Will Barack Obama resurrect the Auto Industry?

An important part of Barack Obama’s energy policy is promoting the production of fuel efficient cars. The problem for him is that the American auto industry is suffering from the current recession to the point that all of them might run out of cash and have to declare bankruptcy. General Motors just announced a third-quarter loss of $2.5 billion. Even more ominous is the $7.7 negative cash flow for the quarter. At that rate GM will run out of cash next spring.

One of the first problems for the Obama presidency is what to do with our auto companies. They are asking for a huge infusion of cash, as much as $50 billion. Private investors are not stepping up so it seems to be up to the government to put up the money if they want the companies to continue operating.

I think the government is going to have to save the auto companies. We are going to need them to produce a new generation of cars that are both very fuel efficient and can run on alternative fuels like natural gas. The problem is that the performance of the auto companies over the past 30 years has been terrible. They have produced large fuel hungry SUVs and pickup trucks, and have consistently lost money. Foreign competitors have been able to profitably make and sell small cars in this country. It is going to take more than just lending some money to these companies.

Barack Obama has an opportunity coming up to really fix the auto industry. Instead of just giving management a big government check, he has an opportunity to change out management and put in place a more enlightened management team with a much leaner management structure. A more enlightened management, like at foreign manufacturers,  they would have an opportunity to treat labor as a valuable asset. Japanese management provides its production team with training and empowers then with both the responsibility and authority to make decisions on the factory floor. They don’t have the contentious relationship with labor. These are the companies that are most likely to deliver the fuel efficient cars of the future. Toyota has already been successful with its Prius hybrid. Honda sells a natural gas powered car in California and Utah.

One way to restructure the companies would be in bankruptcy court. In bankruptcy, the current shareholders and management would be out of the company. The debt holders could be converted into the new share holders. The government could put some equity into the company and get a controlling stake in the companies. One problem in our economy is that there is too much debt. This would be an opportunity to convert a lot of debt into equity. Any bankruptcy would have to be pre-packaged so that the auto companies would not actually shut down. A large government stake in the companies would reassure customers that the companies would be around to honor their car warranties.

There have been some foreign countries that have taken the approach of creating a government owned public company for important industries. The best example that comes to mind is China Mobile, the world’s largest cellular phone company. They are majority owned by the Chinese government but have private shareholders (they trade on the New York Stock Exchange under the symbol CHL.) The government has used its influence in the company to promote public policy by encouraging the company to build a cellular network in rural China. If our government had a large equity position in the auto companies, they would emphasize the production of new generation, fuel efficient cars.

If government did get control of the auto companies, their hardest problem would be hiring a new management team and building a new, constructive relationship between management and the workers. Hiring some seasoned managers from companies like Toyota or Honda would be one place they could look for new management talent.

There are a lot of problems for Barack Obama in trying to really restructure and fix these companies.

1. The first is the United Auto Workers (UAW). They have been in an adversarial relationship for so long it might be very difficult to change. They have supported the Democratic Party. Rewriting the union contracts would take a lot of trust and faith on the part of the union. (Won’t happen for sure if the management is not changed.)
2. A second problem is that in bankruptcy, the workers would have a hard time keeping all of their retirement benefits if all the debt is swapped out for equity. It might be more effective for the government to help out the workers through the Pension Benefit Guarantee Corporation instead of bailing out all of the debt holders. GM convertible debt (nyse:GMP) is currently yielding 28%. The market is pricing in a big probability that these bonds will never be worth face value again.
3. A third problem is the Credit Default Swaps (CDS). I have no inside knowledge, but I would be surprised if there are not a lot of CDSs written against auto company debt. These are basically insurance policies that pay out for losses on principal to the debt they insure. They were written by companies like AIG and other financial companies that the government may have to bail out. If too manyof these contracts are outstanding, the government may have no choice but to just lend more money to the auto companies and keep them going at least until these contracts eventually expire.
4. Political pressure will come from all directions. It will range from giving the existing structure more money to people who think we should just let them fail and have the free market handle the problem.

Henry Paulson and the Bush administration have so far turned down requests for more money for the auto industry. Congress has authorized $25 billion to fund the production of fuel efficient cars. This money will not be available to fund the immediate working capital problem of the auto companies. It appears that Bush is punting this problem to the new Obama administration. That is the most appropriate thing for him to do. Obama and the Democrats will have to live with the decisions that are made today and it only makes sense that he and the new Democratic majority in Congress take ownership for handling this problem.

There are just too many American jobs at stake to not do something to help the American auto industry. It does provide an opportunity to really make a break with the past and set the industry on a path to a profitable future. This is about trying to create a new vibrant, living industry that will generate profits, create good paying jobs, and maybe even create a profit for the new owners. That would be a resurrection. The alternative of putting in more loans without making the hard changes would just create a re-run of the living dead.

 

Topics: Prius , Obama , Toyota , loan guarantee , Auto Industry , Honda