Saturday, December 06, 2008

Where Are The Leaders?

The thing that annoys me the most in this automaker crisis, is the question of leadership. Not the Obama style of leadership, where appearance is all that counts, but the real thing. I think the world of President Bush, but on this issue he’s been sitting back and waiting for someone else to find the answer. Same for President-elect Obama; sure he can say it’s not his problem right now, but considering that he will be at the helm in just a few weeks and therefore whatever is or is not done will bring him the consequences, you’d think he could motivate himself to get moving on a clearly important issue. Of course, the do-nothing Harry Reid and Nancy Pelosi have also been still and quiet in terms of productive suggestions – shrill accusations and rants may play for soundbites, but they don’t move the issue ahead by even an inch. Then of course, we can also look at the recent performances of the automakers’ executives, the UAW, and the many anointed ‘experts’ in the industry, which have amounted to ’help me and let the rest fend for themselves’ - predictable but again not real leadership by any reasonable definition. The reason this problem, which most of us saw coming years ago, has not yet been resolved and may well be addressed in a distinctly foolish manner, is that no one – no one at all – has shown any leadership.

Some decades back, I used to chat with my employees about their long-term plans (still do, of course), and I was struck by how many thought that getting into management would make their lives easy. Just give the orders and make the others work, sweet. Of course the reality is much different. Some managers no doubt try to run their businesses in that way, but that is bad management. Any good manager can tell you, that effective management means you have to direct everyone’s efforts to get the best results, and that responsibility, credibility, and accountability start with you. To my mind, that truth only increases in importance as the rank rises. Look at the top title for most businesses: Chief Executive Officer. It means that the CEO should be the one to state clear priorities, address the top needs, and take full responsibility. That does not mean the CEO is the fall guy for whatever goes wrong, but it does mean that the CEO must take clearly communicated, well-defined actions which protect and improve the company’s long-term health. It’s the same, to a lesser degree, with all of the other chief officers. And in this crisis it’s painfully obvious that the chief officers have been trying to hide from the problems, not address them. It’s also obvious that there are far too many “chief” officers at each of the three companies, for the real chief officers to get a hold of the matter.

The last couple days have shown indications that Congress means to bail out the automakers. As a result, everyone is talking about what conditions should be put in place. For me, it’s obvious that the current set of top officers at each of these companies needs to be replaced, but there’s more. The three automakers need a streamlined, shareholder-controlled leadership design, so here’s what I think needs to be done, as part of any package:

GM – fire all top officers, have the SEC search for new top execs. Do not limit the pay on the new team, but tie it to performance, both short and long-term. Also, limit the number of top officers to ten. And limit ownership by any single person to no more than five percent, or fifteen percent by any family or consortium.

Ford – same as GM, but also change the two-tier system which allows the Ford family to control the company with a minority interest. Ford can turn down the aid if they insist on keeping their structure, but if the public is going to bail them out, it’s overdue for Ford to become a publicly-owned company in every real sense.

Chrysler – same as GM, but require all significant shareholders to sell their ownership down to the 15% cap specified in the GM case, and sell them at the current stock price, not the later price resulting from the aid package. No government aid for a privately-owned company, especially one with a tear-down reputation like Cerberus.

I have a sneaking suspicion that most of the top officers and shareholders will resent and resist this move. But it should be non-negotiable and required prior to receiving any aid. If they need it, these companies should feel the same pain they are or will be inflicting on everyone else around them.

Friday, December 05, 2008

What Color Is Your Accessory

The career book, ‘What Color is Your Parachute’, has been a mainstay for job-seekers and career changers for literally decades. Richard Nelson Bolles has enjoyed a certain niche dominance, as even modern gurus of the field consider this book a “bible” for job-hunting. And like the religious Bible, there are many people who seem to react strongly against even a balanced criticism of the book, so that a person would have to be just a bit reckless and curmudgeonly to speak against it.

Enter the curmudgeon.

Now, even I have to admit that the book has some value, especially since Bolles updates references and resources every year. Of course, that also means he can sell a brand new edition every year, so there’s a money side to it, as well. There are many good things about the book, especially for very young people entering the work-world for the first time, or those who are facing major life changes. My problems come from a number of detailed spots in the book, where Bolles simply ignores what seems obvious to me, and in some places suggests what seem to me either impractical ideas or bad advice. That is the reason for today’s article.

