Thursday, November 20, 2008

How many cars will solvency take?

In its quest to secure the billions of dollars in help it needs to avoid bankruptcy protection, General Motors has developed a simple narrative. "We got caught," said David Paterson, the man charged with selling the GM story in Canada - caught by the financial meltdown and by a collapse in demand for new cars.

As GM folks tell it, the turnaround was speeding along before the crisis hit. The company had shed tens of thousands of workers and killed dead brands like Oldsmobile. It had squeezed the United Auto Workers, curbing absurd union schemes like the infamous jobs bank, which pays laid-off workers to sit around playing Yahtzee. New models like the Chevrolet Volt held the promise of better sales. Then - wham - the bottom fell out. Is it GM's fault that Wall Street got out of control? Of course not.

The point of this chronology is to impart a message: GM is not drifting. It has a plan. And as soon as the auto market comes back to normal, it will be a viable business again because of that plan. Therefore, it's worth it for taxpayers to grant a rescue loan to tide them over. So let's give GM credit for the progress it has made, then ask the inconvenient question: What's "normal" if car dealers can no longer offer abnormally cheap car loans?

The key number here is 17, as in 17 million. The world's auto companies sold that many vehicles in the U.S. every year from 1999 through 2006 (save for one year, when they sold 16.9-million). In 2007, sales were about 16.5 million.

Then came the calamity of 2008. The latest forecast is that sales will come in around 14 million, but even that flatters the truth of how quiet it is in the showrooms. In October, sales plunged by nearly one-third. That translates to an adjusted annual total of less than 11 million cars and trucks. That's why GM and Chrysler have been brought to the brink, but even healthier auto makers like Nissan and Toyota are suffering.

Blame the recession? Yes, but also blame the end of easy money. The Detroit Three spent years training their customers not to buy vehicles without a subsidy - usually in the form of 2-per-cent or zero-per-cent loans. They also taught them not to bother saving for one, because no down payment was required. (Your columnist, when buying a Pontiac Vibe five years ago, was practically admonished by the salesman for putting $2,000 toward the purchase. Didn't I have a better use for the money, he wanted to know?)

Those days are gone now, probably for a long time. Cheap financing is still available, but mostly for those with good ratings and some cash in their wallets. A salesman at a Toronto GM dealership says that on a $20,000 vehicle, customers are often asked to put down $3,000 or $4,000. The problem, he says, is that people who want those cars usually don't have a lot of cash - which is why they're shopping for cheap wheels in the first place.

The auto makers' financing arms, like General Motors Acceptance Corp. (GMAC), are also rejecting more customers, putting them in the hands of banks charging 7 or 8 per cent. Bank of Nova Scotia, Royal Bank and several other institutions do the business, but some banks, like HSBC and Wells Fargo, have pulled back.

So here's the $25-billion question: In the era of tighter money, how far will sales bounce back? "The ability to get back to 17½ [million U.S. sales] without cheap financing is near zero," says Dennis DesRosiers, Canada's top automotive consultant. Still, he's optimistic. "Can they get back, though, to 15½ million, perhaps 16 [million]? Probably. Would that be enough to give the vehicle companies the ability to manage through this crisis on their own? Probably."

But there is a "nightmare scenario," Mr. DesRosiers says. There are approximately 240 million U.S. residents who are old enough to drive, and already a slightly larger number of vehicles in the nation's garages, for an ownership rate of just over 100 per cent. This could drop. "Canada's ownership is only 74 per cent," Mr. DesRosiers says. "So could the U.S. get along with 90-per-cent ownership rather than 100-per-cent ownership? Absolutely. It would be a cultural shift."

Let's do some quick math. Suppose the debt crisis causes more Americans to take the bus. Assume the ownership rate dips, and the number of U.S. vehicles drops by 5 per cent, to about 233 million. Then suppose they begin hanging on to their cars a year or two longer, so that only 6 per cent of them replace their vehicles in any given year (instead of 7 per cent).

The result? U.S. auto sales of 14 million. Would that be enough to keep GM, Ford and Chrysler alive? I don't know. But I do know that Stephen Harper and Dalton McGuinty should be asking the question before they sign up for a few billion in loan guarantees to Detroit.

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