 1.92 million units – see the China Auto Industry Association statistics page for details. That's just shy of a 24 million unit rate, and is surely the largest number of vehicles ever sold in a single market in a month. For GM, sales were 282,000 units – 25% more than US sales that month. Everyone is in the market, or preparing to enter there. The Korean neighbors (Kia and Hyundai, but also Daewoo as part of GM), Japan (or at least the Japan Three of Toyota, Honda and Nissan, and Mazda and Suzuki), Germany (BMW, Mercedes, VW), the Detroit Three and now the French, both PSA and Renault. A host of local firms continue, though most as paper entities. Still, Great Wall, Chery, Geely, BYD, Changan and others.

This raises a host of questions. I focus on two: geography and profitability. I frame my brief analysis using the perspective of the OEMs. Since more and more value added lies with suppliers, that may lead to inappropriate conclusions, but for now I will accept the status quo terms of debate.

...the geography of China's automotive industry makes no economic sense...

First, despite very large production volumes, a side effect of government policy has been to disperse production widely. Even though the Third Front policies of the 1960s are widely understood to have been a failure, the political economy of joint venture approvals has led to factories in locations that make little sense. Today, with the market supply-constrained, that matters little. As competition heats up, however, the costs that accompany scattered locations will become more and more burdensome.

Second, there's profitability. On a global basis, the dark secret is the industry depends on the US market for a disproportionate share of profits. Japan's domestic market is in long-term secular decline, and will remain fundamentally unprofitable despite the dominant position of Toyota. (Suppliers seem to be able to collude with impunity – or so they thought – but Toyota hasn't been successful in being a price leader.) Europe is little better, offset only because of a richer product mix. How profitable is China? To my mind that is the single more important strategic variable the industry faces.

Back to geography. Under Mao local governments were expected to fend for themselves, first and foremost in terms of food but extending to a wide variety of industrial products. Fearing a Soviet attack, Mao deliberately dispersed heavy industry into remote locations. So at the onset of post-Mao reforms, every province and most large cities turned out trucks and passenger cars, even if only a handful a year. In total there were perhaps 120 producers. But political power was likewise dispersed; up-and-coming party officials were rotated through a variety of posts, but anyone slated for top leadership served a stint as a provincial governor or mayor of a prefectural-level city such as Shanghai. To be promoted to the senior leadership in Beijing required presiding over economic growth. So when the government looked to joint ventures to improve motor vehicle production, the result inevitably was one factory here, another there. Local protectionism – in Shanghai you found old generation VW Santanas, in Beijing you found jeeps – reinforced this desire to have your own plant.

China has no equivalent to the 600-mile-long I-75 "automotive alley" in the US, with an agglomeration of suppliers, assemblers and associated engineering centers feeding off of each other in a positive manner. Beijing is 1,300 miles from Guangzhou [Canton] in the south, and several automotive operations are another 400 miles to the northeast of Beijing. Similarly, at the western end of the zone is Kansas City, 700 miles from Detroit and 650 miles from Columbus, OH; Chengdu in the Sichuan basis is 1,200 miles to the west of Shanghai, across rough terrain, and Urumqi is 2,400 miles away.

Perhaps Wuhan will become a nexus – a recent Automotive News China story – but there is none at present at the assembler end. Perhaps suppliers are more concentrated, I know of several engineering centers in Shanghai, proximate to those of VW and GM, the two largest car companies in China. But what this means is that as competition heats up, and the segmentation of the country into regional markets eases, there will be numbers of plants whose location will saddle them with high logistics costs coming and going. As long as the government mandates joint ventures, politics will trump sensible plant siting. The geography of China's industry makes no sense, and will cost firms money.

...GM's & VW's Chinese ventures appear to be quite profitable....

Then there's profitability. Perhaps some suppliers break China out as a separate geographic region, but I've yet to find any. (My understanding is that parts suppliers are not under the stricture of forming joint ventures, though likely many of them have because local partners add value.) Assemblers however are limited to joint ventures, and at the two market leaders (GM and VW) their profits are accounted on an equity basis, rather than as part of normal operating profits. Both however provide that number. It's likely to be an underestimate. The biggest potential divergence would be if these ventures paid dividends; that would reduce retained earnings and the rise in book value. That is, equity income falls, though it would be offset by dividend income. However, neither media reports nor financial statements provide any hint of such payments. Indeed, it's clear that at present all funds are being reinvested. Instead, the (post-tax) equity income is an overstatement because both venture partners have an incentive to use transfer pricing to the hilt, as they get 100% of any excess, but only half if they let the venture book a lower price and higher profits. On the Chinese side that includes the provision of real estate; for VW and GM it would include licensing fees for intellectual property. Both firms have relatively new facilities, and continue to invest at a prodigious pace; they likely have high offsets for depreciation. And of course GM and VW can only report half of total profits.

To the numbers: in the first 9 months of 2013 GM International Operations, under which China falls, realized equity income of $1.4 billion; total consolidated GM profits were $4.3 billion, so the Chinese joint ventures accounted for 32% of the total (and 32% of unit sales). Another way to view the China side is to compare profits in North America with profits in China. GMNA is 6% larger unit sales, and GM China lacks the gold mine of full-sized pickups. But given GM's 50% share, GM's joint ventures in China earned $2.8 billion while North America pulled in $2.2 billion. China makes money.

VW's numbers paint a similar picture. The increased equity valuation of VW's China operations came to €3.5 billion in the first 3 quarters of 2013; total profits were €8.8 billion. China thus accounted for 40% of the total, on 32% of global volume. Of course at present Europe weighs down VW's profits. Nevertheless given its 50% stake, its joint venture partners in China earned €7.0 billion. Its operations are older than those of GM, so it will have lower depreciation charges; its Santana plant in Shanghai, which contained used equipment, is likely fully amortized. Its Audi brand is also the dominant luxury vehicle in China. Still, at roughly US$9 billion it substantially out-earned GM. The bottom line again is that China makes money.

So perhaps we will move towards a bipolar world, in which North America and China come to dominate global automotive profits. As the industry is currently structured, though, China's geography will remain an impediment.

Thanks to David Wiest for discussing equity accounting with me.

BK + Five Years

Automotive News has a retrospective with brief quotes from various participants. Let me briefly mention three that I found thoughtful despite the brevity imposed by the 2-page layout.

First, Mike Jackson of AutoNation notes the severity of the situation, with the possibility of a precipitous bankruptcy cascading across the economy: "We were at times within 24 hours of everything we knew being swept away." It is easy to forget exactly how dire things were, because of the interconnected nature of the supplier chain, and feed-on effects to the financial sector.

Second, John Krafcik, CEO of Hyundai American Motor, notes that car companies are wholesalers, so that when dealers stop buying cars, even at a comparatively healthy company "our cash flow began to get precipitously low" despite negotiating expensive one-off deals with banks to butress their position. But his snippet focuses on the interconnected nature of dealerships, as many of their 800 stores also had GM and Chrysler franchises. That parallel with the supply chain is easy to overlook.

Years back I read Krafcik's 1988 MIT master's thesis. He was a GM employee seconded to the now-shuttered NUMMI joint venture with Toyota, and coined the phrase "lean production" in a paper that later formed one piece of the 1990 IMVP book Machine That Chained the World.

Third, and not least is a short note by Shelly Lombard, an automotive analyst.

It wasn't really a surprise. It didn't mean the company wasn't viable, but it was just clear that this thing needed to be restructure. ... Companies don't go into bankruptcy because the earnings are bad. They go into bankruptcy when they run out of cash.

And of course "GM was blowing through cash" and [unlike Ford] had not mortgaged the company in advance of the crisis to create a cushion. "...so you knew the wheels were about to come off the car."

Mike Smitka

CORVETTE IMPALA

Sim, parece um Corvette 

A tentativa de fazer um esportivo ou grã-turismo familiar não é nada atual, como prova esse conceito da outrora maior do mundo, a General Motors Corporation. Com poucas informações e fotos disponíveis, e sem sabermos como ele se comportava andando, o modelo acabou por ser ofuscado por muitos outros conceitos, chamados de dream cars (carros de sonho) à época, de estilos muito mais ousados e futurísticos.

