Earlier this week General Motors, the new post-bankruptcy GM, issued it’s Initial Public Offering. Initial signs are very encouraging in several ways, which I’ll describe. But first let’s take a note. Only 20 months, less than two years, The conservatives and tea party types were howling for GM to go bankrupt and for the government to not step in – just let it and Chrysler die along with what would probably have been nearly a million good U.S. jobs and the State of Michigan. Let’s revisit those events for a moment below the fold:
GM’s (and same applies to Chrysler/Ford) troubles were essentially two-fold. Part was GM’s fault and part not. The GM fault was long-term and strategic failure of managements.
The GM fault was 3-4 decades of short-term focused, gutless management that ignored products and innovation, played hide-the-real-costs financial games, and refused to see the world (and auto industry) had changed. The Big 3 auto companies in the US thrived for several decades (50’s-70’s) with the help of the UAW union. They had a nice tight oligopoly that played follow-the-leader (GM) on pricing. The unspoken, but understood rules of competitive engagement in the auto industry were simple. By sharing profits and raising the real incomes of auto workers, the companies could buy labor peace and cooperation from the UAW. The UAW did it’s part through pattern bargaining. The pattern bargaining meant no one of the Big 3 could really achieve much of a labor cost or productivity advantage so it was pointless to try to compete on costs. Price competition didn’t happen because there was tacit collusion in the form of price leadership from GM – this supported high profits. Quality competition didn’t really exist yet since there was no way to verify quality objectively. They just asserted quality in advertising – besides competing on quality if very, very hard work for managements. So we were left with an industry making high profits and competing with each other on cosmetic stuff: chrome, fenders, horsepower and advertising. (don’t get me wrong, I loved those cars – I still rue the day I sold my 1969 Boss Mustang). But it wasn’t the stuff that makes for lean, hard-working, innovative management.
In the 1980’s and 1990’s the managements persistently took the easy way out. When foreign car makers began to import and then make in the US cheaper, higher quality small cars the Big 3 just surrendered the segment and moved into SUV’s and pickups in an even bigger way. This made them appear profitable but it also made them vulnerable and dependent on a narrow base of sales. It also meant lower volume and the need for fewer facilities, but management never bit the bullet on closing enough capacity to “right-size”. Labor relations grew a little testier but peace was bought by promising very high healthcare benefits and large pensions. But the future healthcare and pension costs were never fully funded or were funded under overly optimistic assumptions. Management benefitted in the short run from the labor peace and left the bill (the hard part) for future managers. Poor product designs and stagnant technology were covered over by playing marketing rebate and zer.
In North America, by the time the 21st century arrived they were the industrial equivalent of alcoholic, obese, smokers getting by on lots of medications. An early demise was inevitable if they didn’t change. Fortunately they did begin to change. Ford was first when they hired Alan Mulally. Hiring Mulally saved Ford from GM’s fate because he put Ford on a strict change regimen and had the foresight to stockpile as much cash as possible for a future crisis. GM began to change but only cautiously and timidly. When the recession hit Dec 2007 GM knew it was sick, needed to change, and was beginning to make plans for such. But the urgency wasn’t there and the old habits were hard to break. Even more troubling was the debt and unfunded liabilities had accumulated to life-threatening levels. GM was stressed and vulnerable but starting to move in the right direction.
The part of GM’s demise that wasn’t their fault was the credit crunch. The $4.00 gasoline summer of 2008 killed pickup and SUV sales for a while. It got GM’s attention and change accelerated, though still not fast enough. In Sept 2008, Wall Street collapsed because of, well, so much bad stuff that we don’t space here to detail it. Just search on banks on this website. By October of 2008 unemployment was skyrocketing. Unemployed people don’t buy cars. And employed people don’t buy cars when there’s no financing, which had also dried up. GMAC (sold off years earlier to help hide the declining auto-making profits) essentially stopped making car loans. Auto sales collapsed for all. For Toyota and Honda, it was stressful but they were in good condition and weather the crisis better (plus they had a helpful Japanese government). Ford, having been hard at work with more urgency for longer, and having stockpiled a ton of cash, was severely stressed but just able to get through. For GM and Chrysler, though, the Wall Street-driven drop in sales was the equivalent of a severe heart attack. But with good emergency care even alcoholic, obese smokers can be helped back to a robust life and reformed lifestyle. The nation has long had laws that enable such emergency recovery care for large corporations. It’s called a restructuring Chapter 11 bankruptcy.
