Businessweek- "Detroit's Woe, America's Worry"

http://www.businessweek.com/bwdaily/dnflash/apr2005/nf20050426_7826_db035.htm

Detroit's Woe, America's Worry

The biggest problem about the missteps plaguing GM and Ford: They're likely to cause an economic pileup clear across the country. These are tough times for Detroit, and they aren't likely to get better anytime soon. So motorists, consumers, and investors better all brace themselves: The effects of auto industry woes will likely rumble through the economy far beyond Motown's city line.

General Motors (GM ) shocked the financial world in mid-March when it warned of staggering losses in the first quarter of this year -- $1.1 billion in red ink when the number was announced on Apr. 19. Ford (F ) reported on Apr. 20 that it managed to post a profit of $1.2 billion in the period, but that was a punishing 38% drop from a year ago.

Both companies' stocks have fallen about 40% in the past year, and credit markets are reeling at the potential for credit-rating downgrades. "It's a very sad day here in Detroit," says Gerald Meyers, a professor at the University of Michigan Business School and former chairman of American Motors Corp. Even Chrysler, a division of Germany's DaimlerChrysler (DCX ) that's holding up far better than the other two members of Detroit's Big Three, is worried about what troubles at GM and Ford portend for the U.S. auto industry, says Meyers.

LOST IMPACT. Because of the domestic auto industry's size, its misfortunes have an amplified impact on the overall economy and on family budgets, say economists and industry experts. For example, financial turmoil sparked by a credit downgrade for the car companies could have a direct effect on many Americans' savings and retirement accounts. When debt falls in value, mutual funds and pension funds holding bonds issued by these carmakers fall, too. Rising gas prices only add to consumers' pocketbook misery.

Most shocking of all: Given the nature of this downturn, increases in car prices are likely to accelerate. "I don't think you'll see any diminution in the quality of cars or the choice, but I do expect to see higher prices," says David Cole, chairman of the nonprofit automotive think tank, Center for Automotive Research (CAR).

Auto makers are already reporting that incentives, like zero-percent financing programs, aren't stimulating buying the way they used to and are cutting them back, says Tom Webb, chief economist with Manheim Auctions in Atlanta. Used-car prices are also rising, which often presages higher stickers for new vehicles, he says.

TOYOTA UPTICK? The industry's root problem is that it can't really squeeze any more savings out of suppliers or the manufacturing process, says Cole. Given the rising costs of producing cars, auto makers have little choice but to raise prices to return to profitability. "A car just got to be too good a deal, and that era is over with," he says.

U.S. cars won't be the only models that get pricier. Toyota's (TM ) chairman stunned the industry at an Apr. 25 news conference when he hinted that the Japanese giant would consider raising prices in the U.S. to help out American carmakers. Most analysts say Toyota would simply be using Detroit's problems as an excuse to boost its own profit margins. But such a move would also be prudent if Toyota is worried that a serious slump in the U.S. auto industry could spark a recession or lead to more protectionist policies domestically, says Cole.

The downturn in Detroit can't be chalked up merely to U.S. auto makers losing a popularity contest between gas-guzzling sport-utility vehicles and fuel-efficient new hybrid models. Instead, the industry's financial woes are due to far more intractable and long-term trends -- rising health-care and pension costs for workers, increased foreign competition from Asian manufacturers, and rising prices of commodities used to make cars.

MICHAEL MOORE'S SEQUEL. Even though auto industry employment is far lower than it used to be, CAR estimates that every job lost in an carmaking plant has the economic impact of losing 9.4 jobs elsewhere. GM alone still makes up 1% of the economy, says Cole.

Meyers worries that these trends aren't going away, no matter what the economy or gas prices do. "More and more people are going to be finding themselves idle when they would rather be at work," he predicts.

Most of the auto downturn's economic damage will hit states like Illinois, Ohio, and Indiana where carmaking is concentrated. "If you live in Flint, Mr. Moore is going [to have to] to make another movie," says Milton Ezrati, senior economist at Lord Abbett & Co, referring to the location of Michael Moore's 1989 documentary Roger & Me. "He will get rich, but they will remain poor."

BETTER CARS COMING? What most worries economists, however, is the potential for U.S. auto makers' debt ratings being downgraded. "Any threat of default or downgrade affects assets across the country," says Ezrati, who notes that GM and Ford paper is held in virtually every pension fund and money-market account in the country. "A lot of wealth has been destroyed already, but that's not to say it couldn't be worse," he says.