Os anos 1950, os "Fabulous Fifties" são incomparáveis no que se refere a novidades de desenho de automóveis americanos. Foi o máximo dos máximos para a GM e  indústria automobilística americana de uma maneira geral, quando a maioria dos modelos era extensamente modificada ano após ano, e o consumidor se via enlouquecido diante de tantas novidades e versões que, se perder era fácil demais. Se eu pudesse voltar no tempo com foco automobilístico, seria  nessa década de 50 o meu desembarque!

Para divulgar o trabalho imenso do estilo da GM, os executivos da empresa continuaram e aumentaram a extensão do Motorama, a exposição que a GM fazia ao redor dos Estados Unidos para mostrar sua visão de futuro e que pode ser considerada a maior e mais consistente clínica de pesquisa de todos os tempos,   que vinha ocorrendo desde 1931 com interrupções normais devido a crises econômicas e guerras. 

Para o ano de 1956 surgia um Corvette grandalhão, que adotava o nome Corvette Impala. E já que o carro não foi produzido, o ótimo nome viria a ser aproveitado pouco tempo depois.

Corvette já era um nome famoso e empolgante para os autoentusiastas americanos, e a Chevrolet pretendia aproveitar o embalo para trabalhar bem essa marca e ter uma linha de modelos, ou ao menos o esportivo tradicional e esse Impala, para ao menos se criar a possibilidade do banco traseiro e o uso em grupos e famílias.

CONTINUE LENDO >>>

Super investor increases stake in General Motors

As feds are selling GM stock, Buffett is buying.

DealersEdge Headlines

Billionaire Warren Buffett's investment firm Berkshire Hathaway Inc. boosted its holdings in General Motors by 60 percent to 40 million shares, the firm disclosed in a recent SEC filing. That brings Berkshire Hathaway’s holdings to 2.9 percent of outstanding GM stock, according to a report in the Detroit News and SEC filings.

The firm initially purchased 10 million shares in 2012, when the stock was trading in the low $20-per-share price. It closed last week at $34.55, down $1.02. At current prices, the stake is worth more than $1.38 billion.

Mr. Buffett acquired the new shares in GM in the three months ending June 30. That's the same period during which the U.S. Treasury has been steadily selling off its holdings in GM it received as part of its $49.5 billion bailout.

CHEVROLET TAHOE, VIAJANDO COM UM PELOS EUA

Pressionado por necessidades familiares em uma viagem longa em que muito asfalto passaria por debaixo das rodas em quatro estados americanos, era requisito haver lugar certo para bagagem e que ela não interferisse com os passageiros. Vans são boas nisso, na Chrysler Caravan que vi antes de me decidir pelo Chevrolet Tahoe espaço para malas não faltava.

Mas quando a funcionária da locadora me perguntou se eu não preferia um Tahoe pelo mesmo preço da Caravan, meus desejos se realizaram. Não por não gostar das vans, mas pela vontade de utilizar algo mais americano ainda, e com um V-8 GM, melhor ainda.

O modelo que aluguei foi um LT com tração nas quatro rodas temporária sem reduzida, ambos itens opcionais para todas as versões (LS, LT e LTZ), sete lugares, sendo os dois bancos no porta-malas dobráveis e removíveis. Mesmo com eles lá, cabem cinco malas grandes – não tamanho-jumbo – uma ao lado da outra.

Com os todos os bancos no lugar, o porta-malas é de 478 litros. Retirando os dois bancos da terceira fileira, são 1.707 litros. Como eles seriam apenas rebatidos, uns 1.500 litros estariam à disposição. A tampa traseira abre para cima, junto com o vidro, mas este pode ser aberto independentemente para manuseio de volumes menores ou quando o carro está próximo de paredes, por exemplo.

Só com um banco da terceira fileira escamoteado

Com os dois bancos da terceira fileira escamoteados

Tampa traseira aberta ou...

...apenas o vidro traseiro

CONTINUE LENDO >>>

What Does Mullaly Do?

Guest Blogger Blake Grady, edited from April 30, 2013 post on the Econ 244 site

For those of us who do not have much of a business or even economics background, it is difficult to truly understand how large corporations work. One may not truly know the answer to basic questions such as: what does a CEO actually do on a day to day basis? Or: how do meetings of the board of directors work? These questions become even more difficult to answer when dealing with massive - and thus complicated - corporations such as Ford or General Motors.

One of the big takeaways, as I see it, from Bill Vlasic’s Once Upon a Car, is the massive effect a CEO is capable of having. Given my lack of business experience, it was difficult before reading the book to grasp how a CEO is able to run a company straight into the ground – or save it. Through reading about Alan Mulally at Ford, and then talking with current Ford executives in Detroit (as well as Mr. Vlasic) one learns of a CEO's responsibilities and their potential impact on a company. Many of the qualities a CEO must have, at least in a time of crisis, are on display in comparing Mulally to Richard Wagoner. This ranges from the ability to motivate people and to put one's ego in check in order to grasp a situation. In short, Once Upon a Car is a book about competence and incompetence in running a business, focused on one industry.

An interesting side-story, which occurs towards the end of the book, revolves around Sergio Marchionne. Marchionne clearly has a very different style from Mulally, however he also seems to be effective as CEO. Perhaps it is a relentless drive towards accomplishing a concrete goal, and an ability to convince other people to also want to accomplish that goal, that links the two men.

The Prof poses additional questions:

1. is the CEO in a turnaround situation is the best person for normal times?
2. would Mullaly have been able to do anything at GM? he had absolute support from the board of directors (Bill Ford) and a coterie of exceptional senior managers (Lewis Booth as CFO, Mark Fields in several roles) plus there was a sense of crisis and a restructuring in already progress (the “Way Forward”) when he become CEO. At GM the Board was not united, there was no corporate-wide sense of crisis, and at least one key individual (the CFO) could provide neither a clear and timely financial overview of the company, nor a baseline against which to construct business plans.
3. the decision to mortgage the company was made before Mullaly arrived; absent that, Vlasic suggests Ford would not have been able to stave off bankruptcy

Let’s rephrase this with the jargon of formal logic: something can be necessary but not sufficient. We’re attracted to personalities, we’ve been imbued with the idea that leadership matters. I’ll accept the premise that Mullaly (or someone similar) was necessary. (If I wanted to be a devil’s advocate I’d argue that what really mattered was splitting the CEO and the Chairman function in two, but I personally believe that was necessary but not sufficient.)

However, I do argue that Ford was ready for someone like him. GM wasn’t. And because it was bereft of new product, Chrysler was beyond saving – indeed people were jumping ship long before bankruptcy. Except ... Chrysler survived post-bankruptcy long enough to see decent RAM sales and the arrival of new product, and while today at GM the top couple people may be clueless, they're at least forcing lower-level people to make decisions. A standard quip in Detroit is that GM had the stupidest group of bright people you'll ever find – individually brilliant, collectively dysfunctional. Perhaps that's no longer the case.

Toyota as Number One

...remember Japan as Number One?...

I'm just back from a meeting of the Japan Foundation American Advisory Board, where part of the discussion was on the ups and downs of the field, such as high enrollments into the mid-1990s from those approaching the region in an instrumental way. Do you remember a prominent book of that era, Ezra Vogel's Japan as Number One. [mea culpa: he was the advisor for my undergraduate senior paper]

So what of Toyota as Number One? Is this a similar transitory phenomenon? – in many ways, yes. Despite all the doom-and-gloom reportage, though, Japan remains the 3rd largest economy [ahead of Germany, behind China and the US in absolute size] and overall a prosperous place. No, Japan never was going to take over the world. It remains important. Similarly, neither Toyota nor any other single firm will dominate the global auto industry, but Toyota is here to stay.

The metric that is in the headlines is total unit sales. That's not the only such metric; total revenue is another one. As an economist, I look to profits relative to assets. We could also look at quality measures, at the volume of top products (segment leadership), at "car of the year" and similar awards, and at positioning in growth markets. These give different answers – even if we can agree to an objective standard for how product in the industry's shifting array of joint ventures ought to be counted.

Total sales matters to Toyota in several ways. First, the impetus for this post, regaining the lead generates free (and favorable) publicity. After a period of supply disruptions (the 3/11 quake/tsunami followed by the floods in Thailand) and demand shocks (consequent to the US unintended acceleration incidents), this also is an important morale booster at Toyota and its dealers. Gloomy sales staff and gloomy sales go together, though which causes which may be ambiguous. In the US, what Toyota has done though is recover partway (14% of the market, down from 17% a few years back), while it's lower post-bankruptcy fixed costs allow GM to pursue profits rather than volume (18% of the market, rather than 21%). Only VW is picking up market share in North America.

