200k

Hit that minor milestone on the road to my mother's small horse farm out in the country yesterday morning. Since Cheryl's digital camera has been sitting broken in my trunk for the year or so while I've been procrastinating about getting it fixed (or buying a new one), I took the photo above with a $20 digital camera I picked up at the drug story before I hit the road.

Ten years ago, I won a digital camera in some sales contest. Actually, it was a voucher for a $350 camera, but I paid another couple hundred dollars out of pocket to upgrade to a Sony Mavica, which saved photos on a 3.5 inch floppy. New reader and old friend TheRivers/Y. remembers what that dinosaur looked like. I still have it, I'm pretty sure.

Chrysler Sale to Go Forward

According to the AP, the Supreme Court declined to review the appeal brought by those Indiana funds: Supreme Court to let Chrysler sale go forward. From the press release,

the automaker's secured debtholders would get $2 billion in cash, or about 29 cents on the dollar, for their combined $6.9 billion in debt. Some of the debtholders balked at the deal, saying as secured lenders they deserved more. The Indiana funds involved in the Supreme Court appeal hold about $42.5 million, or less than 1 percent, of Chrysler's $6.9 billion in secured debt. They bought it in 2008 for 43 cents on the dollar.

Why didn't any of the bondholders who hold the other 99% of Chrysler's secured debt appeal to stop the deal? I wonder if they bought the debt at low enough prices that they'll still come out ahead with a payoff of 29 cents on the dollar.

Given the extent to which the bankruptcy deals for GM and Chrysler favor the unions over the bondholders, it will be interesting to see if unionized manufacturers will have to pay offer higher coupon rates to attract buyers of their debt in the future. We may find out soon enough¹. According to Tony Jackson in his Financial Times column yesterday ("GM shows gravity of pension challenge"):

In the thunderous collapse of General Motors last week, one detail seems to have gone almost unnoticed. The old GM’s US pension fund, with its near-$100bn (£63bn) of liabilities, is being transferred lock, stock and barrel to the new entity. As a direct result, the new GM could be bankrupt again in a very few years.

[...]

GM’s US fund is, of course, in deficit, but the company has made no contributions since 2003. Back then, it put in $18.5bn, which it raised through a bond issue. Since this counted as a pre-payment, GM is not obliged to pay any more for the next year or two. However, it will then have to start plugging the gap, under the new rules set down by the Pension Protection Act of 2006. This, [independent UK consultant John] Ralfe calculates, would involve diverting $1bn to $2bn annually from operating cash flows. If GM cannot do that, bang it goes again.

We do have a government-sponsored organization designed to take over the pension funds of bankrupt companies, of course: the Pension Benefit Guarantee Corporation (PBGC). Had the PBGC taken over GM's pension, the new, post-bankruptcy GM wouldn't end up saddled with these liabilities, but that would have required GM's pensioners to take a significant haircut, since many of them earn higher pensions than the PBGC's maximum guarantee. Jackson offered the following numbers by way of example in his column,

Its maximum annual payment is $54,000 for a 65-year-old, but only $20,000 for a 50-year-old. And in Detroit, it is commonplace for car workers to retire on full pension at 50.

The PBGC has calculated that if it took over all the auto industry’s pensions, members would lose 40 per cent on average.

A 50-year-old GM pensioner with a $54,000 annual entitlement, Mr Ralfe reckons, would lose 60 per cent. Add that all up, and GM’s annual $9bn pension bill would be cut by $3.5bn.

¹Or not, if the now-bankrupt auto companies end up going to the federal government for more money in the future, instead of trying their luck in the capital markets.

An Economic Stimulus Idea That Seems to Work

One economic stimulus idea that has been proposed a number of times is for the government to spur auto sales by offering a voucher good towards the purchase of a new car¹ to owners of old cars. The first I remember reading of such a proposal was last summer, but here are a couple of more recent examples, from the Brookings Institution ("Refuel Economy with Cash for Old Cars") and from the chairman of Ford in the USA Today ("Cash in Old Cars for New Ones"). As the Brookings piece notes, Germany included this sort of voucher program as part of its stimulus package it implemented in January. The German version offers vouchers of 2,500 euros to citizens who scrap cars that are at least nine years old. According to an article in today's Financial Times ("Berlin hit by cost of car incentive scheme"), this German stimulus program is having a big effect, both in Germany and in other parts of central Europe. A few excerpts from the article make this point:

“In February and March, we made about three times the sales we had in the first quarter of last year,” says Bernd-Uwe Prochnow, sales director at a Volkswagen dealership in Frankfurt. “And the first quarter of last year wasn’t bad at all.”

Car sales nationwide rose 11.9 per cent in February, making Germany the world’s only bright spot for the car industry.

[...]

Car-scrapping incentive programmes introduced by Germany and other European Union countries² are having a dramatic impact on central European car factories, and could help boost the region’s slumping economies, write Jan Cienski in Warsaw and Thomas Escritt in Budapest.