I picked up this book for two reasons – first, my wife hates her job and really wants to make a change for the better. She works as a bank teller, and after thinking the matter through we both agree that bank tellers are universally underpaid and mistreated as employees. Working as a teller means few raises for small amounts, no chance at a career position, and little job security despite years of service. Bank tellers are very similar to call centers in their business practices. This is not to pick on her specific bank; we have learned these conditions pervade throughout the banking industry. But changing careers is difficult, the more so when you are beyond 40 years of age, so I am trying to help find resources to aid in that search for her. Also, as I am about to claim my MBA this spring, I will also be looking around to see what is available. In my case, I like the company I work for, so I may well be moving only in position with the same employer, but you do should always know your options. So, all tools serve some good. And after looking through Mr. Bolles’ book again (I think almost every American has read ‘Parachute’ at least three times in their life by the time they are 45 or more), I see many of the same things I have always liked and disliked about the book. The book serves many good purposes and offers useful tools, but there are four points where I am in sharp disagreement with Mr. Bolles:

1. The book does not offer any guidance to people who have to work to pay the bills, but are searching for better employment - This one bothers me because it’s obvious that Mr. Bolles knows such people are out there; early on in the book he mentions that people may have to work at a job they do not like while searching for the one that they really want. But that’s all he says on the matter. And that is a big failure, from my perspective. While there are people who have been laid-off and people just getting out of school, there are millions of folks who realize their job is a lousy one, and they need to make a change. If I am not picky, I can get a job today, so the question is not about whether I can find work, but what I would be doing, and for how much, and with what future prospects. I think this is one of those places where Mr. Bolles shows just how long it has been since he really had to find a job, because he completely ignores the question of how you can search for a career while working at a bad job. This, even though he notes that the job-searcher should plan to spend at least nineteen weeks in that search, a time frame which will exhaust the savings of anyone I know, making it necessary to keep or take on one of those lousy jobs.

2. The book discusses how to negotiate salary, but makes some assumptions which do not fit my experience, and I find them far more likely to frustrate job-seekers than to assist them - This is an area where I would like feedback from the reader. In my experience, despite a number of summer, temporary, full-time and career positions, I have never yet had a job offered to me where the salary was in fact negotiable. In my present company, for example, when we decide we want to hire someone, we make a written offer for a specific amount, and it’s strictly a yes/no decision; if the candidate does not accept the offer as presented, there is no deal. I have a friend who was recently offered a position with a company, but before accepting the position she asked whether the salary mentioned in the offer might be negotiable; the offer was immediately withdrawn. I expect there are some companies which will negotiate a salary range within reason, but I believe that Mr. Bolles is unrealistic in his assumption that this is the normal condition, especially in a time of recession, where the business has far more leverage than the job seeker. I would like to hear from readers, as to how often you have been able to negotiate your salary, especially during an economic downturn.

3. A major premise of the book, is that the job-seeker can collect specific detailed information about companies by asking folks who work there - This is another area where my experience is exactly the opposite from what Mr. Bolles claims. To be expected to provide confidential information from where we work, is an insult for most people, who understand that being part of a company means protecting its confidential information. My direct reports do not discuss how much they make with each other, yet Bolles thinks they would tell a relative stranger? Mr. Bolles is not correct. And that restraint on discussion only becomes stronger when discussing hiring and positions. Frankly, only someone with the authority to hire a person really knows whether an opportunity exists at all, much less what is desired in that role.

4. One of the strongest points emphasized by Mr. Bolles, is the use of contacts, which he describes as pretty much everyone you have ever met or come into contact with in the course of your life. Mr. Bolles makes a brash set of assumptions regarding the way your ‘contacts’ will be able or willing to assist you in finding work - What Bolles is leaving out, is that there are very good reasons why we do not harass our friends and relative strangers about something that is of little concern to them. There is a certain courtesy in respecting the boundaries of a relationship. It’s the reason we get a little annoyed when a friend falls for the hype and tries to sell Amway or some similar garbage; people do not appreciate being treated as a conduit merely to help someone else get what they want. Yes, if you know someone well enough that you can ask them for a favor, and if they happen to be willing and able to fulfill it (something you should consider well ahead of asking), then you may make the request, but only when done courteously. So, you have contacts who can help you in your job search, but they are people to be respected and whose person demands honorable conduct. Mr. Bolles is exactly wrong to imply, let alone state as he does that you should badger people you barely know about information they may not have or if they do, they may not feel is public property. It fails simple tests of common courtesy and propriety, it disrespects moral boundaries, and in a practical sense it will tag you as a social mooch if you start harassing everyone you know for access to job openings. It makes you look desperate and in the long-term is more likely to harm your prospects than help. I would recommend that the job-seeker be far more selective in whom he/she approaches, and far more courteous in doing so. At the very least, it shows respect for people that you know you will want to meet again.

