Autos and Economics

It's a big, bad world...

2012-01-02T11:17:00.001-05:00

...will 2012 ring in the red?...

It's a big world...but everyone is aiming to expand for a bigger world. Toyota of course intends to get back on track. Hyundai/Kia will hit 7 million units (see the Bloomberg story). GM will stay on top, with VW close behind, or maybe a bit ahead. Honda is simply hoping to recover, and awaits the performance of new models. Nissan is doing well, Chrysler is helping Fiat stay afloat. PSA (Peugeot) – well, because they're neither in the US nor in Japan, I tend not to hear much about them. Of course Mazda and Mitsubishi, dependent on exports from Japan, will be lucky to stay afloat in the face of a strong yen. Suzuki looks more and more like an Indian company, not important globally.

Of course the global market will expand in 2012 – we hope. Europe however is likely to see full-fledged recession, and I think it's optimistic that NAFTA won't feel a cold wind. (New England: brace yourselves for a nor'easter of historic proportions.) Japan – well, the economy will be slow and the number of licensed drivers continues to decline. China's growth will surely be slower than in 2011, while India remains small and (unlike India) has done little to improve the infrastructure that helps make car ownership functional. Brazil may do OK. All this means that the major markets will on the whole be stagnant or, in the case of China, slower but with much greater supply and hence softer pricing. (For the major economies in 2012, I find the December 15, 2011 prognosis of Morgan Stanley's Global Economic Forum thoughtful, particularly in its effort to integrate the projections for individual countries to provide a globally consistent story reflecting the integrating effects of trade and capital markets.)

Now we're not looking at a repeat of 2009. Indeed, on a total unit basis there will be growth.

I think the industry may face another shock, lower energy prices. After all, while emerging markets continue to emerge, if more slowly than in 2011, the developed markets will be moribund, depressing demand in what in the aggregate remains the biggest market for energy. Meanwhile, a period of high prices boosts investment in exploration and extraction / recovery. The output of those efforts takes a few years to start showing up in the market. Upon completion financial imperatives mean those projects will be hungry for revenue and will produce even if they face a soft market. Well, it's now been four years. That may be good news to the Detroit Three in the US, but it will mean that overall the market for energy-efficient vehicles will soften. Yet that's where the industry's players have poured their R&D. Sure, R&D is a long-run strategy that isn't expected to generate much of a short-term pay-back. However, it has short-run profit implications when it doesn't generate any up-front return.

It's hard for me to see 2012 bringing in more black; I can't tell a consistent upside story for the industry on a global basis. Single markets are less and less capable of driving results; we have entered an era where firms need more than their home market to generate profits. (A caution: for years the effective home market for Toyota and Honda has been the US, not Japan. That may also be the case for BMW.) However, I'm not (quite) pessimistic enough to say that 2012 will ring in the red.

Mike Smitka

More TrueCar

2011-12-22T02:21:00.002-05:00

TrueCar.Com Truly Infuriates Many Dealers

by David Ruggles
WardsAuto.com, Dec 19, 2011 8:58 AM

Scott Painter says he wants to help dealers sell more cars. So why is the founder of TrueCar.com under attack by auto-retail people on social-network blogs and elsewhere?

Painter contends he is the dealer's friend when selling them his Zag/TrueCar lead-generation program. Then he says he is the consumer's friend in their price battles with dealers. Is it possible to take both sides of the same issue at the same time? He also says he wants to transform the industry by "commoditizing" new vehicles, which eliminates the need for salespeople and marginalizes losses. Have we been down this road before?

TrueCar has grown dramatically, making enough inroads to raise $200 million from venture-capital investors with which the firm promptly purchased Automotive Leasing Guide, the industry's highest-profile residual value predictor.

In a nutshell, TrueCar as an online lead provider offers dealers a deal that seems hard to refuse. They only pay for online leads that are closed as sales.

In the fine print is an agreement to give TrueCar access to information in dealership management systems. After all, how will TrueCar know how much to bill at the end of the month for the closed and delivered leads without verification?

But the firm also harvests data, in particular transaction-pricing information that TrueCar shares with car consumers visiting its website. After seeing what other people paid for the same vehicles they are interested in, they can make an offer.

Painter says that pricing data does not come from DMS units. Even if it doesn't, it puts additional pressure on dealers under the guise of providing "a public service." Is there another industry where consumers feel they have the right to know a seller's actual true costs?

Scott Painter under fire from dealers.

Eventually dealership people, led by Jeff Kershner, figured out what was going on.< Now, an industry movement is swelling against TrueCar. There is plenty of information on industry social-network blogs, with more being added by the minute. Hundreds of people have weighed in. Jim Ziegler's blog has had more than 12,000 views.

"There really is only one way to stop this nonsense with vendors," says dealer Tamara Darvish of the Darcars Automotive Group in Maryland. That requires "a gentleman's agreement" among dealers not to exchange DMS data for leads, she says. "Unfortunately, greed and ignorance often take priority with some, rather than logic and long-term planning."

TrueCar's Devin LaCrosse provides the other side of the story. By enabling participating dealers to provide upfront, no-haggle price quotes, TrueCar has helped over 5,500 dealers nationwide sell over 400,000 new and used vehicles, he says. TrueCar lowers dealership selling costs "by providing high-quality customers and no need for haggling, and provides free transaction-based pricing data to help dealers price vehicles scientifically."

Some would say TrueCar is not incrementally increasing vehicle-sales volume, just lowering dealers' gross profits. Some dealers are doing more volume at the expense of others, but there is no evidence more vehicles are sold. Kershner, Ziegler and others think dealers unwittingly are enabling Painter to transform the auto business based on his perception of how it should operate.

Why are dealers going along with what seems like a self-defeating initiative? Many were caught unaware. They need to thoroughly read their contract with TrueCar. Dealers who have just learned what is happening are up in arms. Many are as angry at themselves as they are with Painter and his firm.

Everyone can draw their own conclusions. But some people are taking it very seriously. Ziegler calls it "the Battle of Armageddon for car dealers."

WardsAuto Dealer Business columnist David Ruggles is a former dealership general manager.

The War with TrueCar

2011-12-12T14:37:00.004-05:00

Open Letter to the Automotive Industry from Scott Painter, Founder & CEO of TrueCar, Inc.

Responses by Ruggles

Monday, December 12, 2011 12:01 am

Painter: Our world is changing. Unprecedented access to information and a massive shift in consumer behavior has resulted in a challenging new automotive retail landscape. It has also enabled a consumer appetite for data transparency. To hide from evolving consumer behavior is to deny change. At TrueCar, we embrace this opportunity. We also believe that transparency is the centerpiece of trusting relationships. Some in the industry disagree. We would like to make our position clear.

Ruggles:Transparency is NOT the objective of auto dealers. Survival is, followed by net profit. It takes gross profit to have some net profit left over at month end. Is there another industry where consumers feel they have the right to know a seller's actual true costs? What gives consumers the right to that information in the first place? Providing transparency is NOT your only aim – making money in the doing is! The behaviour by consumers wanting to know a car dealer's bare costs is NOT something new. In 1970 credit unions would arm their members with "dealer cost." There were books available on every news stand. The delivery of the information is what is different.

If you want total transparency, give consumers actual bare cost down to net net net. Then allow the negotiation to be based on the gross profit, say a thousand or two. Do you really think consumers understand gross profit? Do they understand the expenses that are paid out of gross profit? More importantly, do they care?

Over the course of time car dealers have had their margins trimmed dramatically by their OEMs. When I started in the business the margin on large cars was 22.5% with a 2.5% hold back. "Trunk money" was available only for special promotions, but it was nowhere near as prevalent as today. The profit a dealer makes these days has moved to "trunk money," as the dramatically narrowed margin and increased availability of information to consumers has dictated it. And you are looking to disclose this information as if consumers have some kind of inherent right to it.

The auto business is a business of negotiation. AND consumers can shop. Consumers aren't bound by the same rules that auto dealers are. You seem to be saying that you would like to remove the negotiation aspect of the business while making money for your own company in the doing. It's not like you are performing some needed public service. You think an "efficient" market for new vehicles is good for everyone? How does that jive with the dealer, who has made substantial investment, making a reasonable return? If they don't, who will be around to provide other essential services to the consumer? The factory?

You're a business man and have closed some deals where negotiation has been required to reach agreement. You also know that in negotiation if neither party gets their feathers ruffled at some point, money has been left on the table. I suspect that in your very best negotiations, you negotiated without appearing to negotiate at all. I suspect that is how you have gotten so many dealers to sign on initially. That might even be how you gathered in $200 million in venture capital. I take my cap off to you for being such an artful negotiator. But don't in the same breath talk about transparency. Your objective is to make your deal while adopting the APPEARANCE of transparency as a negotiating tactic. How do you expect to make money in a negotiating business like the auto business with true transparency? You call it transparency to share transaction data, where ever you happen to get it and however the consumer interprets it. Real transparency is when only the margin is negotiated because the consumer knows our costs as well as we do, but of course they lack the knowledge of what has to be paid out of that margin. To repeat - you are selling the illusion and perception of transparency, but in the doing you are feathering your own nest by portraying yourself as the "good guy" to the consumer who readily accepts the dealer as the "bad guy." The amazing thing is that any dealer has cooperated with you.

And what of the sales people you intend to replace? Or do you deny that that is one of your aims? It seems you are on record about that.

Painter: Our goal at TrueCar is to foster healthier relationships between manufacturers, dealers and consumers through data transparency.

Ruggles: Forget about healthier relationships. Profitable business relationships that are also "healthy" are the kinds of relationships to have. The euphemism "data transparency" means disseminating propriety information to consumers, information that is none of their business. They can shop at the touch and click of a mouse. What more are they entitled to?

Painter: To deliver on this promise, we require a high standard from our 5,800 dealer partners – an upfront competitive price and a commitment to a great customer experience.

Ruggles: Where does the great customer experience come from in a race to the bottom on price? Where does the money come from to accomplish that?

Painter: A discoverable upfront price is the cost of getting noticed. Contrary to popular concerns this does not create a “race to the bottom.” The lowest price only secures the sale 19.2% of the time within the TrueCar network. The sale is still won by location, selection and good old-fashioned customer service.

Ruggles: No race to the bottom? Easy for you to say! If only 19.2% buy based on the lowest price, why would you even try to provide consumers with the lowest price? The cynic in me tells me that your motive is not public service, but your own profit. Let's tell it like it is. That being the case, how on earth would you expect dealers to be your allies in the endeavor? Well, that's easy. A host of dealers with their heads up their asses have already signed on providing initial validity to your premise. In case you haven't noticed, there is a burgeoning group looking to enlighten our fellow dealers.

Painter: At TrueCar, we believe that upfront price is at the core of a good buying experience for dealer and consumer. Informed consumers buy more confidently and are more satisfied. At TrueCar, we publish the most accurate reflection of the retail market that has ever been available. The goal is to establish an objective, credible and transparent baseline for fairness – both for the customer and the dealer. That being said, TrueCar does not set this market. Our dealer partners set their own prices 100% of the time.

Ruggles: Its great that you believe that "upfront price" is at the core of a good buying experience. In our mind, a good buying experience is where the dealer makes a substantial but reasonable profit, the consumer is happy, and a long term profitable relationship is formed. The price is negotiated. Trades are taken. Consumers can shop if they feel they aren't getting what they want.

Whose definition of fairness are we using? Yours? The consumers? As previously mentioned, ask a consumer what they think a fair margin is on a new car and the answers will be all over the map. Most aren't business people. It doesn't even occur to most of them that there are substantial costs that have to be paid from gross profit.

Bottom Line: You are trying to create a system based on wildly variable consumer perceptions, while destroying the system that has worked for years, and to make a few million in the doing.

AND after you have taken down sales people and the dealer network, do you then turn you program on manufacturers? Where does it end? Dealers don't need any more downward pressure on gross profit. And those who help you provide additional pressure on their own gross profits just haven't woke up to that fact yet.

Painter: Dealers earn their business every day and we believe that their marketing programs should too. TrueCar is the only fully accountable source of new business where our dealer partners only pay when they sell a car. Gone are the days when dealers have to assume all of the marketing risk and pay for advertising and for leads as a primary way to secure new customers.

Ruggles: I suspect that more and more dealers will be opting to take their "risk" back in return for not being complicit in their own demise.

Painter: TrueCar requires DMS integration for tracking of this accountable model, the core of what makes us unique. We use DMS feeds from our dealer partners for tracking and optimization of introductions made to the dealership. We don’t use our dealer partners’ information to populate the TrueCar pricing curve. That information comes from entirely separate sources of anonymized data that represent nearly 90% of all vehicle transactions in the U.S.

At TrueCar, data integrity, security and privacy are job #1. Our policies, systems and technology have passed the scrutiny of partners like USAA, Consumer Reports, American Express, AAA and many others. TrueCar has never, and will never, sell or repurpose DMS data for any reason.

Ruggles: IF security and privacy are job #1, you have failed miserably. The credibility gap between TrueCar and dealers is growing. Even if it is true that your access to a dealer's DMS doesn't provide actual transaction data, the fact remains that your company is making money by putting additional pricing pressure on dealers under the guise of providing a "public service."

Painter: In spite of all this, we recognize that change is threatening for some. Ours will always be a high-touch industry. The service of our dealer partners and highly-trained sales professionals becomes increasingly important the more consumers know. At TrueCar, our commitment is to relieve those professionals from needing to resort to high-pressure sales tactics or misdirection. These tactics have been an albatross for our industry and they are at the heart of why consumers have become generally mistrustful of the car shopping experience in the first place.

Ruggles: Change? This isn't change. TrueCar simply puts the dissemination of proprietary dealer information on steroids. Do us a favor and let dealers return to their high-pressure and misdirection tactics of days gone by when we delivered 17,000,000 new vehicles a year. The only way most consumers will be satisfied is to be guaranteed to win the negotiation. And they can't even define what it would mean for them to win. You say consumers have become "generally distrustful of the car shopping experience?" Please tell me, is this some kind of new phenomenon that recently arose so TrueCar could come to the rescue?

Painter: Is TrueCar good for all dealers? There will always be those that resist change. To our dealer partners, we applaud your understanding that truth, transparency, and customer service is at the center of success in our changing market. And, to those that still have questions, we invite an open dialogue. One of the great virtues of transparency is that we have nothing to hide.

Ruggles: The change dealers want to resist is further downward pressure on their gross profits, at a time when their manufacturers are pushing them to spend more and more money on their facilities, thereby further increasing their costs. As a 40 year industry veteran retired from the day-to-day of retail, I can speak my mind. I hope others will do the same.

