The Cascade Effect
I wondered last night why Ford wanted a bailout for its competitors at Chrysler and GM even though Ford isn’t facing imminent bankruptcy. It seemed to me that the collapse of GM and Chrysler would be a boon to Ford and vague talk of a “cascade through the entire domestic auto industry” didn’t really explain it to me. Steven Pearlstein gets a bit deeper in terms of spelling this idea out:
The fear is that if either files, the other two companies would be forced to follow suit as parts suppliers fail and consumers get even more nervous about buying a car from a company in trouble.
This still seems a bit weird to me, but I suppose that makes some sense. I’d like to know more about Ford’s logic, though. Indeed, given the quality of management these companies seem to have had over the past few decades it’s perhaps worth considering the possibility that Ford management is just mistaken.
43 Responses to “The Cascade Effect”
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December 3rd, 2008 at 2:00 pm
You’re kidding me, right?
December 3rd, 2008 at 2:05 pm
Alternatively, you could have read your own comments thread and had the same answer about 3 minutes after you posted last night.
December 3rd, 2008 at 2:16 pm
It’s not just Ford that’s lobbying for a bailout. Honda and Toyota are lobbying for the Fed to Bailout the Big 3 as well.
Normal Econ 101 stuff doesn’t apply to this situation b/c of the systemic risk involved. Much like the banking industry.
If GM goes down, it’ll effect a vicious cycle. There isn’t financing available for a healthy firm to purchase the assets of any of the distressed entities (i.e. Attractive GM lines, Attractive suppliers). Furthermore, the remaining auto manufacturers would not have the capacity to pick meet the existing (albeit recession hamstrung) demand. This is magnified by the failing suppliers.
December 3rd, 2008 at 2:19 pm
This is getting frustrating.
December 3rd, 2008 at 2:25 pm
I can think of two reasons. First, Ford, like the other two, is generally favorable to being bailed out, has benefited in the past from Mr. Dingell’s efforts, and wants to keep the momentum generally in favor of help for the auto industry. It doesn’t want to see the political dynamic shift away from the automakers at this point, because Detroit will never get that back.
Second, Ford probably also has short-term reasons to favor a bailout, which is that the collapse of the two automakers might mean a further decline in prices that would force Ford into an even worse position.
I’m not so convinced by my second reason, but I think there’s something to my first reason
December 3rd, 2008 at 2:30 pm
Because the auto parts manufacturers make parts for all of the Big Three, and if any one of them goes under, the auto parts manufacturers go under, and Ford can’t make cars.
There are a lot of stupid comments in the previous comment thread from last night [like the one I italicized], so I can see why Matt might pass over some of the explanations. For instance, the idea that if various parts manufacturers go under, THERE WILL BE NO MORE PARTS, is fucking absurd. There would obviously be demand for parts, and thus, after the market sorts out, parts suppliers.
Look, no one is saying that automakers going under would be PAINLESS or would not have a “cascade effect” in the same way that if Starbucks went under, it would be very painful and have a cascade effect on lots of other people, suppliers.
But the idea that Starbucks going under would destroy all other coffee shops is, like with the automaker/part suppliers argument, just totally idiotic.
December 3rd, 2008 at 2:37 pm
Also, let me just add, it’s kind of ridiculous that consumers being nervous equates to CONSUMES NEVER BUYING CARS AGAIN. Yeah, ok, so consumers are nervous now, and they would be nervous for months after GM went under.
But wouldn’t stop buying computers if Apple and Dell went belly-up tomorrow. They’d stop buying Apples and Dells. And maybe they’d curtail buying computers for 6-9 months because the economy is awful.
But as someone who will be in the market for a truck – I live on a farm – in the next year, I’ll be buying a Ford or whatever in the next year, regardless of what happens to the other automakers.
Of course, I will be buying it at a discount, and if the warranty turns out to be no good, well that’ll be why it’s so cheap.
December 3rd, 2008 at 2:39 pm
Isn’t this essentially the same post and thread as “Ford Confuses Me,” below?
Joe:
The demand for parts is down because the demand for cars is down. Now, in a broader term, somewhere in the world, when the market recovers, there will be parts again. But will they be in Detroit employing people, if this recession lasts for one or two years, and the current firms go under?
And Starbucks going under won’t destroy other coffee ships, but it might very well destroy coffee exporters and coffee plantations if it happens in the context of a general slump in coffee demand.
December 3rd, 2008 at 2:39 pm
“And maybe they’d curtail buying computers for 6-9 months because the economy is awful.”
Joe, do you feel like you could comfortably go without income for 6-9 months, in this climate?
Also, isn’t there a chance that 6-9 months of failing automakers might make the economy more awful?
December 3rd, 2008 at 2:41 pm
Oh, for fuck’s sake: if you’re just going to be a lazy fucker about this, then stop writing about it. Get the picture, Matt? You sound like Jonah fucking Goldberg.
December 3rd, 2008 at 2:45 pm
You are all missing the point here. MY is clearly making a meta comment about Obama disregarding his base by intentionally fucking with the commenters. Well done, MY, well done.