In terms of total revenue, however, it is Volkswagen that has the lead by a hair. Yes, Toyota has Lexus and Hino, but VW has Audi and Porsche and its own truck division; VW has the Golf and other small cars; Toyota has its minicar subsidiary Daihatsu. GM is more focused on cars and light trucks. So in the 3 months ending September 30, 2012 VW had revenue of €48,848 million, Toyota had ¥5,406 billion and GM US$37,567 million. Using end-September 2012 exchange rates (US$1.00 = ¥78 = €0.78) gives revenue of $62.6 for VW and $69.3 for Toyota. At todays rates (US$1.00 = ¥90.5 = €0.74) the ranking shifts: $66 billion for VW and $60 billion for Toyota. So while Toyota may outsell GM and VW this year in unit terms, current exchange rates suggest VW is #1 in revenue. (GM is a distant #3.)

Then there's profits. Here the ranking is slightly different. VW earned a 4.2% return on €309 billion in assets; Toyota earned 0.9% on its ¥30 trillion in assets; GM earned 1.2% on its US$155 billion in assets. Here Toyota is third, not first. Now these companies are different in their structure; in particular, GM has only a very small finance unit, contributing only 7% to its profits. Similarly, VW gets about 11% of its profits from financial activities. It survives on vehicle sales. In contrast, 25% of Toyota's profits come from finance. So if we think of vehicles as the core of these firms, looking at the recent past we find Toyota trails in profitability.

How about quality? In the eyes of Consumer Reports and others, Toyota is no longer an automatic safe choice. Indeed, this past year they've recalled 4.5 million vehicles, more than their rivals. JDPowers ranks everyone very close to each other (look at the absolute numbers, not the rank order!). No one goes to the service bays of the big multibrand dealers but hearsay is that Toyota does not stand out from the standpoint of mechanics and warranty costs. (I don't know of any hard data.) That doesn't mean Toyota's vehicles aren't good; basically, everyone's vehicles are good, and compared to two decades ago, they're very good. No one is ahead in quality – thanks in part to Toyota's leadership in that area and the competitive pressure it exerted.

Similarly, in "xxx of the year" metrics Toyota is present but no single firm is dominant. Toyota doesn't appear in Ward's "best engines" list, while GM appears only once (Cadillac) and VW once (Audi). Honda, Ford and BMW lead their three regions. Another best car list – sorry, I deleted the email! – had a wide variety of makers as tops in specific segments; my recollection is that Toyota did well in minivans and entry luxury, but had no "winner" in regular cars. No one is outstanding in the sense of capturing a majority of "best" ratings.

Now going forward Toyota's profitability has headwinds and tailwinds. It continues to suffer from the political tensions between Japan and China that affect its sales in the latter market, where VW and particularly GM continue to forge ahead. Its domestic market is weak; as the number of licensed drivers falls, firms producing inside Japan will struggle to match capacity with sales.

In contrast, at an exchange rate of ¥90/$1.00 exports will be much more attractive. In particular, most of Toyota's Lexus brand are exported from Japan, so even without better volume, revenue and profits will rebound. They won't make money in Europe, but GM will lose a small fortune. So far VW seems to have come through well amidst the Euro crisis, but we'll see whether that persists. My hunch is that VW will remain at the top of the global Big Three in profitability, while Toyota will pull ahead of GM. But in terms of sheer volume, over the next few years growth in China and Brazil will benefit GM and VW relative to Toyota, while the US market is unlikely to improve much for anyone. So the #1 sales slot will shift back and forth.

...mike smitka...

Taking the Taxpayers out of General Motors

Ruggles – 12/26/2012

What many stockholders and taxpayers had feared, had Mitt Romney won the recent Presidential election, is coming true anyway. The taxpayers (U. S. Treasury) are quickly being taken out of their remaining General Motors ownership BEFORE the positive impact of the many new and exciting redesigned GM products to be introduced in the next few months can have the chance to boost retained earnings and share price. Waiting another 18 to 24 months could reduce or eliminate the loss that will be taken on the original taxpayer investment.

Having recently arranged for an $11 billion line of credit, and with about $41 billion in available cash and credit, GM is buying the stock back directly from the U.S. Treasury. At least buying back stock directly from Treasury is probably much better than dumping the stock on the open market, thereby diluting the share value and causing the stock price to drop even further. At least that is this stockholder’s point of view.

“Car Czar” Steve Rattner describes the buy back as “welcome news.” I’m not so sure. He goes on to write in the New York Times:

“For General Motors, the separation will conclusively remove the appellation of “Government Motors,” a stigma that the Company had argued affected the buying decisions of a meaningful segment of consumers.”

The divorce will ultimately also liberate G.M. from a number of government-imposed restrictions, importantly including those relating to executive compensation. These restrictions adversely affected G.M.’s ability to recruit and retain talent. Now, compensation decisions will be made by the company’s board of directors, just as they are in every other public company in America.”

Steven Rattner

As an observation, once GM rids itself of taxpayer ownership, GM execs can also resume the use of corporate jets. And we know how car business execs hate to fly commercial.

Others might say, GM has traded the appellation of “Government Motors” for another appellation, “The Car Company on which the taxpayers lost billions.” Rattner himself estimates the loss will come in at about $14 billion. Other estimates are higher.

The taxpayers should pay $14 - $20 billion so GM execs can go back to their spendthrift ways, when waiting 18 months or so would have given the stock the opportunity to rebound based on the recovering economy and an almost complete makeover of their product line? Not in my world. While this writer is NOT a professional stock picker, many folks look to Forbes for financial advice. A December 10 article in Forbes recommended “Roll with GM for 2013,” and gave compelling reasons why.

Others investment experts have weighed in on the subject and most have recommended buying GM stock for 2013, despite the attempt from some naysayers to float a rumor predicting a near term bankruptcy from GM. Of course, these columns appeared before the stock buyback announcement. And the naysayers ignored facts, while misinterpreting others, to create their false assertions.

Ex GM CEO Ed Whitacre was shown the door after he claimed in a national television commercial that GM had repaid its government loans. This was word parsing at its worst, as GM had only returned unused loans it didn’t need. The commercial implied, even though it did not specifically state, that GM was no longer in hock to the government and U.S. taxpayers, which was certainly not true. Some might argue that GM is using tax payer money to buy back taxpayer stock, a move similar to the claim that sank Whitacre.

What would another 18 to 24 months hurt? The President won his second term. What can the political pressure be? Why not give the stock the chance to improve? Is GM actually claiming that the cap on compensation is why they have had high velocity executive churn since the restructuring?

Has the government been “heavy handed” in its ownerships of GM, except for the jets and executive compensation? Recalling the previous bailout of Chrysler in the 1980s, Lee Iacocca chafed under the government supervision he had to live with during that era, ESPECIALLY the one that kept his jet grounded. In addition, the Feds were pushing Chrysler to divest itself of its truck division. All it took was for Ronald Reagan to make a crack to Iacocca at a Statue of Liberty restoration event about how Iacocca should be grateful that Carter was in the White House, and not Reagan, when the bailout was approved and signed, and the Chrysler CEO was more than incensed. He took a huge risk and paid the Feds off early, forgoing over $300 million in interest savings to do so. Iacocca put Chrysler at risk from a cash position perspective, even though the gamble ultimately paid off, but he saved the truck division, which has been the largest source of profits for Chrysler since. And he got his jet back and stuck it to Reagan. So is it ego or legitimate business considerations driving this current GM stock buyback move?

More Rattner:

“In a perfect world, I would not be a seller of G.M. stock at this moment. For one thing, the company is still completing the reworking of its sluggish management processes in order to achieve faster and better decisions and lower costs.”

For another, G.M.’s financial problems slowed its development of new products during 2008 and 2009. Now, a passel of shiny new models offering great promise is about to hit showrooms.”

And in my view, G.M. stock remains undervalued, trading at about 7 times its projected 2013 earnings, compared with nearly 13 for the stock market as whole.”

I think the move is driven by GM ego and arrogance, a really bad sign, and is NOT in the best interests of the U.S. taxpayer. This does not change the fact that while the auto sector restructuring was not conceived and executed perfectly, on balance what was accomplished will be considered a feat by economic historians. The cost to have NOT done the restructuring is incalculable, and most certainly many times more costly than a measly $20 billion. Depression or “moral hazard?” That was the choice. And the “perfect can’t be the enemy of the good.” In my mind, this premature stock buyback adds unnecessary tarnish to an otherwise laudatory endeavor.