Finally, I respect Mr. Bolle’s skill as a writer and salesman (never forget that he wants you to spend money on his book), and as a teacher of certain skills that may be useful in a job search. But I consider my own experience as a manager and a person who has hired, trained, promoted, counseled, praised, disciplined, fired, recommended, and otherwise had significant direct influence with hundreds of employees in my career, and I find it appropriate here to speak to the needs and desires of the hiring manager – many managers do not like hiring people, and so anything that looks like a problem will mean rejection of the application. Unless you are applying for a sales position, the last thing you want to look like is a salesman – no manager ever believes the applicant is as good as he claims. At best, he finds no reason not to hire you and gives you a chance because you were better than the rest, but don’t get cocky about that. I have seen managers hire people on the definition of ‘best’ that in various times has meant the best dressed, the first person to include a cover letter with their resume, the person who uses up the least time in the interview, the person who went to the same school at the manager, the person who happens to fill an understaffed demographic, the first person who does not exaggerate his resume, the person who asks the best questions, the person who manages not to ask stupid questions, the person who already works at the company and wants to switch departments … you get the idea. Finding a good position is never easy nomatterwhat, and there are many good tools you should find and use, but never forget that just as no job is really perfect, neither is any tool complete in itself.

Thursday, December 04, 2008

Strategic Needs – Why Congress Is helping the Financial Markets

Through the first half of this week, I have been explaining why the Congress is right to decline granting the demands of the three major US automakers. Having done so, it seems appropriate to consider why the government was willing to spend so much more to address the crisis in the financial sector. There have been complaints that it appears to make no sense to agree to spend 700 billion dollars on one sector, but deny 50 billion to another that needs it just as much. To understand the decision, we must sort out the relevant conditions and probable effects of any money applied to the sector.

There are significant differences between the financial and automobile manufacturing sectors, so that is where we begin. With over a half-million employees directly impacted by a possible failure of the major automakers, plus as many more possibly affected by the supply chain effects of such a failure, there is clearly a great impact from the decision to assist or not. However, there is no compelling evidence that the manufacture of automobiles is a strategic asset for the United States, nor that the requested assistance would address the fundamental forces causing the crisis. If GM, Ford, and Chrysler were all to fail, the ramifications would be serious but not catastrophic. The domestic auto industry has not been shown to be strategically different from the American companies involved in consumer electronics, textiles, mills or ironworks, indeed it appears to be of a lower priority than several industries which left the country in the past several decades. This is not to say that a federal response would not be needed, but that the requisite actions by the government should focus on a different goal than perpetuating an inefficient system which cannot promise a reasonable return for the investment.

Before considering the financial sector, it is important to note that although the word “bailout” has been in common use by the media regarding each industry, its application to the different crises is not consistent. In the case of the automobile industry, company executives are asking the government to give money directly to the companies, to use as they choose, without credible guarantees of performance. In the case of the financial sector, the money granted by Congress went to the Federal Reserve Board, not directly to the banks, and the Fed will decide how to apply the money on a case by case basis. Further, there are significant assets now in the control of the Fed, which justify the limited risk being taken despite the size of the action. For instance, the combined assets of Fannie Mae and Freddie Mac are over five trillion dollars; in even a worse-case scenario less than a third of those mortgages would fail, meaning that for a commitment of approximately one trillion dollars, the Fed controls guaranteed assets of at least 3.35 trillion dollars, and which under good management could appreciate to over six trillion dollars. When you step away from the panic dance being spun by the media, the two truths about real estate and home mortgages are that some properties are worth nothing close to what they are selling for, but also that many home mortgages have a floor value that will eventually bring back the market. In other words, what is needed in the case of the mortgage crisis is a short-term solution to protect the liquidity of banks and support confidence in mortgage viability, because in the long term prices and purchasing will inevitably return to nominal performance. While it will not be like the heady days between 1995 and 2006, prudent supervision by the Fed could potentially improve President Obama’s re-election chances, as the Fed may be able to release some acquisitions back to private ownership and show a respectable profit in doing so by mid-2012. Certainly, there is every reason to expect that the Fed’s actions with regard to mortgages will be repaid in full in the long term. Therefore, the risk in relation to the money entrusted to the Fed is effectively low with relation to the likely results of not acting, and the prospect of full recovery of costs makes the action even more attractive. In practical terms, the Fed action is a set of loans, not a bailout in the true sense.

It must also be understood that the financial sector is in fact a strategic necessity to the United States. Evidence of this was made apparent with foreign reaction to Treasury bills, notes, and bonds. When the liquidity of the U.S. banking system became unstable, foreign confidence in U.S. Treasury securities also fell, indicating that failure of major U.S. banks would lead to collateral failures of government resources. The scale of this risk made government intervention in the financial sector a critical necessity. Where failure of the major automakers could worsen a recession, failure of the U.S. Treasury would create unprecedented economic conditions, which could not be controlled or corrected by the United States. The closest example would be the collapse of the Argentinian economy between 1998 and 2002, with the distinction that the U.S. economy could not expect effective IMF assistance.