Since both shareholders and bondholders usually lose in a formal bankruptcy, it used to be that Wall Street ( banks, bondholders, and hedge funds) would step in to help finance and direct a restructuring of a large company. It used to be a common practice. But not this time. Wall Street wanted GM dead and in bankruptcy court. See my posts here and here from that time to see how short-term greed had Wall Street set to profit from a GM bankruptcy. Regardless of whether such a severe restructuring happens in or in anticipation of Chapter 11 bankruptcy, such restructurings need medium-term financing. It’s often called debtor-in-possession financing. But in 2009, Wall Street and the big banks refused. Even though these big banks had been bailed out and rescued by The Fed, the Bush administration, and the Obama administration to the tune of hundreds of billions (trillions when you count The Fed’s efforts), they refused. That meant there was a simple stark choice: either the Government finances the bankruptcy/restructuring or GM closes. With automakers worldwide struggling themselves and having excess capacity and weak sales, there was no hope that GM could be auctioned off either in whole or piecemeal. It was either lose another million jobs, prolong the recession and risk it becoming a serious depression, or “bailout” GM. The government made the right choice and invested $50 billion in loans and equity to rescue and restructure GM.
Of course at the time, conservatives, tea-party-types, and free market fundamentalist economists (Chicago school and Austrian types) decried the government’s involvement. Radio talk shows and politicians called it “socialism”. They quickly labeled it “Government Motors”. They claimed GM was hopeless. They claimed that the government can’t run an auto company. They claimed the money was wasted and thrown away. They claimed it was $50 billion giveaway to union workers. Now, 16 months after GM entered a Chapter 11 bankruptcy with government financing we can clearly conclude. The critics were wrong. Dead wrong.
Now GM has pulled off the largest IPO in history. Bigger than Visa. Bigger than Google. The biggest. What’s more, it was done very well. Demand for the shares was so strong that the price was raised just before the offering and the number of shares increased by more than a third. In my opinion, the offering was extraordinarily well handled. Normally when demand is strong for an IPO, the initial price is set too low by the investment banks and the shares too limited so that the stock will be “hot” when it issues and the publicly traded price will skyrocket. That didn’t happen this time. Instead, the value of the strong demand appears to have actually been captured by the company and not the investment banks. Good. Even better is that the offering has reduced the government ownership stakes. The U.S. government, which owned 61% before the IPO had offered it’s shares for sale and now owns less than 33%. The U.S. government, while still the largest shareholder, no longer “controls” GM. The Canadian and Ontario governments also got some of their money back and reduced their ownership stake. The UAW, which showed faith through the bankruptcy by taking all of the money it was owed for it’s VEBA for retiree health benefits now has a lot cash in that VEBA trust as well as GM stock.
Of course many of the critics have now shifted to other panicky complaints. In particular, I’ve been reading lately how the success of the GM rescue, bankruptcy, and now IPO with government help makes it more likely that other big companies will follow suit and demand bailouts themselves. It’s a silly argument, but I’ll deal with that in another post today or tomorrow.
So to conclude this long post, what lessons can we learn from this tale?
- Oligopolies are not healthy, especially if they are allowed to engage in non-competitive tacit collusion. We need stronger anti-trust laws and stronger enforcement. If we had this in the 60’s and 70’s we might have prevented the managerial decay that led eventually to the collapse.
- Certain Wall Street “innovations” run counter to public purpose and should be prohibited. For example, the credit default swaps contracts that motivated Wall St and hedge funds to actually prefer GM’s demise were counter to public purpose. It’s a long standing concept in law that private contracts that run counter to public purpose should be illegal. The situations where CDS contracts do help the economy (which are largely unproven theoretical benefits) do not outweigh the risks posed by the perverse incentives they create. We do not allow casinos to take bets on which houses will be burned by arsonists. We shouldn’t allow banks and Wall Street to make bets on which companies will fail, especially when those banks and hedge funds hold the matches and gasoline.
- Government “rescues” of large entreprises can work and do not lead to socialism, communism, or any other supposed nasty -ism that brings the end of Western civilization and humanity.
- “Socialism”, in the form government investment or bailout of a very large corporation that is structurally important to the economy can work and actually reduces pain in the economy
- Given, the strong demand for shares in the new GM from investors, maybe we can say that “socialism” in practice is actually popular with capitalists.