Posts Tagged ‘Auto Industry’

Are US Auto Manufacturers Too Big to Fail?

Posted by Joshy Madathil.

The automotive manufacturers have suffered as soaring energy prices, the collapsing housing market, and the crumbling banking industry have roiled the US economy.

Does it matter if large US automotive firms fail? 

General Motors, Chrysler, and Ford provide over 200,000 well-paying jobs in the US, and many other jobs in factories around the world. [1][2][3] Paying unemployment benefits would represent a significant cost for the US government.  Warranties of purchased vehicles would be worthless, and many dealers would end up with a surplus of vehicles that would be sold for a loss. These companies’ multi-billion dollar pension plans might also require intervention by the Federal Pension Benefit Guaranty Corporation if the automakers filed for Chapter 11 bankruptcy protection. [4]

The auto industry has posted sharp losses and has had several consecutive months of declines in sales.  In August of 2008, Ford’s sales dropped 26.6%, Chrysler’s 36%, and GM’s 20.4%. [5] GM has also forfeited the crown of market share leader, a title it held for an astounding 76 years, to Toyota. [6]  As difficult as it is to keep the US consumer from spending, high fuel costs, the rising threat of unemployment, and a sluggish economy has made it easier for the consumer to cut down to the bare necessities (see related MarketBlog post on Consumer Spending).

Moreover, the recent housing market debacle and meltdown among financial firms has raised consumers’ anxiety levels and made it difficult to justify the need for a new vehicle — especially with thoughts of home foreclosure and/or recession in the back of everyone’s mind.  Couple this with soaring gas prices and there’s a recipe for disaster brewing — American automakers have relied on the sales of high profit trucks and/or SUV’s to drive company earnings. [7]  Slowing sales in this sector were detrimental to Ford and GM and are reflected in their stock prices.  Ford’s stock is trading at a near 20-year low of $4.80, and General Motor’s hit a 53-year low of $9.38 during July of 2008. [8][9] 

Energy and oil prices have also affected the cost of the materials which go into producing vehicles.  In addition, gas prices have increased the overhead of transporting vehicles to dealers, which cuts into the bottom line and reduces overall profitability. [10] Funding the factory upgrades necessary to manufacture fuel efficient vehicles has become a difficult task for the auto industry. Finding this capital at an affordable rate is an issue for an industry in financial turmoil. [11] The credit crunch from the housing and banking crisis has led to widening credit spreads that increase the rates at which Ford and GM can access capital.  This affects Ford and GM more than the average firm because they are perceived as high risk (and rightly so) to investors who, in turn, demand appropriate returns for their investments. [12][13]

Widening Credit Spread

Widening Credit Spread

So how does a seemingly bankrupt corporation find the capital necessary to re-invent themselves?

The automakers have requested $25 billion in low interest loans (4% – 5%) from the government to help in the renovation and upgrade of current facilities. [14] The automotive industry has shown resilience in the past to overcome market downturns, as evidenced by the auto industry in the 1970’s.  In late 1979 Chrysler was in the midst of bankruptcy.  With the help of a federally-backed loan and the leadership of Lee Iacocca, Chrysler paid back the loans ahead of schedule and posted a $500 million profit by 1983. Through a strategy of consolidating suppliers, employee pay cuts, and the leadership of Iacocca during the process — who took a $1 annual salary during the downturn — Chrysler was able to regain its position in the market. [15][16]

There has been much debate over the question of whether a massive federal loan for the auto industry is justified.   If the industry’s downturn is likely to have a significantly negative impact on the US and global economy, then the government can and probably will step in with the requested support.  With the recent government takeover over of Fannie Mae and Freddie Mac, as well as a $700 billion package in the works to help the financial system, the Feds have shown that they will do what is necessary to maintain a stable economy. [17][18]  Without the necessary facility upgrades and strong leadership at the helm, the US auto industry will remain weak and will not see strong profitability until the US economy has stabilized.