Congress Should Bailout the U.S. Auto Industry


Whether Congress should bailout the Detroit Three and the U.S. Auto Industry

Response by Geoffrey L. Berman, Vice President
Development Specialists, Inc.

It is suggested that allowing the Detroit Three to fail and file bankruptcy is what may be needed to address the long running effects of the worldwide economic slowdown and the historic imprint legacy costs have on the major U.S. automakers. What I suggest is lost in this course of action is an all but unimaginable tidal wave of failure through the supplier chain that would bring billions of dollars of wholesale debt to a halt. Without some immediate relief to those suppliers, the wave of failures would exacerbate the current recession (depression) the U.S. economy finds itself in. A reasoned approach to maintaining normalcy in the supplier market, preserving jobs and capital should go hand in hand with the decision as to supporting the automakers.

Automotive supplier profit margins began eroding in the late 1990’s according to a report published by The Auto Consulting Group, Inc., Ann Arbor, MI in June 1998. “Since reaching a peak of 8.2 percent in 1995, automotive suppliers’ gross profit margins have eroded to 1992 recession levels of 6.5%.” “The findings could spell trouble ahead for vehicle manufacturers….other problems could arise if vehicle sales begin to decline. With debt levels at record highs, some suppliers might be unable to support their current debt load.” Almost prophetic, even if a bit premature, in the prognostication.

By the summer of 2005, Richard Freeman wrote that the “shake out of General Motors and Ford Motor during 2005 has caused the most violent and widespread dismantling of the U.S. auto parts supplier sector in the more than century old history of the automobile.” Names that we know that went into bankruptcy, such as Collins & Aikman, Tower Automotive, Meridian and DANA highlight a few of the largest such suppliers. Friedman continued by noting “the auto supply sector possesses a much larger machine-tool capacity, and employs more workers, than the auto sector itself.”

Yet today, the focus of the press remains on the Big Three automakers and little attention is paid to the supplier segment. Estimates of supplier debt owing from the Big Three reach upwards of $3 billion. What happens to the suppliers holding this debt if the Big Three seek protection under Chapter 11? Unless courts are willing to re-visit the critical vendor concept, or some other judicially created fix, the immediate impact of bankruptcy filings by one, let alone all of the Big Three will cause an immediate domino effect on the supplier sector. It is not hard to imagine supplier credit facilities being reviewed and declared in default by reason of the freeze on the ability to repay such large components of the supplier receivable base (that’s assuming the suppliers’ lenders haven’t already limited working capital lines of credit due to the financial condition of the automotive industry or the fact that the Big Three are such large concentrations of the outstanding receivables that it is only prudent to reduce the lending base to account for such risk).

So what happens? Big Three file for Chapter 11; suppliers holding hundreds of millions to billions of dollars in receivables have those receivables frozen; the suppliers become in default with their lenders; the suppliers can’t meet operational needs, begin down-sizing and lay-offs, or worse, fail completely. More jobs lost, more families out of work, more homes in foreclosure, less disposable income, meaning less spending at retailers and the local mall, leading to more depression within those sectors. Not a pretty picture. While financial struggles by business may be good for bankruptcy lawyers, this is not so good for the suppliers and industry as a whole.

Just how realistic is this possibility today? The Globe and Mail reported just today, quoting Magna International, Inc.’s co-executive officer Don Walker that “many distressed auto parts makers will collapse during the next few months because of severe cuts in North American auto production during the first quarter….North American parts companies have been struggling for years amid drawn-out restructurings by the Detroit Three auto makers that have taken on added urgency because of the collapse in vehicle sales in the U.S. market.”

Bail-out of the Big Three is not just about saving the automakers or legacy costs of the retirees who built those companies. The significantly broader impact needs to be considered – now, before a significant employer sector is put into immediate turmoil because it may (or may not have been) politically expedient to send a message to the Big Three. Failure to do so may leave the current economic struggles seem a mere pittance as compared to the impact tomorrow.

Date published: Nov 19, 2008


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