Auto Bailout: If You Thought it Was Ridiculous Before…

By: Q1_Publishing

To be honest, I figured General Motors would be in bankruptcy by now. With a monthly burn rate estimated to be between $2 billion and $6 billion (depending on source) it would seem this money hole would have imploded sooner rather than later.

But with the stimulus package signed and the goal of creating or saving 3.5 million jobs (on a side note, if anyone knows how you calculate “saved” jobs please let me know – it seems if 3.5 million people are still working by the time the next election rolls around, this will be a “success”) and hundreds of billions of dollars ready to be handed out to anyone who earns a prevailing wage, the government may have revealed their plan to save GM and Chrysler.

This time, they're actually addressing the real issue at hand. After all, it's basic economics. It's all about supply and demand.

The Supply Side

In a week when GM's market cap fell to below its 1938 valuation (yes, lowest since the Great Depression) and announced 47,000 layoffs, it still felt it somehow deserves more taxpayer money to stay afloat, GM and Chrysler handed in their recovery plans.

The plans called for layoffs, restructuring, and more cash – much more cash. GM and Chrysler asked for an additional $7 billion in “loans” immediately and more than $21 billion down the road. This was on top of the $17.4 billion the companies received last year.

But this cash won't address the real problems GM and Chrysler are facing which we identified when they got their first round of handouts:

At the end of October, GM North America reported it has 799,000 vehicles in stock – consisting of both cars and light trucks. That's about five months worth of inventory (when measured against the 166,000 sold in October), which is 15% below last year's inventory, but it's only getting worse.

At current sales rates, inventory will start to grow. GM expects to produce an additional 567,000 (875,000 total for Q4 minus 318,000 October production) over the next two months. If the October sales rate holds up, despite rising unemployment and falling consumer disposable incomes, GM's total inventory will increase to 1,234,000 vehicles.

Since then, sales have only gotten worse and thanks to government life support they're still making more and more cars. But here's where the government is making its most ridiculous move yet to address the overcapacity problem and cover more of the automakers cost.

The Demand Side

This is the big question I had a few months ago. During an interview with BNN , we identified there were a total of 250 million cars, trucks and motorcycles registered in the United States. But there are only 203 million drivers. That's an average of 1.23 vehicles for every driver.

At the time it seemed everyone was focusing on debating the morality, but there were much, much bigger questions at hand whether it was right to bail out these companies or not. For instance, where all the demand would come from? Does everyone who wants a car already have one? How many people would choose to upgrade to a new model in the middle of an economic downturn?

So the government devised a solution: they'll create demand.

One big part of the stimulus package is for the government to purchase $300 million worth of new cars. Sure, it's for hybrid cars (which I guess makes it a bit more marketable to the public – who wants to say hybrid cars are bad), but it's clearly aimed at making a dent in the overcapacity problem.

So now the government is not just subsidizing supply, it's also creating artificial and unsustainable demand.

Ballooning Backdoor Bailouts

On top of that, there are plenty more “backdoor bailouts” for the auto industry. The Detroit Free Press reports there is:

- a tax deduction on auto loan interest which consulting firm R.L. Polk says works out to about a $1,250 subsidy per car purchased (good idea! Especially since the tax policies and implicit Freddie and Fannie guarantees which help create a “house for everyone” bubble worked so well…)

- An income tax deduction for purchase of hybrid vehicle worth about $330 per vehicle

- A $2 billion grant for manufacture of batteries for hybrid cars (read: government pays for a big portion of the cost of production)

- $4,500 vouchers for new cars given only to people who drive cars which get less than 18 miles per gallon (I guess, a nice “thank you” for being part of the problem)

In the end, this whole situation seems eerily similar to a story a friend of mine once told. I lived in Germany a few years ago and worked with quite a few Germans who showed me firsthand how socialism can destroy an economy.

One of them was from East Germany and who used to work in a nail factory before Berlin Wall came down. He told me one side of the factory made nails. The other side of the factory melted them down. It seemed inconceivable to me at first, but it was a way to create “jobs” for everyone.

Hopefully we're not going that way here, but the way it's all shaping up, more questions remain. We'll keep you posted in our Free E-Letter the Prosperity Dispatch .

What happens after we have a new government department (Car Czar and staff) to oversee the production of cars nobody wants? Do we get a new department to hire people to drive them around?

I sure hope not. But if it does, I can't wait to see Rick Santelli's next rant.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

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