Maryann Keller - Recent Speech at a JD Power Conference

For the over four decades I’ve been involved with the auto industry, first as an investment analyst and now as a consultant and director serving on the boards of both automotive companies and auto dealers. Over those four decades, I’ve heard many arguments made against the franchise dealer system…which dealers never fail to disprove time and time again.

One myth promulgated in the 1990s - and now resurfaced by Tesla - is that factory stores save money by reducing distribution expenses wrongly estimated at 30% of total expense. Let’s put aside for the moment that the percentage itself is nonsense, Ford’s ill-fated Auto Collection experiment proved conclusively (as told to me by a former Ford executive last week) that corporate guys are not risk takers and lack the entrepreneurial spirit to manage dealerships. Big corporations control from the top but selling cars requires street smarts and adapting to local market and competition. Ford ended its experiment after a couple of years of market share losses amid mounting evidence that factory stores do not deliver a better customer experience nor reduce costs, in fact they proved to be bad at both. GM, perhaps after watching Ford’s travails, and despite repeating the same nonsense about reduced costs through factory ownership, canceled its plans to buy 10% of its dealers, plus the Saturn stores, and operate them in through what it called GM Retail Holdings.

Ford’s failed experiment demonstrated that, franchise laws notwithstanding, dealers are essential partners in the long process of a car’s journey from the factory to a customer’s garage. Franchise laws protect dealers from arbitrary actions by automakers and given the financial commitments they continue to make in response to factory demands in image programs, equipment, training and even vendor selection, the laws are entirely reasonable. Given the intense competition in auto retailing, it’s hard to understand how anyone could suggest that franchise laws hurt consumers.

Franchise dealers’ cumulative investment in land, equipment and facilities easily exceeds $100 billion. Dealers fund 60 days of inventory and another month of inventory in transit that would otherwise fall to the carmaker. The inventory buffer allows automakers to adjust future production levels. For a company like Ford US inventory funding equals about $15 billion at any point in time.

Tesla may be the first start up to launch a car and change the retail process as well but it is definitely not the only company that saw dealerships as a costly impediment to customer bliss. A few years ago I was involved with one such company funded by venture capitalists, and led by a non-automotive executive, that invested in a small car promising to build to order sold though mall-based stores. The car never made it to production and the company folded after consuming the investors’ capital. .

Despite evidence to the contrary and lacking any real world understanding to the business, a journalist writing on Yahoo Autos last year stated “Instead of building cars and selling them to dealers who hawk them to shoppers, Tesla wants to build only cars to customers orders, eliminating part of the auto industry’s massive overhead costs in inventory. By selling cars directly Tesla’s executives believe they can make their customer happy, and eventually sell more cars for less money.” Well we will see if it is fact is more economical for the factory to pay the rent, salaries, delivery and service or have someone else do it using his or her own capital. And build to order works only as long as there is an order bank…what happens when the orders dry up…do you send the assembly workers home, tell your suppliers to send to stop producing until you call?…..unfortunately auto assembly really doesn’t lend itself to build to order. It is capital and labor intensive even when work is farmed out to suppliers.

Every dealer knows that the vast majority of customers want their car that day not a date convenient to a manufacturer. The dealer has always been the buffer with the automaker facilitating inventory management through various incentives and production adjustments. It is the dealer who finds the market-clearing price for a vehicle even at the sacrifice of his or her profits.

Others have tried experiments in selling away from the traditional retail dealer location on the notion that a big box retailer or mall would mitigate advertising expenses by placing cars where the customers are.

Early in the 2000s, Asbury struck a deal with Walmart to sell used cars in the parking lots of Walmart stores. Asbury would take the cars to where the retail customers were at America’s busiest retailer. A few dealers have experimented (as Tesla is now doing) renting inline space in large shopping malls as storefronts to sell cars. So far, the history of non-dealership settings to sell cars – with perhaps the exception of the infrequent offsite tent sale – hasn’t worked. The Asbury/Walmart experiment ended in less than two years when both parties discovered there were too few car buyers among the static population of regular customers who shopped for food and other necessities at their local Walmart each week.

I suspect that once the novelty associated with Tesla wears off, it too will also discover that mall locations aren’t ideal places to market or sell cars. The enclosed shopping mall typically has several large anchor stores – Nordstrom, Macy’s, Neiman Marcus, etc. – and perhaps eighty to one hundred or so “in line” shops like GAP, the Limited, Zale’s, Sunglass Hut, Apple, etc. A large successful mall might have more than a million or more visitors a year – and that’s about 3,000 folks per day. Those big numbers can dazzle but they aren't what they seem. Much of this traffic represents repeat visitors, as it did at Walmart, coming each week or so to see the changing merchandise at her favorite stores – new fashion and seasonal clothing, makeup, shoes or the latest Apple gadget. Everything can be purchased on a credit card. I used the pronoun “her” deliberately because the vast majority of mall stores are dedicated to women and children not the men who would be the targets for an expensive, high tech performance car.

