Sunday, July 14, 2013

GM, Ford, Chrysler… Does the end justify the means?

Have you heard?  People everywhere (except Europe) are buying cars again.  Automotive News reports that June’s U.S. auto sales are up for six consecutive years. They project 16 million for the full year.  Further, they report that each of the Detroit Big 3 gained market share in the first six months of 2013. 

That’s a far cry from the reports out of Detroit a few years ago.

More interesting is that foreign manufacturers are locating more factories here in the U.S.  Is that a good thing?  You bet.  When companies from another country invest here it creates jobs no matter what the nameplate on the car.  Indeed, Nissan, Mercedes, Toyota, Honda, BMW and the rest are exporting cars from their U.S. factories to the rest of the world.

Bloomberg recently ranked the U.S. as the third most attractive country to locate a business behind Hong Kong and the Netherlands.  China? They’re number 19. 

How can that be?  Here’s how.  While it’s true that the weaker dollar has caused the effective labor cost to drop, what’s more important is that the U.S. is well integrated into the global economy through its transportation and communications systems, has the wealthiest consumer base and is a rules-based economy

Global investors – business owners, corporate executives, shareholders -- are more likely to put their money into a venture governed by a reliable set of regulations, taxes, policies, etc.  “The rule of law” is very important to them.

Rule of law is a confusing term and, used in other than economic contexts, can be construed as “rule according to law” or “rule under the law”. provides a concise definition thusly:  “the principle that all people and institutions are subject to and accountable to law that is fairly applied and enforced; the principle of government by law.”

Was the rule of law abandoned a few years ago when the automakers were circling the toilet for the third time?  Fearful that hundreds of thousands of jobs would be flushed along with the shareholders money, the government intervened, first under the Bush administration, to loan TARP money the automakers and, then under the Obama administration, to engineer a restructuring of both GM and Chrysler through bankruptcy proceedings.

Critics howled but fear ruled the day.  So, what would have happened if the government hadn’t stepped in?  Many of my friends and colleagues have speculated that private investors would have acquired the assets through a Section 363 sale in bankruptcy court.  GM could probably have been had for about $10 billion, chump change for the private equity industry. 

But, I am not so sure.  We were all in a panic in the first half of 2009.  No one was quite sure what would happen next.  Investors like a stable environment in which they can place their bets.  2009 was anything but stable.   Mike Jackson, CEO of AutoNation (NYSE:AN) the nation’s largest auto dealer, has often said, “it’s pains me as a conservative Republican to say this…” but the U.S automakers would not have survived if the government hadn’t taken action.  He goes on to support the oft-reported view that the a GM liquidation would have unraveled the supply chain and brought down many other companies in the industry, causing not only job losses but also disruption of the global economy.  And, this was at a time when the U.S. Federal Reserve was still putting the Humpty-Dumpty financial services industry together again.

Principles are important.  Our leaders, both Republicans and Democrats, violated so many sound principles of capitalism during the nine-month span between the Lehman bankruptcy and the GM bankruptcy that it’s hard to keep track.  The most prolific of the Austrian school of economics, Friedrich Hayek, in his most important work The Road to Serfdom, said, “nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles known as the Rule of Law”.

But, there is no line in the sand that can distinguish between actions that satisfy the principles of the rule of law.  Both the President and the Chair of the Federal Reserve are given a great deal of discretion.  Here’s what George W. Bush told CNN in December 2008, a month before he turned the reins of government over to his successor.  "I've abandoned free-market principles to save the free-market system, to make sure the economy doesn't collapse."

We’ll never know what might have happened if the government hadn’t exercised its discretion.  But, no President wants to preside over the collapse of the economy.



  1. Please pardon the typo in the quotation from Mike Jackson.

  2. Carl Amiaga • The president had no right to circumvent bankruptcy law. This move was strictly designed to protect union pay and pensions. A normal bankruptcy would have forced unions into some reasonable compromises for the long term health of the company. Without a restructured union agreement, bloated labor costs will cause the auto companies to be looking for another bail out within a few years.

