bailout

Short-term thinking costs General Motors, US taxpayers

Posted on by j.giglio

Just after Thanksgiving, General Motors made the jarring announcement that it was closing five factories in Ohio, Michigan, and Ontario, killing the production of several models including the Cadillac CT6, the Chevrolet Cruze compact, the Buick LaCrosse, the Volt plug-in hybrid, and cutting about 14,700 jobs. This is the firm’s largest cost-saving plan since the taxpayer-funded bankruptcy bailout in 2009.

GM received more than $50 billion of taxpayer assistance through the Troubled Asset Relief Program during the financial crisis. While the feds recovered $39 billion, the firm’s management failures cost taxpayers $10.5 billion. General Motors had racked up more than $40 billion in losses since 2005 alone, losses that had little to do with the financial crisis.

Many of the jobs to be eliminated are populated by those who are perpetually in debt, no matter how hard they work. And if you believe senior GM executives will not receive their annual bonuses, then you believe pigs can fly.

The automaker, the leading automobile manufacturer of the 20th century, expects to free up $6 billion in cash flow by the end of 2020, which will enable it to double down on its investment in electric and autonomous vehicles to stay competitive in a fast-changing market and sluggish sales.

The automobile industry is simultaneously facing multiple disruptions. For example, young, environmentally conscious, technology-oriented urban residents increasingly shun car ownership in favor of more convenient, less expensive mobility options. Owning a car and getting a driver’s license aren’t the life milestones they once were.

For years, General Motors has not been building the vehicles American consumers want. As a result, their car lineup has had more misses than hits. It has been slow to respond to competitive pressures and to align firm resources with changing market demands. For example, the rapid rise of Tesla Motors in the electric vehicle market, Toyota gaining market share with its eco-friendly Prius and the subsequent GM bankruptcy suggest that the firm made the wrong decision when it aborted its electric vehicle program in 2002.

In the ultimate irony, General Motors had a head start with electric vehicles. The firm introduced the “Impact,” a concept electric car, at the Los Angeles Auto Show in January 1990. The Impact was met with immediate praise and GM announced that it would become a production vehicle. Based on the proof of concept electric vehicle, the California Air Resources Board passed a zero-emissions vehicle mandate that required all major automobile suppliers to develop them if they wanted to continue to sell in California.

General Motors became the world’s first mass-produced electric vehicle retailer when, in a blaze of glory, it released the EV1 in 1996. The vehicle could only be leased, despite requests by many customers to purchase it.

But in 2002, the firm cancelled the model that might have been its best hope for the future, citing high costs, a limited market for electric vehicles, and the lack of technology to make high-performance cars. GM recalled all the EV1 and, in one of its worst public relations moves, recycled them, meaning the recalled vehicles were taken to Arizona and crushed. The electric powertrain that powered Tesla vehicles was based on the prototype developed for the EV1.

Once again, GM management demonstrated that short-term thinking is extremely costly in the long term. It is a reflection of the firm’s slow adjustment to changing consumer tastes and the failure to tailor the firm’s resources and business strategy to rapidly changing market forces.

General Motors may have been a 20th-century giant with a large past but today its future may be getting smaller. The sands of time may well be running out for the firm to prepare for the automobile industry’s still-uncertain future.

Originally Posted: December 22, 2018

Cyprus crisis can’t happen in the U.S.- right?

Posted on by j.giglio

“Neither a borrower nor a lender be,” prattled Polonius to Laertes in Shakespeare’s “Hamlet.” Well, maybe. Last month, the European Central Bank, the European Commission and the International Monetary Fund decided that Cyprus needed a fast 17 billion euro bailout. They proposed to offer the tiny island 10 billion euros and demanded that depositors in Cypriot banks fork over the remaining 7 billion.

Specifically, they proposed taxing bank deposits. Depositors with more than 100,000 euros in their account would be faced with a 9.9 percent tax while those with less would see a 6.75 percent levy.

As you can imagine, depositors rushed to withdraw funds from Cypriot banks before the measure went into effect. So the authorities shut down the banks for several weeks and instituted capital controls. This had to be unsettling for retirees and the working class, as well as small businesses that need to make payroll using their bank accounts.

Setting aside for now how the crisis was averted and whether something similar could happen here, in the real world few businesses of any size can operate without access to short-term credit to smooth out mismatches in their normal cash flows.

Suppose your family’s widget factory pays its employees every Friday. That means a weekly cash outflow. But most of your prime customers are wholesale distributors who pay for purchases from firms like yours on the last day of the month following widget deliveries. So you have four payroll outflows for each injection of cash from sales.

Like the overwhelming majority of businesses, you cover these cash flow mismatches by drawing down a credit line from your local bank each week to make payroll and repay the drawdowns as soon as payment is received.

But one Friday morning when you get on your PC to access your firm’s bank accounts and transfer enough cash from your credit line to cover payroll checks, you see a chilling message on your screen: “All credit lines are frozen until further notice.”

You scrounge around among your firm’s bank accounts and come up with enough cash to cover this week’s payroll, leaving you pretty well tapped out until a big group of customer payments is due to arrive in three weeks. But what about your next three payrolls?

One option is to simply close the factory and lay off your employees until the payments arrive. But a closed factory doesn’t produce widgets, so you can’t deliver to your customers, who may tum to other suppliers. In any case, your future cash inflows will be lower, which means smaller profits.

Another option is to close the factory and lay off your employees for just a week, when you try to find enough emergency cash somewhere to cover the next two weeks of payroll. Losing only one week of production will reduce your loss, but what if you can’t find the money?

The widget company’s experience isn’t just limited to Cyprus. It was repeated a few million times in the United States during the fall of 2008. The results were massive layoffs, lost wages (which meant less consumer spending) and lost company profits. All of which made a disastrous recession even worse.

Why did this happen in the U.S.?

Because too many banks woke up one morning to find that some of the dicey unregulated derivative securities they held in their portfolios had lost most of their value. In a panic, they tried to conserve as much available cash as they could by freezing lending to businesses and individuals alike.

Back in Cyprus, the banks became a tax haven for overseas depositors. They then invested the money in Greek bonds to generate big returns. When the bonds tanked, the banks were on the verge of bankruptcy and needed a bailout.

But there’s no need to be alarmed. It can’t happen here. The American economy has been strong for months now, the stock market is rising, and your 401(k) is going through the roof. Right?

originally posted: April 6, 2013