David Ruggles

The Industry's Recovery: The Devil is in the Details

2011-12-12T11:11:00.000-05:00

...I'll cheer when the glass is half empty...

The media claims the auto industry as a bright spot in our recovery. If this is good news ... well, read on.

First, sales remain well below peak; we will close out the year as a whole with less than 13 million sales, against a peak SAAR [industry jargon: seasonally adjusted annual rate] of 17 million. So we're still down 24%. Nevertheless, the glass is at least half full, because that's 30% better than the sub-10 million unit level of late 2008-early 2009.

That story is grimmer when we examine the value of motor vehicle and parts shipments; they are still down a full 33%. But again, at $30 billion shipments are still up 30% from their nadir.

Quarterly data from the FRED database of the Federal Reserve Bank of St. Louis. Click graphs to enlarge.

Well, then there's employment. That's up, by about 80,000 in retail and 90,000 in manufacturing. Given the abysmal state of our job market that's something for which we should be thankful. But again, it's from a really, really low base. Well into 2007 manufacturing employed over 1.0 million; compared to January 2007, at nadir the industry had lost 400,000 jobs. Retail saw less of a drop in percentage terms, about 15%, but compared to January 2007, in absolute terms employment at the nadir at dealerships shrank by about 246,000 and parts retailers by 58,000. If we combine the two, January 2007 employment was 2.94 million; the nadir was 2.25 million. Today (Nov 2011) we're at 2.40 million.

Generated by Smitka from BLS data. Click graphs to enlarge.

In the auto sector, retail and manufacturing, we've added 150,000 jobs. Not bad. But we were down 680,000. So at +22% we've not even regained a quarter of what we lost. It's not that things could be worse; things have been much worse.

I'll cheer when the glass is half empty.

Mike Smitka
Professor of Economics, Washington and Lee University
Judge, Automotive News PACE "Supplier of the Year" competition

The Politics of the GM-Chrysler Bankruptcies

2011-12-12T01:06:00.000-05:00

By David Ruggles

During the recent Republican debate held in Mitt Romney’s home state of Michigan, the presidential hopeful was asked about the “rescue” of General Motors and Chrysler. The premise of the moderator’s question was that since the automakers are now doing well, did Romney “regret his opposition to the rescue?” Romney answered, “The government finally followed my advice,” referencing his November 2008 op-ed in The New York Times entitled, “Let Detroit Go Bankrupt.” [Click to read the full article.]

Despite the inflammatory headline, Romney’s article was temperate and well-reasoned. Some readers might have assumed that the “bankruptcy” Romney recommended was a Chapter 7 liquidation, but that was not the case. The piece was written in the context of events of the day, in particular the Detroit Three CEOs appearing before Congress to request a “bailout.” The initial request was for $25 billion in loans or loan guarantees. That appeal later grew to $35 billion, while the total investment necessary to do the job, which has largely been repaid or secured with stock, ballooned to $81 billion.

In his op-ed, Romney stated that it would be better if the two companies in question, GM and Chrysler, were allowed to go through a “managed, pre-structured bankruptcy to allow them to restructure themselves.” Without such a restructuring, but with a “bailout,” Romney argued, the companies would continue on their current unsustainable path and would ultimately have to liquidate. “But don’t ask Washington to give shareholders and bondholders a free pass — they bet on management and they lost,” Romney said in his piece.

Reached by telephone for this column, Steve Rattner, former chief of the Automotive Task Force, called Romney’s 2008 piece “prescient.” He praises Romney’s op-ed as “95% correct.” According to Rattner, the “Romney plan” was followed almost to the letter. The exception: there was “no debtor-in-possession financing available through private lenders, requiring the U.S. Treasury to fill that role,” he said. (Remember the financial system meltdown of 2008-9 – see the note at the bottom.)

After the “government finally took my advice” comment, though, Romney should have left it there. The Democrats seem to be trying to mischaracterize Romney’s stated position in the New York Times article by applying “liquidation” bankruptcy to Romney’s headline, instead of the reorganization he clearly recommended in the body of the column.

Even more confusing is that Romney himself currently seems to be mischaracterizing his own original position. Bloomberg writes: "In Michigan after Wednesday's Republican candidate debate, Mitt Romney defended his opposition to the government bailout that saved jobs in the tens of thousands at GM and Chrysler. (Again, see the note.) According to Romney, instead of asking the government to intervene, the companies should have entered into private sector bankruptcies immediately.”

Never one to waste an opportunity, former Michigan Gov. Jennifer Granholm, a Democrat, said in an interview with Bloomberg that “Romney's view was ‘a knife in the back’ to his home state."

Rattner, too, is puzzled. “I can’t understand how Romney can go from being so out in front of the auto company reorganizations to disavowing his almost perfect original position. In fact, GM CEO Rick Wagoner stubbornly refused to consider Chapter 11 bankruptcy for GM and had to be removed for the reorganization to go forward.”

By the time Pres. Barack Obama was inaugurated, the Bush administration had already advanced $17.4 billion in “bridge loans” from the Troubled Asset Relief Program to the two ailing automakers. Congress had turned down a “bailout” package despite Vice Pres. Dick Cheney admonishing his fellow Republicans, “Do you want to be known as the party of Hoover forever?”

Perhaps Romney is criticizing the Bush administration for the “bridge loans,” but last anyone checked, George W. Bush is not running for President again.

What is clear is that the rescue of the auto industry will be a hot topic in the upcoming 2012 elections. The President and the Democrats will be taking credit for what so far seems to be a good move, despite flaws in the “rescue’s” execution. The Republicans seem determined to claim that the “rescue” was a “bailout” and shouldn’t have been done.

In Republican frontrunner Romney’s case, he seems to be having a difficult time making up his mind what he thinks. His camp did not respond to a request for clarification of his position in advance of this column.

David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs at autosandeconomics.blogspot.com and writes regular columns for several publications.

Note: on this blog Ruggles and Smitka repeatedly examined this issue during 2008-9, arguing that, due to the interlinked nature of the supply chain, made visible in the aftershocks to the industry of the "3/11" Tohoku earthquake, the liquidation of GM would have forced suppliers and hence Toyota, Honda and the rest of manufacturing to close. Without inventory, dealers would have followed, while even repairs on existing vehicles would have become difficult because spare parts production would also have shut down. Remember, there was no private financing to handle normal Chapter 11 bankruptcy – the only alternative would have been immediate liquidation.

The Resilient U.S. Economy

2011-12-12T01:03:00.004-05:00

If the stock market is the pulse of the American economy, the outlook might be better than expected.

In a conversation I had with noted Wall Street analyst and international trader James Vena, he asked a very interesting question: “Where was the Dow a year ago?” Answer: About 12,000. “And where is the Dow today?” About 12,000.

Vena pointed out that the economy has withstood some serious challenges this year, including:

A debt crisis that would threaten the European economy and the Euro currency itself.
A significant cheapening of the U. S. dollar.
A disruption in oil supply from Libya caused by a series of uprisings in the Middle East and a corresponding spike in fuel prices.
An earthquake and tsunami in Japan that would disrupt world trade including components for global auto production.
Flooding in Southeast Asia that further disrupts the global supply chain.
An attempt by a U.S. political party to hold a lifting of the country’s debt ceiling resulting in a lowering of the credit rating.
The bankruptcy of a major legacy U.S. airline.
Continuing U.S. housing foreclosures and a further decline in home values.

The U.S. economy is far from out of the woods. But it has withstood a serious assault in the past year and not slipped into a double-dip recession. Will the upcoming election year bring about new challenges, or will the economy get a break?

Mike Smitka as devil's advocate: but it's housing prices that are weighing down household balance sheets, not the stock market. Until you get into fairly high incomes shareholdings are primarily indirect, through retirement plans -- are Americans really going to cut back on their contributions further in order to buy a new car???? And sitting at 9%-plus unemployment for 2 years is "resilient"?

The Ford-GM Stock Equation

As with the economy, the stock market will continue to evolve. So far this year, though, auto stocks, specifically, have hit some hard times.

Surprising to many is the fact that the stock of General Motors has dropped to about $21 per share from its $35-per-share post-IPO high a year ago. Even more surprising is that Ford’s stock has dropped to about $11 per share from $18 in the same time frame. This decline, despite impressive sales gains and profits, and improved fixed costs, now that both companies' VEBAs have capped legacy costs while their UAW contracts have removed the threat of strikes and wage hikes.

Of course, in the past year there have been headwinds: high oil prices, the Japanese tsunami, and the debt crisis debacle, to name a few. Both companies have taken hits on quality, with GM experiencing bad PR due to some Chevy Volts that burst into flames during crash testing and Ford being slammed in a J.D. Power quality survey.

Despite these obstacles, the two companies have stood firm. GM announced the reopening of the old Saturn plant in Spring Hill, Tenn., to build the Chevy Equinox. Both companies continue to increase volume, marketshare, and profits. They have both been reducing incentives while maintaining sales momentum.

Once GM’s stock price gets to a certain level, expect the Treasury Department to sell quantities of the taxpayer’s GM stock. The outcome: a somewhat depressed price.

So what is your prognostication for the upcoming year? Buy? Sell? Hold?

GM recently began paying a dividend on preferred stock while Ford just announced a 5 cent per quarter dividend, its first since 2006.

David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs here at blogspot and writes regular columns for several publications.

From whence will they come? -- profits, that is.

2011-12-09T09:19:00.001-05:00

In North America the pricing umbrella created by the need of the Detroit Three to fund retiree health care is unwinding, while the Europeans are fleeing the Euro to add capacity here; the Japanese began diversifying out of their yen cost base 15 years ago. In the short run, that may improve profits for the Detroit Three and the Germans at the expense of the Japanese, but will ultimatlely enhance rivalry and lower profits for the industry as a whole. Europe remains in the doldrums, and the excess capacity in China will become more apparent as sales slow to a merely torrid pace. Ditto India. Brazil? South Africa? Sure, there will be markets that grow, but will they grow faster than new capacity is added? I can't think of an exception.

That pressure is obscured by shifts among market segments, particularly in the move away from small cars in the US and China that boosted profits for some firms. It is also obscured by exit, the role of which is inadequately recognized. In Europe VW snapped up SEAT, Skoda and others while Ford and GM consolidated formerly autonomous UK and German operations. In Japan Toyota absorbed Hino, Isuzu, and Daihatsu and now has a large though not yet controlling stake in Fuji Heavy Industries, Subaru's parent. Meanwhile foreign partners have unloaded their stakes in Mazda and Mitsubishi, which face a shrinking domestic market and a yen whose value makes exports unprofitable. No one is likely to value them solely for their engineering capabilities; their demise is only a matter of time. The US looks different partly because of large capacity adjustments by the Detroit Three, but we've also seen the demise of AMC, Suzuki, Isuzu, and Mazda while Mitsubishi's plant continues to run at unsustainably low capacity. If we include the elimination of brands such as Saturn and the cessation of exports by various firms, exit is significant. Inside Korea, Hyundai gobbled up Kia while GM purchased Daewoo and Renault picked up Ssangyong. The survival of brand names makes it hard to know what operations remain. Ditto Australia, where the Ford and GM affiliates were at one time stand-alone companies.

You might say "but China." Few outsiders are aware that there were 120 firms in that market, which was dominated by a host of minuscule operations owned by the governments of provinces and large cities. They had captive markets -- the models made in Shanghai couldn't be found on the streets of Beijing, and vice-versa. Of course some of these firms and subsequent private entrants (Geely, Chery and BYD) continue in business. But the market is dominated by those Chinese firms that poured their efforts into joint ventures; they've created jobs and been able to keep a slice (as a first approximation, half) of the profits, and some of them have quietly gobbled up failing regional firms. That's important because, while the central government in Beijing has been able to eliminate the domestic trade barriers in industry after industry that impeded the creation of a national economy, the legacy of local fiefdoms remains visible in the vehicle market. VW and GM, strongest in Shanghai, have done very well. Who will "own" Sichuan Province, with a population of over 100 million? It won't be a local firm, because their exit continues.

So as I look across the world (OK, on a good day I can only see 40 miles from my mountain ridge home), well, what strikes me is the likelihood that in the aggregate profits will continue to erode. Consumer preference for choice offsets that, allowing an amazing diversity of product to survive in the marketplace. From time to time individual firms will themselves with the right vehicle in the right place, and do quite well. But that will be offset by poor profits elsewhere. In the background, there's the pressure to invest in new technologies. No one can risk not pouring resources into R&D, as regulatory pressure for safer products, lower emissions and higher fuel efficiency keeps raising the technology bar. But with expensive new and less expensive old technologies continuing side-by-side in the marketplace (and typically the dealership), it won't be possible to raise prices sufficiently to generate generate commensurate profits.

With lower industry profits, the losses for those firms that fail to hit a sweet spot will be worse. It will thus be much harder for firms that find themselves on left tail of the distribution of profits to survive. Chances are Saab won't be the last manufacturer to fold in the 21st century's second decade.

Followup: For a story focusing on this issue from that standpoint of one product, see"Toyota Threatened..." by Alan Ohnsman at Bloomberg.

Mike Smitka

Where are the French?

2011-09-26T22:08:00.000-04:00

...they must have all the love they need at home...

Mike Smitka

First it was the Japanese. Then a couple Germans and the Koreans. Now the rest of the Germans. The Italians have one foot in the water. But except for a fleeting presence through American Motors, both with Simca as a subsidiary and later with Renault as an owner, the French -- who dominated the global industry in its formative years in the 19th century -- are nowhere to be found. Why?

Now it may be that Renault's control of Nissan represents de facto entry. Certainly purchasing is handled on a global basis, and there's cooperation in engineering. It may be that some Nissan products currently on sale in fact use a Renault platform (Perhaps one of my readers can fill in the gap.) But the absence is puzzling.

That's even more true of PSA (Peugeot-Citroen). The last time I looked (I'm probably showing my years!) they were doing well in Europe and solidly profitable. They keep up with technology, as seen in the customer base of the winners of the PACE Supplier of the Year innovation award for which I'm a judge. They're simply not here.

So what is their strategy? Do they believe that sufficient technology resides in the supplier base that they do not need sheer size to fund the R&D for tomorrow's products? Are they making enough money in small cars that they've chosen to "stick to their knitting" -- not venture into segments with which they have no experience -- and are therefore passing up the US market with its cheap gas and penchange for fuel guzzlers?