The turnround at factories making smaller and cheaper cars has been striking. During much of November and December, the Dacia factory in Pitesti, Romania, stood empty, its workforce at home on 80 per cent pay. However, Dacia, owned by France’s Renault, produces the €5,000 ($6,600, £4,500) Logan, Europe's cheapest production car, which has become a winner thanks to Germany’s €2,500 government rebate available for new car purchases.

Recently François Foumont, Dacia's general manager, said surging west European demand meant exports would account for three-quarters of the company’s production this year, against two-thirds in 2008. Dacia said it sold 25,500 vehicles in Germany last year, and German orders this year already exceeded that number.

In the Czech Republic, Skoda, a subsidiary of Volkswagen, has seen its sales to Germany more than double to 11,000 in February, and the factory in Mlada Boleslav has gone back to full-time production after working only four days a week in January.

Petr Vanek, a spokesman for Hyundai, which has a factory in the Czech Republic, said the plant shipped 20 cars a month to Germany in January and February, but last month delivered more than 2,000. Hyundai is now hiring about 500 workers.

Fiat, which makes small cars in southern Poland, exported 47,417 cars in March, almost 10,000 more than in the same period a year ago.

The image above, of a welder working on a Logan sedan in the Dacia factory in Romania, comes from this ViaMichelin.com site

¹Some have proposed making vouchers good for the purchase of newer used cars too, which would indirectly boost new cars too.

²The article mentions that France offers a voucher program as well, but the French vouchers are worth only 1,000 euros.

Holman Jenkins's Latest on the Proposed Auto Bailout

From his column in today's Wall Street Journal, "A Bailout that Won't":

Forget Chrysler, which has needed a bailout from Washington or Stuttgart in three of the last four recessions. The tragedy of GM and Ford is that, inside each, are perfectly viable businesses, albeit that have been slowly murdered over 30 years by CAFE. Both have decent global operations. At home, both have successful, profitable businesses selling pickups, SUVs and other larger vehicles to willing consumers, despite having to pay high UAW wages.

All this is dragged down by federal fuel-economy mandates that require them to lose tens of billions making small cars Americans don't want in high-cost UAW factories. Understand something: Ford and GM in Europe successfully sell cars that are small but not cheap. Europeans are willing to pay top dollar for a refined small car that gets excellent mileage, because they face gasoline prices as high as $9. Americans are not Europeans. In the U.S., except during bouts of high gas prices or in the grip of a Prius fad, the small cars that American consumers buy aren't bought for high mileage, but for low sticker prices. And the Big Three, with their high labor costs, cannot deliver as much value in a cheap car as the transplants can.

Jenkins puts his finger on a key problem here. If the government's goal is to get Americans to drive more fuel efficient cars, the way to do that would be to raise federal gas taxes steeply. Then, Americans would effectively be forced to buy smaller, more fuel-efficient cars, and the domestic automakers would be able to sell them the sort of more expensive, higher-margin small cars they successfully sell in Europe. Politically, of course, it's easier for Congress to raise CAFE standards than raise gas taxes.

Iraq, the Automakers, and the Limitations of Technology

As the security situation in Iraq has stabilized, and economic issues have dominated the news, Iraq has gotten less attention recently in the media. Yesterday was an exception, as the New York Times reported that the Iraqi government's cabinet had approved a status of forces agreement with the U.S. ("Pact, Approved in Iraq, Sets Time for U.S. Pullout"). The photo above, of Iraqi policemen celebrating with an American soldier, is from the article. According to iCasualties.org, U.S. military casualties, Iraqi security force casualties, and Iraqi civilian casualties have all dropped significantly over the last year.

Before the security situation in Iraq had stabilized to this level, casualties across the board were much higher and most of the U.S. casualties were caused by improvised explosive devices (IEDs). The Defense Department formed an anti-IED task force and threw money, resources, and personnel into it to deal with the problem. Last year, the Washington Post published an excellent four-part series on this effort ("Left of Boom: The Struggle to Defeat Roadside Bombs"). The phrase "Left of the boom" refers to efforts to disrupt the IED enterprise before the bombs were planted -- tracking down IED makers, ambushing IED planters, etc. No short summary will do that series justice, but one point it made dealt with the limitations of technology in dealing the problem. New technologies did help ameliorate the situation, but there were no panaceas, and many of the more effective approaches weren't technological in nature. For example, the last article in the series noted,

The "Mark 1 Human Eyeball," as troops sardonically call it, is more adept at finding IEDs than any machine. Studies to determine which soldiers made the best bomb spotters found that "it's those who hunted and fished and were much closer to their environment," an Army scientist reported.

[...]

