Should the Big Three Be Allowed to Fail?

By: Olivier Garret | Fri, Dec 5, 2008
Print Email

Should the Big Three Be Allowed to Fail? - Olivier Garret

The fact that after over 30 years of consistent mismanagement and decline, there is still any discussion on whether or not we should allow the now significantly smaller "Big Three" automakers to fail is clear evidence that Washington has lost all common sense.

Why, when after more than three decades of continuous restructuring, GM, Ford, and Chrysler have not been able to change their culture, high-cost basis and ill-conceived strategies, does anyone believe yet another break would change anything? Are they going to be better off next year, or the year after that, or even five years from now? Just because their situation has become even more precarious, it doesn't mean that they will be more successful going forward... more likely the opposite.

"The definition of stupidity is doing the same thing over and over again and expecting different results," said Albert Einstein.

The best thing that could happen to the auto industry is the Big Three filing for bankruptcy protection. As a former turnaround professional, I am convinced that the tools afforded by the bankruptcy courts would allow these companies to restructure dramatically, thus allowing them to renegotiate and drastically lower most of their liabilities. Management would be overhauled, pensions renegotiated, union agreements tabled and made more flexible. Everything that these three companies have attempted to do for years, and could never achieve, would now be possible.

So, why in the world is management siding with the unions in their appeal to Congress?

Because under bankruptcy protection, management becomes accountable to the court, many of their perks and benefits would be curtailed, and they could, heaven forbid, even lose their jobs.

The auto industry, its unions and allies are therefore quick to point out that they, too, are "too big to fail" (have we heard that before?), that the American economy would not recover from the job losses and the economic impact of failures that would have far-reaching implications.

The Center for Automotive Research (CAR) has just released a comprehensive study on the impact of a 100% failure of the Big Three in the U.S.:

I agree - it poses a very grim scenario.

In fact, Senate Bill Sec. 402 seeks to "(C) preserve and promote the jobs of 355,000 workers in the United States directly employed by the auto industry and an additional 4,500,000 workers in the United States employed in related industries; and (D) safeguards the ability of the domestic automobile industry to provide retirement health care benefits for 1,000,000 retirees and their spouses and dependents."

Obviously, the $25 billion approved by Congress on September 24, 2008 is already falling short. It is clearly not enough to deal with a problem of that scale and, the car makers lament, needs to be doubled immediately. But in case you wonder, the industry and its unions do reserve the right to come back for more...

So let's review some of CAR's assertions in light of what we know:

Auto sales are forecast to decline from 16.1 million in 2007 to 14.9 million in 2008. 2009 can be expected to be much worse. Spending on capital goods such as cars and trucks will be affected long-term as a result of excessive consumer debt, tighter credit terms, higher unemployment, and a serious recession (or depression).

If car sales decline dramatically, manufacturing capacity has to be reduced to match demand. This means that the less productive plants would be shut down, employees laid off, and that the supply chain would have to adjust accordingly. This is basic economics so far.

Now comes our choice: On the one hand, we have some highly productive global manufacturers that produce fuel-efficient vehicles the U.S. consumer wants and can afford to buy. On the other hand, we have three inefficient companies that produce unattractive gas guzzlers and are plagued with high legacy costs and liabilities (Big Three workers make $73/hr, Toyota's $48, the average manufacturing worker makes $32). Why should U.S. taxpayers subsidize these losers? Is it so that they can continue to compete unsuccessfully with productive manufacturers and avoid any dramatic (and much-needed) changes in their way of doing business?

In light of the fact that throwing good money after bad almost never works out, I think the U.S. taxpayers should not bail out GM, Ford, and Chrysler. A common-sense alternative would be to save our tax dollars and allow the most efficient manufacturers to gain market share and hire more workers. Ultimately the U.S. market will post sales of 12 to 15 million cars annually. If it takes one, two, or three million fewer workers to produce the cars U.S. consumers can afford to buy, so be it.

A farmer with one modern wheat combine can do the job of a thousand 18th century farm hands. That is a lot of unemployed farm workers, yet nobody demands to return to those good old days. Productivity and efficiency do result in job losses and dislocation, but eventually progress creates new jobs and additional wealth.

Whether a Honda, GM, Toyota, Ford, Hyundai, or VW, currently each and every car still requires one engine and four wheels. Each manufacturer uses basically the same domestic and overseas suppliers, and each has dealers selling its cars (most dealers represent a broad spectrum of brands and will sell whatever car the market wants). The argument that GM closing its doors would result in the loss of 2 million jobs or more is ludicrous as the competitors that pick up the slack will hire workers and buy more from their suppliers. While that may not be good for Detroit, it may be good for the Carolinas or Tennessee.

Simply, business shifting from certain players in the industry to others is called competition. Capitalism and competition are the forces that have made the U.S. the most successful economy for many decades. Granted, it is a harsh reality, but it works, and so far no other system has come even close to creating as much wealth for most of its agents.

Anyone who follows our flagship newsletter, The Casey Report, knows our stance: we hope, most likely in vain, that the new administration will finally come to the realization that no entity is too big to fail. Besides, bankruptcy reorganizations have a much greater chance of success with larger corporations, as they usually have lots of assets to dispose of -- assets that can be sold cheaply to new enterprises, which are then able to build businesses on a much sounder basis. In the process, there is innovation and progress.

The choice is clear: Either the Obama administration can continue on the path of nationalizing entire segments of our economy (so far banking, insurance, auto - next, health, airlines...) and run them into the ground. Or it can let poorly managed companies fail, thereby making it easy for successful businesses and new entrepreneurs to buy the assets of these organizations. Step back and let the markets work their magic instead of blaming the market for ills that were created by special interests and poorly designed regulations.

* * *

Throughout history, the markets have shown "riptides" - powerful trends that can make or break a market sector and, in their wake, the people invested in that sector. It's quite obvious that the U.S. auto industry's day in the sun is over... maybe for good. But just like the tide going out to sea and coming back to shore, for every dying industry, another one emerges.

Investors with the knack to recognize those potent trends have made fortunes in the past, simply by getting in while the investing masses were still clueless. One of them is Doug Casey, famous contrarian investor, speaker and book author. Time and time again, Doug and his team at Casey Research have correctly predicted the next riptide... if you want to know what's coming next, learn more here.



Olivier Garret

Author: Olivier Garret

Olivier Garret
Chief Executive Officer
Casey Research, LLC.

Olivier Garret

Prior to joining Casey Research in January 2007, Olivier Garret was a principal in Kemp Management, a management consulting firm focused on merger & acquisition due diligence, restructuring, and turnaround activities for a variety of private equity firms and financial institutions. In this capacity, he led and participated in dozens of merger & acquisition and restructuring deals in a variety of industries.

In the 1990's, Olivier was CEO and general manager of a number of industrial businesses ranging from entrepreneurial start-ups to divisions of a Fortune 500 company.

He earned an MBA from the Amos Tuck School of Business Administration at Dartmouth College and a Master's in Business from the Université de Paris IX-Dauphine.

Information contained herein is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The information contained herein is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed herein are those of the publisher and are subject to change without notice. The information herein may become outdated and there is no obligation to update any such information. Doug Casey, entities in which he has an interest, employees, officers, family, and associates may from time to time have positions in the securities or commodities covered in these publications. Corporate policies are in effect that attempt to avoid potential conflicts of interest, and resolve conflicts of interest that do arise in a timely fashion. No portion of this web site may be extracted or reproduced without permission of the publisher.

Copyright © 2008-2010 Casey Research, LLC.

All Images, XHTML Renderings, and Source Code Copyright ©