OCTOBER 23, 2009 by MICHAEL HEBERLING
If Washington owns it, it just can’t keep its hands off.
—Senator Lamar Alexander
Twenty-five years ago President Reagan told auto workers in Orion, Michigan, “You’ve demonstrated when the chips are down, what people can do working together freely, rather than at the dictates of some central planner or bureaucratic mandate of government. I happen to believe the last thing your industry needs is the federal government bringing in outsiders to tell you how to run a business.”
Fast-forward to 2009: President Obama fires GM chief Rick Wagoner, the company files for bankruptcy, a government-appointed auto task force calls the shots, and the federal government now owns 61 percent of the new GM.
How did we get to this point and what can we expect from Government Motors?
In its heyday in the early 1980s, GM employed nearly 350,000 workers at 150 assembly plants. It also had a 43.8 percent share of the market. Unfortunately, the good times did not last.
Decades of high labor costs, foreign competition, extensive government regulation, and burgeoning legacy costs steadily reduced GM’s market share to today’s 19.1 percent. A shrinking market means that legacy costs will skyrocket and become unsustainable. Mark Perry at the University of Michigan–Flint estimates that the ratio of retired GM auto workers (plus surviving spouses) to active UAW members was 4.61 to 1 in 2007. Given the state of Social Security, in which fewer workers support a growing retiree population, the phrase “As GM goes, so goes the nation” seems about right.
Given the plummeting market share (averaging 0.85 percent every year), one would think at some point one of the GM chiefs would have taken drastic action to turn things around. One would think wrong. There was no financial incentive to do so. Since the GM board continually rewarded failure with mega-million-dollar bonuses (similar to the practice at AIG), why bang heads to reduce labor rates or eliminate duplicate product lines? GM’s management apparently decided to simply stay the (downward) course, collect their golden parachutes, and hope that the inevitable wreck came on the next guy’s watch.
When time finally ran out for GM in 2008, only two equally bad options appeared to be left for management: bankruptcy or government bailout. As it turned out, there was a third, even more horrible option: a government bailout bankruptcy. When you crawl in bed with the government, it’s not a pretty sight. After the Bear Stearns, AIG, Freddie Mac, and Fannie Mae debacles, it became clear that government money brings some unattractive conditions, including micromanagement, the government’s agenda, and political favoritism.
To oversee the restructuring of GM (and the other auto bailout recipient, Chrysler), the government established a 24-member Auto Task Force, including Obama cabinet members and White House officials. None had any experience in the auto industry. Steven Rattner, an investment banker, was appointed task force leader. According to Neil King of the Wall Street Journal, Rattner “ranked among [New York’s] biggest fund-raisers for Democratic candidates.”
One of the biggest hurdles for the task force was to reduce GM’s $172.8 billion in liabilities and reallocate $82.29 billion in assets to produce a leaner, more competitive company. In normal bankruptcy the secured debt is paid off first, followed by unsecured debt. Anything left over goes to the stockholders. Unfortunately, in this case the GM stockholders came up short. In fact, there was not even enough to pay off all the unsecured debt holders. The U.S. government and UAW came out on top. The chart shows how the debt issue was finally settled.
It should come as no surprise that one of the four parties, the (unsecured) bondholders, balked at the proposed settlement terms. While they were second in the debt held, they came in last with only 10 percent of the common stock, no preferred stock, and no cash. For their objections, they were pummeled by the mainstream media and politicians. What sin did the bondholders commit? They were guilty of “greed” and of being “speculators.” This clearly explained their unwillingness to negotiate in good faith.
Who Are the Bondholders?
Ironically, if we look closely at who these bondholders really are, they don’t seem so ominous, threatening, or evil. As an investment, bonds are unexciting, but they are considered much safer than stocks. While bonds don’t pay that much, the returns are steady. For this reason, they are popular among retirees and working families. This was especially true in the case of GM bonds. According to bond analyst Shelly Lombard, “That’s because unlike most companies that issue debt in large denominations, GM sold many bonds with face values of as little as $25. That made them very attractive to average Americans.” According to the Washington Times, mom-and-pop investors directly accounted for 25 percent of the total. Large banks and investment firms had the rest. But even here, small investors were a major player through their mutual funds and 401(k) retirement plans. Financial-restructuring authority Evan Flaschen said: “The story that hasn’t been told is, this isn’t GM’s union retirees versus the bondholders. It’s retirees versus retirees.”
The government’s treatment of the GM bondholders was simply disgraceful. Investor’s Business Daily said the sordid affair “underscores why GM should have been allowed to undergo a normal bankruptcy—not the politically rigged one that the government forced down all of our throats. A regular bankruptcy would have given GM bondholders first call on its assets. Instead, they literally had money stolen from them.”
At a time when we are trying to restore faith in our financial system, the government chose to run roughshod over the investor class. This near-term political expedient will have long-term negative consequences. Other corporations will have a much harder time raising capital by selling bonds. If American investors get stiffed by the government, how will potential foreign investors view this shabby treatment? Could they be next?
Let the Micromanaging Begin
While many people might say GM did not really have a business model for the past 25 years, can we expect the new one at Government Motors to be any better? After all, there are now 535 members on the de facto board of directors, each making political rather than economic decisions. The recent bizarre treatment of the GM dealerships illustrates this point.
GM planned to eliminate about 2,400 of its 6,000 dealerships. What should have been a pure business decision has, unfortunately, gotten wrapped up in politics. Those dealers slated for closing have appealed to Congress for help. According to CNN, “The push by the dealers to reverse the cuts has garnered strong bipartisan support, especially from powerful Democratic Leaders Financial Service Committee Chairman Barney Frank and House Majority Leader Steny Hoyer.” So far, the Automobile Dealer Economic Rights Restoration Act of 2009 has 250 House and 26 Senate cosponsors. The bill is designed to “re-open profitable dealerships and restore basic fairness.”
The elite class has known all along that the real problem at GM was that it built too many SUVs and light trucks and not enough of the fuel-efficient cars that consumers really want. It now appears that at the new Government Motors environmental considerations will trump business considerations. Congress and the various regulatory agencies, such as the EPA, have been micromanaging the auto industry in the “green” direction for decades with their ineffective and deadly Corporate Average Fuel Economy (CAFE) program. The new CAFE standard calls for all cars and trucks to get 35.5 mpg by 2016. No GM vehicle currently meets the new standard.
Given that the government is now a majority shareholder in the auto industry, expect even more green micromanaging. It has already started. Energy Secretary Steven Chu, who is on the task force, recently said that the Obama administration is thinking about requiring all new cars to run on E-85 gas (85 percent ethanol). This mandate will cost the auto industry $1 billion a year. It is worth noting that E-85 gas is available at less than 2 percent of the gas stations nationwide.
In deciding where to build the new green compact cars that will save the company, the new GM considered the “community impact” and “carbon footprint” of the production facility. Ironically, it ultimately settled on the Orion, Michigan, plant where Reagan had disavowed central planning a quarter century earlier.
President Obama has said that his decision to take a majority stake in GM was unavoidable and that it would be temporary. This remains to be seen. However, we have been down this road before. In 1971, the federal government became the majority shareholder in Amtrak. This too was unavoidable and was to be temporary. Amtrak has been a ward of the state ever since; costing the taxpayer $2.6 billion a year to operate.
I fear that the new slogan in America will be, “Is this any way to run an auto company?”