    On a personal level, a large portion of my retirement savings were invested in GM bonds which were supposed to be safe under existing law. With no pension of my own to count on, my retirement savings were confiscated to pay for unrealistic union pay, pensions, and a myriad of other benefits.

  3. Kevin Williams • Which one is not like the others?

  4. Michael Khoury • As much as it pains me to say this, in this case the answer is yes. The rights of so many people were trampled in the GM and Chrysler bankruptcies, but the rhetoric that the companies could have been saved through private enterprise was nonsense. Had the bailouts not been engineered, I firmly believe that we would still be in a very deep depression. That being said, those who lost so much should have been offered an opportunity to participate on the upside. Unfortunately, they are left on the scrap heap, both individuals and institutional creditors.

  5. Christopher Smith • Well, if one refuses sobriety, then the argument that a little hair of the dog is better than a crushing hangover can easily be made.

    The auto bailout happened. History does not support experiments; we can't go back and find out how much MORE production/prosperity we'd have if the rule of law had been respected
    and bustling, economically prosperous Detroit
    had been permitted to give itself an enema.

    Something is better than nothing, I suppose.

  6. Jeffery Pyle • John, it was fear and political payback that lead to the taxpayer bailout of GM. There was no justification, legal, moral or otherwise for the bailout and no reason it couldn't have been handled through ordinary bankruptcy. Instead, we ignored the law in order to benefit the few at the cost of the many.

    We have bankruptcy laws and bankruptcy courts for a reason.

  7. Brent Ditzler • DISCLAIMER: I've worked for FORD since retiring from USN in 2000.

    Professional Opinion: Quick action saved the industry; rapid forced structured bankrupcy created relative calm in the automotive industry; because, everyone (tier 2,&3 suppliers and thier investors) knew just enough to take necessary action and plan for the future and not head for the exits en masse. It is absolutely true that if GM or Chrysler or both had ceased operations, Ford would have also been taken down by a failing supply base. Unfortunately, having beaten GM and Chryser in the business game it was a bitter pill to play a role to keep them in the competition AND make them debt free.

    Political Opinion: Giving new shares to the unions while wiping out investors with complete disregard for the rule of law was indefensible.

    Personal Opinion: It has been a wild ride!

  8. Great comment, Brent. And, I agree with your Political Opinion. That was an example of using discretion rather than the rule of law.

  9. J. Matthew Good • What I find most troubling about this article is that it insists that private equity would have rescued GM and Chrysler. This completely ignores the fact that Chrysler was OWNED by a private equity firm at the time! It also indicates that GM could possible have been sold for $10bn, but then the investors would have also had to spend another $5bn on new product development.

    Also, the workforce of each would have likely been much less co-operative with private investors taking on a restructuring of either company. But the real problem with GM and Chrysler is their badge engineering, lack of differentiation, and engineering by MBA.

    What I mean by engineering by MBA is their emphasis on cutting costs in the product by minimizing the development and engineering to maximize the quality and value of the product. Why develop a new, improved drive-train when we can adapt the one we already have...? Why design a different body when we can just import an existing Opel or Holden design...? Why improve our construction quality and durability when it isn't showing up in lower warranty costs...? Why use better materials...? Why have better finishes...? Why use brake pads that will last more than the 36,000 mile warranty...? Why build a car that will travel 200,000+ miles reliably with only scheduled maintenance...? Et cetera, et cetera, et cetera.

    Honda, on the other hand, tried to re-engineer the 2012 Civic using the North American penny pinching management method. Sales plummeted. The 2013 Civic was completely redone. Yes, most of the same tooling and structure (almost all in fact) were carried over. But the interiors, rear styling, grille, and many other elements were completely replaced. Sales are back up where they belong for 2013.

