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Posts Tagged ‘auto bailout’

Cash for Clunkers

September 23rd, 2009 No comments

By now the Cash for Clunkers program is well behind us. Before the chaos of this financial crisis, I had never thought that the government would introduce such a program, and I’m not sure I’ll ever see another one like it in my remaining years. Given that, I’m glad that we (specifically, my parents) were able to take advantage of the program. Based on my experience, a few thoughts:

The government’s objective was the lift vehicle sales; there’s no doubt that they were successful. About 700,000 vehicles were sold under the program, resulting in a total of $2.87 billion paid out by the government. In addition to this, we should add the cost of processing the applications and any additional infrastructure needed to execute the program. The cost still comes in under the $3 billion the government had budgeted. This was a great thing for car dealers, for people who were able to take advantage of the program, and for the auto industry in general (production was ramped up and thousands of people were put back to work). However, my concern is about the short-lived nature of the program. I’m afraid that in the books of history, this will be but a blip. Now that the program is finished, we still have extremely high unemployment, we still have lack of desire for American cars, and we still have no evidence of improved American cars (in terms of quality and reliability). So, what will happen to the auto industry and all the workers who were put back to work over the next six months? I hate to say it, but it isn’t looking pretty – auto sales are down again, and I feel like it’s only a matter of time before production stops again. We need a more permanent solution to this problem…

Buying a car through the Cash for Clunkers program was quite an experience. Firstly, finding a car was an issue. Many dealer lots were empty and inventory was scarce. Dealers couldn’t really get cars from other dealers since the problem was systematic. We pulled the trigger pretty quickly – I spent a couple of days reviewing candidate cars, did my usual email blitz, and then ended up deciding where to go. We bought on the Saturday of the final weekend (the program was to end on Monday and Illinois law requires dealers to be closed on Sunday, so we effectively bought on the last day of the program). We visited two dealerships and I’d never seen dealerships so busy. Both dealerships were swarming with people – in the showrooms, on the lots, and in the tiny cubes doing paperwork. Sales people were juggling 4-5 deals at a time. Normally a sales person is asking what they can help you with within minutes of your entering a car dealership. Now you could be looking at a car or trying to get someone’s attention for over a half an hour before you finally got to talk to someone. It was taking about 5 hours to get a customer from agreeing on a price to out the door with a detailed and inspected vehicle (when normally it shouldn’t take much more than an hour or two). I asked the sales guy at the dealership what time they close and how their day yesterday went. He told me that the were supposed to close at 9pm the previous day (a Friday), but couldn’t. They had new customers walking in at 8:55, and ended up staying at the dealership until 1am. They returned to work at 5pm the following day. There was an immense buzz and excitement in the dealerships – something I’d never seen before, and unfortunately am not likely to see in the near future.

The Cash for Clunkers program created interesting distortions in the auto industry. Prior to the program dealers would do anything to get a car off the lot. In addition to rebates, the dealers were willing to pass along any marketing incentives they were given by the manufacturer, as well as part of any volume discounts they got. Basically, if they could make a couple of hundred dollars on a deal (or less!), they’d sell you the car. Heck, it was difficult to understand the quotes you’d get for a car – they’d be below the invoice less all available discounts – a price that just made no sense! As far as choice goes – you could get almost any color with any options – there was so much inventory either on the lot or with nearby dealers that you got whatever you wanted. After the program, things couldn’t be any more different. Cars were scarce – the only color available at all the Chicagoland Honda dealerships we spoke to but one was black. You’d be lucky if you could get pricing any lower than $50 below MSRP or so (I even received a couple of quotes OVER MSRP!). From an economics point of view the government incentive created a surplus for the consumer. However, much of that surplus was consumed by the dealers. As incentives disappeared and demand went up, prices went up by thousands. Of the $3,500 or $4,500 the government gave you, it wasn’t unusual for the dealership to take more than half (as a result of the higher prices). At the end of the day, this gives a double bonus to the dealers, and only a slight incentive to consumers. Dealers win because they reduce inventory and get MSRP for the vehicles sold. Consumers are told they’re getting $3,500 or $4,500, but in reality are getting much less since they paid much more for the vehicle than they would have paid before or after the program.

