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There has been much ado lately about the very sick state of our domestic auto industry. As you may know, Rick Wagoner, CEO of GM, has been lobbying the Treasury and the White House for approximately $10 billion in funds, which is supposedly needed to push through a merger between General Motors and Chrysler (majority owner by Cerberus Capital, which acquired 80.1% of Chrysler from Daimler AG (DAI) for $7.4 billion last year). It seems that no one has the want or the ability to lend GM the money in the private sector, their creditors included. So apparently Mr. Wagoner goes to Washington can be seen as sort of a last ditch effort. The trouble is, the Treasury announced on Halloween that there would be no treats awarded to Wagoner and his lobbying efforts and that GM would not receive a loan to bail out Chrysler.

Was this the right move? Let's start with the business position of the two companies: General Motors is burning through over a billion in cash every month like a pyromaniac. With about $20 billion dollars in cash, analysts estimate that GM needs at least $14 billion to maintain operations. Analysts expect that, with 14 million units in industry sales next year, GM will be down to the wire by the end of the summer. That outlook is awfully rosy, as some analysts have estimated 12 million units or worse (outlays for all durable goods items year-over-year for the third quarter were down by double-digit figures and will almost certainly get worse).

The final blow, in my humble opinion, is that given this rash of news, very few are going to want to purchase an automobile from a company that may not be around long enough before the warranty on it runs out, much less be able to provide replacement costs for the life of the vehicle. This leaves GM in a dire position in which, without any outside assistance, it is surely to file for Chapter 11 bankruptcy within a year.

Then there is Chrysler and Cerberus. The private equity firm took control of the company last year, promising to make the automaker leaner, although not necessarily greener. Chrysler is saddled with, by a wide margin, the most unfavorable product lineup of any major automaker marketing in the United States. Chrysler's fleet consists of fuel-gulping trucks and SUVs as their bread and butter, with inferior small and mid-size models with dismal sales sales figures (their minivans and the Jeep line being their only clearly distinguished products). This product line had no chance of withstanding the onslaught of increased fuel costs that led consumers to more efficient automobiles, a trend that is not likely to reverse even with the recent large decrease in fuel costs.

Chrysler does have one thing going for it: cash. Chrysler has about $11 billion in cash that GM can get their hands on if the deal can be consummated, which is quite attractive for GM, given that they are hemorrhaging the green stuff. Cerberus also has an approximate 50% stake in GM's finance arm, GMAC, which Cerberus would love to get their hands on a majority stake of, as it would allow them access to the Treasury's TARP recapitalization funds. The proposed combination of General Motors and Chrysler would thus have the potential of salvaging some of Cerberus's inherently poor decision to purchase Chrysler, and General Motors would have access to cash, which could stave off bankruptcy, and everything will be hunky-dory.

Unfortunately, GM would have to close the vast majority of Chrysler's plants, close their dealership network (the costs of doing this alone would be over $1 billion, and would seem counter-intuitive as automakers such as India's Tata (TTM) and China's Chery would love to have an established dealer network to peddle their inexpensive autos in the United States and abort contracts with suppliers. The costs of this rape and pillaging would devour most of the $11 billion booty the pirates at GM want so badly and walk about 35,000 directly-affected jobs off the proverbial plank. These actions would tarnish GM's reputation severely, and would put Washington in the politically suicidal business of downsizing automakers.

It is not surprising then, that Paulson and Bush pooh-poohed providing funds for a merger. Their alternative seems to be the same as many cynical Americans: to hell with Detroit. That option initially looks interesting, just like I stated a GM-Chrysler merger initially does. The conventional logic states that Detroit cannot compete with the imports. The cost differential between, for instance, a Toyota (TM) and a GM vehicle, had been about $1,400 (half of that alone is due to GM's health care liabilities for their employees). It seems rational that Detroit's 'bloated' structure should go the way of the dodo, based on a central tenet of capitalism: uncompetitive industries must die. However, I believe this logic to be not only flawed in this circumstance, but horribly reckless.

There are two main flaws with this argument. The first of which being that Detroit is in fact becoming competitive; last year's UAW deal will for all intents and purposes close the labor cost gap (although not the health care gap, as Detroit isn't wholeheartedly funding the Health Care VEBA it established, but I'll get to that point later). Also, the product quality gap has been significantly reduced (and with many automobiles, completely eliminated or bested).

The other flaw is the current state of the capital markets. Detroit does have a viable future, but has little chance of getting private funds to see them through (seems providers of capital have more to lose than the United States if Detroit fails, no surprise there). Without Washington's help, Detroit's potential will thus never be realized.

The argument that the failure of automakers do not pose a systemic risk is completely laughable. The negative feedback loop caused by big three bankruptcies (historically, bankrupt automakers haven't been able to emerge from bankruptcy and have ceased operation) would include the failure of suppliers. This could also mean that healthy automakers with American operations would be forced to close their domestic works as well (maybe a bit of a slippery slope, but this is certainly plausible). In total, it is estimated that up to five million American jobs are dependent upon Detroit. Not to mention, the decimation of our industrial base is a national security risk. Suddenly, "death to Detroit" rings a little hollow.

Here's what I think should be done: Give Ford (F) and General Motors capital injections with the caveat that they cannot be allowed to buy Chrysler, for the very simple reasons that a) Ford has a future, b) GM is too big to fail, and c) Chrysler's business is arguably being dismantled by Cerberus already (Chrysler CEO Bob Nardelli has been doing this since the day he set up shop in Auburn Hills). I am confident that giving Ford and GM capital would allow them to weather this dreadful auto market and will result in their comebacks, if and only if, the United States guarantees health care for all Americans (see Senator Wyden's Healthy American Act, which is somewhat similar to the Massachusetts model, one that has significant bi-partisan support and one I wholeheartedly support as well).
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