In the case of the financial markets, the government assistance was built in three stages – first, the Fed received approval to spend approximately 700 billion tax dollars in cash infusions, commodity purchases, and other discretionary expenditures. The 700 billion dollar figure was not a specific amount planned to be spent, but an agreed ceiling for indebtedness at any one time. People who claim that Paulson did not understand the amount or know what he wanted to do, simply misunderstood the plan’s framework. It should also be noted that the 700 billion is made available in stages, with 250 billion immediately and the rest made available at a later date, to protect Congressional oversight in the main. Also, the bill included creation of a Financial Stability Board (similar in concept to the RTC) and a Congressional oversight panel.

The second stage is the hiring of asset managers by the Fed to select and acquire the appropriate instruments, which could range from specific mortgages to companies, but which would prohibit acquisition of hedge instruments and insure viable plans of recovery and coordinated actions.

The third stage would be the direct acquisition and direction of the purchased assets and instruments. The significance of this three-stage approach, is that each level has its own oversight and coordination, without becoming overly unwieldy.

The reason for laying out this framework, is to understand that the action is neither haphazard nor careless; the revenues used in this initiative are specific, planned, and accounted for. In comparison, the bailout request by the automakers lacks all of these safeguards, amounting to no more than a desire for the government to simply hand over billions of dollars to men who have shown neither the aptitude to protect assets, nor the proper moral priorities needed to keep their companies solvent.

Wednesday, December 03, 2008

Worse Than You Think – Part 3

The three largest automakers in the United States have clearly been deficient in their diligence and results. While there are structural and procedural differences between them what is common between General Motors, Ford, and Chrysler is an inability to produce a viable core product. The key question that absolutely has to be answered, and in full, is how these companies can credibly promise that all money loaned to them will be paid back, not only in full but with interest. If the car companies want an exceptional package to help them, their credibility and logic for requesting it must be just as excellent.

So, with that in mind, let’s examine the latest arguments from the CEOs of GM, Ford, and Chrysler. The information presented here comes from the Detroit Free Press:

First, admitting that they blundered in taking private luxury jets to Washington in their earlier visit, the executives this time promised some symbolic signs of humility, including salaries of $1 a year and the elimination of corporate jets. I will give them a small nod there, but also note that those steps were late and now appear to be reluctant, rather than the actions of truly concerned leaders.

Second, GM’s CEO said if they do not immediately receive what they want, as in almost twenty billion dollars before the end of the month, “the company will default in the near term, very likely precipitating a total collapse of the domestic industry and its extensive supply chain, with a ripple effect that will have severe, long-term consequences to the U.S. economy." That was the wrong thing to say, for many reasons, but topping the list is the sense of extortion implied in it – they are effectively saying ‘give us lots of money without getting any guarantees we’ll behave, or we’ll make sure lots and lots of innocent people get hurt.’ It does not matter if they meant it that way, it’s a threat and a stupid one. It’s also the wrong thing to say, because it highlights how badly these nimrods have bungled their companies; if they cannot keep their businesses running for more than a month if they are not babied, there is no sane reason to give them billions of tax dollars, period. And third, like their previous behavior, this statement demonstrates no sense of personal responsibility, no humility, no remorse for the damage that their poor management has done up to now. By all rights, the first condition of any assistance to these companies would be the complete and permanent replacement of their boards of directors and all chief officers (CEO, CFO, CIO, CAO, etc), on the grounds of clear dereliction of duty. But moving on for a moment, let’s look at what the companies promise to do to become successful again:

GM's total request now tops $18 billion, with $12 billion in loans and an additional $6 billion as an emergency line of credit should the economy continue to worsen. In return, GM pledged to shed four of its U.S. brands, nine factories, up to 31,500 workers and roughly $30 billion in debt through 2012, all to make a profit excluding taxes by 2011.”

Addressing GM’s proposal for a moment, the reader might want to note that GM’s suggestions do not address any core issues – the management practices, structure of labor agreements, or the image problems for American carmakers. These proposals come down to just firing people and shutting down factories. Historically, companies that do this most often produce one of two results – they become smaller players in the industry, or they go out of business. Therefore, while reducing payroll and the number of brands may well be necessary, GM needs to do a lot more if they want to truly become competitive, and that begins with finding and addressing the real causes of their present condition.

So how did they get into this mess? There are a number of myths floating about, which need to be cleared away first:

1. The US market does not make hybrids.
Well, they were slow getting into the game, but Ford and GM make a lot of hybrid models now, more in fact that many foreign carmakers including Honda. American hybrids are not only small sedans, but also include some luxury sedans, trucks, and even a couple sports car models.

2. Detroit only builds inefficient cars.
Not true. While there are some gas hogs out there – what is the moral argument for having a Hummer, anyway – a lot of American cars get 30 mpg or better, and in many cases better than their asian counterparts. GM had some fun pointing out that their Tahoe hybrid gets better mileage than a Toyota Camry, for example. Recent tests indicate that American cars are of equal quality to most popular foreign makes, are often safer and cost less to own and maintain.