I don't know, but I've started to think about the variance in such "macro" strategy across the top vehicle assemblers. Suzuki strikes me as the closest analog, but they have a strong base in India, though it's probably no longer accurate to say that they dominate the market through their joint venture Maruti. Then there's Daihatsu, but they were gobbled up by Toyota and so, for better or for worse, are shackled to the small vehicle niche. Daihatsu long ago exited the US market; Suzuki seems likely to. So maybe PSA made a sensible strategic decision, and refused to join the herd in entering (and now exiting) the US.

My curiosity is piqued, but I have no answers.

Can an Automaker Incentive Battle Goose the Economy?

2011-09-14T14:26:00.001-04:00

David Ruggles

As the economy wallows in the doldrums, is there any cause for optimism? The outcome of the European debt crisis is still unknown, and we know how markets despise uncertainty. There are still plenty of uncertainties associated with the so called “Arab Spring” uprisings in the Middle East, and those could be with us for a while. While fuel prices have somewhat moderated, they remain high. The country’s credit rating took an unnecessary hit, although plenty of money seems to still be seeking to buy our debt. When the Dow fell dramatically after the downgrade of our credit rating, much of the money that left equities found its way into our “downgraded” Treasury bonds. Either the European debt crisis or our government being hamstrung by ideologues has sent the Dow on a downer after the debt ceiling crisis “semi resolution.” The 12-member “Super Congress” still has an important job to do, and there is additional uncertainty attached to that, that will take weeks to resolve.

The economic recovery that seemed so promising 10 months ago has stalled. Real estate prices continue to drop in many markets with many foreclosed properties not even listed to lessen the perception of burgeoning inventories of distressed merchandise. In Las Vegas a realtor friend mentioned that 50% of her deals these days are cash, as many properties don’t qualify for a certificate of occupancy and can’t meet standards for a mortgage. Only 20% of real estate market sales are “conventional sales,” she says. To put this in perspective, previous Federal Reserve Chairman Alan Greenspan says we shouldn’t expect any kind of robust recovery until home values rise at least 10%. His comment was made in an interview before values retreated another 5%.

Unemployment has plateaued at about 9%, with under-employment and fear of unemployment stifling consumers’ will and ability to buy. The President’s new jobs plan has been met with a collective yawn by Congressional Republicans. It is yet to be determined if can even pass, let alone actually make an impact if passed. The first stimulus package of the Administration managed to stem job loss of 780,000 per month, but did not achieve its stated goal of keeping unemployment below 8%. Despite stemming the job loss, the word “failure” is bandied about in political circles. As it turns out, the initial calculations of how much stimulus might be needed were based on preliminary numbers, which showed the economy contracted 3.8% in the last quarter of 2008. Once all the numbers were in, the real numbers showed a 6.2% retraction in that quarter. It turns out that to do the job promised, Paul Krugman, Nobel Prize-winning economist and New York Times columnist was correct, the stimulus needed to have been twice as large. Regardless, we are where we are, the original stimulus has exhausted its funds, the economy is stagnant, domestic auto stocks have tanked, and recovery has been stopped in its tracks.

This economic downturn isn’t like our previous ones. This one was caused by a financial crisis, with a near-collapse of the financial system averted at the last minute by government intervention. In my own business career, I recall the auto business being a major player in dragging the country out of economic stagnation. In late 1971, Pres. Richard Nixon repealed the excise tax on automobiles, touching off a spurt of business that pulled the economy out of stagnation and carried us forward to the first 10 million unit sales year in 1973. That momentum was halted in late 1973 by the OPEC oil embargo, fuel price spikes, and the associated economic downturn. Chrysler and Joe Garagiola helped pull us out of that one in 1975 with the “Buy a Car, Get a Check” promo. We then went through the Iranian hostage crisis in 1979, another spike in fuel prices, inflation, and the recession associated with the Carter/Reagan era and the first Chrysler bailout. Chrysler’s resurgence helped lead the economy out of the depths. In the past 10 years, GM led the industry and the economy out of the doldrums caused by the Sept. 11 attack with “Keep America Rolling” and 0% interest. That was followed by the “Employee Purchase Plan.”

This time around, we experienced the recession, the near insolvency of the banking system, a real estate crisis of epic proportions, and one that stubbornly hangs on, the temporary disappearance of financing of all kinds, bankruptcies of two of the three domestic automakers, and unthinkable job loss. After the restructuring of the auto industry, and a less than perfect “Cash for Clunkers” program, and a brief period of revival, any forward momentum has stalled.

Currently, new vehicle inventories are low. This isn’t a particularly abnormal situation for this time of year, as it is typical for dealers to clear out previous year’s stock to make room for the new model year’s models. But Japanese manufacturers, in particular, have lost ground against their competition because of the supply interruption caused by the tragic Japanese earthquake and tsunami. And they want their marketshare back. According to Kelly Blue Book, Japanese brands were approaching 40% of the U.S. market. Bus since April, that share has fallen to about 30%. Most SAAR projections are running behind pace, including my own. People are talking about an incentive battle from now through the end of the year. As Japanese brands gear up, domestics are expected to respond. And the domestics now have a much lower breakeven point than before their restructuring.

Incentive wars usually drive down used-vehicle values. But we have been experiencing an acute pre-owned inventory shortage. Dealers would welcome some relief.

Rental fleet replenishment is still in long-cycle mode. Wouldn’t it be nice to rent a vehicle again with less than 25,000 miles on it, riding on smooth tires? Can a case be made for a production orgy and short cycling of rental vehicles for a period of time as we had in the 1990s? For all the negativity attached to “push-marketing,” could this be an ideal time for it? The idea of manufacturing plants running at full capacity, paying overtime and adding shifts, and the trickle down through the supplier base and the financing community sounds pretty good right now. And the market could use a supply of low mile pre-owned units. Customers of Hertz, Avis, Dollar/Thrifty, etc., would be happy. And perhaps the auto industry could help touch off recovery like it has in the past.

Bob Lutz - "Car Guys versus Bean Counters" Book Review

2011-08-03T18:20:00.006-04:00

"Car Guys vs Bean Counters"
The Battle for the Soul of American Business
By Bob Lutz

The automotive world has been waiting for this book for months. Lutz gave a preview to a group at a fleet conference I attended in Las Vegas last summer, where he received a Lifetime Achievement Award from the Automotive Fleet and Leasing Association (AFLA). His previous effort, “Guts: 8 Laws of Business from One of the Most Innovative Business Leaders of Our Time” made “best seller” lists.

Now 79, Lutz knows his auto industry history better than most. He has lived it in the most inner circles, having held executive positions for GM Europe, then, BMW where he coined the phrase, “BMW, The Ultimate Driving Machine.” Then worked with Lee Iacocca at Ford, followed him to Chrysler, where he lost out to Robert Eaton for the top job, perhaps the biggest mistake Iacocca ever made. After a stint as CEO of Exide Battery Corp., he rejoined General Motors. Who better to tell us the story of the struggle for authority and dominance in the various domestic auto companies, as well as the recent history of GM’s fall and rise?

According to Lutz, the GM he found when he returned in 2001 epitomized , “The tyranny of process over results.” He does so in true Lutz style as evidenced by his personal motto, “Often wrong but never in doubt.” Anecdote after anecdote kept me chuckling while I marveled at the man’s insight and ability to articulate. While Lutz comes across as confident, he also impresses with his candor and humility, free to admit a personal mistake or miscalculation. Then there is his notorious acerbic wit and occasional tendency to be blunt with comments like, “Global Warming is a total crock of sh*t,” made during a private lunch with reporters in 2008 but repeated over and over again by the press.

Lutz gets some things off his chest as he rails against government over reach, Toyota, CAFE, MBAs, and the “liberal media” one minute, then skewers Limbaugh, Beck, and the radical right wing the next. He spends a chapter on second guessing the tenures and decisions of others but does it in a humble way, pointing out that those people made sincere decisions based on their personal beliefs and information available at the time.

Lutz chronicles the history of GM from the days when iconic stylists like Harley Earl and Bill Mitchell ruled the roost. GM achieved market dominance by executing stylish cars that people lusted for because of their innovation and beauty. Post war Cadillacs, finned V8 Chevrolets, the Corvette, sixties era Toronados and Rivieras, and many other exhilarating vehicles resulted from when “Design” was dominant. This was replaced by the premise that, “You can’t manage what you can’t measure,” which led to bureaucratic process where no one tried to achieve anything other than to be perceived as not having made a mistake. Lutz calls it “analytics run amok,” preferring “art over science,” but seeing the need for both. “It’s the balance that has been out of whack.” He cites “penny wise and pound foolish” anecdotes one after another to make his points.

He singles out for particular scorn the “brand era” at GM, headed by Ron Zarella, brought over from Bosch and Lomb to be president of GM North America. Instead of designing desirable products first and then creating the underpinnings to make that design work, the first step in the new “bean counter” dominated GM was to create cost constrained underpinnings. The Design Department was then given the mission to “wrap the underpinnings in something that looks as good as it can under the circumstances.” This is the opposite of how things were done when “Design was Dominant” at GM. Lutz cites the ill fated Aztec, the “Quasimoto of Crossovers,” as an example. Over the years, GM had established “a stifling thicket of criteria: where the wheels had to placed relative to fenders, how the windshield should slope to permit easy viewing of traffic lights, how ash trays were to open and close, etc. etc.”

GM had purchased a Chrysler 300 to try to determine how Chrysler could develop such a vehicle, but GM couldn’t. The Design Department covered the car with 90 “Post It” notes, identifying areas where Chrysler had violated GM design criteria.

There was a time when GM paint was intended to be purposefully dull so as to not reveal flaws, in search for an optimum JD power score. There was no desire to excel or develop a “smash hit. The focus was on meeting “data points.” By following “process,” executives could avoid the accountability of failure as long as it was perceived they had followed the GM process.

Brand managers were recruited from companies like Procter and Gamble, and cars were developed and marketed by people who were deodorant, baby wipe, and toothpaste experts.

“The ebullient, dynamic, seductive volcano of creation had been transformed into a quiet mountain with a gently smoking hole at the top, spewing forth mediocrity upon mediocrity,” says Lutz.

The internal confusion at GM is exemplified by a conversation Lutz relates with an automotive supplier over lunch. At the time, Lutz was President of Chrysler. He asked the supplier who his favorite customer was. The answer came back, “GM!”

Why,” asked Lutz.

It seems the supplier was able to sell the same bearing under seven separate parts numbers, but in seven different boxes at wildly different prices. The purchasing departments rarely talked to each other. According to the supplier, doing business with GM was sure hard to keep straight, but it was mighty lucrative.

Lutz is careful to exclude GM trucks from excoriation, pointing out that the truck division produced success story after success story. Of course, everything changed when fuel prices suddenly increased, as they did in 2008. Not only did profitable truck sales suddenly cease, but the GMAC mortgage business, which had been subsidizing overall North American operations, started hemorrhaging cash at an astonishing rate.

Lutz tells his own version of the auto CEOs going to Washington D.C. on their private planes. He talks realistically about the firing of Rick Wagoner, and the role President Obama, Steve Rattner, and others played in the bailout. He discusses the fierce debate over whether or not the government should have taken a stock position in the new GM and about whether or not the UAW was favored in the deal. But you’ll have to read the book to find out what he said!

Lutz says, “In a sense, the decline, failure, and rebirth of General Motors is simply a metaphor for what is happening to business in the whole United States.”

According to noted automotive journalist, David E. Davis, Jr., “This book should be required reading for any young person who seeks a business degree." He also applies his advice equally to the current management of GM.

Japan's Twin Earthquakes and other disasters

2011-07-27T11:57:00.003-04:00

Japan is well on its way to recovery from the March 11 earthquake that rocked the country’s northeastern region and generated a tsunami that swept clean swathes of the coast. Automotive output is recovering; between them, Honda, Nissan and Toyota plan to hire over 5,000 temporary workers in an attempt to catch up, which feeds back to help the rest of the economy, as well as the Tohoku earthquake region where Toyota's newest plants are located. But a second and wholly man-made disaster now threatens the return to normalcy.

Despite the magnitude of the March temblor, Japan was well prepared. Few deaths stemmed from buildings collapsing, trains stopped automatically, and factories were relatively unscathed. As roads were reopened and utility service reestablished, the auto industry was ready to resume output. And all along most of the economy trundled on; despite the horrendous scope of damage, the impact of 25,000 deaths and the total destruction of a swathe of coastal land in a society of 127 million is limited. Rapid recovery seemed certain, as was the case after not merely the 1995 Great Hanshin earthquake which struck almost direct under Kobe, but even the 1923 Great Kanto earthquake, which destroyed the Tokyo metropolis.

The auto industry was a hiccup in that process. Today's cars are hi-tech products, and the supply chain is correspondingly complex. Let one example suffice. Making a semiconductor chip takes two months from start to finish, and the ceiling fell in ― literally ― at a plant where an invisible speck of dust results in a bad part. Doing basic repairs, getting the clean room clean again, and then debugging machines is a multi-month process. Given the uniqueness of the chips, symptomatic of their "hi tech" nature, it was just as difficult to transfer manufacturing to a different facility, despite excess capacity elsewhere. Japan is a big place, however, and a river of engineers poured in to help. As a result, even the Renesas' "fab" is back in production, albeit at reduced rates.

The global industry remains vulnerable to disruptions; factories are prone to be unique. One reason is that the industry has not settled upon standards–though a July 26 article noted a new effort in that direction. [See a Japanese-language article in Sankei on a METI-coordinated committee on the issue. It cites Toyota saying that by 2013 they might be able to start purchasing under joint standards, but such standards would not apply to more than 30% of semiconductors.] Part is that things are evolving too fast. But firms also view chips, specialty steels, paints, engine parts, and now batteries as strategic. And there are no institutions in place: the old standard-setter, the Society of Automotive Engineers, is a shadow of its former self. With little commonality, dual-sourcing is not an option, magnifying risk.

Hindsight is not foresight. It's impossible to take into account (much less insure against) every eventuality. While a few mayors along Japan's coast had insisted on unusually high flood walls ― maybe reflecting (possibly corrupt) ties to the construction industry rather than prescience ― disaster scenarios didn't anticipate the magnitude of the tsunami. That increased the human cost, even if relatively few plants were located on the coast: most were inland, where land was cheaper

One exception was power plants, which needed access to water for cooling. We all know about the destruction of a set of four of the six nuclear plants at Fukushima I. Less known is that the Onagawa nuclear plant, run by Tohoku Electric Power, was both directly hit by the earthquake and by a higher tsunami; after all, an idle but undamaged plant isn't "news". However, it was of a modern design, on higher ground, and better managed ― and shut down without problems. Even more telling, a second set of four reactors, the Fukushima II complex, were also effectively unscathed. Yet the Onagawa plant and the other well-run utilities with intrinsically safe nuclear plants are being tarred and feathered by TEPCO (Tokyo Electric Power). In the background not-in-my-backyard politics at the local and prefectural level made construction of new electric generation capacity of any sort a slow process. So there is little excess capacity, exacerbated by the division of the country into incompatible power grids. Every power plant has to be brought back online if the country is to avoid brownouts for the years to come.