What could brighten this ugly outlook? Some innovative new designs might help. "Ironically, bad times in the auto industry often brings out the best in design," says Tim Yost, director of marketing at American Specialty Cars, which works with carmakers to create specialty vehicles. "It forces auto makers to stand out from the crowd all the more. It's ironic because in tough times most businesses hunker down, but in the car business, that's the last thing you want to do." Adds Yost: "A lot of people would say Chrysler is the healthiest auto maker in Detroit. Design had a big role in that."

But rather than waiting for trendy new models and bold, catchy new designs, consumers might want to buy a car now before prices start to rise, Cole advises. As the financials of GM and Ford show all too starkly, the U.S. auto industry can't solve it's problems by sales incentives alone, and more expensive sticker prices may just be one of several ways American families share their pain.

Instead of making a new thread for the following story I decided just to add it this one since bad-news seems to come in groups:

Downgrade to junk status seems certain for GM bonds

BY JAMIE BUTTERS
FREE PRESS BUSINESS WRITER

April 27, 2005

To professional investors and in the private words of many people within General Motors Corp., it has become a foregone conclusion: GM's credit rating will be downgraded to "junk" status.

One or more agencies are expected to cut GM's ratings to junk -- the shorthand description for a risky borrower -- for the first time ever. It is widely expected this summer, though it could happen as soon as this spring or perhaps as late as next year.

With its pejorative name, a junk rating will be a symbolic blow to the world's largest automaker and creator of American icons such as Corvette and Cadillac.

It also indicates a treacherous chain reaction.

For agencies like Standard & Poor's Corp. and Moody's Corp. to describe GM -- and quite possibly Ford Motor Co. -- as more "speculative" than reliable, means they doubt the company will earn enough cash profits to consistently pay its debts and reinvest in the business.

Companies don't typically comment on their credit ratings.

"The credit rating agencies will make their own decisions. It's not our place to speculate on what they might do," said Toni Simonetti, GM spokeswoman. "We're certainly working hard to address the issues in our business, especially in North America, which we know is a concern of the ratings agencies."


GM lost $1.1 billion in the first three months of the year and no longer will say what it expects of the year. Ford earned $1.2 billion in the first quarter, but executives warn that it won't meet its long-standing goal of earning $7 billion before taxes next year.

As a result of that judgment, lenders would typically insist that borrowers in such a situation pay higher interest rates.

But while a junk rating does make it harder to fix the business, it is not a death sentence or a harbinger of bankruptcy. The old Chrysler Corp. fell to junk status twice before bouncing back and years later combining with Daimler-Benz AG.

At its most basic level, a bond is a type of security, an investment tool that allows governments and businesses to borrow money, typically from investors who don't like to take big risks.

A bond usually has a face value, say $1,000, an interest payment and a specified duration, such as 10 or 20 years. So a $1,000, 10-year bond with an 8-percent coupon might sell for $1,000, then pay the holder $80 in each of the first nine years, and $1,080 in the last year.

That's what would happen if someone just bought the bond and held it. But they aren't always held for the entire maturity period.

That's where bond markets and credit ratings come in.

Bond markets, like stock markets, are places where individual bonds are resold from investor to investor. If the company later on looks less capable of paying what the bond promises it will pay, then any new buyer will insist on paying less than the first person paid.

Since there are thousands of bonds in circulation, there's a lot for potential bond investors to study. So many of them use credit ratings as a way to tell how reliable a borrower is.

There are a variety of ratings agencies such as S&P, Moody's, Fitch Corp. and others with their own ratings systems.

But each system ranges from best to worst, with several shades of gray. It's sort of like an institution-size version of individual credit scores that help Visa, Comerica or Marshall Field's determine how much money to loan a given consumer and at a certain interest rate.

But it isn't just a sliding scale of gray shades. When it comes to credit ratings, whatever the agency, there is always a line that separates the mighty and the healthy from the risky.

That's the junk line, and it doesn't get crossed without serious thought. Those on the good side of the line are called "investment grade." On the other side is "speculative grade," or in the most basic term, "junk."

S&P rates GM and Ford at the lowest investment-grade rating, both with negative outlooks, which indicates that a downgrade is likely.

Last month, S&P analyst Scott Sprinzen called GM's rating "tenuous," and the situation has only gotten worse since then.

