The downfall of General Motors

By Brian Ochsner The mainstream media was like a bird dog chasing its tail covering the “Huntergate” story; then the “Portgate” story broke, and that became the frenzy of the week. Meanwhile the business press stayed focused on a more important matter: the struggle of one of America’s largest manufacturers and automakers, General Motors.

During most of the 20th century, GM was one of America and Wall Street’s ‘blue-chip’ companies that were good investments. However, if you examine their financial statements today like a doctor looks at a patient, you’d see a company with financial ‘cancer’ that’s bordering on being terminal. In business terms, they’re not far from declaring Chapter 11 bankruptcy, with Moody’s having cut their bond rating yet again. Here are a few reasons why GM is in such bad shape today.

Over the past few decades, GM management has bowed to the United Auto Workers’ demands for more-than-generous salaries and benefits. As a capitalist, I’m not against anyone making as much money as possible. However, when it puts your employer in financial jeopardy, you should probably think twice about it. The UAW has made some recent minor concessions, but hasn’t taken the strong medicine needed to help cure GM’s financial woes.

The biggest piece of pork that needs to be cut is the GM Job Bank. According to Jim Puplava of Financial, that’s where 5,200 laid off workers receive full salary and benefits of over $100,000 annually, along with training for a new job. Along with this, GM still has the large defined-benefit pension liability on its books. It’s a huge cash drain both now and in the future.

With GM currently losing $15.14/share, it’s crazy to keep any such corporate entitlement program going. I’ve followed the stock and commodity markets almost daily since 2000, and the company that most closely resembles GM’s situation is United Airlines.

In 2001, UAL (a formerly blue-chip company with a good business reputation) had a stock price of $30, while losing $10/share. Eventually it went into bankruptcy, the stock became worthless, then UAL finally emerged from Chapter 11 earlier this year. However, it’s still losing money to the tune of $182 a share -- not exactly the peak of financial health.

Until GM management gets some backbone to stand up to the union bosses, I don’t see conditions improving for the automaker. But that’s not all GM needs to do. At the recent Auto Show in January, GM was trumpeting their great line of SUVs.

That’s great if it was 1999, gasoline was still cheap, and consumers were flush with cash from trading dot-com stocks. That’s not the case in 2006. Especially when the era of cheap energy is over, and folks are being squeezed in a financial vise: higher taxes from government on one side, and the not-so-hidden tax of inflation on the other.

Stevie Wonder must be in charge of the Vision Department at GM. How you can fail to see the market and world changing in front of you, and thus shift your manufacturing (quickly) to more fuel-efficient cars, is beyond me. From an accounting standpoint, the profit margins from SUVs are the biggest of any vehicle that GM makes. But if consumers don’t want to buy these vehicles as much as they used to, it doesn’t really matter or make any business sense.

How can GM regain its competitiveness? First, they need to stand up to the UAW, get significant reductions in salary and benefits, and address the defined-benefit pension plans – which are similar to Social (In)Security and Colorado’s PERA plan. It also needs to eliminate the welfare program called the GM Job Bank – which will save them a decent chunk of cash annually. Then it needs to radically shift its product line to meet market demand, similar to what Toyota is doing.

Even if GM could wave a magic wand and do all these things tomorrow, it still might not be enough. That’s because of the crushing debt load it carries: $330 billion in long-term and other liabilities, compared with $35 billion in cash.

You may be thinking, “Couldn’t GM just declare Chapter 11 Bankruptcy, and get a helping hand from Uncle Sam – a la Chrysler under Lee Iacocca in the early 80s?” Yes to the first part of the question, and no to the second.

I believe GM will file for bankruptcy protection in the next 12 to 24 months, because they’ve simply dug themselves too big of a financial hole. Present and future pension liabilities, above-average salaries and benefits, combined with declining overall sales and market share are the reasons I believe this will happen.

The UAW seems perfectly content not to give any significant ground to ‘the man,’ just like they always have. GM will have a showdown at the OK Corral when its current UAW contract expires in September 2007. I’m not sure the company can hold off Chapter 11 that long if current trends continue.

But a '70s-style rescue from Uncle is unlikely. President Bush has already hinted that Ford and GM won’t get bailed out by the feds if they go into bankruptcy.

The main reason the government can’t step in like it used to, is because of the huge federal budget and trade deficits. Some foreign central banks (such as China and Russia) have hinted they don’t want to hold any more American dollars or US Treasury Notes than absolutely necessary.

Savvy foreign leaders and financiers see the handwriting on the wall: With the world awash in a huge supply of US dollars and dollar-denominated debt, the value of these paper assets will eventually decline. They don’t want to be caught holding any more of these declining-value ‘assets’ than absolutely necessary. This means some of our major foreign lenders won’t lend us the money for more credit craziness down the road. (The best book available on this topic is by NY Times best-selling authors Bill Bonner and Addison Wiggin, titled Empire of Debt.)

General Motors is currently Number 3 on the Fortune 500 list of America’s largest publicly-traded companies. It’s a travesty that management and the UAW fiddled for decades while GM was financially burning. Time will tell if they can put out this financial fire. In the meantime, this story offers some valuable lessons for investors, workers and future retirees.