The New Romney on GM

...loan guarantees would have given all the gains to Wall Street...

David and I blogged in 2009 and then many times since on the so-called auto bailouts. (Since when is bankruptcy a bailout? -- there were no winners, all lost something.) From the start we noted that the vertical structure of the industry -- suppliers, assemblers, dealers -- was central, because GM's failure would have taken them all down. This is not a trivial issue: suppliers employ between 2 and 3 people for every "automotive" worker, and dealerships employ fully as many as all of manufacturing. In 2009 all were teetering on the edge of bankruptcy. Without normal financial markets that would have meant Chapter 7 dissolution, not Chapter 11 restructuring. And let's not forget that the whole industry is woven together in a complex pattern. Most cars are sold today by dealership groups; your GM dealer is also a Toyota dealer. In the strained market of 2008-9, the failure of one would have led banks to foreclose on the other in a rush for repayment. And the supplier to GM is also a supplier to Toyota and to BMW. They would have no more been able than GM to make cars -- or even get repair parts to keep the service bays of their dealers generating revenue. Even in the Great Depression of the 1930s there was never a complete collapse.

Mitt Romney's father may have once been the CEO of American Motors [for those without long memories, the Jeep portion of the old AMC continues to mint money, and to keep Toledo Ohio afloat], but that doesn't mean the son inherited a deep knowledge of the industry. Mitt is ignorant of (or chooses to ignore) this complex structure,
and to pretend that financial markets could have raised tens of billions of dollars in 2009. I'm sorry, at the time banks were cutting their loan portfolios, and investment banks were worried they might be the next Lehman, and had no ability to employ their tricks to issue debt on that scale.

Romney's current stand however is that we should have guaranteed loans. Never mind that banks were cutting their lending, David and I have beaten that dead horse several times. But let's stop and think about the winners and losers under guarantees. If things didn't go well, we the taxpayers would be out a lot of money (but Wall Street would have collected a few tens of millions in fees, and collected interest on top of that). If things did go well, Wall Street would reap all the gains. After 7 years on the campaign trail, Romney is still unable to put himself in the shoes of the American public.

For all his defects, Hank Paulson and crew (among whom we should count Steve Rattner) worked on behalf of the Amerian taxpayer. They structured deals, from AIG to GM, to see that we would share in the upside. At last reckoning, GM's share price is still too low to put us in the black, but on many of the other deals we're in the money, indeed we're making out like bandits, Wall Street style. As a result, by insisting on an equity stake (and on tacking high interest rates on the loans we made, something that gets overlooked), we may not break even in the aggregate. But we're pretty damn close.

If he's elected, maybe Romney will reorient to thinking on our behalf, and not that of his and his buddies. Over the past 7 years he's failed to make that case.

...mike smitka...

Engines of Change By Ingrassia, Paul (Google Affiliate Ad)Once upon a Car By Vlasic, Bill (Google Affiliate Ad)

GM and the Upcoming Presidential Election

by David Ruggles

Amid the political turmoil of election season the rescue of the domestic auto industry by the George W. Bush administration and the Obama Administration is certainly a political football. The President and the Democrats have to defend the fact that the “rescue” wasn’t done perfectly, although a debate rages over exactly what those imperfections might be and who is responsible for them. Many Republicans are sticking to their position that the domestic auto industry should have been allowed to liquidate and eventually reform, although that logic doesn’t play well in the key “swing states” Ohio and Michigan. Governor Romney was adamantly against the “bailout” saying “Let Detroit go Bankrupt” and declaring that “a bail out would insure their failure.” Of course, this is all confused by Romney’s attempt in the Republican debates to actually take credit for the rescue saying, “They took my advice.” (His campaign has repeatedly declined comment when asked to clarify their candidate’s position on the issue.)

It also seems to ignore the fact that in the case of liquidation, there would have obviously been a huge cost dropped on the various states for unemployment compensation, a ripple impact through the banking system, chaos in the supplier base, and a disruption of military procurement. The ultimate result could have been a true Depression. Most pragmatic politicians wouldn’t have taken the risk, despite rhetoric to the contrary.

Some of the criticism leveled at supporters of the auto manufacturer rescue is based on the fact that if GM stock were liquidated today, based on its current value which is down a third since its’ IPO date, the taxpayers would sustain a loss in the tens of billions of dollars, which is entirely true. Of course, no one has calculated the cost of NOT doing the rescue, a calculation which would have to be based on speculation and would be subject to considerable argument.

Another issue rarely heard has to do with the billions of dollars of pension liabilities that would have been dropped on the Pension Benefit Guarantee Corporation. While a close estimate of that financial burden is not available, a comparison is. When United Airlines dropped their pension liabilities on the PBGC about 8 years ago as a part of their Chapter 11 bankruptcy, the amount was $6.6 billion. While this is technically an insurance fund, the obligation for pension obligations abrogated by liquidating OEMs and suppliers in the case of an auto industry liquidation would have easily run into the tens of billions of dollars, rendering the fund insolvent. This would have either landed on the back of taxpayers or pension checks would have ceased for many retired Americans. The impact on the psyche of the country and on consumption in the economy can only be imagined.

In the meantime, President Obama and Governor Romney and their political parties have both been banned from GM properties until after the election. There will be no political grandstanding on bailed out automaker facilities! Imagine banning the person who represents one of your largest stockholders, without whom you would not exist.

The two automakers have also refused to furnish vehicles for the national political conventions. It’s a smart move for GM and Chrysler to stay away from politics when possible. After all, they want to sell vehicles to both Republicans and Democrats.

While things are somewhat different for Chrysler now that FIAT has bought out the Federal Government’s stake, are GM executives hedging their bets in case President Obama loses in November? While it hasn’t been talked about a lot, it has occurred to more than a few GM stockholders (myself included) what would happen if Romney is elected and immediately dumps all of the government’s stock in General Motors. This would certainly be devastating for the stock price, but what does Romney have to lose? He could claim to have relieved of GM of its Government Motors moniker, while hurting millions of private stockholders. He could blame the losses on the previous administration, and move on. If reelected, it is a given that President Obama would hold on to the GM stock, selling small amounts at a time to maintain the stock price, while hoping the improving economy would further bolster the value of the taxpayer’s stock.

It is also a given that President Obama’s role in the restructuring in the domestic auto industry gives him a serious advantage in the November election. It is hard to imagine Ohio and Michigan going Republican. And without those two states, the road to the White House becomes a near impossible journey. And if GM shareholders across the country get wind of Romney’s intent to dump the taxpayer’s GM stock at once, it could impact the way people vote in other closely contested states.

Auto Bailout Redux: Warren Buffett

...it was Bush who bailed out GM -- Obama forced it into bankruptcy...

Steve Rattner's blog points out a February 27th CNBS interview with Warren Buffet that affirms what David Ruggles and I have argued from the start on our Autos and Economics blog, and reiterated here: that the alternative to the government provision of DIP financing for an orderly Chapter 11 restructuring of GM and Chrysler (as though bankruptcy is a bailout!) was a catastrophic dissolution via Chapter 7 ("close your doors forever" bankruptcy). As Buffett notes, capital markets weren't functioning, and there were no sources of working capital for firms seeking Chapter 11. Indeed, he himself told one of those firms "no" -- and unlike banks, he was not constrained by liquidity concerns and depleted capital. Rather, everyone was hunkered down, and clearly uninterested in what a priori was a very risky venture.

Now it's not as though the reorganization was perfect; lots of dealers had their franchises yanked, which neither lowered operating costs at GM nor improved their sales. That seems to have resulted from the input of a consultant who had worked for NADA (the National Auto Dealers Association). Of course every dealer wishes for one less competitor, but that's a tension with every franchise system: what's good for the franchisor is not always good for the franchisee. With hindsight there might have been wiggle room on other terms and conditions. But it's hard to fault what was done from a real-time perspective. Indeed, the speed with which the Chapter 11 restructuring was consummated should give creditors in other bankruptcies, who often shell out staggering legal fees for years on end, food for thought. And speed was critical to the revival of GM and Chrysler, and for keeping suppliers and the rest of the domestic auto industry afloat.

