The future of American auto.

The future of American auto.

The future of American auto.

Moneybox
Commentary about business and finance.
Aug. 26 2003 5:53 PM

The Road to Nowhere

Is the U.S. auto industry doomed?

The U.S. auto industry is driving straight off a cliff. Or so we're being told.

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The problem is an industrywide strategic failure, argues New York Times reporterMicheline Maynard in her new book, The End of Detroit.Amid the prosperity of the 1990s, the Big Three focused on SUVs and high-margin trucks while neglecting technology, quality, and design. As her publisher notes: "Maynard predicts that, by the end of the decade, one of the American car makers will no longer exist in its present form."

Or maybe it's a structural financial problem, as longtime auto analyst Maryann Keller suggests. "Their market share is going down and their costs are not competitive," she said in an Aug. 18 New York Times article that described how production at one of Ford's most productive U.S. plants may be phased out. "This is the 11th hour for the auto industry."

No, it's an actuarial problem, says Gary Lapidus, a Goldman Sachs analyst. (Goldman has performed investment banking for Ford and, even in this new era, doesn't cavalierly dump on clients.) In a report, cited in the Financial Times last week, Lapidussuggested that Ford, General Motors, and DaimlerChrysler were understating their collective unfunded pension liability by $40 billion. Should investors factor this information fully into the companies' stock prices, the prices might sag between 20 percent and 70 percent, Lapidus suggested.

In fact, it's all of the above, says Jeffrey Garten, dean of the Yale School of Management, in his latest Business Week column. "Before this decade is over, the U.S. auto business may go through some of the agonizing downsizing and even bankruptcies seen lately in steel and airlines," he writes. He then sketches the broad outlines of the inevitable bailout: "Health-care benefits for current workers and obligations to retirees would be gradually cut back"; outsourcing would be limited; and Washington "would provide certain tax breaks and loan guarantees and it would assume some pension and health-care obligations."

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Do all these declinists know something that investors don't? After all, for dying companies, the Big Three enjoy remarkably large market caps: $21.5 billion for GM, $20.3 billion for Ford, and $37.5 billion for DaimlerChrysler. Throw in all the money that has been lent to the companies, and you have to come to the conclusion that either there's an awful lot of stupid money invested in the survival of the U.S. auto industry or the declinists are mere alarmists.

Certainly, it would be folly to ignore the evidence in favor of decline. Global excess capacity and intense price competition have made it difficult for companies with high fixed costs and obligations to make cars profitably. Meeting all pension and health-care obligations will sap an immense amount of the Big Three's resources. And the demographics will make the problem worse over the coming decade, not better. General Motors has 2.5 retirees for every worker on the job.

But historically, declinist prophecies (a staple of business journalism) have more often than not paved the way for that other staple of business journalism, the comeback story. David Halberstam's The Reckoning, which described a foundering Ford and an ascendant Japan, appeared in 1986, and Roger & Me, Michael Moore's gloomy tour through a ravaged Michigan, appeared in 1989—nicely setting the stage for the 1990s boom.

So, what are today's declinists missing? To begin with, many of the Big Three's competitors are in far worse shape, particularly basket cases like Korea's Daewoo and Italy's Fiat. Excess capacity is already (slowly) being wrung out of the global car industry.

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Second, internal restructuring is already underway. This year's labor negotiations—to replace the boom-era labor contracts inked in 1999—are likely to produce disappointing results for hourly workers. Yes, the United Auto Workers union possesses a great amount of leverage—things are so tight that no company can afford to risk a strike. But given the economic and political climate—manufacturing is in a long-term secular decline in this country—the Big Three are unlikely to seal their own near-term doom for the sake of short-term labor peace. It's safe to assume that the companies will gain the upper hand in negotiations and that tomorrow's workers won't be eligible for anywhere near the amount of benefits that yesterday's workers are. Meanwhile, as big business continues to embrace the idea of big government, plans like the new Medicare drug benefit may lessen the Big Three's legacy obligations.

Most important, the Big Three have more ballast than they did in the 1980s. It is true that recent auto company profits have more to do with financial engineering than automotive engineering. "General Motors Corp., for example, earned more than three times as much from selling mortgages in the past quarter as from cars," Jeffrey Garten notes. Ford, as Moneybox has described it, is a profitable bank lashed to an unprofitable carmaker. And in the last quarter DaimlerChrysler's hedging and currency effects produced more than half its operating profits.

That's not necessarily a bad thing. Financing provides diversification that can tide companies over during periods when assembly lines hemorrhage money. And the auto industry certainly isn't alone in seeking salvation in numbers. Adam Lashinsky of Fortune argued in a recent column that General Electric, the industrial behemoth that makes jet turbines and light bulbs, would be more aptly named General Financial. The company's massive and growing finance arm is bringing in 40 percent of the 2003 profit.

Sure, the auto business is miserable just now. And undoubtedly the liquidation or bankruptcy of one or more giant players would help those who remain. But it's hard to go out of business when you have a great deal of brand equity, ready access to the capital markets, and the potential to print money when you have the right product mix at the right economic climate.

The auto industry may not be facing an endgame, but instead a prolonged corporate version of Survivor—a long-running drama in which the remaining three players can continually buy immunity.