An American Tragedy: Detroit Meets Reality

By David L. Brown

What lies in the future for the American automobile industry? I am a realist now, not a pessimist, so let’s look at the situation from a realistic point of view.

I note that sales of American automobiles and light trucks have dropped by somewhere north of 40 percent since last year. That was as of November, and December isn’t likely to improve that record. That is a substantial drop, and truly bad news for the auto makers.

One might like to think that with a little help they can get back on their feet in a few months and begin to sell new product again, get factories rolling, improve their cash position. But… There are some problems with that.

For one thing Detroit has continued to build cars and light trucks that they cannot sell. That might seem like a poor business decision, but it wasn’t really a current decision at all because years of contract negotiations with suppliers, unions and others set them up so that it is almost impossible to stop making cars that don’t sell. Union workers get paid whether they work or not. Suppliers are contracted to deliver parts and components to assembly factories on a just-in-time basis. Those supplies keep coming, so the auto companies are virtually forced to keep making the vehicles.

I read a report recently by someone who has business contacts with auto company facilities. He described how as he drove to a GM plant he noticed that every abandoned shopping center or unused parking lot for miles around was packed with new, unsold cars. The same story can be seen anywhere that cars or light trucks are made. Dealer lots are also overflowing with inventory and the seriousness of the situation can be measured by the offer I received a few months ago to buy a brand-new 2008 Dodge quarter-ton pickup for 50 percent off of the MSRP. Half-price sales on expensive-to-produce items such as pickup trucks hint at an almost unimaginable level of desperation.

Here is a graph showing market share of U.S. auto sales by the top five manufacturers for the ten year period through November (credit: Wall Street Journal):

autosale.jpgIt is sad to report that the blue line represents GM sales, the orange line is for Ford, and the maroon line is for Chrysler. All zooming steadily down. But what about the other two lines? Sorry, but the green one is for Toyota and the brown one at the bottom represents Honda. The U.S. auto industry has been sinking steadily for more than a decade while Japanese companies took an increasing market share.

Now here is the graph for all U.S. auto sales for the past year, including imports and cars made in America by foreign companies:

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The blue bars indicate sales of cars and the tan bars represent light trucks. Notice the vicious downward trend starting about last June or July. Keep in mind that this trend is in spite of price reductions of as much as 50 percent off of list. The decline began when the gas prices went through the roof, but the high price of petroleum and other events were also creating other problems for the auto market. Credit began to dry up, causing the suspension of lease programs. Money for purchase loans began to be pulled back. And perhaps worst of all, consumers began to realize that the resale or trade-in values of their present vehicles were so low that they couldn’t afford to get rid of them.

What do you do if you owe $25-30,000 on a two-year old gas guzzler, and the book value has dropped to half of what you owe? To sell is to take a huge loss and you’d have to come up with the difference. Most people can’t. Dealers would give you a pittance in trade for a more economical model. So you have two clear choices: Keep up the payments and continue to drive the old vehicle, or stop paying and let it be repossessed.

And there you have another huge problem for Detroit as the economy declines—the likelihood of rising numbers of repo’s to add to the unsold inventory. Present owners will either not buy a new car because they can’t afford to take the loss on the old one, or they’ll walk away and let the Repo Man deliver it back to the Detroit company where it can join the ocean of unsold inventory.

I do not have statistics to share about how many unsold 2007 and 2008 model vehicles there are in the inventories of the Big Three and their dealers. But let’s just assume there are something like 40 percent of the number of vehicles the Big Three would have sold in a previous year, counting both 2007 and 2008 models. That is based on the falloff in sales this year through November, and allows for carryover inventories from 2007 models.

GM, Ford and Chrysler sold about 7.5 million vehicles through November, 2007, and 40 percent of that figure yields about 3 million unsold cars and trucks. My gut tells me that figure may be somewhere in the ballpark. If so, it means that before they can sell any newly manufactured models, they will have to push out 3 million new cars and light trucks that already are sitting on lots all across the nation. No wonder Chrysler’s offering as much as 50 percent off list prices. It might move some of the iron, and yet one has to wonder how much the companies lose on each of those deals. It can’t be pretty.

