Timing Detroit

Today’s argument by the Big 3 (2 ½?) seems to have morphed into an issue of timing: even if one thinks the auto industry should go under, now is not the time. The recession having been declared since the last failed attempt to wring taxpayer money out of Congress, the auto makers argue that if they go down now, economic Armageddon will ensue.

Aside from other criticisms of this plea, it begs the question at issue. If now is not the time to let GM go bankrupt, when is? Is it Q4 09, when the recession has (hopefully) abated? Or when the jobs market recovers (and is the present measure of that believable)? And why should the taxpayers give them 30 billion dollars while we wait for their deaths?

The arrogance of the Big 3 is appalling. But the issue of timing is not without substance. The timing being discussed, however, is, like virtually all of the issues discussed in America today, wholly off the mark. The timing truly at issue is that of the deleveraging of the American consumer. And that timing is now.

The Big 3 are indirect victims of the credit crisis. American consumers are badly overleveraged. They have too much debt, especially mortgage and consumer debt. The widespread and heavily encouraged trading of home equity for consumption debt over the last decade is especially illustrative of the problem. Yet the household-by-household deleveraging of the US consumer is now underway; foreclosure and deprivation of consumer credit are the fastest routes to ending further household debt imaginable.

Part of the Big 3’s problem, however, is the nature of the housing bubble. Virtually all of the housing orgy of the last 10 years took place in the suburbs. The six-ton, three-car household is the Siamese twin of the housing boom. While toasting on the Kool-Aid served up at their new home and mortgage closings, these new suburbanites borrowed to buy the cars and SUVs they needed for their new, auto-centered lifestyle. The single-station wagon family gave way to the one-sedan, two-SUV family, complete with three-car heated and enclosed attached garage. Detroit drank this Kool-Aid along with US consumers. The GM model for US sales sustainability was similar to their profitable Chinese operation: as long as more housing is being built, and cash is available to finance auto purchases, they can continue selling automobiles without structural change.

The overleveraged-Kool-Aid fest is not limited to US households. Investment banks (remember them?) had absurd leverage ratios, with overconcentrations of the sugar in the Kool-Aid -- housing-based derivative securities. Banks extended credit to consumers based on insufficient collateral (their homes) so they could consume discretionary goods like electronics and second and third automobiles. Then, there’s the big daddy of leveraged finance, Uncle Sam. Accumulating an enormous federal debt and ballooning deficits, the US borrowed huge sums from China (and other nations) to balance its current account, all the while maintaining a weak enough dollar for Chinese imports to offset the debt racked up by US consumers, business and government.

And that’s the tie that binds the whole affair. US consumers are going to consume fewer discretionary goods and services in the future, because they have to. Permanently higher commodities prices – primarily gas and food -- drive higher household budgetary anxiety and result in lower discretionary household spending. Combined with substantially higher health care costs, an aging population and a contraction of credit to fund any household expenses, a long-term trend toward lower discretionary consumption emerges.

Indeed, they already have. Consumer spending, as reflected in retail sales, consumer confidence and the US savings rate, all point to household spending contraction on everything other than necessities. The Bush economic stimulus checks were not spent by consumers, they were hoarded by households or used to pay down household debt – to deleverage (like the TARP funds given to banks).

The implications are enormous. The model of a global economy that has arisen is one of the US borrowing, through household and government credit, to fund imports from overseas. Imports in turn create wealth for households and private business in China, and elsewhere. That wealth creation is the true definition of “emerging markets.” (Last October when the People’s Republic of China cut central bank interest rates in concert with the US and ECB was the final death knell of Chairman Mao.) If US consumers consume less – if they consume some amount that is in fact sustainable given the actual, non-inflated value of their collateral assets -- the global model gives way to global crisis.

Which brings us back to Detroit. The issue is not whether the Big 3 can be allowed to fail at this time -- during recession. Nor is it how long before they will begin making green (and unprofitable) cars. That is the same as asking what month of 2009 they should be allowed to go bankrupt. The real question is: How will they structure themselves to profit from deleveraged US households that can only afford one-ton of auto each? If the time has now come where consumers buy fewer cars as a matter of household finance, how will the Big 3 shrink to meet this demand?