Let me close with a personal reflection. We will continue to quibble over the appropriate role of government in our society. We will always find fault, too, because by and large government is engaged in providing services that can't be quantified or for which market prices aren't available -- economists and environmental scientists can construct models to delimit how much less pollution is worth, but that's a far cry from trying to figure out how much a gallon of milk is worth.

Overall, however, I've always been impressed with the service orientation of those in the public sector, from local school teachers (the biggest component of Leviathan, and certainly not in it for the money!) to individuals such as Mr. Rattner (who incurred a pile of legal bills for the privilege of serving). Kudos! -- our society would be poorer without them

Mike Smitka
An essentially identical post is at the US and Economics blog.
My apologies if this shows up at an odd time; I may have forgotten to hit "publish" after writing it, or else went back to edit it without realizing I had to re-publish it.

The Industry in the face of the Euro's (partial) demise

...Eurxit and beyond...

The Euro as currently configured is not sustainable, from both an economic and from a political perspective. Spain cannot possibly deflate its way back to balance, and 20% overall unemployment and 50% youth unemployment is not politically tolerable. The only way out – forcing German banks to write off their Spanish debt now, matched by stimulus sufficient to turn Germany into a net importer – is not on the policy horizon, though in due course German banks will in fact have to write down debt.

If Spain falls, so will other parts of the Euro zone. Greece of course, and Portugal, and Ireland but not Italy? – I'm not euro-centric and don't know enough to create my own list. I assume France, Spain, Benelux, Austria and Finland will remain. To highlight issues, however, it is sufficient to focus on Spain.

The Euro exit process – I've seen the term "Grexit" used for the likely initial case – is not clear-cut. I would hope that central bankers and pan-European financial institutions are (quietly) working on possible scenarios. If so, in our leak-prone world, they really have been quiet. At the moment, a sensible assumption might be a three years of chaos in those exiting, since there seems to be no planning to support a quick and clean break (cf. the 1997 Asian Financial Crisis). In the interim, those remaining on the Euro would face a corresponding period of deep recession. Then would come two years of recovery that would leave economies below peak, followed by an era of more gradual reconstruction. The total: five lean years, less than what drove Israel to Egypt, but potentially just as devastating to the European heartland.

Not all auto firms are equal. For several – Fiat, Peugeot and Renault – Europe dominates their operations. So far VW appears exceptional, because its German sales base has escaped the current crisis and it is larger outside Europe. Then there are BMW and Mercedes, in the upper segment of the market, about which I know little, and so will hazard no guesses.

Other firms have a footprint in Europe, but are not dominated by what happens there: Fordwerke and Opel are but one part of the global operations of Ford and GM. Europe is peripheral for Toyota, Nissan, Honda and Hyundai. Their parent companies may or may not decide to tough things out – GM will have the hardest time –but unlike Euro-centric firms they have the option of exiting. That would matter if both Ford and Opel/GM leave the market, but otherwise would not remove enough capacity to change the equation.

Then there are automotive suppliers, the larger of which have substantial bases in the Americas and Asia, but still have their core in the Euro zone. My sense from visiting suppliers on a regular basis is that they've done a good job of geographic rebalance, to the benefit of firms headquartered in Europe and the detriment of those headquartered in the US. Asian suppliers are on average relatively weaker in Europe, and so will be less affected. Catastrophic failure of any of the large European suppliers would be catastrophic to the industry, the equivalent of Lehman Brothers in the financial world. Renault would (quietly) cheer the failure of PSA or Opel. All would lose in a meltdown of the supplier base.

Shifting gears from firms to geography, Eurxit (pardon the neologism) would bring a large devaluation to Spain. That is most obvious relative to the Euro; imports from Germany and France [Grance? Framany? – the new Europe will need new jargon] would be much more expensive. However, I would also expect the (new) peso to depreciate relative to currencies in peripheral Europe, since Hungary, the UK, Russia and Turkey already reflect a more sustainable level relative to the Euro.

If it could avoid collapse during the transition, Seat as a local firm (albeit also a VW subsidiary) would benefit from a large shift in relative prices that would improve its strategic position. It could become a true value brand in Europe, with increased exports and (due to the higher cost of imports) would have a near-unassailable position in its home market. Seat might still be Skoda's poorer brother, but its place in the VW family would be more secure. Now the labor cost component of local [Spanish] assembly is modest, and many parts and components are imported, muting the initial benefit. Over the space of a few years, however, local content would rise and with it the peso component of the cost base.

In contrast, firms remaining in the Euro cost base would see their export markets shrink, and the burden of the zone's excess capacity is already heavy. Who has deep pockets? VW, yes, but (potentially) Ford, Opel, Toyota, Nissan, Honda and Hyundai. Chrysler isn't big enough to fully balance Fiat, nor Nissan to balance Renault. Absent government intervention, it is hard to imagine all of these small firms surviving five lean years. In addition, GM's pockets aren't deep; Ford is still rebuilding its balance sheet. Eurxit won't help the US economy and it won't help China, so won't help either firm. So it is conceivable that one of them would exit. It is almost inevitable that the European market would witness multiple bailouts, given a greater political sensitivity to unemployment than in the US. This would be to the detriment of VW, and to any of the branch operations of US and Asian-based firms that remain.

This is my first pass at the implications of Eurxit. Additional differentiation would come from breaking down market shares of individual firms between Eurxit and Euro countries; who is strong in the Mediterranean periphery, and hence more vulnerable? Who has the weakest balance sheet among OEMs and among suppliers? On which side of the divide will Italy lie? Who has a stronger base in the non-euro periphery (Turkey, Hungary, Poland, Russia) and so may be better positioned to pick up pieces of the market via exports?

We can always hope for a miracle European unity, that France and Germany can act as one. So far the fear factor is failing to force fraternity. The initial Eurxit – Grexit? – may change that, but my hunch is that by the time it will be too late.

Finally, this places a fundamental strategic choice in front of firms not irrevocably committed to Europe: do you marshal resources for a long and expensive slog there, or do you prepare to retreat and instead concentrate on the Western Hemisphere and Asia? Even with a reconfigured "euro" divide Europe will remain on average prosperous, and with a population larger than the US will remain potentially profitable. But is every current participant willing to wait until 2018 to realize that potential?

...Mike Smitka...

Bad News for Toyota? – the Detroit 3 are Back

...the Detroit 3 are returning to the midsized-car segment...

I'm tossing out back issues of Automotive News to try to fit into a corner office with more windows but less shelf space. I know, crocodile tears for this academic with his shelf-filling collection of books and journals. Anway, one headline caught my eye: "What can save the Detroit 3? Cars!" [a John K. Teahen, Jr. editorial from Sept 18, 2006, p 16].

The context was the near-exit of GM, Ford and Chrysler from the car market, which decreased monotonically from 89% of their sales in 1965 to 35% in 2005, while (correspondingly) trucks went from 11% to 65%. Now admittedly trucks were incredibly profitable on a unit basis, while small cars were a necessary evil, intrinsically unprofitable but needed for CAFE (the Corporate Average Fuel Economy mandate). But the decline at the Detroit 3 was disproportionate to the shift towards light trucks in the over US market.

One point is that ambitious designers, engineers, and senior managers all want to be associated with halo the ka-chenk of good bottom-line vehicles. Teahen argued that the Chevy Impala remained a potential money-earner, with hoped-for sales a bit above the 296,000 of 2006. In fact, on a platform basis, output was higher – 500K – reflecting the multiplication of nameplates that were in fact the same basic car, but the implication of the editorial was that it wasn't making much money. And even with the shift of the overall vehicle market towards light trucks, such sales pale besides the 1-plus-million mark hit of 1965. GM wasn't putting its heavy hitters on car projects.

I've argued before on this blog that Toyota lavishes undue attention on the Prius and on the Lexus marque, again reflecting the status of these projects within the company as a whole. Reputedly Toyota's working to correct that bias, devoting more effort to the 2012 version launched in December 2011. Time will tell if it is better executed and better selling.

Today, however, the Detroit 3 are a factor. They have very different cost structures, with the removal of the millstone of legacy costs from around their neck, a function of the aging of workers "retired" under pre-2007 restructurings, the impact of the VEBA and (for GM and Chrysler) additional costs shed under bankruptcy. Labor is no longer a fixed cost. They thus no longer need to maximize revenue [which for you economics junkies is also implied by the low marginal price of labor]. Instead they can aim to make money from cars. We see that in reduced incentives, reduced fleet sales -- that is, higher prices -- and a normalization of residuals. (I can't speak of leases -- I lack knowledge and suspect that option continues to suffer from the aftershocks of the financial upheaval of 2008-9.)