Another interesting dimension of the program is that the government didn’t put any restrictions on re-selling vehicles bought under Cash for Clunkers. What prevents someone from buying a new car at a steep discount and then turning around and selling it? Granted that after factoring in taxes and the dealerships’ higher prices this idea isn’t too lucrative, but depending on the situation (getting the full $4,500 and buying one of the less popular vehicles), one could make $1,000 or more doing this. Not preventing this from happening results in car prices (both new and used) falling (since there would be several new clunkers cars hitting the used market with less than 1,000 miles). Practically this may not be doable for most people since they’d lose the use of the vehicle (i.e. if I used my clunker to get to work everyday and then traded it for a new car, I can’t exactly sell my new car since I will no longer be able to get to work!), but I do find it interesting that the government didn’t limit this behavior.

Finally, one unfortunate side effect of this program is the cost to people who were in the market to buy a vehicle but don’t have a clunker to trade in. Because of the spike in demand, car prices shot up. If you had a clunker to trade, that was fine since the government rebate more than accounted for the increase in prices. However, if you didn’t, that $13,000 car you were looking at just jumped to $16,000 with no recourse for you. If you can delay your purchase until the program is over, inventory is sufficiently replenished, and demand has slowed again, you may be able to buy that car for $13,000 again. However, hopefully manufacturers learn from their mistakes and don’t create so much supply this time, keeping prices high. Even if prices to fall to the pre-clunkers level, the annoyance and inconvenience of not being able to buy for months is still significant.

I’m glad that I was able to be involved in a Cash for Clunkers transaction – it was great to see a buzz in dealerships that I’d never seen before. Getting $4,500 for our old van (which was probably worth no more than $500) didn’t hurt either. However, I’m not sure that in the long term the program will be as effective as the administration had hoped…

Categories: Economics Tags: , ,

Auto Worker Compensation

December 15th, 2008 No comments

I came across this New York Times article, shedding some more light on the highly controversial $70+/hour ($150,000+ per year) that auto workers allegedly make.

The essence of the article is that the $70+/hour figure that has been the focus of much attention is not entirely correct – it’s actually lower than that. However, it’s still much higher than Japanese auto makers like Honda, Toyota, and Nissan. The average hourly cost of a Big Three unionized worker is $73. The chart below breaks it down for Ford (whose cost is $71/hour).

Auto Worker Compensation Break Down

Auto Worker Compensation Break Down

 The cash paid to a worker (i.e. the salary your paycheck reflects) is about $40/hour, and benefits (health insurance and pensions) add another $15/hour, bringing this component of compensation to $55/hour. This is about twice what the average American makes, which should serve as a key counter-point to Mr. Stein’s comments:

They are our brothers and sisters. They fight our wars. They maintain our middle class lives. Maybe they get paid a lot, but they have been giving back for years. When will it ever be enough?

The NYT article notes that the salary plus benefits cost at Japanese auto makers is about $45/hour, with the $10/hour difference coming mostly from the benefits, not the cash compensation.

The remaining $15/hour of the about $70/hour for Big Three employees comes from benefits for retirees. These are costs that must be paid since they were promised, and are independent of the number of cars sold. So, in economic times like these, the revenue from car sales falls sharply, but the costs don’t since they’re fixed – now you see one dimension of the auto industry’s issues. The article goes on to say that this cost is a function of both the generours benefits and the number of retirees – suggesting that as Honda and Toyota mature to where the Big Three are on the American manufacturing scene, they too will have many retirees and similar costs. Of course, there are a few key differences – the benefits at the Japanese makers aren’t as high, and I doubt they’ve hired as many people due to improvements in automation as well as leaner product lines (they’re not making as many varietys as GM, thus likely employing fewer people). Yes, retiree costs at Japanese costs will go up in the future, but I’d be surprised if it was anything like what we’re seeing at the Big Three today.