3. American cars are unpopular.
GM alone sold nine and a half million cars last year, and is the world’s largest seller of automobiles. In the United States (the largest single-country market), Ford sold almost nine hundred thousand more cars last year than Honda, and Chrysler’s US sales beat those of Nissan and Hyundai put together.

4. It was stupid for the companies to invest so heavily in trucks and SUVs.
Not at all. Historically, trucks and off-road vehicles have been the most profitable segment for the industry, which is one reason why Toyota, Honda and Nissan have been trying so long to make popular SUVs and light trucks.

Part of the problem, then, is getting down to the facts of the matter. From the earlier financial reviews of the companies, we see that the cost of making these vehicles, on average, exceeds the revenue they bring in. So, trite as it sounds, the first major plan would have to address either justifying raising prices to cover the costs and a reasonable margin, reducing costs to the point where the company makes a reasonable profit margin, or both to achieve that necessary goal. A lot of people get worked up by that word, but profit is a company’s pulse, a vital need. And for all the sophistication of modern management, it’s amazing just how many people forget the first need – if the company does not make money, it can do no good for anyone.

We’ll come back to that. For here, let’s go back and see what the executives plan to do to make their companies competitive.

Ford's recovery blueprint said it would invest $14 billion over the next seven years to boost its vehicles' fuel efficiency, and it said it would improve the overall efficiency of its fleet by an average of 14 percent next year. And Ford is calling for a partnership among automakers, suppliers and government to develop new battery technologies.”

Well, it’s a plan, sort of. The problem is, Ford’s cars and trucks have been increasingly efficient for more than a decade now, but it’s lost ground anyway. This plan does not do anything really new, so it’s not likely to solve Ford’s long-term problems.

GM would focus on four brands — Chevrolet, GMC, Buick and Cadillac. It would sell Saab, shrink Pontiac to a niche brand and consider selling or closing Saturn, GM President Fritz Henderson said Tuesday. GM plans to trim U.S. dealerships from 6,450 to 4,700.”

As I said earlier, this is nothing more than dumping payroll and facilities. By itself it can assure GM of nothing more than reduced revenues and the prospect of corporate death. It may be necessary to take these steps in order to drastically cut costs now, but they do nothing to address the root causes of GM’s condition.

Chrysler said it would cut costs by slashing employee benefits and terminating its lease car program. Of the three companies, only Chrysler left open the possibility of a merger.”

Note that Chrysler has the lamest proposals of all three, doing nothing to address the costs of making their vehicles.

All three automakers plan to meet with the United Auto Workers union today in Detroit to debate what cost savings could be wrung from the union contracts. Up for discussion was the possibility of scrapping a much-maligned jobs bank in which laid-off workers keep receiving most of their pay.”

It took a while to get there, but here we finally see a step that could make a substantive difference to the survival prospects of these companies. The question here, is whether the UAW truly understands the decision before it; if they refuse to agree to major concessions, the union could do serious and permanent harm to all of its members, and obliterate the union itself as a significant labor force.

Looking at the numbers, it appears that 640 thousand employees work at the three companies. That by itself is an interesting number, but it’s important here because if the average pay and benefits total per employee were reduced by, say, twenty thousand dollars a year, that would create savings of 12.8 billion dollars. What that means, is that even if the UAW agreed to massive pay cuts across the board, this would not bring in all the savings that the three companies say are immediately necessary to survive.

Stepping back to the basics, again, any business needs to do a number of things in order to survive. Making a profit, of course, is the first goal, but to do that you have to make a product, market it in a way that creates demand, and transact the sale to bring in the money. That works for everything from lemonade stands to car makers. Having addressed the myths before, we have to ask just why efficient, attractive, well-made cars for reasonable prices are not selling as well as their competitors. Well, some of that is a lag in image – I’m old enough to remember when Toyotas and Hondas were not very good, and they only sold because they were cheap. In 1978 there was no high-end Honda or Toyota sold in the US; it was all cheap cars all the time. And even when their cars began to improve in quality and comfort, it took a while to win over American car buyers. The domestic companies would seem to be facing the same situation now, an image problem that won’t go away in the short term, not least because these companies continue to reinforce the negative impressions. GM’s mistakes include holding on to GMAC (what, pray tell, is the rationale for a car company holding mortgages?), threatening to raise prices in 2009 after a similar claim in 2007 failed, and as I mentioned in part 1 they wrote off a slew of tax credits (39 billion dollars in all) in the tacit admission that they may never have taxable income in the forseeable future to apply them against. The combination of those three blunders would scare off just about any investor doing his homework, let alone a CPA deciding whether this is a viable business which can be expected to repay a loan in eleven figures. As for Ford, well just yesterday I mentioned that the company revisited its horrific Pinto design and coverup escapade with the incredible F150 flambe’. Nothing like torching your top model, to create similar results in your net income reports. And as for Chrysler, can anyone think of a single model from this company in the last quarter-century, where it was the clear leader? Whether cars, trucks, or SUVs, there is not one Dodge or Chrysler product which is clearly superior to the field in quality, value, or features. Yes, they made the 300, the Dodge Ram, and some of the Jeeps are pretty good, but that’s as good as they manage – even the Dodge Charger is just a ‘good’ car, not great by anyone’s definition.

