Auto Bail-out: Take 2

The Auto Industry has until tomorrow to come back to Congress with the terms of its restructuring. Having the automakers develop the terms of their restructuring strikes me somewhat like asking a heroine user to develop their methadone treatment plan: they may be best educated to understand the problem but the least prepared to deal with it realistically.

The problems facing the industry are many, and for the most part were avoidable had the industry recognized and embraced the need for change earlier rather than fighting it and maintaining business as usual. The truth is that the models developed by Detroit are largely uncompetitive, the costs are too high, there is too much debt on the corporate books, there are too many models and too many parts, and there is too much investment stranded in plants supporting uncompetitive and overlapping models. The dealership model is costly and largely unnecessary.

The numbers seem to vary depending upon the source, but based on reasonably reliable sources it appears that on average an auto worker makes about $28/hour. However, the labor costs per employee including benefits for existing and retired employees are more than double that. Huh? The reason is that the unions demanded and the auto companies complied with providing a level of benefits that is unsustainable. Foreign manufacturers, who are newer to the US labor pool, are not burdened with these costs, which equal (depending upon the estimator) approximately $2000 more per car for the US models.

So the question now is, who should bear the brunt of the restructuring? The answer is simple - all constituents:

1) The automakers need to trim the number of nameplates they maintain and models they produce by roughly half, close plants accordingly, and lay-off a proportionate number of workers. This will be painful, but not doing so puts all models, plants, and workers at risk. The unions must accept this.

2) Workers will need to accept benefits more in line with other industries.

3) Retirees who are under 67 years old will see some reduction in benefits. Those over 67 will not be affected.

4) Lenders will need to accept a reduction in the principal amounts of the debt they have lent to the industry. They were irrational in providing this level of credit, prolonging the industry's lack of recognition of their problems, and need to share the pain. They should convert a significant portion of their indebtedness to equity.

5) Dealers will be shut down. There is simply no reason, with fewer makes and fewer models, to maintain the same number of dealers. In addition, the advent of the internet diminishes the need for them. Dealers should be replaced with regional showcases for new models. Existing dealers should focus on service, and perhaps selling used cars, rather than stocking new models.

6) Automaker leadership will need to be examined sternly, and for the most part, replaced.

7) The above mentioned items will only be able to be accomplished through bankruptcy. Unfortunately, many of my elected California representatives, as well as representatives from other states, equate bankruptcy with "failure" and therefore oppose it. This simply is not true, and it is disingenius to continue repeating it.

Chapter 7 would in fact be a "failure," ie a liquidation of the companies. But no one is advocating, or ever has advocated, Chapter 7, rather Chapter 11 bankruptcy is what has been proposed. Chapter 11 is a "reorganization," and does not require that the automakers shut down. This process gives the companies the power to reject untenable contracts, including leases, dealer arrangements, and employment contracts. Without this power, the automakers are subject to the whims of too many competing interests.

8) The government will need to step in - A: Congress must address the benefits of the retirees. Reducing the number of workers in the industry will actually increase the average cost per worker, so the government will need to take on some of this pension and benefit obligation. Perhaps all of it. If not, the industry will never be able to be competitive.

9) The government steps in - B: The companies will need to receive what is called Debtor in Possession financing during the bankruptcy process. However, in order to get banks to provide this capital, the government will need to guarantee it.

10) The government steps in - C: The government will need to provide buyer incentives to get models moving. These should include tax rebates for fuel efficient and electric cars. In addition, the government will need to guarantee loans for the sale of new cars - preferably fuel efficient ones.

11) Existing shareholders (including management), as a consequence of the foregoing, will be wiped out. At best they may participate in the recovery through substantially out of the money options.

None of the government activities should occur unilaterally - they should occur pursuant to a negotiated - or prepackaged - bankruptcy, ie chapter 11. The government needs to stop taking it on faith that its bailout targets will do the right thing - they have all proven they won't.