Unfortunately, Japan now suffers from a second earthquake, entirely man-made. The disaster now unfolding reflects politics.

Why? Prime Minister Naoto Kan of the ruling Democratic Party of Japan (DPJ), facing a divided Diet (parliament), was too quick over the past year to offer compromise to the opposition Liberal Democratic Party (LDP). (Perhaps that reflects his background as a community activist and lawyer, where the key skill is being able to hammer out compromises where common interests are central.) In the process, he alienated many in his own DPJ, without ultimately gaining the cooperation from the LDP that he needed to pass legislation. Then, under pressure from all sides, Kan struck off on his own with a populist measure to keep all nuclear power plants closed once they shut down for maintenance under a routine 13-month cycle. Within a year, then, all will be closed and remain off-line. Most are of the more modern Onagawa design, but they may now never be permitted to resume operation despite providing 30% of Japan's electricity. The economic impact of this will be huge and last for years, even as the economic disruption from the Tohoku earthquake itself ends.

Still, it is useful to remember the basic competitiveness of the auto industry, with multiple suppliers and assemblers following a wide array of strategies. Contrast Nissan, relatively unaffected by the quake, with Toyota. Twenty-five years ago Nissan began moving its production inside Japan to Kyushu, 1,500 miles south of the quake's epicenter, while reducing capacity in the Tokyo region. [Nissan had also been planning to boost output and so had built up inventories of chips and other items with long lead times before the quake struck on March 11th, so there was an element of luck involved, too.]

Toyota's strategy was different. It had acquired Kanto Jidosha and Central Jidosha in the Tokyo area in the 1950s, which together with Toyota Auto Body account for 30% of the company’s Japan-based output. In the 1990s, rather than paring capacity, they added plants to the northeast of Tokyo ― right where the earthquake struck.

That extra capacity left Toyota vulnerable to a second earthquake: an appreciation of the yen, at ¥78.5 per dollar as I write this, over 50% stronger than the ¥121 level of July 2007. With the extra capacity, and a commitment to pay employees whether there was work or not, Toyota increased its dependence on exports; Nissan did not. Toyota also has a byzantine web of domestic subsidiaries, a structure as unwieldy as the General Motors of old, with internal politics to match. So domestic production was attractive not only to alleviate union pressure but to protect the turf of incumbent executives and middle managers.

Now the earthquake itself will have a fleeting impact. Japan is after all a large place, with 127 million people. Horrific as 25,000 deaths may be, that and accompanying losses to the capital stock are tiny relative to the size of the economy. Capital can be fixed, and the size of the economy makes that relatively straightforward: a cumulative 4,200 engineers and other skilled workers poured in from the rest of the domestic semiconductor industry to revive production at the Renesas plant. The same story applies to electric power lines, roads and bridges, and other infrastructure, including the Sendai airport that was but recently under water. Many farmers were unable to plant this year's rice crop, the fisheries industry is only partially functional, and tourism is dead -- and all are important to the rural Tohoku region. But Toyota's plants are running again, and those of their suppliers.

Yes, the Tohoku earthquake was a disaster, as is the ongoing rise of the yen. The impact of both is amplified by dysfunctional politics ― electoral and corporate. Nevertheless, the industry as a whole is remarkably robust: its size and the variety that comes from rivalry lessens the impact of even major disasters. Toyota may be hit, and its recovery will be far slower than most observers seem to believe. A few American consumers may be disappointed, Toyota's U.S. dealerships moreso. But the global industry will hardly notice.

Mike Smitka

Taxpayers, The Auto Bailouts, and Politics

2011-06-05T09:24:00.002-04:00

Last November, General Motors’ IPO set a record for money raised at 20.1 billion dollars. This is all money returned to the taxpayers’ Troubled Asset Relief Program (TARP). The success of the IPO was not only driven by new investors, but also by stockholders and lenders who had been “stiffed” in GM’s Chapter 11 bankruptcy of 2009. The company recently reported its highest quarterly profit in more than a decade, helped by demand for fuel-efficient cars and a big gain from selling its stake in its former auto parts business. The biggest U.S. automaker said Thursday that it earned $3.2 billion, or $1.77 per share, in the first quarter. It was a great start for the year considering the spike in U.S. gasoline prices, a trend that would have sunk the company just a few years ago when it relied on gas-guzzling pickups and SUVs for profits. Earnings will accelerate if U.S. auto sales continue to creep back up toward the 15-million to 17-million vehicle-per-year sales rates the U.S. industry last saw in 2007.
"GM is making a lot of money at ‘depression levels’ of sales. As the market improves it should make even more money." said Dave Cole, chairman emeritus of the Center for Automotive Research.
The U.S. Treasury will remain GM's largest shareholder for now. It will likely take several years to unload the entire stake to keep from diluting its stock price. Taxpayers still own about 33% of GM shares. The stock price will need to rise to about $48.00 for the U.S. government to break even on its follow-on stock sales. At $48 per share, GM would have a market value of more than $90 billion.
Chrysler Corporation paid back more than 7.5 billion in loans to the American and Canadian governments in May. Chrysler had until 2017 to repay the loans, so this was six years ahead of schedule. The company has now paid back most of the loan money that saved it from going under. The government loans were high interest loans, about which Fiat/Chrysler Sergio Marchionne recently opined. Instead of merely complaining about “loan shark rates,” the company did something about it. The high interest on the U.S. Government loans certainly induced Chrysler’s partner FIAT to borrow the money to pay off the bulk of Chrysler’s outstanding government loans. Chrysler raised just over 3 billion through a bond sale and took out 3 billion in lower interest loans to come up with the money to pay back the government loans. This will save more than $300 million a year, according to the company.
The automaker still owes taxpayers about $2 billion. Treasury could get most of that back by selling its remaining 8.6 percent stake in the company, which it was given in exchange for the loans. Chrysler’s IPO has yet to be scheduled but FIAT just announced it is increasing its stake in Chrysler to 51% from the current 46% in advance of the upcoming IPO. As Marchionne recently observed, “The longer we wait, the more it costs,” referring to FIAT’s intention to buy shares from the U.S. Treasury.”
Chrysler’s recent earnings have also been strong, despite a market impacted by high fuel prices and a weak, but recovering, economy. Both companies stand to do extremely well as the economy improves and the SAAR rises to recent historical levels.
Both companies have announced initiatives to increase production and rehire thousands of workers. Chrysler alone has added more than 8,000 jobs since its bankruptcy.
In the meantime, Ford continues to do well in the still recovering economy despite having to bear the weight of interest on debt it accumulated to ride out the economic storm without having to seek taxpayer involvement. Ford has benefited from union concessions it received to maintain parity with its competitors.
The auto industry bailout, financed through the Bush Administration’s TARP program, spared the GM, Chrysler, AND Ford from liquidation and saved hundreds of thousands of manufacturing jobs at those companies and its suppliers.
To add perspective, had either company been forced into liquidation, the cost dropped on the taxpayers in the form of the Federal Pension Benefit Guarantee Fund would have been at least $38 billion. This in addition to the damage that would have been done to the North American industrial base, including military procurement at a time of two wars.
While Americans have been known to pile on “losers,” failures, and those who make mistakes, they love “redemption.” While there are those who refuse to buy a GM or Chrysler vehicle OR buy their stock because they were bailed out by the government, the companies’ strong sales and profit results indicate that, on balance, they are achieving a large measure redemption. The popularity of Chrysler’s “Made in Detroit” advertising campaign is further evidence.
In the meantime, the 2012 election campaign is getting underway and yes, it looks like the bailout of the auto industry could end up being one of many points of debate. One can expect Democrats to replay videos of Republicans who opposed the bailouts ad nausea. Already an ad paid for by the Democratic National Committee recaps positions taken by Mitt Romney, Newt Gingrich, and Tim Pawlenty.
Romney takes a significant hit in the ad. The former Massachusetts governor, whose father was governor of Michigan as well as the top executive at American Motors is being reminded of the hard-lined position he took in a 2008 New York Times Op Ed, “Let Detroit Go Bankrupt.” Yet Romney and others continue to use opposition to the bailouts as a campaign point, advocating a free-market system free of bailouts and subsidies. They maintain that even now it still looks like the bailout came at quite a cost to taxpayers, despite substantial evidence to the contrary. They maintain that allowing the automakers to go into liquidation wouldn’t have been such a terrible thing, which is easy to say since it didn’t happen.

Democratic candidates will point to the relative success of TARP and the auto company bailouts and paint a picture of what would have happened had TARP not been enacted and either company had liquidated.

As politics heats up leading up to the 2012 national elections, expect debate over the auto bailouts to play a major role in determining political winners and losers.

David Ruggles has spent his working life in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs at autosandeconomics.blogspot.com and writes regular columns for several publications.

Contango

2011-05-04T20:13:00.006-04:00

And other issues not commonly understood by consumers about the world oil market

The higher the price of gas at the pump, the more sensitive consumers are to allegations of oil market price manipulation. Most consumers are unaware exactly how any manipulation takes place, but they can't square the doubling of the price of a gallon of gas when the price of a barrel oil doesn't double, so they are suspicious there is a culprit to be blamed. Oil companies become the bad guys as they report high profits.

Well there IS oil market manipulation by the most major of oil traders. AND it isn't even illegal. But it takes tremendous amounts of capital to manipulate the world market price of oil. For a variety of reasons, the best known energy trader manipulating the world market price of oil is Koch Energy, probably because of the Koch brothers high profile participation in the political process.

So what is "contango?" Contango is the strategy of purchasing large stocks of oil and storing it in offshore supertankers and giant containers, creating a shortage or exacerbating a real or perceived shortage in the market. The trading company then it sits on those supplies until oil prices rise.

Ever wonder how gas prices can be $4.50 per gallon in say July 2008, and then drop to $1.90 when President Obama was inaugurated In January 2009 six months later? Crude oil prices dropped from more than US$145 per barrel in July 2008 to less than US$35 per barrel in December 2008.

When the contango hoarders turn their stocks of oil loose on the market at the peak price, it tends to flood the market with oil, especially when consumers have cut back on consumption due to the high price. At the same time all producers pump and transport like crazy to take advantage of the high price, including those in the oil patch. The end result is a glut and cheap fuel at the pump. And consumers end up with fuel price volatility. U.S. consumers tend to think they are entitled to the "glut" fuel prices, rather than the highest price or even an intermediate price.

For those who recall, the Bass Brothers' play on silver in 1977 and 1978 was a form of contango.

But there is another example of "hoarding" on a much larger scale. OPEC has been hoarding oil for 35 years. In 2011 there are more members of OPEC than in 1973 and world wide consumption has accelerated. Yet, OPEC doesn't produce any more oil today than they did in 1973. OPEC is not in the business of just selling volumes of their finite resource, as much as maximizing the price they get for each barrel. The U.S. produces about a third of its oil domestically. We get another third from Mexico and Canada. The final third comes from OPEC. What is not clear to most Americans is that if we double our domestic production, and eliminate the OPEC purchases, we still have not freed ourselves from the world market price of oil. Why? Because Americans do not own the oil produced here, the oil company that makes the investment to find it and produce it owns the oil. The chances of an oil company selling their oil to the U.S. consumers at less than the world market price is slim and none. Yet, I don't hear a lot of talk about nationalizing the oil companies.

Further, when we increase production, OPEC cuts theirs back a like amount to maintain the supply/demand balance. The graph at the following link shows the production of OPEC over the decades: (graph link)

More domestic production WOULD improve our balance of payments situation, but it would quickly eat up our meager oil reserves. The U.S. maximized domestic oil production in 1970 and uses 25% of the world's production while owning less than 5% of known reserves. We ramp up production, OPEC cuts theirs back, and we use up our reserves without saving a dime. So much for “Drill Baby Drill.”

Off shore and ANWR reserves seem like a lot of oil until weighed against U.S. consumption. OPEC sits on 70 - 80 percent of the world's known reserves, to put things in perspective.

There are those who think we are better off to use up others' reserves and keep ours for a rainy day. The Bakken Formation oil shale reserves in the Dakota and Montana ARE huge! Bakken currently produces about 500 million barrels of oil per day.

BUT oil shale development requires large expenditures of water and energy, produces air pollution and carbon emissions and leaves toxic byproducts that endangers the environment, especially the water table. For example, a fully developed Bakken formation could leave the entire Southwestern U. S. with a huge water problem. In addition, the high cost to produce from oil shale in Bakken is only viable when the world price of oil is between $80. and $100. per barrel. Major investment in Bakken on oil shale development has been tentative as investors are afraid OPEC would open their spigots to drive down the price of oil, throwing them into bankruptcy.

While there isn't much we can do about hoarding by OPEC, there have been initiatives to tighten regulations on commodity and derivatives trading. Lobbying against this regulation has been fierce. In fact, the same Commodities and Futures Trading Commission (CFTC) is the same government agency that tried to regulate credit default swaps and collateralized debt obligations on Wall Street. Larry Summers, Alan Greenspan, Robert Rubin and others blocked the efforts to regulate commodities and derivatives by firing the chairman of the CFTC, Brooksley Born, and replacing her with Wendy Gramm. Yes, this is the same Wendy Gramm that was on the board of directors of ENRON when its energy trading speculation and suspect accounting wiped out millions of investors AFTER she had blocked regulation that would have prevented it from happening.

For now, large energy traders continue to benefit from the lack of regulation while U.S. consumers suffer to a greater extent than necessary.

Over his 40 year career David Ruggles has been in every phase of the retail automobile business and has consulted with and done training for hundreds of auto dealers in the U.S. and Japan. He conducted a yearly seminar for one of the world's largest privately owned Toyota dealer groups for eighteen years, and has himself been a dealer for Chrysler, GMC, Mercedes Benz, Ford, Mazda, and Subaru. Author of the Ruggles Report, and a regular contributor to the National Bureau of Asian Research, he blogs at autosandeconomics.com and writes regular columns for several trade publications and The Daily Post online newspaper. He is a member of the International Motor Press Association.