For many bond investors, the difference is day and night. Most insurance companies, mutual funds and pension funds are prohibited from holding speculative-grade securities.

At least, sort of.

If one of the major ratings agencies downgrades a borrower to junk status, some portfolio managers must sell the bonds. Period.

Others may be able to hold on to them -- perhaps thinking they will return to investment grade, or simply to wait until the prices get a little better.

Even then, if two major agencies rate the bond below investment grade, then it must usually be sold.

And if only high-risk investors are allowed to buy a bond, they will demand a high return. That means the current bond-holders are selling for less than they paid and taking a loss.

Because there can be such a complete changing of hands when a company's rating is downgraded to junk, credit rating agencies tend to be slow to push a rating across that line.

Some in the industry say that the lowest investment-grade rating -- such as the BBB- S&P placed on the debt of Ford and GM -- really means that a company is no longer a high-grade borrower, that it just hasn't finished being cut yet.

For the issuer -- the company that did the original borrowing -- it doesn't really matter at all.

Unless it wants to borrow money again.

That's when a company like GM, or more precisely GMAC, which lends money to dealerships, car buyers and homeowners, faces some challenges.

On the face of it, the lower prices -- and higher interest rates -- on GM's current bonds imply that GMAC will have to pay more, perhaps far more, to issue new loans next year and the year after.

But GMAC has instead arranged tens of billions of dollars it could borrow from other reasonably cost-effective sources if it needed to.

Though all of this adds up to higher borrowing costs for GM, it doesn't necessarily stop there. So when and if GM goes to junk, in a sense it takes the whole automotive industry with it.

With fundamentally similar circumstances, ratings agencies may then find it difficult to give Ford a higher rating than GM.

In essence, they have to ask if Ford is in better financial shape than GM. Perhaps it is.

A downgrade of GM or Ford could also have significant ripple effects. For Michigan-based auto-parts makers that get most of their business from GM or Ford, one of those companies' debt falling to junk could make the supplier look less likely to pay its own bills -- saddling those parts-makers with higher borrowing costs.

Seems like the next few years could be really fun.

Why GM's Plan Won't Work
...and the ugly road ahead


The following story is huge so the I only posted a small portion at the end @ http://businessweek.com/magazine/content/05_19/b3932001_mz001.htm

Coming Confrontation?

Wagoner appears even less likely to start a fight to completely rewrite the union's health-care plan. The union's opposition could soften if GM's fortunes slip dramatically in the next year. But the UAW has almost never agreed to a huge giveback in the middle of a contract. (It did so in 1980, when the federal government demanded concessions as part of its Chrysler bailout, and again for Ford and GM in 1981, when spiking gas prices and a recession slammed sales.) Says Sean P. McAlinden, economist at CAR: "Why would union workers on the verge of retirement agree to cut retirement benefits?" GM's Kowaleski responds that there may be ways to get what GM wants while giving the union something in return: "Do not underestimate the breadth of scheming that can go on to come up with a win-win for everybody."

There might be loopholes Wagoner could exploit. Read one way, the labor contract does not guarantee benefits to retirees -- who account for two-thirds of GM's health-care costs -- and only covers active workers, says Sanford C. Bernstein's Johnson. But one GM insider says that interpreting the contract that way would spark a "nuclear war." The UAW could find any number of ways to strike key supply factories and gum up the company. Wagoner knows that firsthand. While president of GM North America in 1998, he played hardball with the UAW over a dispute involving two union locals in Flint, Mich. Those workers, who made parts needed by every GM assembly plant, struck for 54 days over what they said were local issues. That shut down the entire company, costing it $2 billion and nine percentage points of market share, though GM recovered all but a point of that by yearend.

Labor experts believe Wagoner is raising a hue and cry now to position the company for bigger concessions when contract talks open. "If you want to get the union to cut medical benefits in September, 2007, you don't start in August. You start now," says Harley Shaiken, a labor professor at the University of California at Berkeley. But if the sales picture deteriorates over the next year, GM probably will have little choice but to force a confrontation sooner and radically reshape its cost structure.

THE ENDGAME: A SMALLER GM*

Will Wagoner be around to make that choice? By approving his plan and his takeover of the troubled North American business, the GM board has signaled that it is being patient -- too patient, some analysts think. All indications are that Wagoner will be given a couple of years to get traction for his strategy. But if the cash burn rate accelerates and GM's stock deteriorates further, outside forces will pressure the board to take action, or will seize the wheel themselves. "If the board feels they're on the right path, they won't make a change that disrupts that," says CAR's Cole, who has close ties to GM's brass. "But in two to three years, if there is not an improvement on the revenue side, it's over for these guys."