The Detroit carmakers promise that they will be introducing new, more economical and affordable cars. This should be taken with a grain of salt, because they’ve already proven that they do not know how to make small, efficient cars at a profit. According to Lee Iococco in his book “Where Have All the Leaders Gone?” GM’s Saturn Division has never made a profit. Saturn was the company’s big push to create the kind of cars Americans might want to buy, and it has failed miserably. Will they be able to make a profit on small, efficient and affordable cars in the future? Probably a long shot, like the odds that Tiger Woods will miss a three-inch putt.

Now GM promises that its electric Volt car will be the answer to the market’s dreams. Trouble is, the market is in the toilet now, today, and the Volt won’t be delivered in any quantity for about three years. How is GM going to survive until then? Will the government continue to shovel cash into this money pit for three years while they continue to make cars that they can’t sell and parking them all over the landscape? Somehow I don’t see that as a viable option for GM.

Chrysler is in even worse shape, with its sales down by nearly 50 percent over a year ago. Ford is in the best shape of all, with sales down only around 30 percent.

But the trouble for Detroit doesn’t stop there. Because of the credit crunch their finance arms have been cut off from their traditional sources of cash to lend to new car buyers. Banks have pulled in their horns and commercial paper (short term loans) are no longer available. Car companies used to make loans to just about anybody who could manage to walk into a dealership without falling down. Now, only those with the best credit ratings are getting loans. Others will have to pay cash or find other sources. As just mentioned, banks are not likely sources, so many potential sales will never be consummated.

Some of the car companies have suggested converting their finance arms into commercial banks, but from whence will they get deposits? Do they expect the government to shovel even more money into fattening up the balances of these faux banks? Well, probably.

And there’s more: Last summer GM and other major auto makers shut down their leasing programs. A high percentage of vehicles were “sold” on leases, and with tight credit that needed to be stopped. Another problem with leases is that when the lease expires the lessee had the option to buy the vehicle at a pre-determined price or walk away. With the market saturated with unsold new and used cars the lease buy-outs are far above the present market values, so most lessees will turn in the keys and walk. That means that car makers will be inundated with a steady flow of low-mileage, late model off-lease vehicles to sell.

Now the bottom line is that until the Volt and similar vehicles might be available two or three years from now, there might be enough cars and light trucks already in inventory, or coming in on expiring leases, to provide all the vehicles the market will need for the next three years or so. That’s a thought. Imagine that Detroit doesn’t need to make any new vehicles for the next three years. But (and this is a big Catch 22) it can’t stop making them because of pre-existing contracts.

What alternative is open to the worst afflicted auto companies, GM and Chrysler? In my opinion, only one that makes any sense: Bankruptcy, and perhaps even the bad Chapter 7 liquidation kind rather than a recovery plan.

Meanwhile, note in the chart above the rising sales curves for Toyota and Honda. For those Americans who cannot wait for three years to buy a Volt, the hybrid and high-efficiency cars from those companies, for the most part made in America, will be the vehicles of choice. That trend is already plain to see.

Remember, I am no longer writing from the perspective of a pessimist, but as a realist. To my thinking, the scenario above is pure, hard-core realism. To imagine a resurgent Detroit any time soon, or even ever, is truly a stretch, with the possible exception of Ford. Let’s just hope that our government doesn’t throw too many taxpayer dollars into this money pit before the saga finally comes to the inevitable end.

We used to hear it said that some corporation or financial institution was “too big to fail.” They are still saying it in reference to the big automakers. I suggest that, au contraire, in the case of GM and Chrysler, they are “too big to save.”

Ford, if it can survive the present turmoil, may have a chance to become the Big One in the American automobile industry.

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