Hidden victims of the auto bailout

Didn't hate the auto bailout yet? Still weren't sure if it was a net positive or negative for our country at large? Maybe this article will help you make up your mind.

Vicki Denton died several years ago after the airbag in her 1998 Dodge Caravan minivan failed to deploy during a head-on collision in the Georgia mountains. In 2009, a jury found Chrysler responsible for her death because of a manufacturing defect, awarding her surviving son and other relatives $2.2 million.

The family was near collecting those damages on the eve of Chrysler's government-brokered bankruptcy. Now, two years removed from a $12.5 billion bailout, Chrysler Group LLC still hasn't paid the damages, and doesn't have to.

The reason: The company's restructuring allowed it to wash away legal responsibility for car-accident victims who had won damages or had pending lawsuits before its bankruptcy filing. The same holds true for General Motors Co., which discarded the liabilities as part of its own $50 billion bailout and restructuring.

In rescuing the car makers, the U.S. government prevented a potential meltdown of the auto industry and further shocks to the economy. But in the process, it created a wide universe of relative winners and losers. The U.S. Treasury received large ownerships stakes in the restructured auto makers, as did union retiree trusts. Chrysler's banks got some, not all, of their loans repaid in cash, and GM's lenders were fully repaid. On the other side, thousands of dealers, asbestos victims and other creditors received little to no recompense.

Among the creditors who suffered most, car-accident victims represent a distinct mold. Unlike banks and bondholders, this group didn't choose to extend credit to the auto makers. As consumers, they became creditors only after suffering injuries in vehicles they purchased.

Wow. This is pretty disgusting, and the judges who allowed these debts to be erased (both of whom are named and quoted in the article, which deserves to be read in its entirety) should be ashamed of themselves.

Of all the terrible precedents set during the financial and auto bailouts (and there are tons of them, some of which--like this one--we're just now finding out about), this might be the worst I've come across so far. It makes me sick to my stomach that a company can be excused of responsibility for its negligence...simply by becoming even more negligent to the point of bankruptcy. The fact that something like this was explicitly allowed (and in fact endorsed) by our federal government only makes it that much worse.

I was anti-bailout from the get-go, and this sends me over the top. Buy American? No thanks.

UPDATE: A commenter correctly pointed out that Ford did not accept bailout funds, and therefore should not be included in my snarky "don't buy American" conclusion. Fair point. I have much respect for Ford for fixing their own problems. GM & Chrysler? Not so much. Buy Ford.

[Wall Street Journal]

Ugh

I was hoping to start the New Year off on a happy note (hey, look at that, 1/1/11, first time the date has looked like that since 9/9/99--but I'm really looking forward to 11/11/11)... but how often are things really that happy around here anyway, right?

Steven Rattner, a co-founder of the private-equity firm Quadrangle Group LLC, will pay $10 million to settle kickback allegations involving New York’s pension fund, less than half of the $26 million state Attorney General Andrew Cuomo sought in a lawsuit.

Rattner also agreed to be banned from appearing “in any capacity” before any public pension fund in the state for five years, the attorney general’s office said yesterday in an e-mailed statement. Cuomo, New York’s governor-elect, sought a lifetime ban from the securities industry...

Rattner, who is no longer with Quadrangle, caused the New York-based firm to pay kickbacks to obtain $150 million in investments from the pension fund, according to Cuomo’s civil securities-fraud suit. Rattner also was accused of setting up a DVD distribution deal for a movie produced by the brother of a pension fund official.

Rattner last month settled a parallel probe with the U.S. Securities and Exchange Commission for $6.2 million and a two-year ban from associating with broker-dealers or investment advisers.

Rattner, Rattner, Rattner... where have I heard that name before? OHHHH, right.... here.

Rattner, 58, helped overhaul General Motors Co. and Chrysler Group LLC when he headed the U.S. government’s Automotive Task Force. He said in the same statement he was “pleased to have reached a settlement.”

