(no subject)

The Big Three US automakers are in Washington today, asking for various forms of government backing to avoid collapsing. Their basic argument is that if any one of them were to declare bankruptcy, the other two would also have to do so immediately to remain competitive, and that doing so would cause so much dislocation in the industry that the entire upper midwest would essentially immediately fall into a severe depression.

There are a lot of moving parts in that argument, but I would like to spend a moment talking about how this came about. In the bad old days of the 20s, 30s, 40s, and 50s, an automotive company was a way to turn a steel plant into money. How much money you could turn it into depended essentially upon how efficiently you could use the steel to produce your car, and how attractively you could bundle a set of features together into a vehicle that a larger number of consumers would pay the most for.

However, because cars were a large, durable item, with a high resale value relative to their original purchase price, one of the most effective ways to increase the number of consumers who could buy them was to offer financing to the consumer. Eventually every automotive manufacturer did this, which began a slow transformation in what kind of company the manufacturers actually were. Over time, they began to make a larger and larger fraction of their profit off of the loans that they were selling to the consumer, and a smaller and smaller fraction off of the difference between what it cost them to make the cars and what the consumers were willing to pay for the cars. In effect, the automobile manufacturers became, largely, finance companies.

Now, this used to be a pretty neat trick. A large automobile manufacturer, traditionally, could borrow much more cheaply than a consumer could. After all, any given consumer could go broke at any minute, but the car company is much less likely to. In a traditional-until-recently car purchase, your down payment goes to pay the commission of the salesman who sells you the car and the expenses of the dealership to have the vehicle on their lot. The loan, effectively, is for the amount of the actual cost of the car, and the profit margin to the manufacturer is the interest on the loan. The dealership makes some of their actual money on the service contract, some of which is being flipped back to them by the car company (taken out of the payments that you make on that loan), some of which comes from service that they persuade you to get above and beyond the basic warranty on the vehicle, and the rest of their money on the sale of the used car you trade in to them when you buy a new one. This basically pays everyone's salaries, and they all go home happy, assuming that you like the car you just bought.

However, it falls down horribly if any one of several things happen -

1. The consumer's cost of borrowing falls to approach the manufacturer's cost of borrowing
   
2. The manufacturer's cost of borrowing rises to approach the consumer's cost of borrowing
   
3. The demand for cars falls sufficiently that the auto manufacturer has trouble meeting their fixed costs on the profits from the remaining sales
   

All three of these things have happened over the last year. In the past, Detroit has had to contend with product mismatches and supply mismatches, where their costs have increased faster than the consumer's willingness to pay more for a car, or when Detroit just wasn't building the cars that Americans wanted to buy. But that didn't create nearly the same kind of crisis that we're seeing today. Building the wrong cars? Discount them heavily to move them off the lot, and start building the cars people do want to buy. Raw materials and labor prices spike? Suck up some of the losses, start piling on features to justify high enough prices to make up for the change, and change product mix to reduce the raw materials cost.
But changes in the real total demand for cars presents a special problem. Normally, when we hit the end of a business cycle, what's happened is that the absolute supply of a given sort of goods have exceeded the absolute demand for them, and all of the suppliers of those goods have a bad day while the excess supply gets slowly bought up by the market. Eventually there is more demand than supply, and suppliers can begin to expand again. But right now, the US makes about 2 million more cars a year than anyone actually wants to buy. Worse yet (if you're a car company), one of the things that car companies have been competing with each other about is who makes the most durable vehicle. Ten year warranties have become common, compared with three year warranties back in the early 80s. A reasonably running vehicle with a hundred thousand miles on it used to be a sign of an unusually hardy vehicle. Now it just means that the vehicle hasn't been unreasonably abused. That means that, effectively, the pool of supply of cars has been increasing, because while Detroit keeps making cars, the cars they make are lasting longer, which reduces the number of new cars that need to be produced to meet the rate at which demand naturally expands. Since Detroit makes their money on selling you a loan to buy a car, this is a structural business model problem, instead of just a capacity problem.
Secondly, the credit market has gotten much better at evaluating how risky consumers are, and for a while there was a phenomenal amount of money available to be lent out. That drove the price of borrowing for consumers down. When the US credit market was much less developed than it is now, the fact that your auto manufacturer could write you a loan for your car enabled millions of potential drivers to buy cars. However, with the phenomenal amount of capital available to lend over the last few years, and the creation and then expansion of the credit rating industry, the price of borrowing for consumers has plummeted. Which has made life more difficult for companies whose profit margins depended on the difference between their cost of borrowing and the consumers'. Further, because it's now possible for, say, your bank to loan you money and then combine that loan with a lot of others and sell them all off to a third party as a bond, your bank can offer much more credible competition for the car companies in the race to offer you a loan for that shiny new car. Which has forced the car loan margins to tighten, reducing how much money they can make on every vehicle.
And third, the credit crunch, which has driven up everyone's cost of borrowing, including the car companies, has now collapsed how much consumers can borrow, and how many consumers can borrow. Since the way that the car companies actually make money is by selling loans, that means that the amount of money they make has shrunk a great deal - sure, if the car companies had the money, they could go ahead and choose to loan it to consumers, but, in fact, they were simply going to turn around and borrow it from someone else, and no one with money to loan feels especially good about when they're going to get it back. So GM's ability to walk out and borrow a bunch of money to turn around and loan it to you to buy a car is... constrained.
In short, the basic business model of the modern American automotive manufacturer has blown up, and they now very hurriedly need to come up with a new one, or face dissolution. It is not a pleasant day to be an automotive manufacturer.
As Gary Larson once observed, Bummer of a birthmark, Hal.