Cars and Roads

2011-04-28T11:17:00.001-04:00

I'm now teaching my annual 4-week-long Spring Term course on the auto industry at Washington and Lee University, Economics 244, which will include one week in Detroit. Ironically, it has left me too busy to blog on the auto industry. So this will be short.

It's very easy in our narrow focus on the manufacturing and distribution of cars to overlook the revolutionary impact that comes from greater mobility. A note on a World Bank project in Laos highlights that. (Here's the link.)

The blog by Victoria Minoian traces the changes the follow from building a road that allows motorized access. Rural farmers can now grow vegetables for town and city markets, and not merely for own consumption. That is, they can earn a cash income. Doctors can access a village otherwise cut off on frequent occasions by high water. Children can get to school &endash; though perhaps by bicycle rather than motorized vehicle. There's little point in building good roads without motorized vehicles; but without roads, vehicles are also of little use. Of course the location of the village from which these examples were drawn reflects that constraint: it was alongside a river (the Mekong, not just a little river). The village wasn't necessary poor by local standards. But while boats and rivers make a difference, roads and motor vehicles make a bigger one.

Mike Smitka

Long Term Residual Outlook

2011-04-15T01:17:00.003-04:00

I have been privileged to discuss residual values and the pre-owned market with a number of industry experts over the years. An thought that was born in a late 2008 discussion over a beer with Matt Traylen, then Chief Economist for Automotive Leasing Guide, has since become full-blown reality.

At the time, the stock market was tanking, new vehicles sales had slowed to a crawl, the auto manufacturers were begging for money before Congress, the acronym TARP had just been coined and the economy and our lives were looking bleak and uncertain.

Most lenders had announced in previous weeks that they were getting out of the leasing business, or dramatically “pulling in their horns.” The asset backed securities market had disappeared, pulled down by the mortgage backed securities market and we were hearing unpleasant terms like “toxic assets.” This reminded me of some earlier dark days in the auto industry when a dealer or leasing company might take particular vehicles to auction and they wouldn’t even draw a single bid, a particularly difficult position when one had a payroll due.

It was easy to understand how a bank holding a lot of “toxic assets,” but little cash, could become a “zombie bank,” a term invented to describe the Japanese banks after their own real estate bubble burst. That is a bank with a “strong” balance sheet but no cash to loan or to return to depositors who arrive “electronically” at the bank to make a withdrawal. Marking these assets to market was not practical because values could not be established as no one would bid on these mortgage backed securities or their “first cousin,” auto loan backed securities. Regardless, “mark to market” would have rendered the U.S. banking system insolvent and caused a complete meltdown. A strong case can be made that the U.S. banking system WAS, in fact, insolvent but for a few accounting entries.

After acknowledging that most of the major players had announced their exit from the leasing business, the collapse of available financing for fleet and daily rentals, and the dramatic drop off in overall new vehicle sales volume, Traylen and I asked, “Where will pre-owned inventory come from down the road?”

While used vehicle sales plunged from a high of about 44 million units in a single year to about 35 million units in 2009, it became apparent that once demand began to trend upward toward historical volumes, there would be an acute shortage of available inventory.

Within a few months, GM and Chrysler went through bankruptcy and Cash for Clunkers plucked another 600,000 potential pre-owned vehicles out of the system and fed them to the crusher. What was really crushed was the Buy Here Pay Here business. What the government called a “clunker,” they call “inventory.”

Today, there is considerable pent up demand for pre-owned vehicles and the banking system has recovered to the point that ready financing is available again. There are still serious issues to be resolved in the economy, not the least of which is high unemployment, but demand is building.

Other than unemployment, the biggest impediment to full economic recovery is the fact that 25% of American mortgages are in negative equity territory. The large numbers of foreclosures have left empty and/or abandoned houses in neighborhoods across the country further depressing home values. Few neighborhoods, regardless of affluence, are immune from this.

Economist Alan Greenspan, past chairman of the Federal Reserve Bank, recently stated that he did not believe the economy could reach full recovery momentum until the real estate market experienced at least a 10% increase in home values. It just is not clear how long it will take for home real estate to become stabilized, let alone regain value. On the other hand, the rebound of the stock market has restored almost 16 trillion dollars of mostly American wealth.

Against this mixed backdrop of economic news and general economic uncertainty, there is much more demand than available pre-owned inventory, which is driving wholesale pre-owned prices ever higher. We see pent up demand in the new vehicle business by the steady increase in sales results.

New vehicle incentives have a considerable impact on pre-owned values. If incentives lower the true transaction price of new vehicles, the value of same make/model pre-owned vehicles drop a commensurate amount.

Restraint of late on the part of auto manufacturers to refrain from over production is keeping dealer inventory levels in line with demand. It is likely that OEM restraint on overproduction and incentives will be ongoing as they have new policies and labor agreements in place. The fact that dealer floor plan arrangements with lenders are much more restrictive than before has also helped maintain this equilibrium. Few dealers have the liberal floor plan arrangements these days that once allowed for the massive stocking of vehicles on behalf of a manufacturer looking to “force the market” with incentives.

But now that financing for leasing has recovered, OEM captive finance arms are focusing on shorter terms to try to create additional supplies of pre-owned inventory. Financing for the daily rental business has allowed rental companies to begin to return to more traditional replacement cycles. The same is true for fleets. But the shortfall that began in 2008 will not be able to be made up in the short term.

So what is the outlook going forward and how will it impact residual values?

Experts say we will continue to experience pre-owned shortages for at least as long as 5 years. Some niches will be more acute in this respect than others, and segment values could change with fuel prices and other issues.

But the tremendous shortfall in pre-owned inventory supply will take years to balance out as demand increases in line with economic recovery. In talking to experts like Tom Webb, Chief Economist for Manheim Auctions, Tom Kontos, Chief Economist for Adesa Auctions, Ricky Beggs, Managing Editor and Vice President for Black Book, Rene Abdalah, Vice President of Residual Value Insurance Group, Eric Ibara, Director of Residual Value consulting at Kelly Blue Book and Traylen who is currently head of M.A.T. Consulting, the consensus is that the shortage will be with us for at least 5 years. Residuals are expecting to stay quite strong!

However, in projecting residual values, there is a somewhat different outlook between Abdalah of RVI and Ibara of KBB and their counterparts at Automotive Leasing Guide. Both companies are convinced that as long as fuel prices increase gradually, American consumers will adapt without drastic short-term consequences. Consumers will tend to buy the largest vehicles they can afford.

Other than “early adopters,” most consumers will only pay a technology premium for “electrics” and hybrids if the government pays it for them through tax credits or other subsidies. When fuel prices suddenly spike, as they did in 2008, fuel economy becomes the consumer’s primary motivator. However, experience shows this is a short-term circumstance.

As we have seen repeatedly, and as recently as the price spikes in 2008, high fuels prices are followed by oil gluts and extreme fuel price declines as oil producers rush oil to market to capitalize on the high market prices, creating over supply. In 2008, the cycle began in April when the price threshold broke $4./gallon. By the time January 2009 arrived, a gallon of regular was $1.90.

So while there may be some price spikes along the way, Ibarra and Abdalah expect the overall fuel price trend will be gradual. As a consequence, manufacturers will have to deal with substantial Corporate Average Fuel Economy (CAFÉ) fines if consumers do not naturally purchase a product mix that lends itself to the auto manufacturers’, and the government’s, CAFE objectives.

In the past we have seen manufacturers prefer to pay significant consumer incentives to move vehicles they need to move to avoid the CAFÉ fines. With CAFÉ requirements at extremely high levels, it is logical to expect the focus of OEM incentives to be on fuel efficient vehicles. The CAFÉ standard for 2016 for cars is 39 mpg and 30 mpg for trucks. This will drive down the values of like make/model pre-owned vehicles. Lessors need to consider this very real possibility looking down the road.

At the same time, manufacturers can be expected to raise the price of larger less fuel efficient vehicles and reduce incentives to try to make more gross profit per unit, while somewhat depressing volume to enhance their CAFÉ calculation. As a consequence, Kelly Blue Book and RVI Group residual projections are higher for “heavies” than ALG’s projections while ALG’s projections are higher for smaller fuel efficient vehicles.

If a cataclysmic event takes place and oil goes to $200. plus per barrel, and stays there, all bets are off anyway.

Lenders, fleet operators, and private capital leasing companies will have to make their own overall residual setting decisions and come to their own conclusion about each size and fuel economy segment. However, there is no doubt that overall residual values will stay historically strong in the years to come as strong demand for pre-owned vehicles overwhelms the available supply.

David Ruggles has spent his career life in every phase of the retail automobile business and has consulted and trained with hundreds of auto dealers in the U.S. and Japan. Ruggles has been a dealer for Chrysler, GMC, Mercedes Benz, Ford, Mazda, and Subaru. Author of the Ruggles Report, and a regular contributor to the National Bureau of Asian Research, he blogs at autosandeconomics.com and writes regular columns for several trade publications and The Daily Post.

David can be reached at ruggles@msn.com and by phone at 312.925.1863

Dealers Push Back

2011-04-05T19:34:00.004-04:00

Emboldened by recent healthy profits and the prospects of a recovering economy, auto manufacturers are pressuring their surviving dealers, at least the ones that have survived arbitrary terminations and recession, to upgrade their facilities. This, at a time when Dealers are desperately trying to repair their balance sheets and reconstruct relationships with their bankers after a bloody few years of just trying to “hang on.” Dealers have enough problems dealing with recalcitrant banks just to maintain reasonable floor plan lines and capital loans without having to ask for facility renovation money. Perhaps after a few years of recovery and bolstering their balance sheets, Dealers might be in a better position to entertain the idea of facility upgrades. And for the ones who can get financing or have cash, does it or will it make economic sense given current trends?

Manufacturer’s demands and requests are often supported by “focus groups” where consumers are asked what value they put on a dealers facility. Everyone seems to like a nice clean facility. Let’s face it, shiny granite, marble and wood DO make an impression. So do boutique expresso bars, nail salons, shoe shine stations, and other “foo-foo” features. The problem is, as much as consumers like these things, a growing number aren’t willing to pay for them. The consumer thinks the value of their business is the 35K they just paid for a new vehicle, not the $2k the Dealer retains out of which they pay their expenses.

Increasingly, consumers care less and les about fancy facilities as their PC and monitor tend to be their showroom of choice. While a facility on a high traffic piece of property might bring consumers in to take a sales person’s time to answer questions and take a demo drive, the negotiation is much more likely to take place “on line” these days. This IS the “new normal.” This is where high overhead becomes a disadvantage. As one consumer said to a Dealer friend, “I can’t drive your overhead, why would I want to pay for it?” This same Dealer, who shall remain nameless, is being pushed by his manufacturer to erect an elaborate sign to replace the one that existed when that manufacture terminated his franchise. Having regained his franchise through arbitration the OEM just can’t understand that the old sign was “grand fathered” and the new one has to meet CURRENT city code. The sign is a small part in a major push to “encourage” the Dealer to invest more in an already impressive facility. But this is just another day in the life of a dealer.

Dale Pollak, chairman of vAuto, is right when he wrote in a recent article that there is no need for dealers to do warranty and repair work on a high dollar piece of property. Is the added convenience worth the extra overhead?

The retail auto business is trending in such a direction that Dealers need to be more conscious of overhead costs than ever before. Manufacturers need to “get a clue.” If their Dealer can’t compete because of unnecessarily high overhead mandated by the manufacturer, it becomes increasingly difficult to find another investor Dealer for that point.

And as the Internet provides a more efficient market for each new generation of consumers, high cost facilities become even more of an albatross. In other words, expect the current trend away from “in showroom” negotiation to “online” negotiation to accelerate.

Manufacturers and some Dealers seem to ignoring a demographic fact. Consumers my age tend to put a lot of value on relationships, proximity, and convenience. But younger consumers are different. They have never known life without the Internet. They feel empowered by it. They are much more likely to use the “Taj Mahal,” high overhead dealer for information and service and warranty work, but to use the Internet for negotiation. They will travel for the cheapest price. I wish this weren’t so, but it is what it is.

As such, we’re in virgin territory in the retail auto industry. The new “book” is still being written. Manufacturers cling to commonly held dogma, as do many Dealers. But the future will only be loosely based on old models. The day is coming when Dealers will have to bid for a consumer’s business on line!

The pre-owned business will most likely increase in relative profit importance in tomorrow’s dealership. Warranty income will probably continue to dwindle due to the increased quality of vehicles. Financing and after market income is under the scrutiny of Elizabeth Warren and federal bureaucrats.

The future will belong to those Dealers who are prepared for it, and not encumbered by yesterday’s standards.

So when the manufacturer comes calling Dealers may need to learn how to, “Just say NO!”

Written by David Ruggles for Auto Finance News

"Turning Oil Into Salt" book review.

2011-04-05T19:22:00.003-04:00

Book Review of "Turning Oil into Salt," a book by Gal Luft and Anne Korin

If you believe in global warming, you believe we need to get off of fossil fuel. If you believe we need to reduce the strategic value of oil, it is a somewhat different calculation. People get these issues confused. Reducing our dependence on fossil fuel is generally considered the province of "Green Liberals," "Al Gore Disciples," "Tree Huggers," "Global Warming Alarmists," etc. That isn’t totally true as evidenced by the video at made by unlikely partners, Newt Gingrich and Nancy Pelosi.

But reducing the strategic value of oil is something everyone should be able to agree on, even for those who are skeptical that a global warming hazard even exists. The following video was made by ex CIA head James Woolsey: http://www.youtube.com/watch?v=3mWeyREivdk

So why are you reading this in an auto publication? Because according to Gal Luft and Anne Korin, the authors of "Turning Oil Into Salt," MORE government intervention into the auto industry is required to reach a solution. Many of us are rolling our eyes at even the thought, but the stakes couldn't be higher. "We ARE engaged in a war against fundamentalist Islam, and we ARE paying for both sides of the war," say the authors.

Today, roughly two-thirds of the world's oil is used for transportation, and most vehicles are able to run on nothing but. Oil's strategic status stems from it=s virtual monopoly over fuel for transportation, which underlies the global economy and our way of life. To understand the implication of an over dependence on a strategic commodity we can look at history. At one time, salt had a virtual monopoly on food preservation. Wars were fought over salt. Finally, Napoleon, who's army "traveled on it's stomach," had had enough and offered a significant sum of money to the person to eliminate his army's reliance on salt. Within a few years, a French chef invented food "canning." After canning, electricity, and refrigeration, salt has lost its strategic status and we no longer go to war over salt.