And then there are the management structures. Take a look at GM’s org chart – there are fifty-two “chief” officers and “general” officers of the company, and we are not even out of the C-suite yet. Can you say ‘Peter Principle?’ Sure you can, and here is a prime example. What stands out here, is that there are ten direct reports to the CEO, all of whom have more power than a CEO at 95% of all other corporations. This alone can help explain why GM puts out so many redundant models and brands, and cannot find a way to reach a cogent, clear business plan.

The Ford org chart is no better; fifty-seven top corporate officers, many of which seem to have some less-than-vital roles. And let’s not forget that while this is ostensibly a public company, the Ford family have arranged things so that in the end, they make the calls. Nothing like having a position with lots of responsibility, but in the end no real authority, huh?

There is no org chart available for Chrysler, although from what I read in trade magazines, the ghost of Lee Iococca is as big on sprawling confusion of well-dressed mandarins, as anyone at GM or Ford. Let’s not forget that Chrysler is technically a private company, answerable much more to Cerberus and Daimler (who still hold 19% of the company) than to the public.

As harsh as it sounds, the fact is that none of the three companies in trouble has the right management team in place to deal with the problems. None of the three companies, for example, has explained where the money – if granted – would be applied, apparently hoping to just use it in general operating expenses. In fact, GM’s CEO as much as said that he wants a no-strings gift of billions of dollars to be applied directly to current payroll and accounts payable. The desire may be understandable, but this clearly does nothing to address the root causes of the crisis. And so, the only rational response is to refuse that trap. In the final analysis, so many problems exist that only a complete reorganization can possibly address them effectively.

Yet, GM’s CEO says that in the case of bankruptcy, debtor-in-possession may not be possible for GM. There are a number of reasons for that. First are the reasons put out by CEO Rick Wagoner himself:

1. The size of GM’s debt and needs would make financing very difficult, even without the current credit crisis going on;

2. Bankruptcy would be used, he says, to address legacy costs and capacity utilization, two areas where GM is already making improvements and planning ahead; and

3. There is a likelihood that the weak consumer interest in a trouble American carmaker, would collapse completely in the event of a bankruptcy.

There are additional reasons to think that GM does not want to go through bankruptcy, however, and one of the biggest I can think of went into effect in the middle of 2002. Chief officers of every public corporation in the United States sign quarterly reports confirming their personal and specific responsibility for the material accuracy of their financial statements. Where in the past an executive could claim he had no knowledge of unethical practices turned up in an audit or SEC investigation, the provisions of Sarbanes-Oxley closed off that loophole and set guards at the door. A bankruptcy for GM would mean a set of forensic audits at the minimum, and any substantive violation would lead to fines and criminal charges for everyone in the C-suite. I’d lay odds right now that there are things in GM’s numbers that no executive wants to have to explain.
So let’s be clear: It may well be that General Motors, Ford, and Chrysler are not looking at a Chapter 11 Bankruptcy and reorganization, but at liquidation and a lot of very bad legal troubles. Given the conditions discussed above, a Congress determined not to reward businesses that fail, and a public mistrust of these companies, it appears unavoidable now. And yet, there is still no solid indication that the executives at any of these three corporations is prepared to address that reality.

Monday, December 01, 2008

Worse Than You Think – Part 2

Yesterday I trashed GM pretty hard, and they deserved it. The short version for GM, is that the management is both clueless and dishonest, and if they manage to avoid heavy penalties from the SEC, it would only be because the government decided not to pick on the mentally handicapped.

Let’s move on now to Ford. Ford is just plain weird from the start, a two-tier company which on the one hand wants to be a big public corporation, but on the other refuses to allow the stockholders’ control of their own company, by keeping a level of stock in family hands, an effective oligarchy. Ford is also noteworthy for its selection of pyrotechnic vehicles, from the traditional Pinto to the more modern F150.

Looking at the 2007 Annual Report, we see that Ford received 154.4 billion dollars in revenue, on sales of 6.55 million cars and trucks, or $23,562 apiece. But the car part of the company lost 5.0 billion dollars on the year, or $763 lost per car or truck sold. Only a 1.2 billion dollar profit on its financial services made things a bit better for Ford.