What does that imply for those who remain focused on cars, particularly Toyota, Honda, and Nissan? On the one hand, they ought to benefit from less discounting. On the other hand, they are hurt by reinvigorated Detroit 3 products. The latter, I believe, dominates: from Toyota's perspective, they have two new, heavy-weight competitors in GM and Ford (and in some product categories, a 3rd in Chrysler), and while Hyundai has been around for a while, sales of the Sonata are only now such as to represent a major slice of the mid-size segment of the Camry and the Accord. If you've become a bit sloppy dare I say arrogant? the sudden appearance of new competitors can be very painful.

My prediction thus is that Toyota (and Honda) will resort to greater discounts and higher fleet sales. That should be good news for new car buyers. (Car renters will have greater choice, but price may not budge much, better residuals will work against higher initial acquisition costs for Enterprise and their rivals.) But since Toyota relies on exports from high-yen Japan for Lexus and (to a lesser extent) the Prius, they've taken a major hit to profits on that front. I'll leave it to financial analysts to pour over segment results of the major players, particularly Toyota, to see if the new competition means their US profits take a hit as well.

Mike Smitka

comments welcome, here or via email!

Toyota vs GM: Guess Who's the Dinosaur!

...economic theory says dominant firms adopt strategies that undermine their dominance ...

This isn't an enthusiast site, and I'm not a car guy. My family didn't have a second car growing up so tinkering with one never became a hobby. My attitude is horribly utilitarian: a car's function is to get me from point A to point B. So my own vehicle is 24 years old, my secondary one is 14 years old (while my wife's is only 8 years old). When I go on long trips I try to rent a car. And when I visit auto suppliers as a PACE judge or otherwise do the limited travel in which a normal academic engages, I also rent cars.

That said, I have written on this blog about the logic of a leading firm to "never be first" (in its heyday this was the case at GM, and in the past two decades became an operating motif at Toyota). Furthermore, there is an internal bureaucrat logic at large companies. I've not interviewed people about this, so I'm not being my normal careful academic self in stating it, but I surmise that if you're an ambitious engineer / designer / marketer at Toyota, you wanted to be associated with the Scion (Akio Toyoda's pet project) and with Lexus (prestige and profits). To work on the Camry would be a ho-hum posting. You wouldn't be using it as a platform to launch new technologies. It isn't a platform for future products for developing markets.

That would be quite different at a Hyundai or at today's GM. Hyundai started out with a very small market presence, both quantitatively and prestige-wise and in the size of its cars. The Sonata received a lot of attention, details well done including NHV, but I've not driven one for a couple years so don't know the new model. GM needs to reconquer the sedan market. I've driven both the Malibu and the Impala -- the latter so quiet that I had to double-check that I'd turned on the engine, and with a "clean" interior. I was impressed.

Then there's the Camry – I drove a new one with a few thousands miles on it. It was noisy, wind noise in particular. Then there was an occasional vibration from somewhere in the instrument panel, a matter of both design and (poor) build quality. Next was the instrument panel itself. I counted 12 active functions in the speedometer area, a cacophony of visual information (the mixed metaphor seems appropriate). Speed. Tachometer. Miles per gallon performance. Engine temperature. Odometer. On and on. Other than the speedometer, you really had to take your eyes off the road to decipher these functions – and it wasn't clear why a driver of a modern, automatic transmission family sedan would want a tachometer or most of the other functions. Dysfunctions, actually. There was also a large and hard-to-use LCD display -- and the gas mileage information on it didn't match that found next to the speedometer. Furthermore, the hands-free phone function didn't work consistently, particularly dialing out. The developers clearly hadn't done their homework on testing the bluetooth protocols of various phones against their system. Finally, it drove like a modestly responsive boat. That may be what older drivers want – and by older, I mean those pushing age 80. I don't think that's really their target market in theory, and in practice age 70-something drivers wouldn't be particularly receptive to the boatload of gadgets confronting them every time they got in the car.

So, this is congruent with economic theory. A dominant player plays it safe, and puts its resources into growth areas and pet projects of senior management. Over time of course they lose their dominance. But this sort of thing is not easy to turn around, viz. GM's experience. Toyota has a well-entrenched bureaucracy, structured in ways that date back to when they were an exporter of models developed in Toyoda City. On the marketing side in the US there was Toyota, and Southeast Toyota, and Southwest Toyota, rather than a national structure. And they've bought into the upmarket strategy, with profits (and internal kudos) from Lexus and not small cars. That no longer matches their actual market base and production base, and it leaves them ill-suited to tap new markets such as China and India.

I strongly suspect that this is well-known at Toyota itself; after all, there was an internal coup in Toyota that elevated Akio Toyoda earlier than planned under the normal bureaucratic progression, even before the recall scandal. The Camry suggests however that organizational dynamics are deep-seated and have to date resisted change.

Mike Smitka

Auto Bailout Redux and Mitt Romney

See the post on my parallel blog, US and Economics on Mitt Romney's puzzling statements on the government-led bankruptcy of GM and Chrysler. First, as I discuss there, Romney knows finance and so must know he's wrong. Second, and not discussed there, from my end it's not a bright strategy to take this stance in Michigan. After all, the UAW membership in my experience is strongly Republican in leaning -- it's the leadership who support the Democratics. So he's not exactly helping his cause, though I don't follow the ins and outs of campaign strategy and presume I am missing something.

Readers of this blog likely remember that it was Bush who bailed out the industry, with $17 billion or so in loans (the figure is from memory) with no strings attached except for providing a "plan". Obama would have none such, and let these firms file for bankruptcy. In the absence of a functioning financial market, the US government provided the DIP financing that is a normal and necessary part of Chapter 11, and took an equity stake when firms exited, again normal bankruptcy practice -- but the whole thing was extraordinarily well done, as large-scale bankruptcies normally take many years, not 90 days.

Now Rick Santorum is saying similar things -- see the following -- but we have no illusions that he knows anything about finance or economics. He seems to think that the normal "private market" Chapter 11 bankruptcy is quick, that recovery after one is prompt, and that in early 2009 private equity markets would have lent $50 billion to the industry. All three parts of this sort of claim are incorrect.

From Automotive News (link here):

GM and Chrysler would be "alive and equally as well, or better off, than they are now," Santorum told about 300 people at a Detroit Economic Club luncheon today. "The markets would have reacted to restructure it to be more competitive."

Read similar coverage on Bloomberg: http://www.bloomberg.com/news/2012-02-17/auto-recovery-defines-terms-of-engagement-for-michigan-primary.html

Mike Smitka

Book Review of “All the Devils are Here
The Hidden History of the Financial Crisis”

“Hell is empty and all the devils are here” - William Shakespeare - The Tempest

This brilliantly written book should be required reading for any registered voter in the USA. With all the misinformation “out there” about who and/or what caused the financial crisis, it is important to know where to go for answers. This book is “The Source.” The authors are Bethany McLean and Joseph Nocera. McLean was co author of the highly regarded book on the Enron crisis, “The Smartest Guys in the Room.” Nocera is an acclaimed financial writer for the New York Times. The authors’ mission is to tell the story accurately and honestly with no particular political agenda, to explain the complex in a way that can be understood by those not steeped in Wall Street “speak,” and to provide insight into the personalities and characteristics of the major players. The level of research evident in the book indicates to me that the authors were already well connected before they began their research for the book.

Why is the issue of the financial system meltdown important to those who follow the auto industry, and other sectors of the economy? In the late 1970's, consumption represented about 60% of the total economy. 30 years later, consumption was up to about 70%, despite the fact that the income of the middle class had remained stagnant during that time span. How did this occur? The additional consumption funding came from credit fueled primarily by “securitization.” Wall Street’s version of “securitization” had been invented and had grown to 40% of the total credit market by 2008. This expansion of credit fueled economic growth. When the mortgage backed securities market collapsed, it took down the entire securitization market including, credit cards, student loans, commercial loans, auto loans, dealer floor plan, and many other forms of credit. Losing a major portion of available auto credit and funding for dealer floor plan and working capital, pushed already shaky auto manufacturers over the brink, as auto sales slid and dealers dropped like flies. The resulting vicious cycle took the economy downward into recession. The Troubled Asset Relief Program (TARP) was all that stood between the economy and a major depression.