How can this be accomplished with oil? According to Luft and Korin it only requires Congress to mandate that from a specific date forward, all or most vehicles sold in the U.S. must be manufactured as Aflex fuel@ vehicles, capable of running on gasoline and/or a variety of alcohols and blends. This has already been done in Brazil where 80% of new vehicles purchased in 2008 were flex fuel. The additional cost to produce a flex fuel vehicle is about $100., which includes the cost of premium fuel system components, a fuel sensor and computer chip reprogramming. The first Model T Fords ran on gasoline OR alcohol. There are a variety of alcohol fuels available. Alcohol does not mean just ethanol, and ethanol does not mean just corn, a particularly bad fuel feed stock. Other alcohol based fuels include methanol made from coal and ethanol from almost anything. And speaking of coal, Germany fueled its WW2 war effort with diesel fuel made from coal. A lot of this technology is old, having been rendered unnecessary when we had cheap oil spurting out of the ground.

According to the authors the average vehicle in the U.S. is in service for 16.7 years. Once 15% - 20% of the total vehicles on the road are flex fuel, the market will take over. Refueling infrastructure will develop and additional alcohol production will come to market with coal/methanol probably eclipsing corn as a feed stock, much to the chagrin of Midwestern farmers and Senator Charles Grassley.

Add in additional vehicles operating on compressed natural gas and electricity, plus additional conservation based on increased fuel efficiency “encouraged" by CAFE, and dependency on oil could be reduced 35% in 10 years, the exact amount we import from OPEC. We would also be less dependent on oil in general and all of our oil could be sourced from North America, including Mexico and Canada. There is even a "Drill Baby Drill" component to the Luft/Korin plan, although the U.S. has some disadvantages. It costs OPEC less than a dollar per barrel to lift their oil from the ground, while it costs us almost $10. They have about 78% of the world=s known reserves, but only produce 40% of the world's supply, as they work to maximize the price of each barrel they sell. OPEC produces less now than they did in 1973, despite having more cartel members.

In the meantime, we have less than 5% of known reserves but consume 25% of the world's production. And the lower the American price at the pump, they more we consume and the more pressure we put on the world market price of oil to rise. Unfortunately, we don=t get a discount for our volume purchases.

A bill called the "Open Fuel Standard" (OFS) is pending before both the House and the Senate. Of course, it has been pending for months. The bill ensures that 50% of new vehicles sold in the U.S. with an internal combustion engine would be warranted to run on gasoline, ethanol, or methanol. Diesel vehicles would also be warranted to run on bio-diesel.

In 2009 there were no fewer than 33 Make/Models warranted to run on up to 85% ethanol, but no warranty for methanol. Expanding this to more models and including blends of methanol should be easy. Brazil has done it and at one time, auto manufacturers and oil companies in this country considered using methanol as an octane booster, but chose lead instead.

There are currently 8 million flex fuel vehicles on the road out of 200 million total vehicles but we have not yet reached the critical mass necessary for the market to respond with refueling infrastructure and additional investment in alcohol production. In light of the increased price of fuel at the pump, the Open Fuel Standard bill needs to be rapidly advanced while the issue of high fuel prices is fresh in people’s minds.

Some say the expansion of alcohol fuels and the OFS bill is being held hostage by agribusiness lobbying efforts. along that same line, for some reason, we place a 54 cent per gallon tariff on imported Brazilian sugar cane ethanol. A barrel of oil is 42 gallons. You can do the math. Brazil can produce rivers of sugar cane sourced ethanol. Wouldn’t we prefer to buy ethanol from Brazil than Oil for OPEC? It would certainly decrease our reliance on oil, but corn farmers and Midwestern politicians object.

"Turning Oil into Salt" is must reading for auto industry professionals. And it's a quick read, making it's points in only 138 pages.

David Ruggles, written for WARD's Dealer Business

The Impact of the Japanese Earthquake on the Industry: Quick Assessment

2011-03-12T11:44:00.000-05:00

It's still too early to judge the impact of the quake on Japan's auto industry. Toyota had expanded to the northeast (Tohoku) during Japan's "bubble" and so is the most vulnerable. Nissan has plants east of Tokyo that would be close enough to the epicenter to potentially have damage. And ports in the area are swept clean of surface equipment and full of debris. There's vivid TV footage of a jumble of Infiniti's on fire at the port of Hitachi in Ibaraki Prefecture, about halfway between Tokyo and Sendai.

For the time being the ground is still shaking; a quick check of the Japan Meteorological Agency website shows more than 200 aftershocks, many in themselves significant earthquakes [As of 11 am EDT on 12 March]. Of course most would be hardly noticeable in a stamping plant – but not all. Plants in the area may not attempt damage assessment for a day or two. It's unclear whether major roads have any hard-to-repair damage; there are no reports of collapsed tunnels. That would be important as ports may be slower to recover.
My initial, largely uneducated guess is that small car production at Toyota's plants may require a couple weeks to recover; all it takes is one blocked road to one supplier or a hard-to-repair die to stop production. Even then, plants may not be able to run at full capacity for some time to come because electric power is likely to be rationed to large commercial users in that part of Japan.

More in a few days. David Ruggles is likely to pitch in; his wife was en route to Tokyo at the time, only to have her flight diverted to Anchorage. Sooner or later she will make it there, and be able to help us add texture to our posts.

Mike Smitka

40 Years of Watching Oil Prices Impact the Auto Industry

2011-02-27T06:40:00.004-05:00

When the price of oil rises SUDDENLY, usually caused by some world event, there is a rush to produce and sell at the higher world market price. This mitigates the shortage in a short period of time and invariable produces a glut. As the price rises, greed drives some members of OPEC to sell over their agreed upon allotment creating a "black market" supply. Sometimes Saudi Arabia tries to counter this by cutting back on it's on production, despite the higher world price. Other oil producers rush available supplies to market. In the U. S. oil patch, dormant wells are revived as the higher price makes it practical to borrow money to repair and update pumping and storage equipment. Small producers in the oil patch generally fix up their equipment when the price goes up and run the equipment until it fails or needs a general overhaul. If the market price is still high, they go ahead and spend the money to make repairs. If not, they shut down the well and wait for the next price spike. The bankers they do business with understand this cycle.

Tankers and storage facilities are topped off and tankers will end up anchored offshore waiting to off load. When the price falls, it takes a while to move the high priced oil through the system, resulting in prices at the pump that stay high seemingly longer than they should. Oil companies who were sitting on low priced inventory suddenly have that inventory revalued at the new higher price, resulting an really high short term profits and a grassroots backlash at oil companies in general.

In the meantime, one can watch the stock price of tanker companies like Frontline Tankers. As the market senses a boost in oil production sparked by higher market prices, their stock moves up in anticipation of higher traffic.

Even in periods of low oil prices, producers try to produce higher volumes as they attempt to make up for the low market price with volume, which tends to further keep the world market price down over time.

The residual value predictors are again proven "wrong," although their numbers are usually pretty good except during these "artificially" triggered market price spikes. Dealers experience extreme value drops on held pre-owned inventory that is not deemed fuel efficient by the current market. This makes them extremely wary of trading for more of the same at any price as auction prices no longer provide any useful information of true value. Often, a dealer will take a "heavy" to the auction sale and it won't even draw a bid. The term "toxic asset" applies here. If the dealer practices "mark to market" accounting, he/she will write down "heavy" inventory immediately, causing a huge loss and drawing the extreme scrutiny of the dealership's lenders and investors. If "mark to market" is NOT followed, inventories are drastically over stated. The entire new and pre-owned auto market is disrupted as consumers look to trade off their heavies and move to something more fuel efficient. This despite the fact this cycle has repeated itself at least a dozen times over the last 40 years.

Trading "heavies" during a time of high fuel prices can be a punishing experience for the consumer, as their trade in has been devalued by market forces and the fuel efficient vehicle they want to buy carries a premium. Historically, consumers become dissatisfied with their new fuel efficient ride about the time fuel prices drop again. Many of these consumers will go back out into the marketplace to trade their new fuel efficient vehicle in on another "heavy." Again, market forces have driven down the value on their trade and placed a premium on what they want to buy. The consumer becomes frustrated and blames their plight on the dealer.

As we move into a new era of vehicles where fuel efficiency can be achieved in ever larger vehicles, it is not clear if the historic formula will continue to replay itself in exactly the same way.

For example, the Hyundai Sonata achieves 34 highway/28 city MPG in basic 4 cylinder form. A tiny MINI Cooper only achieves 37/29 MPG.

In my own view, everything is relative. The person trading a Tahoe on a Malibu will still be dissatisfied even though the Malibu offers tremendous size and comfort while still getting excellent fuel economy. But a Malibu isn't a Tahoe. It won't tow and it won't go off road. And it won't carry 7 passengers. So my money is on the cycle to continue along historical lines.

In the 1980's Lee Iaccoca proposed a 25 cent fuel tax. Conservative car guy Bob Lutz continues to call for a European style fuel tax. Recently, New York Times columnist Tom Friedman called for an increase in fuel tax of 5 cents per month for 20 months, making the case that the buying power of the current fuel tax has been halved by inflation since the last increase in 1993. He proposes to pay down the national debt with the money. I presume he thinks that is a better way to go than instituting some new tax brackets at the top of the income scale. Or perhaps he proposes to do both. Even people like Alan Mullaly and Bill Ford have expressed the desire for a fuel tax, instituted in such a way as to provide some market predictability. On the QT, most auto execs AND politicians will whisper the same thinking, although they are reluctant to come out with it publicly.

No doubt the country's politics will prevent us from getting a pure solution. The system in use in Europe and Japan works way to well for us to adopt it. It seems evident that the Middle East will continue to be impacted by events such as are happening in Egypt and Libya. It is reasonable to expect that the dissatisfaction of the masses will drive change in many more oil producing countries, including Iran, Saudi Arabia, and Venezuela. I suspect the world price of oil to remain volatile for years to come with shortages caused by political events followed by gluts caused by backlash over production. There will be a great profit opportunity for those who can predict these cycles while auto manufacturers and dealers will suffer from the whip saw effect.

A little perspective follows:

38 -- That's the number of miles per gallon (US gallons) that the average passenger car in the UK is getting according to the British Department of Transport.

22.4 -- That's how many miles per gallon (US gallons) the average passenger vehicle in the United States is getting according to the Bureau of Transportation Statistics.

9200 -- How many miles the average UK driver travels in a year.

13000 -- Number of miles driven each year by the average US driver, 40% more than in the UK.

"To put those numbers in some context, the average US driver will use 580 gallons of fuel each year, compared to 242 in the UK, 139 percent more. Even allowing for fuel that’s less than half the price ($3.88 per gallon vs. $8.52 per gallon, currently), US drivers are still poorer to the tune of nearly $200 a year."

Source: Ars Technica

Are gas prices high?

2011-01-21T18:45:00.000-05:00

Jim Treece at Automotive News had a neat little column in today's Automotive News ("Gas too high? Aw, stop griping"). I'd played around with data in the past; here are two graphs. One presents the inflation-adjusted price of gasoline, from 1919 through 2010. Prices are up -- but we're coming off of almost 20 years of the lowest gasoline prices in US history. The second adjusts in a different way: GDP per person, using a 2000 hour work-year to ask how many minutes it takes to buy a gallon. I could have used average hourly compensation (but what of retirees?) or average consumption; that would change the details but I don't think it affects the basic picture. And any such method would have its own drawbacks.

Mike Smitka

Another Round with Rattner

2011-01-21T04:30:00.004-05:00

I’ve been “stalking Steve Rattner for months now in an effort to get to the nuts and bolts of the auto industry bailout and subsequent restructuring. There are those who have hung the “car czar” moniker on him, and he tries to be flattered by it. But as Rattner explains it, his great great grandfather was a fur trader in Russia and would turn over in his grave at the thought of any of his offspring being referred to as any kind of czar.

I have followed the workings of the Auto Task Force in the news, agonized daily with my dealer friends in the industry, watched hours of CSPAN hearings, attended Rattner’s presentation at a Federal Reserve Conference in Detroit in May 2010 in advance of his book “Overhaul, An Insider's Account of the Obama Administration's Emergency Rescue of the Auto Industry” read the book, wrote a book review on it for a variety of publications, participated in an internet teleconference for press members, and now I have attended his presentation to the International Motor Press (IMPA) in New York City Thursday January 20, 2011.

Any undertaking of the size and magnitude of the auto industry restructuring will have it’s critics, and the government’s revamp of the auto industry is no exception. With any endeavor of this size, mistakes will be made. In my own view, shedding dealers was a mistake. Rattner himself watches the sales progress being made by GM and Chrysler on a regular basis these days for signs of progress. Dealers are the customers of the manufacturer. Shedding customers will not sell more vehicles. The report provided by the Special Investigator of the Troubled Asset Relief Fund agreed and excoriated the Task Force for enabling the dealer terminations. When I asked Rattner about the dealer terminations in May 2010 he said the Task Force tried to make sure all parties involved made sacrifices. The Task Force regarded dealers collectively as a single constituency. As the economy and business climate improve, GM and Chrysler will need additional dealers to maximize market share, or will lose ground to competitors.

Rattner fielded a variety of questions and the occasional speech. When asked about GM’s IPO, he says he believes the government can now afford to be patient and wait to sell their GM stock at a premium as the stock continues to rise. He believes GM’s stock is still a bargain at current value, even compared to Ford. I didn’t ask if he owned stock in any of the auto companies, but in the interest of full disclosure, I own some of both GM and Ford. The taxpayers own about 26% of GM and a larger percentage of GMAC/Ally. Chrysler is still controlled by the U.S. government, although Fiat just increased it’s holdings based on meeting previously established benchmarks.

When asked why “car guys” weren’t part of his Task Force, which was made up of people with no real interest in cars but plenty of real world expertise in business restructuring, Rattner was ready with an answer. He asked everyone to recall when the “car guys” Rick Wagner, CEO of GM, Alan Mullaly, CEO of Ford, and Robert Nardelli, CEO of Chrysler came to Capital Hill to beg for a bailout. They came in separate private jets, for which they were soundly scolded by members of the Congressional committee. Mulally came because he knew that Ford would crater if either GM or Chrysler went down, as it would send a ripple of disaster through the supplier base. Such a disruption would have shut down all North American auto production and would have pushed Ford into bankruptcy as well. The three CEOs testified that for a mere 25 billion dollars, allocated based on company size and need, a disaster could be averted. Also on the auto maker side of the discussion was respected economist for Moody Ratings, Mark Zandi. Zandi took direct issue with the CEOs, stating it would take 75 billion dollars at a minimum, and up to 125 billion dollars. The bailout was ultimately 82 billion dollars, which is being repaid or redeemed rapidly. It is obvious the “car guys” were in complete denial as to their financial condition, even Ford’s Mulally. I have thought from the beginning that Ford was not so much smarter and forward thinking than the other car companies in their move to borrow money while they could, to sustain them in case of a severe downturn. It was more a case of the Ford family wanting to protect the status of their favored status of the stock. The family lives off the dividends of that stock.