Other unconventional initiatives include "human terrain teams," made up of anthropologists, social scientists and sundry experts who advise brigade commanders on tribal structure, local customs and cultural nuances. A preliminary assessment last month of an HTT in eastern Afghanistan concluded that the team had "a profound effect" in reducing "kinetic operations" -- gunplay -- and had even discerned that a local village would help stop Taliban rocket attacks against U.S. troops in exchange for a volleyball net.

More broadly, the successful (so far) counterinsurgency efforts in Iraq, although aided by technology (e.g., hand held fingerprint scanners, reconnaissance drones, etc.) have relied more on 'left of boom' approaches that are attuned to local politics (for detail and insight on this, see, for example, David Kilcullen's posts on the Small Wars Journal blog. Dr. Kilcullen, a retired Australian army officer and counterinsurgency scholar, has served as a counterinsurgency adviser to the U.S. in Iraq and Afghanistan).

What brought this to mind recently -- the frequent lack of technological panaceas to complex real world problems -- was a column by Thomas Friedman last week about Detroit in the New York Times ("How to Fix a Flat"). In that column, Friedman wrote,

Any car company that gets taxpayer money must demonstrate a plan for transforming every vehicle in its fleet to a hybrid-electric engine with flex-fuel capability, so its entire fleet can also run on next generation cellulosic ethanol.

Lastly, somebody ought to call Steve Jobs, who doesn’t need to be bribed to do innovation, and ask him if he’d like to do national service and run a car company for a year. I’d bet it wouldn’t take him much longer than that to come up with the G.M. iCar.

Friedman, before he became sought after as an expert on energy policy, was better known as an expert on the Middle East (he was for the war in Iraq before he was against it). Here though he seems to underestimate the technological challenges in designing an innovative new car (see, for example, "Tesla's Wild Ride"), and not acknowledge the extent to which Detroit's problems are political and not technological, i.e., being trapped between the Scylla of UAW labor costs of $73 per hour and the Charybdis of federal CAFE regulations that require automakers to build small cars that don't have the profit margins to make up for the high labor costs¹.

¹Friedman does note in passing the Big Three's high labor and health care costs but quotes an environmental lobbyist asking why GM didn't lobby for Hillary Clinton's proposal for nationalized health care. How that would have assuaged GM's retirees, who were already eligible for a national health program (Medicare) when they reached age 65, but preferred the more generous plan their union had negotiated, he doesn't ask.

Bailing Out The Big Three

A lot of ink has been spilled recently on the proposed bailout of the automakers by the federal government, including a sensible editorial in today's Los Angeles Times ("Kick the automakers' tires first"), John Tamny's column today on RealClearMarkets ("Time to Pull the Plug on General Motors"), and Frank Ryan's column in today's Investor's Business Daily ("Bailouts Merely Institutionalize U.S. Mediocrity"). All make good points about the mistakes made by the domestic auto industry, but none of these address the need for the U.S. to have at least one viable domestic automaker for national security purposes: the world's superpower ought not have to rely on foreign manufacturers to build its tanks. Clearly, there is overcapacity in the domestic auto industry. The Lex column in last Thursday's Financial Times ("American Cars"¹) underlined that point:

America’s love affair with the automobile has reached such a level that there is now one car on the road for every person old enough to drive.

[...]

Suburban sprawl and improved car quality have allowed many families to amass not just two but three, four or even five roadworthy vehicles. The median American car is now 9.3 years old, 50 per cent older than in 1990, which is an odd statistic given how easy it has been to buy a new one – until recently that is. The rate at which cars are scrapped should track sales in the long run but car sales have managed to exceed vehicles being retired by a third on average since 1990.

In a pinch, many Americans no longer need to buy a new car as their old one just keeps on running. And, even if their clunker dies, there is a surplus of used vehicles.

Political considerations aside, this would seem to be a perfect opportunity for private equity. A private equity firm could buy GM's senior debt as GM slid into bankruptcy, bring in new management (there's still no shortage of manufacturing expertise in this country -- think Boeing, John Deere, etc.), use bankruptcy to get out of labor contracts and cut costs, cut capacity, and rebuild GM as smaller, profitable company. A slimmed-down, profitable GM could then merge with what was left of the other two domestic automakers as the industry consolidated.

Of course, in the real world, there are plenty of political considerations. There's the politically powerful UAW, well-connected auto dealers, the prospect of hundreds of thousands of job losses in auto-related businesses, politicians who want to be seen as being pro-labor, etc. Perhaps the politically palatable solution might be to provide some sort of temporary financial assistance to the automakers, and give them a couple of years to work out a modus operandi with each other (i.e., mergers), their union and their dealers to reduce capacity and costs. That might allow the inevitable layoffs to be phased in after the economy recovers. If President Bush is smart, he'll do as the WSJ editors suggested yesterday ("Nationalizing Detroit") and let the Obama Administration and Congress handle this after January 20th.

¹The graphic comes from this column.