Thoughts on the GM Bankruptcy

Of course, the big national new story this week is the GM bankruptcy. Since we are now all shareholders of GM, I think there are two important questions we should ask ourselves.

· Can a US automaker be cost competitive?

· Do the benefits of a bailing out GM exceed the costs?

In regard to the first question: Can US automakers, in general, and GM, in particular be cost competitive? The answer here is yes. Unlike other industries where the US has lost market share to overseas production, the US auto industry has lost market share to foreign producers operating in the United States. This seems to me to indicate that it would seem possible that a restructured US auto producer could be competitive. By filing for Chapter 11 bankruptcy GM can help reduce its debt overhang and reduce their legacy costs. These costs have made it more difficult to compete with other producers that do not face these costs. Even though GM may be able to strip a fair amount of the debt and legacy costs, they still must overcome some other problems that GM has faced the last few decades. They still must comply with the regulations and CAFE standards imposed on the entire auto industry by the US government. Since these costs are applied to all producers, it will simply make all cars more expensive and will not put GM at a competitive disadvantage. More importantly, they must find a business model that works; that is, they must start producing cars that consumers want to buy. Growing up in family where my father worked for GM, I constantly heard how GM `now’ understood the competition and how GM `now’ understood its consumers. In fact, if I had a dollar’s worth of GM bonds for every time I heard this statement, I would own 10% of the company. The fact is that GM never successfully adjusted its product line to satisfy the wants and needs of its consumers. When I think of what I want in a car, I typically think of two things I want out of a car. I want a car that is going to be practical; that is, it gets good gas mileage and it gets me from place to place reliably. Second, for some people or sometimes we want cars that are `cool’. From the time we first get our drive’s license, cars help define our independence and freedom. When I think of practical cars and `cool’ cars, GM cars never come to mind. In the end, even with a lower cost structure the new GM that emerges needs to reinvent their business model and deliver cars that people want to buy. Finally how long will the government have ownership in GM? The main problem with government ownership is that the diverse interests of the government will push GM to achieve objectives other than producing cars that satisfy the wants of consumers. As a result, this leads to inefficient production and raises costs; something GM is trying to move away from. If GM remains in the hands of the government too long, it may end up not having a cost advantage at all. I am sure the Obama’s economic team is aware of this and they can move ownership back into the hands of the private sector.

The second question is: do we want the government to help GM? The answer to that question depends largely upon who you are. A better way to restate this question is: Who benefits and who loses from restructured GM? Clearly, those who benefit are the employees of GM and the suppliers that keep their jobs. Had GM not received support from the government last fall it is likely that GM would have gone into liquidation. The GM workers and suppliers that lost their jobs would have probably faced pretty high displacement costs and re-employment costs. Thus, the currently employed autoworkers and the suppliers gain. They may have lower benefits or receive lower wages going forward, but they are clearly better off now than if GM would have gone into liquidation. If a viable GM emerges, consumers may also benefit from the increased competition that keeps prices down as well as an increase in variety of cars to choose from. As for the losers: It appears the GM bondholders are likely to come out on the losing end of this deal. They were holding $27 billion in debt now they will receive 10 percent of a company of unknown value. In addition to the GM bondholders, one wonders if the type of deal will create other problems in capital markets making it more difficult to raise funds. Would someone want to buy bonds in a company, if they felt the government could step in and significantly reduce the bond’s value? Finally, the taxpayers may lose as well. If a viable GM emerges and the government sells off its 60% ownership how much revenue is this likely to be raised? Currently, the government has invested about $50 billion in GM. Will these shares be worth $50 billion in 2012 or whenever the government sells off the shares? I am skeptical.