    Only time will tell whether GM and Chrysler will learn from their mistakes like Honda, or if the old engineering by MBA attitude will return. But at least for a short time, both were allowed to let engineers be engineers and not bean counters. And private equity would never have allowed that!

  10. @Matthew. You have mis-read my statement about private equity. I said that many of my friends and colleagues had the view that private investors would have stepped up including private equity. I went on to say that "I am not so sure". Investors like a stable environment and the 2009 economy was not stable.

    I agree with your assessment of the industry and how it got itself into the position it found itself by the time of the crisis. I also agree with your assessment of how the industry should be functioning to be competitive. If you're interested in cars (and, you obviously are), there's a great book by Bob Lutz called Car Guys vs. Bean Counters. I wrote about it in my blog about two years ago. The post was titled They Don't Write Songs About Volvos. Here's a link if you're interested:

  11. Jonathan Gorman, CPA • Total Govt Cash provided by bailout < Cash returned to Government

    In any BK some creditors lose. They had their day in court.

  12. Michael Hernton • Two comments so far have indicated that the law was broken, I'm trying to figure out how...The companies were bailed out under TARP, meaning the President used the broad authority granted to him by Congress to execute the bailout. If there was a problem legally speaking, I'm sure someone would have filed suit. On another note, Savvy investors jumped ship on GM well before the stock went to zero, or they hedged their position. Anyone else that got hit really shouldn't have been in the game. I'll accept the premise that something odd happened here, but it was an extraordinary time that called for that type of action. All of the architects involved talked about looking for private money make the deal happen, no large investors wanted to be a part of it. This was deal was a necessary evil, that is easy Monday morning QB, and of course had the deal not been made the auto industry would probably be in shambles with Toyota, Kia and Hyundai picking up the slack, but leaving half of the American job out of the recovery equation

  13. @Michael. The law was not broken per se. In my blog, I pointed out "there is no line in the sand that can distinguish between actions that satisfy the principles of the rule of law. Both the President and the Chair of the Federal Reserve are given a great deal of discretion."

    The rule of law, in concept creates a degree of assurance for investors. In the case of a bankruptcy, the "law" can be made by any judge. Bankruptcy court is a court of equity not a court of law, which means that the judge can make the rules.

    In the GM bankruptcy, the government became the debtor in possession which, aside from its political influence, gave it lots of clout in determining the structure of the final deal. By itself, that was unprecedented. What was egregious was the granting of stock to the unions while the the bondholders were left high and dry. That was an extraordinary departure from precedent. However, the judge used his discretion and approved it.

    Some laws are "black line" laws meaning they are written and ratified. Others are set by precedent. When people's discretion intervenes with the expected course, investors shy away. An extreme example was Chavez nationalizing the oil industry in Venezuela.

    That global corporations and investors still put their money into U.S. investments is an indication that they view the resolution of the GM bankruptcy as an anomaly not an indication of a complete breakdown of the rule of law.

  14. J. Matthew Good • I'm glad you clarified that. It looks like you might need to find some smarter friends and colleagues. :-) I don't believe that either would have survived even if the economy had been stable. The task was (and still is) too daunting.

    Thanks for the link to your article on Lutz's book. I'll have to get a copy. I think it could have been titled Everyone Else vs. Bean Counters though. While I can't prove a cause and effect relationship, there is certainly something suspicious about the coincidental rise of the MBA in our culture and fall of our industrial supremacy. Combined with the focus on price over quality at all levels of the economy, I don't see much improvement in our future. The demise of the middle class will only accelerate the race to the bottom on quality and durability. Ordinary people often cannot AFFORD anything but the cheapest option. My previous example shows that even venerable quality driven companies like Honda can fall prey to the Bean Counters. Of course, in the long run, it cost them MORE, with the expense of re-doing everything after only one year. But I'm sure the Bean Counters found a way to excuse their failure the first time.

  15. @Matthew. More good thinking on your part. The subtitle of Lutz' book is "The Battle for the Soul of American Business". He contends, as do you, that the MBA focus has destroyed many American corporations.