Private-equity investors seem to believe that the company's global cost handicap will eventually force it into bankruptcy court to shed union and dealer obligations. Wall Street bankers already are salivating over the opportunity to pick off GM's profitable mortgage operations. But the auto business is a whole other animal. For now, the legacy costs are too onerous and the politics of chopping so many jobs just too dicey for it to be worth the trouble of a takeover. Says one senior banker: "The joke used to be that all of the airlines would have to go through a car wash...now the car companies are going to have to go through the car wash. That's the challenge for anyone looking at these businesses and saying, Look, how do you deal with starting at a $2,000-a-car disadvantage vs. the rest of the world?"

Just mention the word "bankruptcy" to any of GM's top executives and the mood gets frosty fast. "That's definitely not the plan," Wagoner said in a January interview. No wonder: Bankruptcy would almost certainly follow a catastrophic failure in the marketplace, or a play by a private-equity investor seeking to break up the company. In either case, management would be out on its ear.

GM's cash hoard makes a court filing unlikely -- at least for now. If it happened, though, a GM bankruptcy would boggle the mind. The auto maker would bring to a judge four times the assets of the largest case filed so far, by WorldCom Inc. in 2002. Its 324,000 worldwide employees are about 70,000 more than Kmart Corp. (SHLD ) had before it filed that same year. GM could almost certainly find a judge who would allow it to dump many of its most burdensome obligations, says Lynn M. LoPucki, a law professor at UCLA. GM's pension plans are fully funded for now, but if GM's finances worsen or its pension investments sink in the coming years they might still be dumped on the federal Pension Benefit Guaranty Corp. GM also could shed its union contracts, firing anyone who didn't want to take lower wages or benefits. Ending health-care obligations to retirees alone could save $4 billion to $5 billion a year.

Imagine the uproar, though, if that happened. Even if GM could demonstrate to a judge that it had negotiated for the cuts in good faith, the UAW would certainly respond with a strike. That would burn up in a few months much of the cash that any raider coveted. And pensioners could still sue for their benefits. "If there was value, you wouldn't get away scot-free," notes Wilbur L. Ross Jr., who has taken interests in bankrupt steel, textile, and coal companies.

Bite the Bullet

Breakup or bankruptcy are the ghosts of GM's future. They become much more substantial threats if current management can't deliver on its promised turnaround over the next couple of years -- or if the board doesn't find someone who has a better idea of how to deploy GM's $468 billion in assets.

It was a former General Motors chief -- the legendary Alfred P. Sloan Jr. -- who foresaw the problems that are now tying his company in knots. "Any rigidity by an automobile manufacturer, no matter how large or how well established, is severely penalized in the market," Sloan wrote in his 1965 memoir, My Years With General Motors. Of course, Sloan was talking about a competitor, Henry Ford, and his refusal in the 1920s to change his business model to build different cars to suit the changing tastes of American consumers. But Sloan's indictment stands just as well for today's GM.

What would a healthy GM look like? It might have five fewer assembly plants, building around 4 million vehicles a year in North America instead of 5.1 million. That would slash U.S. market share to around 20%, but factories would hum with real demand, stoked less by rebate giveaways and cheapo rental-car sales. Workers would have a cost-competitive health-care plan but would fall back on government unemployment benefits when hard times demanded layoffs.
Profitable auto sales and finance operations would fuel a richer research budget, tightly focused on four or five divisions instead of eight.

This new GM might make two-thirds as many models: Chevrolet, perhaps its most recognized global brand, handling trucks and mass-market cars; Saturn, behind its cool new Euro styling, selling more expensive cars with design flair. A resurgent Cadillac would parade advanced technology and luxury. Hummer would only last as long as brawny SUVs are hip. GMC, which is very profitable these days, would stick around if Chevy couldn't satisfy America's yen for trucks. Pontiac, Buick, and Saab would follow Oldsmobile to the scrap heap.

Maybe Wagoner will decide to bite the bullet and spend the billions needed to launch such a dramatic overhaul now, rather than waiting. And maybe the UAW leadership will get religion and offer more than token help. Where they decide to take GM will matter a great deal to the army of auto workers toiling away in its factories, the vast web of businesses that feed off of them, and legions of investors. As we learned a long time ago from outfits like AT&T, no company is too big to fail, or at least shrink dramatically. Not even mighty GM.