“Securitization” was the process that “allowed mortgages to be converted into a “bond” by combining numerous mortgages into one huge financial instrument. First, Wall Street invented “tranching” to divide up the securities into segments, typically three, based on the inherent risk each tranche entailed. This protected the highest risk level tranch from loss by paying off defaults from the lower rated tranches first. The next step was to devise “derivative” contracts to “insure” the risk. Based on derivative “insurance” like credit default swaps, Wall Street was now able to convince regulators that it was not necessary to “reserve capital” as a hedge against default claims. Now, if only they could get these securities rated AAA by rating agencies like Fitch and Moody, Wall Street nirvana could be achieved. Now junk could be sold around the world as high yield AAA rated securities. AAA is the rating equal to the rating of Treasury bills. To say the least, billions of dollars were made, huge bonuses paid, and many innocent people bilked.

Guarantors of risk were not required to have the money to make good if their bets didn’t pay off. Yet, traditional depository banks were still required to reserve capital, as had been the norm ongoing. This rendered traditional banks to be uncompetitive UNLES they sold their own mortgage originations to Wall Street. If a depository bank originated a mortgage, it could sell that mortgage to Wall Street, buy it back as a part of a AAA rated security, and avoid the “capital reserve requirement. Rating agencies like Fitch and Moody were paid by the Wall Street banks whose products they rated.

Junk mortgages could be assembled into a MBS (Mortgaged Backed Security), tranched into 3 segments based on “risk,” “insured” with a Credit Default Swap contract where no capital reservation was required (it was assumed that Wall Street would not take risks not in their own interests), obtain a AAA rating to represent the securities’ safety as the highest grade, which allowed them to be purchased by entities limited to AAA investments by law, like pension funds, and sold around the world . Profits were privatized on Wall Street as huge profits were made and mind boggling bonuses paid to executives. The risk, however, was socialized to U.S. taxpayers.

The U.S. government, in the form of the George W. Bush administration and it’s Treasury Secretary Hank Paulson, was put into the position of allowing the world financial system to collapse or step in with TARP. Fortunately, Congress approved TARP, which despite its imperfections, saved the world from an incomprehensible disaster. After all, it was the U.S. government’s lack of oversight that stood by and let it happen in the first place. Other countries were looking to the Americans as their own economies were severely impacted by the actions of American investment bankers.

Governments are generally expected to protect it’s citizens from avoidable disasters. The Republican Party found this out after the Great Depression. Democrats paid a price after Jimmie Carter. Even President Barack Obama has been blamed by some despite the fact he had nothing to do with the disaster, other than casting some votes while a Senator. Unfortunately, many voters lack the ability to grasp complex issues, and fall prey to simplistic explanations.

In 1979, the Wall Street version of securitization was invented and launched by Merrill Lynch. Government Sponsored Enterprises (GSE) in the form of Fannie Mae, Freddie Mac, etc., had securitized the first mortgages in previous years. The GSEs were given objectives of how many low down payment low income loans they should make at a minimum by Congress. The compensation packages of the executives of the GSEs were predicated on these objectives. Interestingly, the GSEs were already making these types of loans at a much higher rate than the objectives they were given, making huge bonuses a given. Further, the GSEs received credit just for purchasing AAA MBSs containing them from Wall Street. The GSEs thought that was safer than holding the paper themselves. In fact, Wall Street had rendered the GSEs superfluous.

Wall Street was allowed to create a “betting market” on almost anything. The problem was not so much deregulation, but a refusal to regulate at all. During the period of time Wall Street was “rocking and rolling” American home ownership increased only 1.7%. Yes, we have paid a terrible price for such a small increase in the percentage of those who get to experience the American dream. Yes, mortgage originators “approved” huge numbers of loans with little chance of them being paid back. And they did this because they were never going to hold the paper anyway, just as an auto dealer sells auto loans to his/her banks. It was all being sold to Wall Street because they could take the lousy paper, turn in into AAA rated securities, and sell it to anyone. But the real problem was with home refinances and home equity lines of credit.

So who caused the meltdown and who were the players? In 2008, I wrote that the meltdown was caused by an “unholy alignment between liberal and conservative political causes.” This was after watching hours of testimony on CSPAN and studying the subject intensely. After two years of additional study, including watching Hank Paulson, the Bush Treasury Secretary and author of TARP, testify before Congress under oath, I have adjusted my thinking. But my own personal opinion is not important. All of us have to satisfy ourselves. For those who want to believe the meltdown of the financial system was caused by the overly altruistic “holding a gun” on lenders, forcing them to make loans they knew would never be paid back, you will be disappointed. It’s a non issue.

Some major “players,” their roles, and some resources are listed as follows:

“All the Devils are Here,” Nocera and Mclean

“On the Brink: Inside the Race to Stop the Collapse of the Global Financial System,” By Henry Paulson”

The last chapter of Bush speech writer David Frum’s recent book: “Comeback: Conservatism That Can Win Again”

“Overhauled” by Steve Rattner

George W. Bush speech on American home ownership from 2002

http://autosandeconomics.blogspot.com/

George W. Bush - consciously worked to prevent anything from slowling the housing juggernaut that was fueling the economy. He also had the guts to stand up to his own party’s ideologues to move to save the economy from destruction by proposing and passing TARP along with his Treasury Secretary. Moved against Congress to bail out GM and Chrysler by using TARP funds after Congress had turned down a bailout package.

Alan Greenspan - a disciple of Ayn Rand, Chairman of the Federal Reserve, fought regulation of derivatives at every turn

Larry Summers - under the Clinton administration was an opponent of regulating derivatives. Teamed with Robert Rubin to squelch Brooksey Born’s bid to regulate derivatives. At the time, Born was Chairperson of the Commodities Futures Trading Commission. As a member of Barack Obama’s administration, Summers was a key player in the bailout of GM and Chrysler, and the direction of many TARP funds.

Robert Rubin - Treasury Secretary under Bill Clinton - worked to quell efforts to regulate derivatives

Brooksey Born - Chairman of the Commodities Futures Trading Commission - moved to regulate derivatives, and was squelched by Rubin and Summers.

J P Morgan - invented the credit default swap by paying the European Bank for Reconstruction and Development to assume it’s risk in their exposure to Exxon, which tapped 4.9 billion of it’s 5 billion dollar credit line after it’s notorious oil spill disaster. It never occurred to anyone to ensure the EBRD had the funds to make good in the case of a default. It turns out it didn’t make any difference. Years later, the were many claims to be paid and only the U.S. taxpayer to pay them.

Moodys, Standard and Poor, and Fitch Rating - Were paid by the same companies who’s products they were supposed to rate. Enabled Wall Street to sell junk as AAA level investments.

The Three Amigos - Lewis Ranieri - Salomon Brothers bond trader - “I wasn’t out to invent the biggest floating craps game of all time, but that’s what happened.” David Maxwell - CEO of Fannie Mae, formed an uneasy alliance with Ranieri and Wall Street. Larry Fink - After creating some of the first mortgage backed securities he later served as a key government advisor.

Blythe Masters - helped invent the credit default swap for J P Morgan

Joe Cassanno - Ran the Financial Products division for American Insurance Group (AIG) - Began selling credit default swaps (CDS) on collateralized debt obligations (CDOs) “Collateral triggers” built into AIG CDSs helped bring the company down.

Phil and Wendy Gramm - As Senator and later as Chairman of the Senate Banking Committee, Phil blocked attempts at regulation at every turn. Wendy Gramm, a PHD economist, was installed as Chairperson of the Commodity Futures Trading Commission (CFTC) by Geroge H W Bush when it’s current Chairman, Mark Brickell, was moving to regulate derivatives. The move stopped the move to regulate in its tracks.

Roland Arnall - Appointed to the post of Ambassador to the Netherlands by George W Bush while his company, Ameriquest, a major sub prime mortgage “lender,” was a leader in blatantly deceptive lending practices. At one point, a group of ex auto business F&I managers operated a consulting company, specializing in showing fledgling mortgage brokers how to falsify and manipulate documents. They went so far as to have a web site devoted to creating phoney pay stubs, tax returns, job letters, etc. In fact, Wall Street wasn’t really concerned about documentation, as they were able to turn lousy mortgages into AAA rated investments under most circumstances.