It's pretty sickening that a man who has so brutally violated the public trust by masterminding a kickback scheme with the New York pension fund was given such an important position within another government-owned entity, especially at a time of great vulnerability. Of course, Mr. Rattner would never take advantage of the public trust again... would he?

[Bloomberg]

 

Beware of GM

The big news in the markets today is General Motors' IPO, which raised over $20 billion in what will go down as the biggest IPO (or, in this case, re-IPO) in market history. The stock priced at the high end of its expected range, and it has traded higher since trading began at the New York Stock Exchange this morning. Along with it, just about all stocks are higher across the board.

It's been a cause for celebration for the U.S. government, which was able to drop its stake in GM from 61% to about 33% (ultimate cost to taxpayers is, of course, TBD). But some investors aren't sold just yet, and with good reason. From The Washington Examiner,

Why hasn’t anyone asked the company or its federal minders why they have from all appearances artificially created over $1 billion in U.S.-based EBIT (earnings before interest and taxes) through October by overstuffing its dealers with excessive levels of inventory?

According to the Wall Street Journal’s cheerleading Andrew Bary, the IPO is generating a great deal of fanfare. The Associated Press’s Sharon Silke Carty is decidedly less enthusiastic (“the world’s most charming used car salesman couldn’t cover up major concerns”), identifying four good reasons to for investors to sit the IPO out. One of them is that “Years of fuzzy math (are) still not fixed.”

From here, it seems that the company has created a unique category of fuzzy math: shipped-ahead profit.

Essentially, per FASB standards, car manufacturers are allowed to book revenues "when a vehicle is released to the carrier responsible for transporting it to a dealer and when collectability is reasonably assured." In other words, once a car is shipped out to a dealer, it's a sale for GM, regardless of if they've been paid or not. This is common industry practice, and nothing out of the ordinary, but...

As of the end of October, GM dealers in the U.S. were sitting on inventories of almost three months' worth of sales, up from the low-60s only five months earlier.

The dealer inventory build-up has occurred despite at least two factors that would normally dictate lower inventory levels. First, after eliminating Saturn, Pontiac, and Hummer, GM is down to four brands (Chevy, GMAC, Buick, and Cadillac). Second, the company has substantially reduced its dealership roster. Yes, the company did offer to reinstate 661 dealers earlier this year. But while the rebound in the number of outlets could explain an increase in absolute inventory levels, it doesn't explain why vehicles are sitting on dealers' lots 23-24 days longer than they were in May.

Is 86 days of inventory an abnormally high level? In ordinary circumstances, I would say so.

In other words, beware of GM. The increased level of reported earnings might not be a huge factor in inflating GM's IPO price, but it is a factor, and it may be indicative of more window-dressing behind the scenes. As a result, any taxpayers who cheered the return on their GM investment this morning by investing in its stock might find themselves wishing they hadn't a few months down the line. Be careful out there...


[The Washington Examiner]

Behind the scenes of the auto industry bailout

In a fascinating piece for The New Yorker, Malcolm Gladwell takes a look back at the ins and outs of the auto industry bailout, nearly two years after the fact. While the Wall Street bailouts have garnered many more of the headlines and a disproportionate amount of public scorn (largely because banks and bankers are easy targets), the auto bailouts were also extraordinarily large, and arguably more complex.

Gladwell's piece is interesting on a few fronts, but his insight into the nuts and bolts of how these bailouts got done is simultaneously intriguing and unsettling. No one man should hold as much power as these men wielded, at any point in time--a sentiment that our Constitution would echo. Gladwell writes,

“Team Auto,” as [Steven] Rattner refers to the group that he assembled to help supervise the bailout, consisted of about a dozen people, some in their twenties and early thirties. They started work in March of 2009. One of the first major issues was whether to save Chrysler. To settle the question, Rattner tells us, Team Auto gathered in the office of Larry Summers, the President’s chief economic adviser. 