The NYT article makes a very important point: Even if we took away the $10 of the $15 for retiree benefits and trimmed down the cash compensation to $45, to match the Japanese auto manufacturers, we’d save the Big Three $800/vehicle. The article also mentions that the Big Three typically sell their cars for about $2,500 less than the equivalent cars from Japanese manufacturers, suggesting that the cost saving won’t fix the problem. The issue – that Americans just don’t want to buy American cars.

Quality and efficiency problems have plagued American cars for years. The Big Three claim they have learned their lesson, yet their sales numbers beg to differ. For the 25 years or so that Japanese cars have been selling here, they continue to gain market share.

There is no doubt that improving the cost structure for the auto makers will help - in a situation like this, every penny helps. But it alone will not be sufficient to solve Detroit’s problems. The Big Three have to completely reorganize their operations. And it seems to me that the best way to do that is some kind of organized bankruptcy (where they re-emerge as much smaller, more efficient operations), or some kind of organized sale to the Japanese brands (with obvious conditions around keeping American jobs and manufacturing).

Categories: Economics Tags: ,

Mr. Stein on the Auto Bailout

December 15th, 2008 No comments

I recently read a piece from Ben Stein titled “Bail Out Detroit – Now“. I’m not a regular follower of Mr. Stein, nor do I have an opinion on his writing – I just happened to see this on the Internet. However, I must say, this was utter garbage! I haven’t seen total crap like this in a while. Below are Mr. Stein’s comments, along with my thoughts:

First, we are on thin ice economically. To allow our largest heavy industrial component to fail at this delicate moment is suicidal. To put a couple of million more Americans into unemployment is just not sensible. Mr. Barack Obama is talking about public works projects to employ hundreds of thousands of Americans -bridge building, school building, airport building. These projects take time to start, disrupt local community life, and are famously wasteful.

Why not be smart about it and NOT LET AMERICANS GET UNEMPLOYED IN THE FIRST PLACE? (Please pardon the shouting.) There are millions of Americans already hard at work making great American made cars and trucks. Why not keep them on the job? Wouldn’t that be smarter than allowing the whole upper Midwest to fall into oblivion and then rescue it over a fifty year period?

Yes, I agree that these are trying economics times, and, in an ideal world, we would only have issues like the auto industry failing when everything else is hunky-dory (heck, in an ideal world, we wouldn’t have issues at all, but you get my point). However, we don’t live in an ideal world, we live in reality, where more than one problem can, and most certainly will, arise at a single point in time. These problems have to be dealt with – it is not acceptable to simply say “we have other problems right now, so let’s just throw money at this problem to make it go away for now”. Furthermore, I don’t see anything wrong with Mr. Obama’s plan to put Americans to work in public works projects. To be clear, I believe Mr. Obama is suggesting this plan to combat the rising unemployment in the U.S. (independent of the auto industry issues) and to create domestic economic growth (though the sustainability of this growth is another question altogether), not as an answer to what several thousand auto workers will do if the industry goes under. Thus, I think Mr. Stein’s assertion about not letting Americans get unemployed in the first place is unfounded. Finally, I disagree that millions of Americans are already hard at work making great cars. If these cars were so great, more Americans would be buying them and we wouldn’t be in this predicament. The problem is that these cars aren’t so great and haven’t kept up with the quality and efficiency improvements in the industry – thus leading to the companies current problems. I see no value in burning tax payer money so we can keep building these sub-par vehicles.

Somehow, we can give bailouts to investment banks where the top dogs make hundreds of millions a year for running the company into the ditch and wrecking the whole credit picture in America. Somehow we can have bailouts for Fannie Mae and Freddie Mac, whose bosses were trading on the credit of the taxpayers to make themselves rich while pumping up a serious housing bubble.