Wagoner appears even less likely to start a fight to completely rewrite the union's health-care plan. The union's opposition could soften if GM's fortunes slip dramatically in the next year. But the UAW has almost never agreed to a huge giveback in the middle of a contract. (It did so in 1980, when the federal government demanded concessions as part of its Chrysler bailout, and again for Ford and GM in 1981, when spiking gas prices and a recession slammed sales.) Says Sean P. McAlinden, economist at CAR: "Why would union workers on the verge of retirement agree to cut retirement benefits?" GM's Kowaleski responds that there may be ways to get what GM wants while giving the union something in return: "Do not underestimate the breadth of scheming that can go on to come up with a win-win for everybody."Why would retiries or employees need to take benefit cuts if these programs were properly funded by sound financial investments?...or maybe I'm missing something, I'll admit I'm no expert, but...

Why would retiries or employees need to take benefit cuts if these programs were properly funded by sound financial investments?...or maybe I'm missing something, I'll admit I'm no expert, but...

Consider GM's stock value. Consider what the decline in GM's stock value will do to the "fully funded" status of the the pension plan. Consider GM's stock value.

from http://businessweek.com/magazine/content/05_19/b3932014_mz001.htm

10 Turning Points for GM

It has made some painful missteps over the recent past. Here's a look back at some key developments in its downturn

1) December, 1991: Chief Executive Bob Stempel announces a massive downsizing, including closing 21 factories, just before the holidays. GM posts a record $4.5 billion loss for 1991. A year later, the board gives Stempel the boot amid persisting financial problems.

2) March, 1993: Just hours before CEO Jack Smith is to announce the promotion of purchasing czar Inaki Lopez to head GM's North American auto unit, Lopez sneaks away to join Volkswagen. Smith learns of the defection minutes before a scheduled press conference.

3) Late 1994: As productivity falls and auto operations bleed red ink, GM's stock sags. The revamped Chevy Cavalier compact car, built at GM's Lordstown (Ohio) plant, is the company's most recent -- and all-time worst -- vehicle launch.

4) May, 1995: Ronald L. Zarrella, whom GM hired in late 1994 from Bausch & Lomb as marketing chief, launches a disastrous brand-management strategy that justifies keeping all of GM's many models. The strategy sought to sell cars from GM's different divisions as if they were packaged goods, using marketing rather than vehicle attributes to differentiate like models in the GM family.

5) June-July, 1998: GM suffers a debilitating 54-day strike at two Flint (Mich.) parts plants that shuts the auto giant down. The strike costs GM $2 billion, embitters workers, and ripples across the U.S. economy.

6) January, 1999: Debut of the Pontiac Aztek, a minivan *** SUV, which overnight becomes synonymous with hideous design. GM execs apologize and make excuses for the vehicle months before it hits showrooms, despite it being the company's first attempt at the hot "crossover" market. Sales never come close to projections.

7) December, 2000: GM decides to kill off Oldsmobile in an effort to trim its stable of brands. Illustrating how hard it is for GM to shrink, the Oldsmobile axe ends up costing about $1 billion, after restructuring and dealer buyouts. GM also loses more than a point of market share as a result.

8) March, 2000: GM agrees to buy 20% of Fiat. The deal, which GM hopes will give it more heft in Europe, gives the Italian company the option of forcing GM to buy the rest of it after 2004. GM eventually takes a write-down on the failed investment and never attains the payoff it envisioned. Facing the possibility of having to absorb Fiat's heavy debt, GM in February, 2005, agrees to pay it $2 billion just to escape the deal.

9) September 19, 2001: To help jump-start the U.S. economy, GM launches 0% financing eight days after the terrorist attacks on New York and Washington. It was the right call at the time, providing a much-needed economic boost. GM's mistake was to stick with the program for years.

10) March, 2005: GM shocks Wall Street with the news that earnings are falling sharply, leaving its credit rating teetering on the edge of junk-bond status. A month later, it follows by announcing a $1.1 billion loss for the first quarter, and executives say they can no longer provide earnings guidance for the rest of the year. GM's reliance on SUVs and incentives to goose sales hasn't stopped its U.S. market share from sliding, to 25.6%.