The case against Chrysler was that most of the jobs lost by letting the company fail would eventually be offset by gains made by Ford and General Motors, as those companies picked up Chrysler’s old customers. Letting Chrysler fail would make Ford and G.M. stronger. But did the team really want several hundred thousand jobs to disappear—even if the losses were short-term—in the middle of a severe recession? 

Chrysler’s failure would also mean that Michigan’s unemployment-insurance fund, for starters, would need to be bailed out. One of Rattner’s team members made a counter-argument: “Given the uncertainty in our economy, it was better to invest $6 billion for a meaningful chance that Chrysler would survive than to invest several billion dollars in its funeral.” Summers put the matter to a vote. The tally was 4-3 in favor of letting Chrysler die. When the vote came to Rattner, he said that it should live. Summers agreed. Chrysler lived.

It's downright scary to appreciate how close a company was to dying, and how fickle the reasoning was behind its rescue. This is far too much power for a small panel of people to have, especially this type of panel. Keep in mind, the people on "Team Auto" were not elected, nor were they subject to any sort of Congressional approval process. And yet they were charged with the task of making massive decisions on how to deploy taxpayer resources, with the implicit understanding that any recommendation they made would be rubber-stamped by the Obama Administration. That's troubling. It amounts to a Constitutional end-around, and regardless of your feelings about the bailout, the underlying decision-making process was flawed.

To be fair, I've largely been an opponent of bailouts of all types, and that of the auto industry in particular. While I appreciate that the frictional costs of a large company going through bankruptcy can be extremely painful, and that the costs can be highly localized (as in Detroit), I think that the precedent that a bailout sets is extremely dangerous and leads to moral hazard, which can breed even more painful (if somewhat more spread and less obvious) consequences in the long run.

Gladwell's piece is both fascinating and frightening, as we realize just how much power we have entrusted to people we know nothing about (including, in many cases, their names). For an administration that preaches transparency and accountability, this seems not to jive. To have laymen making major decisions regarding the deployment of tax dollars is at best perverse, at worst non-Constitutional and illegal. Kudos to Gladwell for passing along this story.


[The New Yorker]

R.I.P. Blockbuster

With today's unsurprising news that Blockbuster Inc. will file for Chapter 11 bankruptcy protection in the immediate future, we prepare to say goodbye to another brick-and-mortar company done in by industry changes brought on (in part) by the internet. While Blockbuster is not officially closing its doors, it has plans to close nearly half of its retail stores, while expanding its self-serve kiosk business (those Redbox-style things you see at gas stations and grocery stores). Nevertheless, the handwriting is clearly on the wall for Blockbuster, and their competitive responses might be a case of too little, too late.

Ultimately, Blockbuster was caught sleeping while Netflix and iTunes took over the rental market, with Redbox further eroding its margins. Much like Circuit City before it, Blockbuster was slow to respond to obvious changes in the way that consumers used their product, and it will likely meet the same end. Ironically enough, Blockbuster tried to step in and buy Circuit City before its failure.

Of course, what I choose to focus on in this news is what happens to an industry when its biggest player is allowed to become bankrupt. It would be hard to argue that the media industry is less robust or consumer-friendly than it was when Blockbuster was in its heyday. Rather, the death of Blockbuster is an instance of creative destruction, a necessary step in the evolution of the rental business. Why, then, do we feel compelled to respond differently when the company in question is a bank, airline, or car company? Are we holding back progress in those industries simply to preserve the comfort of the status quo?

Bankruptcies might not be pretty, and they might in some cases create painful frictional periods as we adjust to a new reality (and as displaced workers find new jobs). I, for one, wish I knew what our economy would look like if we allowed for institutional failures in all industries. What would be the car industry analogue to Netflix, if GM were allowed to fail? Who would become the Amazon.com of the airline world? Unfortunately, as long as we continue to selectively protect certain large failing businesses, we will never know.

[Wall Street Journal]