GM is toast

After today's annual report, I don't think there's any question of GM's staying out of bankruptcy. The company's revenue fell from $180 billion in 2007 to $149 billion in 2008, with the worst crash in the fourth quarter. Car sales have continued to plunge into the new year. The company's current asset position continues to deteriorate by about $2 billion a quarter even with massive Federal injections of cash. With cash & equivalents now down to just over $14 billion, they can't go on this way for much longer. Though no one knows exactly how much working capital the company needs on hand at any time, the estimates tend to fall around $10 billion. Dip below that, and they'll rapidly be catapulted into insolvency.

But don't take my word for it--listen to their auditors:


Image from flickr user D'Arcy Norman



GM warned last month that its auditors, Deloitte & Touche, could raise those concerns, but the announcement underscored the stakes for G.M. as it sought up to $30 billion in government aid to restructure with a bankruptcy filing.

"Our recurring losses from operations, stockholders' deficit and inability to generate sufficient cash flow to meet our obligations and sustain our operations raise substantial doubt about our ability to continue as a going concern," the company said in the filing.

GM has burned through $13.4 billion in less than six months. What will $30 billion buy us? Another year, at best, with no signs of a turnaround in the market for cars. Autos, like other big consumer durables, are especially sensitive to downturns like this. There's only so much food you can cut out of the budget, but you can certainly drive the 2001 Grand Caravan for another year.

Too, auto companies have a hard time downsizing to deal with crashing demand. They are, in a way, highly leveraged, as Tyler Cowen describes Asian countries:

The usual story is that these nations are "heavily dependent upon exports." But if I may wear my Don Boudreaux hat for a moment (or more), is not the state of Kentucky also heavily dependent upon exports? Is not the Cowen household heavily dependent upon exports? Why is being dependent on exports so especially bad for parts of Asia?

One answer is that Asian exports, which travel great distances, are often consumer durables and such purchases are especially easy to postpone. Services are often more robust.

Another answer is that many Asian producers have chosen high fixed costs in a way that requires steady or rising revenue over time. That is their version of being highly leveraged without taking on much explicit debt. Again a central lesson of this depression will be how many different ways there are to leverage.

Their fixed costs include not just the infamous pension and healthcare costs for retirees, but also plants, environmental liabilities for cleaning up manufacturing sites before they can be sold, and an operating structure that makes it extremely costly to shut down plants for any length of time and then open them up again. If you plan to keep operating the plant in the future, you have to do things like heat the factory to keep the pipes from freezing, and service the machines; also, the costs of reassembling a laid off workforce mount with every month that the plant remains shut down. People will not hang around a dying factory town indefinitely, though the depressed state of the Michigan economy actually does help mitigate these costs relative to a place like Japan.

Though I've been against the bailout, on the grounds that failing automakers simply don't pose systemic economic risks, some of the advocates have made a reasonable argument that it was worth spending a tiny fraction of the TARP funds to get the automakers over a temporary hump. But the hump is clearly, at this point, a rapidly inclining mountain of problems. And given the reasonable assumption that Chrysler will also need repeated future infusions, the fraction of TARP we will spend on these two companies alone no longer looks that small.

There's another problem: how long before having to compete against government subsidized bankrupts forces Ford to jump into line for funds? If we keep funneling money to GM and Chrysler, expect to see Ford at the lending window sometime soon. Their retained earnings borrowings cannot compete with an unlimited well of federal money.

It's time to stop talking about keeping GM out of bankruptcy, and start talking about what measures might be necessary to keep GM as a (smaller) going concern rather than outright liquidation. One thing to look at is warranties: consumers are understandably worried about buying a car where the warranty may not be good in a year. There may be a government role in guaranteeing that coverage.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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