Why was Rick Wagoner removed? Wagoner was steeped in GM corporate culture and was in complete denial about the condition of the company and the need for bankruptcy. Finance specialists like Rattner “bet more on the jockey than the horse.” Not knowing how much his company would need to survive was really the straw that sealed his fate. The report GM filed after the Bush administration bridge loan was so deficient there really was no other choice for the Task Force other than to replace Wagoner.

Why was the UAW favored over other constituent group? Rattner says is more a matter of perception than anything else. First, world class car companies need skilled workers to build the vehicles. Bankers and bondholders can’t build cars. In addition, he went through a list of concessions imposed on the UAW. The 320 job classifications previously in place are no more. There is no more “jobs bank,” where the Detroit 3 paid workers to stay home to watch Oprah and drink beer.. The union has agreed to serious wage and work rules cuts. Their heath care fund has been turned into a VEBA. Fortunately it has been funded by stock, laying a lot of risk on the union but looking like it will pay off well based on current stock value. The union pensions had already been funded UNLIKE the pensions of the white collar workers and the executives like Wagoner. GM had decided that it was better to bet their executive’s pensions on GM than on the stock market or other investments. That bet didn’t pay off, but the Task Force included a generous pension replacement for white collar workers. The value of bond holders and stockholders had already been determined by the market. The stock was trading at less than fifty cents at time of bankruptcy declaration, and GM bonds were next to worthless. In fact, many bondholders had bought their holdings at distressed prices and were looking to make a killing. Many held bonds that were “insured” by credit default swaps that would only pay off in the case of a complete default. That group of bondholders WANTED to be wiped out, to the consternation of the legitimate bond holders. Rattner then asks rhetorically, what should they have done different with the UAW given the real world situation they were in?

Rattner is the guy that engineered the nuts and bolts of the restructuring and is clearly relishing the current tide of success of GM and Chrysler. Despite my disagreements with some of the actions of his “Task Force,” his book is must reading for those interested in economics, the auto business, and politics. “Car Guys” probably wouldn’t have terminated dealers, but would they have gotten anything else right?

David Ruggles has spent his working life in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the US & Japan. Ruggles has been a dealer for Mercedes Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Nagano Prefecture Japan. He blogs at autosandeconomics.com and writes regular columns for Ward’s Dealer Business, Auto Finance News, and the Daily Post.

2011-01-10T00:11:00.001-05:00

Book Review of “All the Devils are Here
The Hidden History of the Financial Crisis”

“Hell is empty and all the devils are here” - William Shakespeare - The Tempest

This brilliantly written book should be required reading for any registered voter in the USA. With all the misinformation “out there” about who and/or what caused the financial crisis, it is important to know where to go for answers. This book is “The Source.” The authors are Bethany McLean and Joseph Nocera. McLean was co author of the highly regarded book on the Enron crisis, “The Smartest Guys in the Room.” Nocera is an acclaimed financial writer for the New York Times. The authors’ mission is to tell the story accurately and honestly with no particular political agenda, to explain the complex in a way that can be understood by those not steeped in Wall Street “speak,” and to provide insight into the personalities and characteristics of the major players. The level of research evident in the book indicates to me that the authors were already well connected before they began their research for the book.

Why is the issue of the financial system meltdown important to those who follow the auto industry, and other sectors of the economy? In the late 1970's, consumption represented about 60% of the total economy. 30 years later, consumption was up to about 70%, despite the fact that the income of the middle class had remained stagnant during that time span. How did this occur? The additional consumption funding came from credit fueled primarily by “securitization.” Wall Street’s version of “securitization” had been invented and had grown to 40% of the total credit market by 2008. This expansion of credit fueled economic growth. When the mortgage backed securities market collapsed, it took down the entire securitization market including, credit cards, student loans, commercial loans, auto loans, dealer floor plan, and many other forms of credit. Losing a major portion of available auto credit and funding for dealer floor plan and working capital, pushed already shaky auto manufacturers over the brink, as auto sales slid and dealers dropped like flies. The resulting vicious cycle took the economy downward into recession. The Troubled Asset Relief Program (TARP) was all that stood between the economy and a major depression.

“Securitization” was the process that “allowed mortgages to be converted into a “bond” by combining numerous mortgages into one huge financial instrument. First, Wall Street invented “tranching” to divide up the securities into segments, typically three, based on the inherent risk each tranche entailed. This protected the highest risk level tranch from loss by paying off defaults from the lower rated tranches first. The next step was to devise “derivative” contracts to “insure” the risk. Based on derivative “insurance” like credit default swaps, Wall Street was now able to convince regulators that it was not necessary to “reserve capital” as a hedge against default claims. Now, if only they could get these securities rated AAA by rating agencies like Fitch and Moody, Wall Street nirvana could be achieved. Now junk could be sold around the world as high yield AAA rated securities. AAA is the rating equal to the rating of Treasury bills. To say the least, billions of dollars were made, huge bonuses paid, and many innocent people bilked.

Guarantors of risk were not required to have the money to make good if their bets didn’t pay off. Yet, traditional depository banks were still required to reserve capital, as had been the norm ongoing. This rendered traditional banks to be uncompetitive UNLES they sold their own mortgage originations to Wall Street. If a depository bank originated a mortgage, it could sell that mortgage to Wall Street, buy it back as a part of a AAA rated security, and avoid the “capital reserve requirement. Rating agencies like Fitch and Moody were paid by the Wall Street banks whose products they rated.

Junk mortgages could be assembled into a MBS (Mortgaged Backed Security), tranched into 3 segments based on “risk,” “insured” with a Credit Default Swap contract where no capital reservation was required (it was assumed that Wall Street would not take risks not in their own interests), obtain a AAA rating to represent the securities’ safety as the highest grade, which allowed them to be purchased by entities limited to AAA investments by law, like pension funds, and sold around the world . Profits were privatized on Wall Street as huge profits were made and mind boggling bonuses paid to executives. The risk, however, was socialized to U.S. taxpayers.

The U.S. government, in the form of the George W. Bush administration and it’s Treasury Secretary Hank Paulson, was put into the position of allowing the world financial system to collapse or step in with TARP. Fortunately, Congress approved TARP, which despite its imperfections, saved the world from an incomprehensible disaster. After all, it was the U.S. government’s lack of oversight that stood by and let it happen in the first place. Other countries were looking to the Americans as their own economies were severely impacted by the actions of American investment bankers.

Governments are generally expected to protect it’s citizens from avoidable disasters. The Republican Party found this out after the Great Depression. Democrats paid a price after Jimmie Carter. Even President Barack Obama has been blamed by some despite the fact he had nothing to do with the disaster, other than casting some votes while a Senator. Unfortunately, many voters lack the ability to grasp complex issues, and fall prey to simplistic explanations.

In 1979, the Wall Street version of securitization was invented and launched by Merrill Lynch. Government Sponsored Enterprises (GSE) in the form of Fannie Mae, Freddie Mac, etc., had securitized the first mortgages in previous years. The GSEs were given objectives of how many low down payment low income loans they should make at a minimum by Congress. The compensation packages of the executives of the GSEs were predicated on these objectives. Interestingly, the GSEs were already making these types of loans at a much higher rate than the objectives they were given, making huge bonuses a given. Further, the GSEs received credit just for purchasing AAA MBSs containing them from Wall Street. The GSEs thought that was safer than holding the paper themselves. In fact, Wall Street had rendered the GSEs superfluous.

Wall Street was allowed to create a “betting market” on almost anything. The problem was not so much deregulation, but a refusal to regulate at all. During the period of time Wall Street was “rocking and rolling” American home ownership increased only 1.7%. Yes, we have paid a terrible price for such a small increase in the percentage of those who get to experience the American dream. Yes, mortgage originators “approved” huge numbers of loans with little chance of them being paid back. And they did this because they were never going to hold the paper anyway, just as an auto dealer sells auto loans to his/her banks. It was all being sold to Wall Street because they could take the lousy paper, turn in into AAA rated securities, and sell it to anyone. But the real problem was with home refinances and home equity lines of credit.

So who caused the meltdown and who were the players? In 2008, I wrote that the meltdown was caused by an “unholy alignment between liberal and conservative political causes.” This was after watching hours of testimony on CSPAN and studying the subject intensely. After two years of additional study, including watching Hank Paulson, the Bush Treasury Secretary and author of TARP, testify before Congress under oath, I have adjusted my thinking. But my own personal opinion is not important. All of us have to satisfy ourselves. For those who want to believe the meltdown of the financial system was caused by the overly altruistic “holding a gun” on lenders, forcing them to make loans they knew would never be paid back, you will be disappointed. It’s a non issue.

Some major “players,” their roles, and some resources are listed as follows:

“All the Devils are Here,” Nocera and Mclean

“On the Brink: Inside the Race to Stop the Collapse of the Global Financial System,” By Henry Paulson”

The last chapter of Bush speech writer David Frum’s recent book: “Comeback: Conservatism That Can Win Again”

“Overhauled” by Steve Rattner

George W. Bush speech on American home ownership from 2002

http://autosandeconomics.blogspot.com/

George W. Bush - consciously worked to prevent anything from slowling the housing juggernaut that was fueling the economy. He also had the guts to stand up to his own party’s ideologues to move to save the economy from destruction by proposing and passing TARP along with his Treasury Secretary. Moved against Congress to bail out GM and Chrysler by using TARP funds after Congress had turned down a bailout package.

Alan Greenspan - a disciple of Ayn Rand, Chairman of the Federal Reserve, fought regulation of derivatives at every turn

Larry Summers - under the Clinton administration was an opponent of regulating derivatives. Teamed with Robert Rubin to squelch Brooksey Born’s bid to regulate derivatives. At the time, Born was Chairperson of the Commodities Futures Trading Commission. As a member of Barack Obama’s administration, Summers was a key player in the bailout of GM and Chrysler, and the direction of many TARP funds.

Robert Rubin - Treasury Secretary under Bill Clinton - worked to quell efforts to regulate derivatives

Brooksey Born - Chairman of the Commodities Futures Trading Commission - moved to regulate derivatives, and was squelched by Rubin and Summers.

J P Morgan - invented the credit default swap by paying the European Bank for Reconstruction and Development to assume it’s risk in their exposure to Exxon, which tapped 4.9 billion of it’s 5 billion dollar credit line after it’s notorious oil spill disaster. It never occurred to anyone to ensure the EBRD had the funds to make good in the case of a default. It turns out it didn’t make any difference. Years later, the were many claims to be paid and only the U.S. taxpayer to pay them.

Moodys, Standard and Poor, and Fitch Rating - Were paid by the same companies who’s products they were supposed to rate. Enabled Wall Street to sell junk as AAA level investments.

The Three Amigos - Lewis Ranieri - Salomon Brothers bond trader - “I wasn’t out to invent the biggest floating craps game of all time, but that’s what happened.” David Maxwell - CEO of Fannie Mae, formed an uneasy alliance with Ranieri and Wall Street. Larry Fink - After creating some of the first mortgage backed securities he later served as a key government advisor.

Blythe Masters - helped invent the credit default swap for J P Morgan

Joe Cassanno - Ran the Financial Products division for American Insurance Group (AIG) - Began selling credit default swaps (CDS) on collateralized debt obligations (CDOs) “Collateral triggers” built into AIG CDSs helped bring the company down.

Phil and Wendy Gramm - As Senator and later as Chairman of the Senate Banking Committee, Phil blocked attempts at regulation at every turn. Wendy Gramm, a PHD economist, was installed as Chairperson of the Commodity Futures Trading Commission (CFTC) by Geroge H W Bush when it’s current Chairman, Mark Brickell, was moving to regulate derivatives. The move stopped the move to regulate in its tracks.

Roland Arnall - Appointed to the post of Ambassador to the Netherlands by George W Bush while his company, Ameriquest, a major sub prime mortgage “lender,” was a leader in blatantly deceptive lending practices. At one point, a group of ex auto business F&I managers operated a consulting company, specializing in showing fledgling mortgage brokers how to falsify and manipulate documents. They went so far as to have a web site devoted to creating phoney pay stubs, tax returns, job letters, etc. In fact, Wall Street wasn’t really concerned about documentation, as they were able to turn lousy mortgages into AAA rated investments under most circumstances.

President Barack Obama - Was duped and gave Arnall a pass during Senate questioning regarding Arnall’s ambassadorship because a mutual friend, Deval Patrick, the current Governor of Massachusetts, sat on the Ameriquest Board of Directors. His administration inherited the economy in a dreadful condition, although without the strong and decisive action of George W Bush, Hank Paulson at Treasury, and Ben Bernanke at the Federal Reserve Bank, things would have been much worse.

These are only a few of the personalities and characters involved. Before a reader allows themselves to be intimidated by the prospect of not understanding everything in the book, please understand that the people perpetrating these evils on the world didn’t fully understand what they were doing themselves. People don’t usually buy books about business for entertainment purposes, but I couldn’t put this one down. It read like a riveting“who dunnit.” Don’t pass up the opportunity!

Ruggles

Buying your last new car

2010-12-20T18:23:00.000-05:00

Mike Smitka

Retirees have been good car customers the past decade, particularly those who retired in 2005-2007. Will the next decade will be a different story? -- initial data suggests "yes." And it won't be a good one.

A recent working paper^[1] by Wade D. Pfau at the National Graduate Institute of Policy Studies in Tokyo argues that data show the likely financial status of retirees in 2000 -- not a bad year -- will be worse than for any group since 1926. The basic issue is that returns on investments are low; the "rule of thumbs" for how much you needed to save and the rate at which you could draw down savings are proving optimistic.

Pfau examines the long-accepted 4% rule of thumb for an equity investments: that it's safe to draw down that much of principle. But he finds that US returns during 1926-1980 were higher than they have been during the past 30 years. Furthermore, they were higher than in a wider sample that includes 17 other developed countries and a longer time period; in many cases, a 3% rule of thumb was too optimistic. The past is no guide to the future, but will we see a return of historic dividend levels and capital appreciation anytime soon? Never mind bond performance -- with near-zero interest rates, that's no help for the average investor.

