What Lies Ahead For General Motors

The most urgent piece of economic news and policy over the next several weeks will be the fate of the General Motors Corporation. It will take precedence over the general policy response to the worsening recession.

The problems in the auto industry go well beyond the Detroit Big Three. All eleven of the major automakers with operations in North America have come under severe stress, as a result of the sudden reluctance of consumers to buy new vehicles. But the situation at GM is even worse than many people perhaps realize.

As I wrote here, GM’s immediate financial situation is why they’re in dire straits now. As of the end of September, they reported about $16 billion in balance sheet cash. At a burn rate of roughly $1 billion a month, they (and we) figured they had enough cash to get through a good part of next year. The plan was to hope that economic conditions recovered enough by then to improve their cash-flow position, and get some new capital into the company.

What happened to change all that, is that US consumers suddenly went on strike in October. GM reported October sales that were 45 percent below the levels of October 2007.

I’ll give you a minute to pick your jaw up off the floor. You’re ready to go on now? Ok.

With that big a hit on their top-line revenue, GM’s cash position has deteriorated far faster than they had planned. If the consumer stays on strike through the end of the year, GM probably doesn’t have enough cash to keep operating.

What does filing for Chapter 11 bankruptcy do for GM under such circumstances? Not a whole lot. Leave aside that a great many of GM’s customers might suddenly become reluctant to buy a new vehicle from a bankrupt company (because of fears that the warranty would not be honored, or that parts and service might be harder to get).

The real problem is that bankruptcy doesn’t solve GM’s cash squeeze. There’s not a banker in the world right now that would lend them a penny. Companies go into Chapter 11 when there’s a reasonable expectation and a credible plan to emerge from bankruptcy and continue operating.

But in GM’s case, there are very serious questions about their markets and about their whole business model. They rely on cash flows from high sales volume to keep afloat a cost structure that should have been rationalized long ago. I believe that GM, as currently constituted, is insolvent.

But the immediate problem facing GM now is a cash shortage that could leave them literally unable to operate before too much longer. Possibly before the end of the year.

And that’s why GM’s management is pulling out all the stops to lobby for an immediate infusion of cash from you, dear taxpayer. In this effort, they’re joined by their close allies in the leadership of the United Auto Workers, as well as Michigan governor Jennifer Granholm, and Michigan’s Congressional and Senate delegation.

The Bush Administration and congressional Republicans have supported a plan to redirect $25 billion appropriated last September for use by the Detroit automakers. This money had been the quid pro quo to induce the Big Three to accept higher gas-mileage standards, and was to be used for factory retooling, alternative-fuels R&D, and the like.

Instead, the Republicans would disburse this $25 billion immediately and permit it to be used as operating capital. At GM’s current run rate, this presumably would allow them to stay alive for another two to four months.

Congressional Democrats, who started debating the issue yesterday, aren’t in favor of that idea, or at least they say they aren’t in favor. They want to allocate at least $50 billion to the Detroit Big Three during the current lame-duck session. I don’t know if they intend to take it all from the Treasury’s TARP plan (which was supposed to be for stabilizing the financial industry), or if they’re thinking $25 billion from TARP and $25 billion from the fuel-economy grant I just mentioned.

The issue comes down fundamentally to this: should the taxpayers throw an enormous of money that is unlikely ever to be repaid into General Motors, to keep them operating in their current bloated state? They have far too much production capacity, their labor costs are far too high, and they have far too many dealers.

GM needs to shut down some capacity, renegotiate with the UAW, and change their production mix to more fuel-efficient vehicles. And in all candor, they’ve known this for decades. Rather than complete these reforms over time (which would have exposed them to market risk), they instead very effectively negotiated with Congress for an endless parade of market-distorting regulations that shielded them from competition.

Now that the string has run out, they’re looking for a direct input of taxpayer cash to keep operating more or less as they always have.

The case to provide an emergency bridge loan for GM is basically this: they expect that sales will recover quickly from October’s extremely depressed levels. And they also expect that the North American market will rebound to at least 16 million vehicles sold per year by 2010. (This year’s rate will barely break 11 million.)

Neither of these assumptions is very good. If we put 25 or 50 billion dollars into GM now, it will just be the first of a long series of emergency cash infusions. And the temptation to keep throwing good money after bad will be impossible to resist.

What’s the downside if we don’t bridge GM now, during the lame-duck Congressional session? Well, if they’re forced into Chapter 7 bankruptcy and are forced to stop operating, it’s going to throw a lot of people out of work and also wreck a lot of smaller companies (GM’s suppliers and dealers).

To press this point, GM announced today that they’re postponing by a month the incentive payments that they owe their dealers for sales made in October. Outside estimates are that about half a billion dollars are being withheld from dealers.

This of course is being presented as a cash-preserving move. It also has the surely-unintended side-effect of causing GM’s dealers some very direct pain. Those dealers are all burning up the phone lines to their Congressmen right now, threatening to dump lots of employees on the street right before the holidays unless GM gets their bailout.

It’s going to be politically impossible not to bridge GM at this point in time. The Republicans know this. The Democrats know it too, which is why late yesterday they started posturing that there would be no lifeline, and that the Republicans are to blame. This way, the bailout will happen with Republican votes. And the Republicans will still be portrayed in the media as having tried to throw three million people out of work.

For their part, GM and the UAW would just as soon wait until the next Congress and the incoming Democratic administration. Since the new Senate will be all but filibuster-proof, the Big Three and the UAW can expect to get a much better deal from Congress than they would now.

By “better deal,” I mean a much more open-ended commitment from the Federal government, which would allow the Big Three to avoid meaningful and painful reforms. That also goes for the state of Michigan, which delivered critical electoral votes for Obama, and for the UAW.

It’s ultimately going to be a far worse deal for the taxpayers and for the people who buy automobiles. General Motors will still be as uncompetitive as ever, but now its losses will be socialized. Welcome to industrial policy, American-style.

-Francis Cianfrocca