December 3rd, 2008 at 3:03 pm
This is not that complicated- Ford’s thinking “for the grace of God”- meaning that they themselves are in a perilous situation and may need some help in the future. Also there is corporate incestuosness going on- a major league player will be compensated more if his opponent fails- nevetheless, they all belong to same union. Let’s simply view as corporative collective bargaining- whatever conditions are imposed in the bailout will probably affect Ford- so they want a seat at the table- that would not happen if they were dissing GM. Capice?
December 3rd, 2008 at 3:21 pm
Well that’s the tricky part. If a supplier gets half its business from GM and half from Ford, then sure, it could manage to cut back and still be around to supply the Ford parts, but maybe it can’t handle that shock to its cash flow. Then Ford would be stuck trying to find a new supplier of, lets say, starter motors.
December 3rd, 2008 at 3:44 pm
“If GM goes down, it’ll effect a vicious cycle. There isn’t financing available for a healthy firm to purchase the assets of any of the distressed entities (i.e. Attractive GM lines, Attractive suppliers). Furthermore, the remaining auto manufacturers would not have the capacity to pick meet the existing (albeit recession hamstrung) demand. This is magnified by the failing suppliers.”
On the whole, I buy the general argument that a huge and rapid
restructuring of the industry triggered by a GM liquidation
would be painful for the US, and even painful for Ford and Chrysler.
But the two points you make here are just nonsense.
If GM is forced to liquidate, then their assets *will* be sold. The only questions are, sold to whom ? and at what price ? If other auto manufacturers are short of cash, and
credit is not available, then the assets will be sold at a
very low price. But liquidation is liquidation: the creditors
take over the assets and sell them for whatever they can get.
Then would the remaining automakers have the capacity to meet demand ? Well, going back to Econ 101, “demand” is not a
fixed quantity. There’s a price-demand curve. So the answer
is that if a big chunk of supply vanishes, then we will quickly move to a different point on the price-demand curve,
with prices rising to bring demand down to match the reduced
capacity.
In more detail, if GM stops selling cars, then Ford/Toyota
etc will see their sales rise, and when and if their sales
rise far enough to match their production capacity, then
they’ll first stop incentive programs, then start increasing
prices, to optimize their profit in the new market conditions.
Cars will generally get more expensive, car makers will be
*much* more profitable (it’s a business with very high fixed
costs, so running factories below capacity really hurts).
The only temporary glitch in that picture is that GM and its
dealers would have a substantial overhang of inventory (cars
ready to sell) which would have to be cleared out by selling
at very heavy discounts (who wants to buy a car from a
bankrupt company ? someone, but only if the price is right).
So that would probably disrupt the market for 3 months or
so.
December 3rd, 2008 at 3:45 pm
Could someone please name some of these parts suppliers that serve the big three and would go out of business? I thought GM spun off Delphi and Ford spun off Visteon and those two were the major parts suppliers for GM and Ford. Delphi already went bankrupt and is still in it. So are you all saying Delphi would go double super bankrupt if GM went bankrupt?
It is the competitive disadvantage that a rival’s bankruptcy protection would put on Ford or alternatively the competitive disadvantage of your rival suddenly get a boatload of free money.
On the other hand the idea that they just cant stop thinking like an oligopoly and insist on being treated the same even after circumstances have overtaken them is not so crazy either.
December 3rd, 2008 at 3:46 pm
I don”t get why people would be wary of buying a car from a company going bankrupt. People say this all of the time so I assume it’s true, but I don’t see the logic. Is it just the availability of future spare parts that people worry about?
December 3rd, 2008 at 4:08 pm
“I don”t get why people would be wary of buying a car from a company going bankrupt. People say this all of the time so I assume it’s true, but I don’t see the logic. Is it just the availability of future spare parts that people worry about?”
You typically get at least 3 years warranty on a new car. If
you’re buying from a company that’s going out of business,
that warranty protection is probably meaningless and worthless.
And you probably want to have a dealer nearby. If the company’s
bankrupt, the dealers will either disappear or change to
another manufacturer.
Then the supply of spare parts is a concern, though I think
this is somewhat overblown now that cars tend to be built on
common platforms, and have parts from independent suppliers.
Most of the components that need replacing – alternators,
spark plugs, starter motors, brake pads, timing belts – are
already available from third-party suppliers. And if you need
something big like a new engine or transmission, there’ll be
junkyard parts.
So at one level, I think you’re right: if GM went bust, all those GM cars in inventory would still get sold to somebody.
But I think they would be sold at a hefty discount: if you
can get a brand-new Kia with a meaningful 10-year warranty
for say $12K, then you probably wouldn’t want to mess with an
unwarrantied Chevy Cobalt unless it was discounted to $8000
or less (effectively the price of a used car). And flooding
the car with 1M such discounted vehicles overnight might
further depress prices.
December 3rd, 2008 at 4:12 pm
Mario:
Parts, servicing, warranty, financing, etc.
December 3rd, 2008 at 4:15 pm
Thank you.
December 3rd, 2008 at 4:20 pm
Could someone please name some of these parts suppliers that serve the big three and would go out of business?