Part of what happens is that down years accentuate the depletion of assets, and down years early on do the greatest damage. That is, those who retired in 1999 and 2000 had to liquidate a larger than anticipated share of their holdings in the bad years of 2001 and 2002. Even though asset prices recovered for the next 5 or so years, that didn't help because they'd sold off so much of their portfolio. Those who retired early were the most vulnerable, in what Pfau notes the finance literature calls "reverse dollar cost averaging."

So what of recent retirees, many of whom saw their paper wealth and chose to stop working at comparatively young ages? I fear the worst. Recent losses on assets make "downsizing" housing, the biggest component of wealth, problematic. The bond component of portfolios is earning almost nothing (though if an individual was prescient and held only "long" bonds they'd have a nice capital gain -- but if they saw the future that clearly, they are probably still working...). The initial hit to stock portfolios was huge, and many invested aggressively. Of course inflation is low -- unless you have a less-than-golden healthcare policy. Or have an old home that isn't well insulated, and, since you're home all the time, you keep constantly warm.

The logic and data of Pfau's article is thus quite unsettling, even if (as he notes more than once) the past is not a good guide to the future. His references though don't suggest that the future will be rosy: John Bogle's Enough: True Measures of Money, Business and Life, John Wiley, 2009; Dimson, Marsh and Staunton "Irrational Optimism" from the Financial Analysts Journal 60:1, 2004; and John West, "Hope is Not A Strategy," Fundamental Index Newsletter, October 2010.

Of course we could be on the threshold of an era of strong growth. But my position as an expert on the Japanese economy is clear: their "lost decade" and what the US is looking at are analytically similar (though our growing population should shorten the period of stagnation).

For the auto industry, that means that a higher than normal share of the baby boomers have already bought their last new car.

[1] See Will 2000-era retirees experience the worst retirement outcomes in U.S. history? A progress report after 10 years by Wade D. Pfau.
Note that I have not looked for data on new car purchases by retirees; my small sample of relatives and neighbors may be sorely misleading. If you have such data, please let me know!!

George W. Bush 2002 speech on home ownership

2010-12-12T16:56:00.003-05:00

David Ruggles

The following is posted as a reference to a book review I am working on. The book is "All if Devils are Here, the Hidden History of the Financial Crisis" by Joe Nocera and Bethany McLean

President George W. Bush addresses the White House Conference on Increasing Minority Homeownership at The George Washington University Tuesday, Oct. 15, 2002

THE PRESIDENT: …. I appreciate your attendance to this very important conference. You see, we want everybody in America to own their own home. That's what we want. This is -- an ownership society is a compassionate society.

More and more people own their homes in America today. Two-thirds of all Americans own their homes, yet we have a problem here in America because few than half of the Hispanics and half the African Americans own the home. That's a homeownership gap. It's a -- it's a gap that we've got to work together to close for the good of our country, for the sake of a more hopeful future.

We've got to work to knock down the barriers that have created a homeownership gap.

I set an ambitious goal. It's one that I believe we can achieve. It's a clear goal, that by the end of this decade we'll increase the number of minority homeowners by at least 5.5 million families. (Applause) … And it's going to require a strong commitment from those of you involved in the housing industry…

I appreciate so very much the home owners who are with us today, the Arias family, newly arrived from Peru. They live in Baltimore. Thanks to the Association of Real Estate Brokers, the help of some good folks in Baltimore, they figured out how to purchase their own home. Imagine to be coming to our country without a home, with a simple dream. And now they're on stage here at this conference being one of the new home owners in the greatest land on the face of the Earth. I appreciate the Arias family coming. (Applause.)

We've got the Horton family from Little Rock, Arkansas, here today. … They were helped by HUD, they were helped by Freddie Mac. …

Finally, Kim Berry from New York is here. She's a single mom. You're not going to believe this, but her son is 18 years old. (Laughter.) She barely looked like she was 18 to me. And being a single mom is the hardest job in America. And the idea of this fine American working hard to provide for her child, at the same time working hard to realize her dream, which is owning a home on Long Island, is really a special tribute to the character of this particular person and to the character of a lot of Americans. So we're honored to have you here, Kim, and thanks for being such a good mom and a fine American. (Applause.)

I told Mel Martinez I was serious about this initiative… And the good news is, Mel Martinez believes it and means it, as well. He's doing a fine job of running HUD, and I'm glad he has joined my Cabinet. (Applause.)

And I picked a pretty spunky deputy, as well, Alphonso Jackson -- my fellow Texan. (Applause.) I call him A.J. …

I see Rosario Marin, who's the Treasurer of the United States. Rosario used to be a mayor. Thank you for coming, Madam Mayor. (Applause.) She understands how important housing is. …

All of us here in America should believe, and I think we do, that we should be, as I mentioned, a nation of owners. Owning something is freedom, as far as I'm concerned. It's part of a free society. And ownership of a home helps bring stability to neighborhoods. You own your home in a neighborhood, you have more interest in how your neighborhood feels, looks, whether it's safe or not. It brings pride to people, it's a part of an asset-based to society. It helps people build up their own individual portfolio, provides an opportunity, if need be, for a mom or a dad to leave something to their child. It's a part of -- it's of being a -- it's a part of -- an important part of America.

Homeownership is also an important part of our economic vitality. If -- when we meet this project, this goal, according to our Secretary of Housing and Urban Development, we will have added an additional $256 billion to the economy by encouraging 5.5 million new home owners in America; …

Low interest rates, low inflation are very important foundations for economic growth. The idea of encouraging new homeownership and the money that will be circulated as a result of people purchasing homes will mean people are more likely to find a job in America. This project not only is good for the soul of the country, it's good for the pocketbook of the country, as well.

To open up the doors of homeownership there are some barriers, and I want to talk about four that need to be overcome. First, down payments. A lot of folks can't make a down payment. They may be qualified. They may desire to buy a home, but they don't have the money to make a down payment. I think if you were to talk to a lot of families that are desirous to have a home, they would tell you that the down payment is the hurdle that they can't cross. And one way to address that is to have the federal government participate.

And so we've called upon Congress to set up what's called the American Dream Down Payment Fund, which will provide financial grants to local governments to help first-time home buyers who qualify to make the down payment on their home. If a down payment is a problem, there's a way we can address that. And when Congress funds the program, this should help 200,000 new families over the next five years become first-time home buyers.

Secondly, affordable housing is a problem in many neighborhoods, particularly inner-city neighborhoods. … I'm doing is proposing a single-family affordable housing credit to encourage the construction of single-family homes in neighborhoods where affordable housing is scarce. (Applause.)

Over the next five years the initiative will provide home builders and therefore home buyers with -- home builders with $2 billion in tax credits to bring affordable homes and therefore provide an additional supply for home buyers. …

And we've got to set priorities. And one of the key priorities is going to be inner-city America. …

Another obstacle to minority homeownership is the lack of information. You know, getting into your own home can be complicated. It can be a difficult process. I had that very same problem. (Laughter and applause.)

Every home buyer has responsibilities and rights that need to be understood clearly. And yet, when you look at some of the contracts, there's a lot of small print. And you can imagine somebody newly arrived from Peru looking at all that print, and saying, I'm not sure I can possibly understand that. Why do I want to buy a home? There's an educational process that needs to go on, not only to explain the contract, explain obligation, but also to explain financing options, to help people understand the complexities of a homeownership market, and also at the same time to protect people from unscrupulous lenders, people who would take advantage of a good-hearted soul who is trying to realize their dream.

Homeownership education is critical. And so today, I'm pleased to announce that through Mel's office, we're going to distribute $35 million in 2003 to more than 100 national, state and local organizations that promote homeownership through buyer education. (Applause.)

And, of course, one of the larger obstacles to minority homeownership is financing, is the ability to have their dream financed. Right now, we have a program that all of you are familiar with, maybe our fellow Americans are, and that's what they call a Section 8 housing program, that provides billions of dollars in vouchers to help low-income Americans with their rent. It encourages leasing. We think it's important that we use those vouchers, that federal money to help low-income Americans go from being somebody who leases to somebody who owns; that we use the Section 8 program to not only help with down payment, but to help with continuing monthly mortgage payments after they're into their new home. It is a -- it is a way to help us meet this dream of 5.5 million additional families owning their home.

I'm also going to encourage the lending industry to develop a mortgage market so that this script, these vouchers, can regularly be used as a source of payment to provide more capital to lenders, who can then help more families move from rental housing into houses of their own. …

Last June, I issued a challenge to everyone involved in the housing industry to help increase the number of minority families to be home owners. And what I'm talking about, I'm talking about your bankers and your brokers and developers, as well as members of faith-based community and community programs. And the response to the home owners challenge has been very strong and very gratifying. Twenty-two public and private partners have signed up to help meet our national goal. Partners in the mortgage finance industry are encouraging homeownership by purchasing more loans made by banks to African Americans, Hispanics and other minorities.

Representatives of the real estate and homebuilding industries, through their nationwide networks or affiliates, are committed to broadening homeownership. They made the commitment to help meet the national goal we set.

Freddie Mae -- Fannie Mae and Freddie Mac -- I see the heads who are here; I want to thank you all for coming -- (laughter) -- have committed to provide more money for lenders. They've committed to help meet the shortage of capital available for minority home buyers.

Fannie Mae recently announced a $50 million program to develop 600 homes for the Cherokee Nation in Oklahoma. Franklin [Raines], I appreciate that commitment. They also announced $12.7 million investment in a condominium project in Harlem. It's the beginnings of a series of initiatives to help meet the goal of 5.5 million families. Franklin told me at the meeting where we kicked this office, he said, I promise you we will help, and he has, like many others in this room have done.

Freddie Mac recently began 25 initiatives around the country to dismantle barriers and create greater opportunities for homeownership. One of the programs is designed to help deserving families who have bad credit histories to qualify for homeownership loans. …

There's all kinds of ways that we can work together to meet the goal. Corporate America has a responsibility to work to make America a compassionate place. Corporate America has responded. As an example -- only one of many examples -- the good folks at Sears and Roebuck have responded by making a five-year, $100 million commitment to making homeownership and home maintenance possible for millions of Americans. …

The non-profit groups are bringing homeownership to some of our most troubled communities. …

The other thing Kirbyjon told me, which I really appreciate, is you don't have to have a lousy home for first-time home buyers. If you put your mind to it, the first-time home buyer, the low-income home buyer can have just as nice a house as anybody else. And I know Kirbyjon. He is what I call a social entrepreneur who is using his platform as a Methodist preacher to improve the neighborhood and the community in which he lives.

And so is Luis Cortes, who represents Nueva Esperanza in Philadelphia. I went to see Luis in the inner-city Philadelphia. … But he also understood that a homeownership program is incredibly important to revitalize this neighborhood that a lot of folks had already quit on. …

Again, I want to tell you, this is an initiative -- as Mel will tell you, it's an initiative that we take very seriously. … Thank you for coming. May God bless your vision. May God bless America. (Applause.)

The Crisis Yet to Come

2010-11-15T16:11:00.002-05:00

The Atlanta Fed's blog from October 27, 2010 has a chilling piece on the source of the downturn in revenue at the state level (and by implication the local level, too). Quite simply, they note and then back with data that (duh! - with hindsight) real estate assessments lag the market. Hence the downturn has to have other sources, specifically declines in individual income tax receipts and sales tax receipts. Real estate tax receipts have actually continued to rise, as higher assessments from the era of peak prices continue to track up.

That's chilling, because it implies that state and local governments will continue to see revenues fall as assessments are updated to track the market down. Now the level of dependence on real estate related revenue varies widely. But on average it suggests that even if incomes begin to recover, government revenues will continue to fall.

Indeed, a recent paper by Cogan and Taylor quantifies the magnitude of the downturn: budget cuts by state and local governments fully offset the much-maligned Obama stimulus package. They had earlier taken a stand on the "multiplier" (the extent to which an expenditure increase or tax cut would stimulate activity). [Look for a discussion of multiplier estimates by Brad de Long.] But when they went to check what ex post performance might show, they found a problem that rendered that discussion moot: ex post, there was no multiplicand to be multiplied. Of course that's not reassuring going forward, because in 2011 there won't be a stimulus package to offset what state and local government are doing. When teachers are fired next summer, and as road maintenance crews are axed and parks closed, there won't be anyone stepping in to hire them or pay for them to be rehired. Now Cogan and Taylor think the multiplier is small; I'm not convinced by their arguments. But small multiplier or large, the job losses will be real.

John F. Cogan and John B. Taylor, "What the Government Purchases Multiplier Actually Multiplied in the 2009 Stimulus Package." National Bureau of Economic Research Working Paper No. 16505, October 2010. http://www.nber.org/papers/w16505

If we thought banks were too big to fail, what of the government of the 10th largest economy in the world, California? They are starting their 2011 budget cycle with a $25 billion deficit and a long period of underfunding state and local pension funds. I doubt there's enough available for cutting on the expenditure side, and while I've never lived there, my sense is that there is no ability to enhance revenue, given the demonstrated ability of vocal citizens' movements to impede government via referenda. Pundits may be comparing us to Greece to argue that we need to cut the Federal deficit, but they really don't understand the dynamics of bond markets. But they can and should look at California, and ask whether we will feel compelled to bail them out as the EU did with Greece.

Mike Smitka

Addenda

Readers might see a contrarian position at Slate Moneybox, Default Position: Why we needn't worry too much about municipal bankruptcy by Annie Lowry. She argues first that the incentives are strong to avoid bankruptcy, while a crisis increases policy options. Second, though only implicit in her argument, bond holders can be forced to renogotiate without bankruptcy. While she does not mention it, many bonds are very close to private placements, and that facilitates renegotiating debt. (I handled sovereign debt renegotiations during a banking career decades back.) Third, and again less explicit, the biggest obligations are not formal bonds but retirement systems. It may be possible to renege on those -- tell retirees "no more pension." That may not need Chapter 9. In sum, all of those lessen the role of formal bankruptcy.

Elsewhere I calculated the numbers for California. Their accounting is arcane, but at the state level the budget is around $100 billion with a projected $25 billion deficit. That means tax receipts of $75 billion, so that closing the gap via revenue enhancement would in the extreme require a 33% increase in taxes (and more in tax rates, given exemptions). But in the background California's GDP is approximately $1 trillion, so the gap is on the order of 2.5% of personal and corporate incomes. Of course the state has perhaps $500 billion in unfunded pension obligations. Now in most places where I've lived government salaries are below market so these pensions are in effect part of the total package. I don't believe it ethical to adjust those retroactively. But in any case the magnitude of the problem is well within the taxing ability of the state, without leading to exorbitant rates. The problem is one of politics, not economics.