Monday, November 24, 2008

Be careful what you wish for.

Whether in December or early next year, the likelihood that the US auto makers will receive $25 billion is a near certainty. What happens next from the perspective of Detroit? When it all plays out, will the net be a positive result from the auto industries perspective?

Lets take a quick peak at what we have:

Last week I touched on some of the reasons why the bailout would not help Detroit, but the more things move along, the bailout is more likely to hurt Detroit in the long run. In fact, they have put themselves in an even worse financial position just by asking for federal money.

1) As a general rule, the last thing you want to do when you are under a load of crushing debt is to take another loan.

2) One of the claims made is that they need the Federal loan since the credit crisis prevents them from obtaining private money. The problem is not the credit crisis, the problem is that no private lenders believe that Detroit will be able to repay the loan. Apparently, the markets do not either. In spite of the near guarantee that they will be getting the loan they are requesting, investors don't view GM as a good buy.

3) When an individual applies for any type of loan (car loan, mortgate, credit card, etc), their credit score gets dinged just a bit. Applying for 2 or three loans in succession they will see a significant decrease in their score. Continue down this path and the individual risks damaging his credit for a long time. The reason? Lenders begin to see the individual as desperate for cash. Most people in this situation are at the point where they cannot meet their financial obligations and are merely seeking to keep the lights on a bit longer.

By going straight to the feds, and announcing that they cannot obtain private financing, Detroit has pretty much sealed its fate. They are acting like the desperate individual described above and their stock prices show this. While bankruptcy certainly is a black mark on one's credit score, it is still easier to obtain credit with a bankruptcy and modest debt that is well within one's means than it is to be in the desperate situation described above.
4) When Detroit receives the bailout, it will certainly come with strings attached (and understandably so), but unfortunately, the strings will be of the "Well Meaning Leftist" type - such as requirements to develop green vehicles (as if CAFE already doesn't do that) and restrictions on CEO pay.

CAFE standards forced Detroit for years to sell vehicles that lost money. To recover and earn a profit, they had to rely on the SUV & light truck market. Additional requirements to sell unprofitable vehicles is certainly a greater recipe for failure.

While certainly the current CEO's have done a poor job for their pay - and certainly nobody would fault the boards if they voted them out, capping the pay for the top executive position would prevent the best and brightest from even attempting to tackle the daunting task ahead. What incentive would they have for taking the job in the first place when they can make more money elsewhere? Applying a salary cap places another handicap on the companies already far behind their foreign competitors.

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