Well, Fortune 500 companies listed in the “motor vehicles and parts” industry and which do not actual manufacture motor vehicles include Johnson Controls, Goodyear, Delphi, Lear, TRW Automotive Holdings, Visteon, ArvinMeritor, Federal-Mogul, Autoliv, Tenneco, and BorgWarner. There’s a bunch more in the Fortune 1000.
December 3rd, 2008 at 4:50 pm
Sure! But production will shift overseas (not good for the US) and take a matter of months to “sort out.” That’s more than the margin by which Ford is clinging to existence.
December 3rd, 2008 at 4:57 pm
Joe, do you feel like you could comfortably go without income for 6-9 months, in this climate?
Of course not, but the point is to then help the workers. Not direct money at propping up a shitty bunch of companies who were in trouble in 2005 when the economy was going much better.
People are focusing on the fact that we need to protect autoworkers. We don’t need to protect autoworkers. We need to protect/help workers. Period. That they work for GM is beside the point.
December 3rd, 2008 at 5:29 pm
Another supplier off the top of my head is American Axle. A good google search will reveal many parts suppliers outside of the Delphi family making things from struts to brake components to even frames.
December 3rd, 2008 at 6:02 pm
Almost 80% of the people who work making cars work for parts suppliers. Most of the value comes from part supplies. The Detroit Three share 80% of their U.S. suppliers. Disrupting the supply chain is a massive, big thing that would definitely have spillover effects on others — if you’re a supplier that does 50% GM/Chrysler, 50% Ford, you could easily go out of business if GM and Chrysler go, and then you don’t deliver your parts to Ford. Disruptions would be big and take time to route around. Lead times for new models are long. Parts are not fungible from different suppliers, companies work with their suppliers to fine-tune their parts to fit in a particular car. Supply chains would eventually be reestablished, some domestic suppliers would switch to servicing transplants (whicht hey already do), but the disruptions would affect the economy in the meantime.
This is all like auto industry 101. Doesn’t Matt even have a spare hour to research stuff?
December 3rd, 2008 at 6:05 pm
Joe: “We need to protect/help workers. Period. That they work for GM is beside the point.”
But since many, many workers work for GM, and since many more work for companies that rely on GM, and since keeping GM alive is vastly more efficient than paying these workers directly, we can best help workers by keeping GM alive. Unless you have a better idea?
December 3rd, 2008 at 6:09 pm
7% of Borg Warner’s business is to GM and Chrysler
15% of Autoliv’s business is to GM and Chrysler
20% of TRW Automotive’s business is to GM and Chrysler
American Axle has over 70% of its business with GM, but has been rapidly trying to diversify over the last few years.
These were just the first I looked at. I do not think you can maintain that Ford is depending on GM and Chrysler to keep these companies in business.
December 3rd, 2008 at 6:32 pm
I think this is a similar situation to immediately before the bank bailouts. In that case, bank leaders were arguing that taking a bailout would demonstrate underlying weakness in the bank, driving down stock prices, reducing depositor confidence, and leading to people taking their money out of the bank.
With the auto industry, Ford is also concerned about investor confidence, but more importantly, consumer confidence. They’ve been saying for awhile now that no one will buy a car from a company that is bankrupt or looks like it will be bankrupt. So it makes a lot of sense for Ford to tell Congress: “we’re doing great, but our competitors aren’t. If they fail, we fail, so give them money. Also, give us money if we happen to be wrong about how great we’re doing and go bankrupt tomorrow.” The big 3 asked for $25B, and Ford asked for $9B (bridge loan). That sounds like their share of the proposal from the last trip.
December 3rd, 2008 at 8:59 pm
Maybe Ford sees that its competitors are going to be bailed out and wants a piece of the action. Personally I don’t really know much about this issue, but none of the arguements for the car bailout make sense to me.
December 3rd, 2008 at 9:59 pm
I’d say Ford’s logic is, “WTF? You’re giving our competitors money? We need some too!” The reason they offer in public sounds more like BS.
December 3rd, 2008 at 10:40 pm
This isn’t that hard to figure out. Ford understands that there is a possibility that even with access to federal loans GM or Chrysler might not make it. If either GM or Chrysler in the next 12 months it’s not going to be because they aren’t selling enough hybrids (Toyota’s latest sales figures show them in same bad shape ford is in) – it’s going to be because the economy is in much worse shape than we think and no one is buying any cars. If this worst case scenario turns out to be true, Ford will need some cash to make it through. However, Congress isn’t likely to want to move auto rescue package part two. In short, Ford is engaging in just the kind of smart, long term thinking that its critics say its not capable of.
December 4th, 2008 at 11:32 am
A little nasty, but I think she’s got it right.
http://emptywheel.firedoglake.com/2008/12/04/supplier-shock-explained-in-simple-terms-for-matt-yglesias/
December 4th, 2008 at 2:25 pm
It’s pretty simple. Ford wants the bailout money because it doesn’t want to face competition from government-backed GM and Chrysler. “If they get it, I want it too.”
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