  16. Carl Amiaga • Michael...I don't think you really appreciate what happened here. There is a hierarchy of financial interests when a company cannot meet its financial obligations. Bond holders accept a certain interest rate with the knowledge that they are first in line to have their principal repaid, all or in part based upon the remaining assets, even if the stock goes to zero. Savvy bond holders were counting on the rule of law being followed. TARP money being used does not mean that bankruptcy law doesn't have to be followed. Does presidential "broad authority" allow him to confiscate Michael Herndon's house and retirement account to execute the bailout? Although banks issue stock, they can't just confiscate depositor money if they get in trouble.

    The US financial system is based on laws that detail the risks of investments. The president had no authority to steal the principal investment of bond holders and give it to unions as a repayment for votes. GM and Chrysler would not have gone out of business in a bankruptcy but they would have had to restructure their commitments with the unions to make the companies viable into the future.

    If investors cannot trust that their money will not be taken by the government when it feels that it is necessary...goodbye financial system. Why do you think gold prices spiked right after this?

  17. Carl Amiaga • John...I would not agree that there was no law broken. The US could wipe out its debt by simply saying that it will not honor Treasury Bonds and law broken and no financial system left either.

    I do agree that investors hope that what happened here was an anomaly. Additional anomalies will really spook investors.

  18. @Carl. The actions that caused your personal losses were egregious and completely out of line with "the rule of law". But, I don't know what law was broken, do you? I am not a lawyer and I don't have perfect knowledge of the bankruptcy case. So, I am not challenging you. I am asking you to inform me.

  19. Jonathan Gorman, CPA • Total Govt Cash provided by bailout < Cash returned to Government

    In any BK some creditors lose. They had their day in court.

  20. Carl Amiaga • Hi John...I am not a lawyer either though I have studied business law. The Prospectus and other paperwork for the issuance of the Bonds detailed priority of repayment and is a contract between the issuing company and the bond holders. The president has no authority to unilaterally change contract terms. By circumventing the legal rights of the bond this not breaking the law?

  21. @Carl. It wasn't the President or his administration that had the final say. Bankruptcy court is a "court of equity" in which the judge makes the decision as to what is acceptable.

  22. Michael Hernton • In an effort for full disclosure I'm a law student, have a MBA, have passed Series 3, 7, 63, and 65. I've taken a hard look at the bail outs of LTCM, the bank Bailout and Auto Bailouts as an academic and professional study. Under the Necessary and Proper Clause the Constitution grants broad power to Congress to pass laws and the for the President to execute those laws. The mechanism that Congress has in place to over rule the President is to repeal, or de-fund a law that has passed. In my opinion no law was broken. Whether we like it or not the economic situation surrounding the bailouts called for unprecedented action. In answer to your question Carl, the Constitution does authorize the Government to rewrite or ignore contracts in the event of an emergency. A person that suffers a loss under these condition can attempt to enforce their rights by claiming that the loss was violation of the 5th Amendment takings clause, made famous recently to laymen as eminent domain.

    Section 262 of the Restatement on Property covers the topic in regard to a trespass to chattel (private property not considered real property or real estate) (Privilege Created by Public Necessity), which pertains to trespass to chattel rather than to land: “One is privileged to commit an act which would otherwise be a trespass to chattel or a conversion if the act is or is reasonably believed to be necessary for the purpose of avoiding a public disaster.”32

    We can argue whether the emergency is great enough to invoke the privilege mentioned here. In my first post on this topic I said that savvy investors were aware of when to go to cash and get out of their positions in GM stock or GM Bonds. When I say savvy, I don't mean the average joe or jane, but portfolio managers saw all of the tell tale signs. So they had a choice hold onto the assets and ride it out, which some did, because of tax consequences, or to hedge using options or some other inversely correlated asset, or go to cash and go long the Euro which would have made sense at the time.