The 2006 report shows a 17.0 billion dollar loss for the car and truck part of the company, and the 2005 report shows a 3.9 billion dollar loss for the car and truck part of the company – like 2007 the financial services helped the final numbers look better. The 2004 report shows a 200 million dollar loss for the car and truck divisions, so what we are seeing is a progressively poor performance as years go by. That trend has neither been effectively diagnosed nor addressed, and the fact that the board of directors at Ford is not directly accountable to stockholders. While Ford has managed not to commit apparent fraud with its books the way GM has done for half a decade, the letters to stockholders which start off every Annual Report show no sense of accountability or effective planning.

Stopping here for a moment, we can see a slight difference between GM and Ford. Ford managed to handle its financing well enough to avoid the catastrophic damage we see happening to GM, but both companies are unable to make an operating profit from their core products.

Now on to Chrysler. If the words ‘Chrysler’ and ‘Crisis’ sound similar, you may be remembering how these guys almost killed off the company before. At the end of the Carter years, Chrysler was doing pretty much what it's doing now - making cars that do not fit what the public wants, and headed full speed towards self-destruction, and therefore pleading for the government to save its sorry rear. The thing to note about that help that Chrysler got that time, was not only that it was much smaller than what they want now, it also left the company largely untouched. No management changes, no strcutural changes, it basically assumed that they were doing a good job and could be trusted not to screw up again. And here we are.

Chrysler's ownership has been a mess for several years now. This 'American' company stopped being a really American company some years ago when it became DaimlerChrysler, and was actually a foreign-owned private company until September of 2007. That's right, a company whose foreign owners dropped it like a flaming bag of turd, thinks it makes sense to ask for money from the U.S. government on the claim that it's a good investment. Anyway, looking at the 2007 numbers we see Daimler reporting that Chrysler lost $2.9 billion during the first 9 months of 2007; Chrysler denied losing that much but never released hard numbers to show how badly they actually did. Their new owners, Cerberus, are best known for cutting their investment in Chrysler by over 50% in the first half of 2008 - it appears they only dropped that much, because they could not find anyone willing to take any more of Chrysler after that. Cerberus had also been a big buyer in GMAC and they dumped that, too.

So maybe it was just one bad year? Cerberus' 2006 report shows that it was a good year for the company ... except for the 1.1 billion Euros ($2.4 billion) lost by Chrysler. Chrysler was doing all right before it, but the SUV and Jeep-heavy company started failing when gas prices began a sharp rise.

(to be continued in part 3)

Worse Than You Think – Part 1

Congress surprised me a little while back, when they decided not to bail out the ‘Big 3’ automakers, who were hoping for just about fifty billion tax dollars (25 billion already requested and they wanted to add another 25 billion just because). Given the way the press is spinning the 700 billion set aside to address the financial markets, I was worried that the Congress would just toss off another 50 billion without looking into the matter. But instead, Congress displayed an unexpected but welcome prudence, demanding that Detroit demonstrate better responsibility. I wondered just what was missing, so I started looking into the financial health of these companies. Boy howdy, these guys are in really bad shape, and more, throwing money at them won’t do a lick to change their crash course.

Before I go into these companies, I need to explain why extra money won’t help. There are a number of factors which can cause a company to fail. In the case of the financial markets, most of the banks made mistakes but in general are fundamentally sound in design and practice, so that infusions of cash and credit are sufficient to get the company back into good working order, and there is high confidence that the money spent will be repaid in full. Other causes exist for business problems which may or may not be addressed effectively with cash, but there are certain conditions which signal severe risk of failure. The three major US automakers all exhibit such indications of imminent failure, and these conditions cannot be ameliorated by simply increasing cash flow for a short time.

The first case to consider is General Motors, which was created in 1908. GM’s company profile states that the company has 266,000 employees in 35 countries, and in 2007 sold 9.37 million cars and trucks. Looking at the highlights from the 2007 Annual Report, I see that GM took in over 178 billion dollars in revenue (or around nineteen thousand dollars per car or truck sold) from sales and just under 3 billion dollars from finance and insurance services. Despite this, the company’s adjusted net income is a reported loss of 23 million dollars for 2007. But that’s not the part that worries me. The loss before a reported “change in accounting principle” for 2007 was 38.7 billion dollars, meaning these geniuses spent an average of over twenty-three thousand per car or truck manufactured, so that they lost four thousand dollars on each and every car or truck they made that year.

That line about changing the accounting principle bothered me; that’s not normal GAAP and if it happened more than once in a short span it’s a very bad sign about a company’s reporting. So I went to the next report and had a look at 2006 ...

