Comment by JJ Hornblass on November 20, 2008 at 11:24am

Dear Professor, thanks for your post. Your "initial" take is very valuable. I have been trying to understand what would be the macroeconomic effects of a GM bankruptcy, so thanks.

Here's my follow-up question to your post: The possibility of a double-digit unemployment rate you wrote of implies, I believe, that another 5 million or so people will be out of a job if GM goes bankrupt. Each worker has her own investment potential, meaning she can use her skills to generate more value. When people become unemployed, do they not soon become positive contributors to the economy again? Is there a metric for this?

Just to give you a firm example, I was talking with someone earlier this week who managed a mortgage company. Just his advertising budget alone was $100 million. Thousands of people worked for him. The venture fell on hard times, like so many other mortgage ventures, and he found himself thrown out. He looked for a job for a while, but couldn't find one. He needed to work so he did what knew he could do: he become a mortgage broker. So this person went from managing a vast company to brokering a loan or two a month. Yet, he is now positively contributing to the U.S. economy, albeit not as substantially as he did before. Is this not an economic dynamic that will play out should another 5 million people become unemployed? Will they not in relatively short order (my friend was unemployed for a few months) begin creating new value for the economy? How can the net effect of their unemployment be truly measured to account for subsequent economic activity?

Comment by Michael Smitka on November 20, 2008 at 12:32pm

Over time people do find new jobs. When the economy is doing well, that's not an issue, we have a constant rise of one industry offsetting the decline of another. So there's a matter of timing.

Second, geography matters. For most Americans, their biggest asset is their house. When an industry goes under that is both large and involves large units, then communities take a hit and it's not just the job that goes, but also wealth. Furthermore, given the way in which we finance local government, the community takes a huge hit with schools and everything else. That accentuates the loss of value. And it also means new companies will be very slow to move in. People have to move where the jobs are (absolutely unclear at the moment that such a place exists!), and they've lost the resources to do so.

Third, some skills are portable, some are not, and you need the job market to make that link. Much of the value of an organization comes from the ability of its members to function together. Destroy the team and you destroy that value. If GM goes under, then over time Toyota will add a few more plants. But it won't happen fast enough or in the same geographic area or probably with the same hiring criteria (while age discrimination isn't legal, how many 55-year-old ex-Detroiters will they end up hiring.)

Again, if this was a single worker, such things wouldn't matter. Indeed, with luck someone might land a new job in the same community before unemployment insurance runs out -- though the job match is likely to be worse, meaning a cut in productivity for the employer [or a worker who is underemployed] and a cut in pay for the worker. But if it's 160,000 at the same time, then there aren't going to be any jobs to land in the same community -- and the things that tend to cause 160,000 jobs to be lost at the same time probably mean that everyone else is shedding workers, too, across the country. The former is a microeconomic story (as is your friend's), the latter a macroeconomic one. Unfortunately we're having to deal with the macroeconomic one right now. And the human cost of massive unemployment, of perfectly capable individuals unable to find jobs, is huge. To lose a job is traumatic, to lose income is traumatic, and it affects family and community and not just the individual. Such unemployment -- regional and structural -- tends not to end quickly in good times; it can last for years in bad times. And the jobs that are found tend to be bad matches -- as in the case of your friend, an experienced manager with all the skills that entails reduced to grunt work. (In contrast, in good times the average spell of unemployment is fairly short -- and includes lots of people who quit their jobs because they expect to find something that is a better match. Not many people quitting at the moment.)

Comment by JJ Hornblass on November 20, 2008 at 4:02pm

That is wonderfully helpful. Thanks. (But now I am truly depressed.)

Comment by Michael Smitka on November 20, 2008 at 9:39pm

But I'm a practitioner of the dismal science, and try to live up to my name. Hopefully I'm inappropriately pessimistic about the magnitude of problems the industry faces.

PS I was in a brief interview portion on a local public radio station today (WVTF in Blacksburg VA). The full thing (22 minutes) will be on their web site at some point, but isn't up yet.