Amazingly, we can have whole fleets of C-130′s fly to remote areas of Iraq and Afghanistan with pallets of hundred dollar bills piled from floor to ceiling. Then we can pass them out to warlords who make tea for our soldiers one hour and blow their guts out the next. We can send CIA operatives into Somalia and give millions, maybe hundreds of millions, to warlords to fight other killers.

But we cannot find it in our hearts to save our fellow Americans in Ohio and Michigan and Indiana who make the cars and trucks that about half of us buy?

Okay, this is just plain old silly. I would hope that someone writing on economics would understand the difference between the bailout of the auto industry and the bailout of the financial services industry, and the underlying reasons behind each. The crisis in the financial services industry and the need for a bailout there is to address short-term liquidity issues. Yes, the real estate bubble burst and that created problems. But most of the carnage we’re seeing now is not directly caused by the actual decrease in real estate asset values, it’s caused by good old fear – the rising of the hairs on the back of your neck as you think about your portfolio value and risk exposure. Investors are scared, much like my toddler daughter when confronted by a new insect – she’s never seen it before, doesn’t understand it, and just wants to hide in a corner of safety until it goes away. The corner of safety for investors is cash, and they’re staying in it until there are clear signs that the insect known as the current crisis goes away. Until then, there’s no liquidity in the market, things don’t trade, and so asset prices fall. After this short-term fear has passed, investors will come out of the cash corner to play again, and we’ll see much more liquidity and an improvement in prices. So, in the meantime, the Fed is providing liquidity (think of it as your mom trying to catch the insect and throw it outside). When things return to normal and asset prices come back to a rational level, the Fed will get its money back.

The auto bailout is quite different. Here we have companies that have been run poorly with very bad cost structures. The impact of foreign cars on the industry has been known for about 25 years now, yet American auto manufacturers have failed to respond. Their labor costs are too high, innovation and sales too low, and understanding of the consumer virtually missing. Throwing money at them will not result in them having an epiphany and completely changing their operations overnight. Given that a bailout would reduce the risk (and thus pressure on mangment) of an imminent failure, the companies are very likely to continue operating as normal – meaning they’ll burn through the bailout money and likely face bankruptcy in the near future. The difference between the two bailouts is that one is akin to an investment, and the other is plain old foolishness.

By the way, I do completely agree with Mr. Stein’s thoughts on the billions we’re spending in Iraq while neglecting our country. But that’s a different topic…

And please don’t tell me how GM and Ford and Chrysler have made bad cars that people don’t want. I drive only American cars, only GM cars actually, and they are the best, coolest cars I have ever driven: my 1962 Red Corvette, my mighty Cadillacs whose potent engines and super brakes have saved my life many times on the freeway.

Sorry Mr. Stein – too late. Please see a few paragraphs above. By the way, I wish most Americans felt the same way about American cars, but they clearly don’t – hence the problem.

Why are we so angry at the unions? They negotiated their deals in good faith. It’s not their fault that roller coaster gasoline prices messed up their world.

Wait, let me get this straight – you’re saying that it’s not fair that an increase in fuel prices shed light on this inefficiently run industry and absurd compensation practices, and ultimately may cause unions to lose the ridiculously sweet deals they negotiated with poor management who should’ve known better? Wow.

Yes, they did negotiate a deal with management. That deal is between them and management. If management can turn these companies around and deliver on the deal, good for both parties. However, they did not negotiate a deal with the taxpayers, so why should the taxpayers get involved to deliver on the unfairly sweet deal?! What about the other hard-working Americans in this country? They don’t have nice fat pension plans and benefit plans – is it fair to them that tax revenue benefits the auto workers?

The bottom line is that these business were run inefficiently – the cost structure was too expensive, the products weren’t what consumers were looking for, and management was too slow to adapt to a changing industry. Just like any other company, its employees, and any deals these employees may have had with the company – the firm has to turn itself around, or become extinct.

I’d love to hear what other people think about this (Mr. Stein’s piece specifically, or the auto bailout in general). I’ll also be posting other things I’m reading and thoughts I have on the subject…

Categories: Economics Tags: ,