President Barack Obama - Was duped and gave Arnall a pass during Senate questioning regarding Arnall’s ambassadorship because a mutual friend, Deval Patrick, the current Governor of Massachusetts, sat on the Ameriquest Board of Directors. His administration inherited the economy in a dreadful condition, although without the strong and decisive action of George W Bush, Hank Paulson at Treasury, and Ben Bernanke at the Federal Reserve Bank, things would have been much worse.

These are only a few of the personalities and characters involved. Before a reader allows themselves to be intimidated by the prospect of not understanding everything in the book, please understand that the people perpetrating these evils on the world didn’t fully understand what they were doing themselves. People don’t usually buy books about business for entertainment purposes, but I couldn’t put this one down. It read like a riveting“who dunnit.” Don’t pass up the opportunity!

Ruggles

Opel & GM

Mike Smitka
Further to my earlier post, Is there a GM without Opel?, the sticking points of GM's negotiations with the Magna-Gaz/Sberbank are over intellectual property rights: Opels are (currently) the core of GM's international operations and rights thereto can't be freely given away. My opinion stands: GM cannot afford to let Opel go and remain an ongoing enterprise. Too many of its engineering resources are bundled into Opel, and vice-versa. Germany doesn't want restructuring, enough unemployment already, and as partners in the current "trust" that controls Opel... How this works out is crucial. And apparently some at GM concur.
More posts shortly, following up on the June Business History Conference in Milan, on the tension between "administration" (as in MBA) and management (as in long-run health) and on health care. But first I have a book review, a manuscript review and an article to complete, all on the Japanese economy. And it's hard not to spend time reading about political turmoil, with PM Aso about to dissolve the Diet for an election that will almost surely dislodge him (and probably the ruling LDP coalition) from power.

Toyota and General Motors

Mike Smitka
The new General Motors was spun out of bankruptcy on Friday, July 10th. Its prospects are uncertain. The new cost structure and (one hopes) an end to complacency should lead in time to successful enterprise. Eventually: we should find caution in that GM's now much larger rival Toyota continues not only to lose money, but to lose it at a faster rate than GM-old.
What gives?
First, Toyota has gone where the money is: larger vehicles in North America. Toyota now sports V-8 engines, a full-sized pickup truck and a range of SUVs and other light trucks. Does that sound familiar? Well, so are the consequences: red ink. It was making its Tundra pickup in both Indiana and Texas; no more. All production is now in Texas – and that plant was closed for over 3 months in summer-fall 2008, and runs only one instead of two shifts. So it has billions in sunk costs that are generating little to no revenue, and is reluctant to lay off workers, as that policy has been a mainstay in its battle to keep plants union-free. Nor is the prognosis good: even if gasoline prices stay low, Toyota has few rural dealerships. Despite cutbacks, the Detroit Three still do.
Second, Toyota has focused on the American market in general, again because that is where the money is. The company is a modest player in Europe, and a latecomer to China; the population in Japan is aging, and the number of licensed drivers in its home market is in decline. It may book profits in Japan, because that's where the production of most Lexus vehicles is still located. But sales depend on the US.
It gets worse: product planning also followed the money. Anyone of my generation can remember (or often owned) a Toyota at one time (my first new car purchase, in 1981, was a Toyota Tercel). They were small, sparingly powered rust-buckets, but with good mechanicals for their time (by today's standards, they were junk). No longer are Toyotas small or sparingly powered. That pairing generates profits – the public perception of fuel economy is swayed by the Prius, but the Prius makes no money, at least since the price was lowered to fight the Honda Insight at the same time that the yen strengthened. But back to that pairing: such vehicles are peculiar to the North American market, and don't sell well in Japan or Europe. Those markets are left with larger vehicles that don't fit, they're just a bit too large on every dimension. Toyota thus struggles to sell such potential high-margin vehicles everywhere else in the world.
Third, they became a big company with big ambitions, replete with MBAs in various HQ functions. For those who don't know their history, Toyota was bailed out by the Japanese government in 1950, because they kept "pushing the metal" on dealers despite a recession. One measure, along with kicking the Toyota family out of management, was to split off the sales functions to increase their ability to say "no" to the factory. The separation between Toyota Auto Sales and Toyota Motors lasted about 30 years, but they've now been merged for 25 years. Headquarters staff over the past decade came to dominate product planning, investment planning, well, MBAs plan. But not always well, not when they are far removed from the "real" world of sales and manufacturing. Sure, Toyota was earning a better return on equity, 5+% instead of the early 3-4%, while return on equity was pushed to 15% and above. And sales kept increasing, first overtaking VW, and then briefly GM.
They were going to rule the world; they had already taken over Daihatsu and Hino inside Japan, and more recently acquired stakes in Fuji Heavy Industries ("Subaru") and Isuzu, both former GM affiliates. They upped their share of Denso to a controlling stake. And there was Lexus, and the Tundra, all those other nice high-margin vehicles. To support this growing empire took a lot of investment. But while the product plan looked good on paper, it wasn't necessarily what the people on the ground were comfortable making and selling. Furthermore, product proliferated, a car for every niche for every name plate. Inside Japan Toyota maintained 5 distribution channels and 47 cars in its 4 "legacy" channels, 9 for its new Lexus channel, and 13 more at Daihatsu (covering the minicar end of the spectrum). Add another 14 light commercial vehicles – but leaving out all of the heavy truck and bus makes of Hino – and they have 83 model names inside their domestic market. [my count] Toyota's brands are muddied and the cars are bland.
It doesn't take much imagination to see what happens to marketing costs. To make matters worse, Toyota outright owns several large (40-plus sales point) urban dealerships, because they can't operate as profitable ventures. (Not that people seconded from headquarters – with salaries paid by the parent company – improve matters.) And think of the engineers: they're so busy doing product, and all that totally new stuff for the US, that they don't have time to do things right, at least by their standards. Recalls are up sharply. Costs, too, because forcing commonality takes time, and time they do not have. (Remember, in today's auto industry most manufacturing is at parts firms, so using parts in common is the key to cost control.)
Fourth, they have their own unions to contend with, and those unions include engineers and regular office workers, not just factory hands. Plus it's easier to coordinate inside Japan, because even today language skills are weak. So we now find Toyota entering a steep recession with the ability to build 10 million vehicles, all according to plans from HQ, but with sales of only 6.5 million. Worse, they have added to that capacity not only in places such as Texas but also in Japan, where they can now build 4.5 million vehicles. In the process they have allowed their export share to gradually rise from under 40% in the mid-1990s to roughly 65% in 2008. But egven as exports have fallen due to the global recession the yen has strengthened, amplifying their losses.
We may not have seen the worst of it. Toyota has quietly added a couple stamping facilities, bought from a failing domestic supplier. But it surely has many other suppliers, pushed to match its expansion, that have weaker cash reserves and weaker management. As things stand, they will have to pick up the tab (which to me is ethically appropriate, but is surely not part of the financial projections of their MBAs). And already their ROA has swung from 5.9% in April-June 2007 to -10.4% in Jan-Mar 2009. That's a swing in profits before taxes of Δ¥1,654 billion (or ΔUS$17.8 billion at this weeks average of ¥93 per dollar). Toyota maintains a sterling (though recently lowered) credit rating and sits on $30 billion in cash and securities and $40 billion in financial receivables. But it also has $64 billion in short-term debt and long-term debt due this fiscal year. Far better than GM, but as a big, heavy firm its cushion is not as comfortable as it once was.
Wish the new president Toyoda Akio good luck! If it wasn't for his ability to borrow to tide things over, he'd be facing a tougher battle than GM's new CEO Fritz Henderson.

This article relies on Toyota financial reports, on a 3-part series in the Daily Automotive News 小室祥子「トヨタ・新時代への展望」『日刊自動車新聞』 連載: 26, 27, 30 June 2009 and an article in Bungei Shunju 井上久男「覇者トヨタに何が起きたのか」『文芸春秋』March 2009, 94−108. While I did not stumble across it before drafting this note, see also the 22 June 2009 Bloomberg article Toyoda Asks How Many Times Toyota Errs Emulating GM Failures by John Lippert, Alan Ohnsman and Kae Inoue. Based on it, I edited my comments on the operation of the San Antonio, TX truck plant. They also note that Toyota dedicated its Woodstock, Ontario car plant in December 2008, and provide other examples of the firm's (overly) ambitious expansion plans.