Comment by Michael Smitka on November 21, 2008 at 7:53am

New query: how are dealerships structured? At BuyAmerica Cars BMW Chevrolet Chrysler Dodge Ford Infiniti Lexus ... are the operations separate subsidiaries with their own bank lines? Or is finance centralized? My underlying question is whether the failure of the GM portion, big floor plan but worthless inventory, would sink the whole shebang or whether the BMW Infiniti Lexus portion could continue?

Comment by David Ruggles on November 21, 2008 at 9:53am

Over the years I have been through a lot of auto industry ups and downs. At one point, I was a partner in a Chrysler/Ply/Dodge/GMC truck store in a small river town in IA. This was 1978 - 1980. We floor planned all inventory through a local bank but financed most deals through GMAC, even the Chryslers. GM was buying deals hot and heavy and we had a real advantage over competitors who only had local banks or Chrysler Credit for financing options. The Chrysler Credit financing was "limited repurchase" as opposed to "WOR" (without recourse) which meant the dealer had to stand good for repossessions and losses to a large degree. Limited repurchase is a lengthy explanation. They also had to have an entry on their books called "Allowance for Doubtful Accounts." Then one day GMAC issues in edict that they will no longer finance new vehicle deals that are non GM products. It had a devastating impact on our business. We were still profitable through it all but with a possible impending Chrysler bankruptcy we had an opportunity to sell the store and took it.

In today's auto world, this dealer could floor plan his BMWs through BMW Credit and some of his other inventory through a local banks or through another manufacturer's captive. Capital loans are a different story. Most of the capital loans are through local banks, but the captives have been engaged in that business as well. Keep in mind that new vehicle floor plans floor plans are based on a manufacturer buy back guarantee that is included in the franchise agreement. If a dealer terminates his franchise, or is terminated by the manufacturer, OR goes bust, the manufacturer agrees to buy back all new inventory that is current year AND unmodified and under a stipulated odometer mileage. Capital loans are for the entire business. Multi franchise stores will typically have one capital loan through a bank, whereas a single point dealer might have a cap loan through the OEM captive.

The answer to the question; I have a friend who has multiple franchises under many roofs. Under one roof, his original flagship store, he has Chrysler/Jeep/Dodge/BMW. If Chrysler disappears he has no "buy back" option for his Chrysler inventory which now must be sold for a song. Who knows what the market might be on new but unwarrantiable vehicles? On the flip side, the BK manufacturer can't arbitrarily come in and demand that he pay off his inventory. If the dealer had cash, he COULD pay off the inventory, but why do it? He would hope they came and "repossessed" the new vehicle inventory OR any late model pre-owned inventory. (Captives will sometimes floorplan late model inventory as an inducement for the dealer to buy off daily rental and lease units.) As a practical matter, the dealer might sell of inventory and refuse to pay the floor plan source for the vehicle if the floor planning entity is the manufacturer's captive. Trying that with your local bank would get you shut down. Local banks would want to be instantly paid off for new inventory that is no longer covered by a manufacturer buy back guarantee, or at least have those vehicles curtailed as used vehicles.

In the meantime the upheaval from all of this would be catastrophic. The loss of business, the fact that the manufacturer wouldn't be paying monies owed to the dealer (holdback, warranty reimbursement, carry over allowance, rebates, etc.) might put the dealer's operation and balance sheet so out of whack that it might throw his other financing out of compliance with his other underlying lending agreements. The flip side of this is the dealer probably wouldn't pay his parts account statement to the manufacturer. As a practical matter, a multi franchise dealer would be left with the challenge of angry customers who would expect the dealer to do warranty work without reimbursment from the factory on the BK lines. He would try to sustain his overhead through pre-owned sales, fixed ops, and his remaining viable lines. So its a mixed bag, depending on the dealer, and a huge mess. Its very difficult to quantify.

Comment by Michael Smitka on November 26, 2008 at 11:33am

Thanks, David. Snow here in northern Michigan visiting parents; Las Vegas is warm & sunny?

Working on additional stuff, will try to figure out how to most effectively post on this site.

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