Auto-Bailout Mechanics

Industry insiders say “burn them down and start over.”

By Henry Payne

Detroit, Mich. — General Motors is not competitive.

That is the conclusion, not of conservative D.C. critics or Wall Street investors, but of officers with the Detroit auto-parts suppliers who do business every day with America’s largest car company — and with its Japanese competitors.

It is an open secret in the Motor City that — even leaving aside its high labor costs, surplus of brands, and bloated dealer network — GM’s manufacturing culture is inefficient compared to foreign rivals Toyota and Honda. Conversations with numerous supplier reps confirm an antiquated Detroit culture that does not thoroughly engineer products before contracting production with suppliers. As a result, production runs for Detroit automakers like GM are frequently interrupted to change specifications. Those interruptions add costs — costs that Japanese manufacturers rarely incur. The problem is so prevalent that employees for JCI — major international supplier Johnson Controls, Inc. — often joke that their acronym stands for “Just Change It” because its American clients routinely run up unnecessary costs by altering production contracts.

Can a $25 billion taxpayer bailout help General Motors change its culture? “No,” says one supplier executive. “You have to burn them down and start over.”

But with Washington now in union-beholden Democratic hands, that scenario — bankruptcy — is not going to happen. In the current downturn, many financial experts predict that a GM bankruptcy would be a dicey scenario not just for the industrial heartland, but for the country as a whole — and so argue that Washington faces a Hobson’s choice as it considers a bailout for Detroit automakers. The question is when, not if.

But handing over $25 billion to U.S. automakers may be a short-term national benefit — but it would only draw out Detroit’s slow slide to failure, with no return on the public’s investment. On the other hand, not breaking the Detroit Three’s free-fall into bankruptcy (or some form of government receivership) might be painful for the nation in the short run, but would offer the best route to industry revival over the long haul.

Thirty years ago, the federal government successfully bailed out Chrysler Corp. But today’s landscape looks very different from that of the late 1970s. At that time, the Big Three’s Japanese competitors did not operate a single manufacturing facility in the U.S. Today, Japanese, German, and Korean manufacturers all operate plants here — employing 93,000 American workers from Kentucky to Alabama. In other words, a bailout for a Detroit company is no longer essential for maintaining America’s auto-manufacturing base.

This time the bailout’s focus is on GM, which is projected to exhaust its cash reserves by year’s end. [Ford’s cash — thanks to a shrewd mortgaging of company assets two years ago — will last into 2009. Chrysler is already assumed to be lost — as its owner, Wall Street equity firm Cerberus, is desperate to abandon the auto business.] GM argues that it has taken steps to become more competitive and that it only needs federal money to bridge the current, freak financial crisis so that its cost reforms can go into effect as scheduled in 2010. The company is correct up to a point.

Critics such as columnists Robert Samuelson and Charles Krauthammer are not entirely correct in saying that GM hourly labor costs are $25-per-hour higher ($73 v. $48) than their Japanese competitors. In fact, 2007’s historic, contentious labor pact provides for a “two-tier” wage scale that reduces employee costs to $55 per hour — within striking distance of non-union Japanese plants.

Striking distance isn’t enough, though, and industry analysts agree that GM must do more. But in its appeal to taxpayers for $25 billion, GM has arrogantly refused to provide a revised business plan in return for the money. Instead, it has played the fear card, arguing that withholding the funds will lead to a national depression. But GM’s excessive overhead costs demand explanation.

Writing for the Wall Street Journal, Michael Levine of NYU’s School of Law points out that GM and its chief competitor, Toyota, have nearly identical U.S. market share (20 percent for GM, 19 percent for Toyota). Yet GM has eight brands and Toyota only three. GM also had 7,000 dealers (due to state franchising laws) versus only 1,500 for Toyota. These problems cry out for restructuring, yet GM insists on postponing hard decisions hoping instead for an infusion of taxpayer booty.

Worse, federal cash will come with strings attached, thanks to a liberal Congress that wants to turn Detroit into ground zero in its battle against so-called global warming. The result would be Nancy Pelosiimposed targets forcing automakers to make more high-mpg cars whether there is market demand for them or not. Absent structural reforms, mandating money-losing small cars would only hasten Detroit’s demise. Even left-wing New York Times reporter Keith Bradsher — author of the SUV-bashing book, High and Mighty — has documented how congressional fuel mandates have put Detroit at a competitive disadvantage ever since their inception in 1975.

Short of “burning them down,” then, what is the solution? A Democratic Washington has many in Detroit resigned to a bailout that will preserve the viability of their 401ks if not the American auto industry.

But if bankruptcy is out of the question, its government-ordained cousin — public receivership — has precedent. A receivership modeled after the airline stabilization board that helped rescue U.S. airlines in the aftermath of 9/11 could have the effect of both restructuring GM as well as assuring its survival after reorganization. Analysts from NYU’s Levine to former Wall Street Journal business editor Paul Ingrassia have endorsed this approach.

It would be painful, but it would also be the transformational moment that U.S. automakers have promised for far too long.

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