Furthermore, new car models are only really new only every four to six years. The merchandise doesn’t change very often – so on the second or third visit to the mall, the car store looks exactly as it did last month or even the month before. What was fresh once is now stale with the passage of time…so visitors to the mall just skip past that new car display.

What the uninformed forget – or figure out after an attempt or three – is that automotive retailing is very different from traditional retailing. The product car dealers sell is expensive, generally requires financing, and often involves a trade. It often includes helping shoppers match their budget to a car that might not be their first choice but rather one they can afford. The process is slowed by required disclosures and regulations resulting in a pile of documents that have to be signed even for the most straightforward transaction.

A car weighs 4,000 pounds and takes up 50 square feet of space. It can’t be delivered overnight to one’s front door by Fedex. And most folks don’t have a big enough credit limit on their Visa card to pay for it. And what do they do with their trade? Or get it serviced?

While we are talking about myths, how about the still repeated one that people hate dealers so, if given the chance, they will buy a car online. I almost don't know where to start in taking this one apart…..In the early days of the Internet, Silicon Valley funded and lost hundreds of millions, maybe even a billion dollars, on ill-fated ventures that promised to do just that. CarOrder.com, Greenlight.com, and CarsDirect.com (in its original configuration), among others, all promised to avoid the dealership experience. A few actually did that by buying cars from dealers and then reselling them at lower prices to customers until they blew through their capital. Build to Order.com proposed that you would place your order for a fully customized car while lounging in a company-owned showroom entertainment center. Again here the premise was to build these cars using an automaker’s parts and technology but avoiding high labor costs and dealerships and give the customer the exact car they wanted. Build-to-order.com never built anything for anyone.

In 1999 and 2000, I ran priceline.com’s experiment with selling cars online, which like most others of the era no longer exists. The essential elements of the priceline model were replicated by TrueCar.com and of course they too ran afoul of franchise laws for the same reasons as priceline. What I learned then – and this is still true today – we could connect buyers with dealers and that the price of a vehicle was the easiest part of a deal. The other elements are harder to control and often the cause of frustration for the customer and the dealer. People don’t like to hear that their trade isn’t worth the value they saw online or that their poor credit doesn’t qualify them for the no down payment, zero percent loan. There are few people who would think about buying a house online from a few photos taken make rooms seem larger than they are or the neighbors Beware of dog sign. Buying a car is comparable to buying a house, why should we think it should be as easy as buying a pair of shoes from Zappos with a return receipt in the box in case they don’t fit.

Although many automotive websites claim to have “sold” millions cars, even today twelve years after priceline decided to concentrate exclusively on travel, automotive websites link a buyer to a dealer who actually sells the car. The Internet has mostly replaced the newspaper as a source of information about cars and dealers but it has not reduced advertising expense per vehicle or made buying a car as easy as buying a book.

Add up all the monthly traffic to all automotive sites, including automakers, dealers and independent sites – and you’d get more than 100 million possibly close to 200 million unique visitors using the web to get information about buying or selling a new or used car. Except there’s one problem if this traffic is somehow suppose to represent potential sales…the total number of new and used cars sold by dealers at retail and excluding fleet each month is only about two million units, and that is probably generous given that not all retail customers go online..some might just release the same brand of the leased car they are returning to the dealer. So the real shoppers – however you want to define that number – are only a small fraction of the total visitors. So just like newspaper, radio, or TV advertising, dealer spend on the internet is likely no better targeted – once again dispelling the notion that the internet would solve the age-old problem of knowing which 50% of a dealer’s advertising works.

And what was once promised as to the beauty of the Internet for used cars…listings of available cars with pictures, even videos, and stated pricing would make it easy for shoppers to find the best car at the best price. But what has happened is that for any given vehicle, within a similar bandwidth of age, mileage, trim, the price range for specific models is usually within a few hundred dollars, not enough to make price the deciding purchase factor. The Internet hasn’t created a pricing advantage for any seller and customers simply have confirmation that similar cars within a market are priced the same. With the exception of hard to find cars, the differentiating factors are having the car the customer wants, proximity of the dealership and the dealer’s reputation in providing a good customer experience.

In summary, technology is a wonderful thing…and dealers have adopted it nearly full tilt. Sophisticated software to manage every aspect of the business is now de riguer…BDC’s to support internet sales…and eDocuments will eventually become the norm. But the point is that the system of franchised dealers – using their own risk capital to fund their businesses and guarantee millions of dollars of inventory, promote their own brand and that of their OEM, provide the expensive tools needed in their service departments, and manage the endless headache of a workforce – will not be superseded by technology or factory owned mall stores. Factories have learned that they cannot do a better job than independent businessmen at the retail level. And new start ups – many of whom will come and go – with new systems of selling and servicing retail automobiles will all reach the same conclusion: the dealer network is the best way. Thank you for listening today.

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