    The underlying issue is predictability, which is why investors get into the game to begin with; we learn the rules of the markets and act accordingly. These moves with the Bailouts were Black Swan Events, that moved out to 4 or 5 standard deviations. No one knew with any certainty that the market was going to go down as far as it did. In looking at GM specifically, their business model was bad because of the concessions they made with the unions years ago. It stopped being a car company and became a financial institution that made money by selling car loans and house loans (GMAC). It was only a matter of time before the company collapsed under its own weight.

    All in all I think the administration did a bang up job in preventing the collapse of GM and Chrysler, and thereby preventing the collapse from cascading into the rest of the economy. I don't mean to be cavalier when I this, but someone was going to be crushed in that deal, eggs and omelets and all. One of the things that a prospectus doesn't touch is what happens in the event of a cataclysm, except to say the warning that is on every type of assets disclosure which talks about past performance isn't indicative of future results and all assets bear some risk. A financial planners answer to that is diversification.....

  23. This comment has been removed by the author.

  24. John Orr • @Carl I'm in no way an expert when it comes to the fall of the auto industry, but I would imagine the same sort of hierarchy exists. I read a book recently, "The Fate of the States." It discussed the current status of states and the debt they hold...ultimately we are in serious trouble, but that's neither here nor there. What is applicable here is the priority of payment if a state were to go backrupt. If a state were to go bankrupt, it's number one priority would be to pay off / settle the pensions of its retired union employees. This is prior to basic social needs for a community. I find it hard to believe that large corporations wouldn't follow the same priority of payment thus bondholders would be more or less left to fend for themselves, but I could be wrong.

    Ultimately, I don't meant to offend anyone, but unions are out of hand. They are a cancer in this country. Originally, they were set up to protect the rights of those individuals and maintain safe working conditions during the industrial revolution and I can respect that...but as per usual things have been taken to another level and now I can't replace a ceiling tile without discussing the effect it will have on the union.

  25. Chuck Rosselle • I think the reason manufacturing returned is due to recognition of the worth of the American worker, not just the rule of law. At least I hope so. Western Europe also has the rule of law, but they're manufacturing here as well. The Reagan administration supported Sematech and we learned how to "bend the rules" to compete. We successfully kept Semiconductor Equipment Manufacturing along with high end logic chips. But the lesson was forgotten. Manufacturers have had to re-learn that having productive workers who don't necessitate rework and can think on the job counts for a lot in dollars per hour. That doesn't even include the transportation savings and set-up time enhancement. I only hope that we institutionalize the lessons this time, get out of the accountant mid-set and begin to apply them across the board. As you said, who can lead.

    As far as government intervention is concerned, I think we need to stop thinking of it as throwing money around and consider it as the government becoming the investor of last resort. Henry Morgenthau (Hoover's Treasury Secretary) famously said that the Great Depression should run until "the rot is worked out of the system". What he meant was until private investors were comfortable investing again. The problem is, as was alluded above, when fear trumps greed its a long time until someone wants to be the first investor in. If you have confidence in the American system, government should not be afraid to invest at the bottom when no one else will. But it better know what it is doing. Largely it has worked out; few remember the multiple City Bank bailouts under Nixon once Walter Wriston convinced him to relax Glass-Seagall, nor the Chrysler/Iaccocca bailout, nor Rubin bailing out Mexico and Asia so they could keep trading with us. All were successful. It was rather remarkable that after the banks got bailed out, Bernanke was able to essentially print money, put it in their hands and re-pay the government without causing rampant inflation or devaluation. I think that's as close as any Central Banker has ever gotten to converting monetary into fiscal stimulus.

    I have to hold my nose in order to admire bailing out the guys who initiated all of this, and some of what was actually done in the name of fiscal stimulus seems to have been poorly conceived. But it appears to have kept the economy from tanking. There will be continued finger pointing at Fed and governmental balance sheets but economic growth has a way of cleansing a lot of sins. Let's hope somebody figures out what worked (and has worked in the past) and why. God forbid if we ever need to do it again, but if so let's do it better. Who will lead, indeed (just not a finance guy)!

