Motown Needs Mo' Money

While credit may be scarce, there is no shortage of irony in the current financial crisis. Less than two months ago when the first draft of the Troubled Assets Relief Program (TARP) was debated before Congress, six of the eight Detroit-area representatives rejected the bailout. At the time, the $700b rescue package was seen as an endorsement of the reckless investment practices of America's biggest banks. Lawmakers from the Rust Belt were skeptical of saving any industry that claimed to be "too big to fail."

Now Detroit representatives are back in Washington, hats in hand, frantically seeking a bailout of their own. As the financial meltdown sends shockwaves through the real economy, the American automotive industry sits on the brink of collapse. At the end of September, President George Bush signed a spending bill that included $25b in low cost loans for car manufacturers. These funds were designed to allow automakers to retool production facilities in an effort to build more fuel efficient cars. Still, the rapidly deteriorating economic conditions have industry leaders pleading for additional help from the federal government.

Most analysts recognize that the automotive crisis spreads beyond the employees of the big three domestic car manufacturers: General Motors, Ford, and Chrysler. Indeed, the multiplier effect of the automotive industry means that trouble for these corporations will seep into other sectors of the economy. That is to say, the knock-on effect of losing one automotive job could lead to the loss of as many as 5 other jobs across suppliers, transporters, and other car-related industries. Some reports suggest that looming bankruptcy for the domestic autos puts more than 3 million jobs at risk and threatens to wipe tens of billions of dollars from the US economy.

GM and Ford are burning through cash at a staggering rate, each at more the $2b per month. Moreover, Chrysler recently failed to secure a cost-cutting merger with GM that may have been the company's last hope. The main problem with the automotive industry is simple: less cash is coming in, while huge sums are going out. The 30-40% drop in sales have left these corporations with excess capacity (there are more cars than there are willing buyers) and they have massive debts (some $45b), which they can no longer service because of declining revenue. 

However, the domestic autos cannot simply close factories and layoff workers to save money. On account of labor agreements, contractual obligations, and pension payments, GM, Ford, and Chrysler all face inflexible costs. Share values are plummeting and the industry is unable to sell commercial paper (and thus finance its operations with corporate bonds) because the market is so risk averse. It seems there is little hope for the historic manufacturing base of the American economy.

Look abroad, however, and there is a very different outlook for GM and Ford. Foreign sales are sliding in the current market conditions, but promise to act as a buoyant force on revenues in the future. Indeed, over the next forty years, the growth of the car industry will come from emerging markets. Of particular note are the BRIC economies: Brazil, Russia, India, and China. As these countries become richer, their populations (which represent huge markets) will funnel disposable income into automotive sales.

The industry realities are all slightly different across the BRIC countries. Brazil has no real indigenous manufacturing base; instead, GM, Ford, Wolkswagon, and Fiat control about 80% of the market share. In Russia, the Putin government all but did away with domestic car companies and has attracted foreign brand manufacturers. Both GM and Ford have controlling positions in Russia, which is expected to quickly pass Germany as the largest auto market in Europe. Bureaucratic red tape has traditionally hamstrung India's car industry, but Tata Motors is a viable domestic producer that is looking to expand globally. Nevertheless there is still room for competition from foreign brands.

China is the most interesting economy in that it has irresistible potential for market growth. Indeed by 2050, China is expected to have an automotive fleet that outnumbers the current global passenger fleet of 700 million cars. The domestic auto industry has consistently used a long-term strategy of joint-ventures with GM and Wolkswagon to support Chinese brands. While manufacturers in Shanghai will eventually look to stand alone, there is certainly potential for an American footprint on the Chinese car market.  

If, as predicted, the number of cars on the road swells to 3 billion by the end of this half-century, there are very real implications for climate change. Indeed some analysts have rather cataclysmic predictions for the environment unless zero-emissions vehicles are built. BRIC countries are likely to worry about traffic congestion in the short-term, but they will soon have to consider the effect of passenger cars on local air pollution. Nevertheless, it is likely that these issues will fall under the imminent regulations of a Kyoto successor.

The realities of global demographics suggest that there is vast potential for automakers (American or other) to exploit in the future. In the short term, however, there are very painful decisions facing the major corporations that have, for too long, built inefficient gas guzzlers in the US. In recent days, Congressional support has coalesced around an automotive bailout, but the measure still faces stiff resistance from President George Bush and Treasury Secretary Henry Paulson.

Earlier this week, president of GM North America Troy Clarke sent an email to 29,000 salaried GM employees, asking them to lobby their elected officials on behalf of the company. Desperate times have indeed led to desperate measures.