  26. David Booth • @Brent. I don't understand your comment that the action saved the auto industry. You know a lot more about this industry than I do, so I'm hoping you would clarify that statement. Do you think we would be buying fewer cars today than if this bailout didn't go through? If not, wouldn't we simply be buying more cars made by Toyota, Honda, etc ... If that is the case, the bailout didn't save an industry it simply propped up some of the companies in the industry at the expense of others. Keeping in mind that Honda has exported 1 million cars overseas that it made in the U.S., it is difficult to maintain the argument that we needed to protect our domestic production capability. ... I look forward to your feedback.

  27. Craig Elmore • The question is "Did the end justify the means?" not "Was it legal?". In my opinion the answer to the original question is: no. We can all speculate on what would have happened had there been no bailout, restructuring and confiscating of assets. Personally I agree with David but that's irrelevant. The real issue to me is the extreme manipulation of the system. It may be technically legal but it's wrong. The end justifies the means approach is a dangerous way to run a nation, especially when you don't know who will be the next person in charge.

  28. Carl Amiaga • Craig...I completely agree.

    John...I understand hat the courts ultimately approved the bankruptcy deal but with plenty of pressure from the president. There was the typical demonizing of innocent, law abiding citizens so that he could justify an unjustifiable deal of transferring assets to the union. I believe the phrase was "greedy bond holders".

  29. Brent Ditzler • Craig,,,I don't think we would be buying cars at current rate and quantity because the economy would not be in the shape it is in currently if GM CHRYSLER FORD had ceased to exist; because EATON, VISTEON, DELPHI, JCI, LEAR, and the countless other tier 1, 2, 3, 4 suppliers that supply ALL North America Auto production would not exist in their current state and US production by Honda, Toyota, NISSAN, BMW, VW, etc. would be severly hobbled also. Heisenberg's uncertainty principle applies in that you can't say the current state would exist if you change a preceeding state.

  30. Ralph Michalske, MBA • Hi Chuck,

    I found your comments regarding Sematech and keeping Semiconductor Equipment Manufacturing in the US interesting. Most of the high tech semiconductor manufacturing equipment used in the industry comes from elsewhere. Applied Materials, Teredyne, and a few small manufacturers have plants here, but you'll have to go to Asia or Europe if you are seriously looking for equipment. This is mainly because semiconductor diffusion has moved to Asia which has become the center of mass for the semiconductor industry nowadays. There once was a time we could have changed this with manufacturing of solar panels in America which consume large amounts of semiconductor silicon. However, Asia out-gunned us and has taken over control of the solar industry. The same was done, years ago, with the LCD manufacturing industry which also uses semiconductor manufacturing equipment.

    Semiconductor equipment manufacturing and semiconductor diffusion fabs are rapidly exiting our shores. It's too late for any bailouts, from government or elsewhere. America will just proudly acquire this technology elsewhere forever, just like we do for textiles, steel, small appliances, hand tools, shoes, and other things.

    One thing Bernanke has learned and we are slowly also learning is that there are no interest rates below zero. Let us call it the Bernanke Law. This law is a serious problem for him and the overall US economy. Quantitative Easing can provide some relief and stimulus when you encounter Bernanke's Law, but it's much like putting a cork in the dike or levee (as the people from Louisiana call it). The relief is never permanent. Bailouts can work, but they must be quick and enough. Lucky for us, the 2008/2009 bailouts for the banks and auto industry were swift and enough. But nevertheless, a close call. You're right to reference the Walter Winston/Citicorp and Lee Iacocca/Chrysler bailouts of yesteryear. I'd almost forgotten those.

    Who will lead? That's always a good question. Leader's must acknowledge laws and directives. However, the best leaders will always exercise good judgment over bad laws, covenants, and directives where they can.