And saw the same notation, changing a two billion dollar loss in 2006 to a reported two billion dollar profit. In 2006, GM made just about 9.2 million cars and trucks and sold them for just over 207 billion dollars, or $22,585 each. But that year it cost GM about $22,800 for each car or truck they made, so while it was not as bad as 2007, the problem was there as well – it just got worse in 2007. We know why; sales for low-mpg cars and trucks fell through the floor as gas prices shot up, while the cost of making the things still climbed. And that change in accounting principle bothered me, so I checked out the footnote they stuck on it for an explanation; it read: “A reconciliation of adjusted amounts in these Financial Highlights and in the Chairman’s Letter to Stockholders to amounts determined in accordance with accounting principles generally accepted in the United States may be found at, Earnings Releases, Financial Highlights”. If that does not make sense to you, you are reading it correctly, because there is no direct link to that explanation – you have to chase it down, so I did. Buried in the letter to stockholders and features, in rather fine print, GM noted that in 2007, GM’s total adjusted net loss in 2007, excluding special items, was $23 million, reflecting a $1.1 billion loss attributed to our 49 percent stake in GMAC. While GMAC’s traditional auto financing business performed well, those results were more than offset by massive losses in GMAC’s mortgage businesses. Including special items, GM reported a loss of $38.7 billion, or $68.45 per diluted share in 2007. This loss is almost entirely attributable to the non-cash $38.3 billion special charge in the third quarter related to a non-cash valuation allowance against deferred tax assets. The valuation allowance has no impact on cash, and does not reflect a change in the company’s view of its long-term financial outlook.”

By itself that might fly. But remember, we also saw this the year before, so I looked at the 2006 version, and found this:

Following a review of deferred income taxes and our accounting for derivatives under Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, we restated our balance sheet, stockholders’ equity and reported net income in our financial statements from 2002 through the third quarter of 2006. These adjustments had no material impact on cash flow for any of the restated periods.”

In plain English, this is what most people would call a lie. GM took a two-billion dollar loss, and spun the numbers to call it a two-billion dollar profit. They did this by changing the way they addressed their mortgage losses. I expect they thought this would be a one-time thing, but the fact it is, this change materially changed GM’s representation of their financial condition, which violates GAAP. While GM claims to have followed SFAS 133 with regard to its derivative accounting, the FASB clearly states in the summary of that Statement, an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. Those methods must be consistent with the entity's approach to managing risk.” [emphasis mine]

This means there are two problems with GM’s claim – first, they did not establish this accounting at the inception of the hedging action, but after the fact, and two – this change materially changed the reported financial condition of the company, which violates the FASB’s Statement of Concepts No. 5. This ought to have provoked an SEC investigation, and I am guessing only GM’s size prevented that from happening prior to now. Certainly the action violates GAAP as I know it.

So, two accounting principle changes in as many years, both of which alter the corporation’s reported financial condition. Feeling iffy yet? Well, let’s go back to 2005 and see if they were still playing Hinky Financial Reporting then as well. And yep, there it is again. A 10.4 billion dollar loss is adjusted to show only a 3.4 billion dollar loss, because of “Hughes Electronics and Special Items", again with a footnote telling us to go hunt down the details.

Before I get to that detail, I want you to note what the executives at GM were saying after the 2005 year, before they started playing games with their 2006 and 2007 numbers: We also have a renewed commitment to excellence and transparency in our financial reporting. The recent discovery of prior-year accounting errors has been extremely disappointing and embarrassing to all of us. Credibility is paramount, for GM as a company and for me personally. While I will not offer excuses, I do apologize on behalf of our management team, and assure you that we will strive to deserve your trust. The fact is that errors were made, and we can’t change that. What we have done is disclose our mistakes and work as diligently as we can to fix them.”

It’s, ahem, pretty obvious that GM never fixed its problems, nor did they stop covering up their poor management. In 2005, once again GM changed its numbers to make a loss look prettier, changing a 10.4 billion dollar loss into a 3.4 billion dollar loss by fooling with the books. The detail in the 2005 Annual Report advises that for 2005, GM adjusted its numbers on the basis of a stock split of a former subsidiary, Hughes Electronics: In December 2003, GM split off Hughes by distributing Hughes common stock to the holders of GM Class H common stock in exchange for all the outstanding shares of GM Class H common stock. Simultaneously, GM sold its 19.8% retained economic interest in Hughes to The News Corporation Ltd. (News Corporation) in exchange for cash and News Corporation Preferred American Depositary Shares. As of the completion of these transactions on December 22, 2003, the results of operations, cash flows, and the assets and liabilities of Hughes were classified as discontinued operations for all periods through such date presented in GM’s consolidated financial statements.”

Note that GM’s decision to accept shares from News Corporation PADS was a voluntary act by GM, and so it is difficult to argue that the corporation should be allowed to separate those losses from its financial reporting; it’s not as if the losses really go away if you do not admit them.

I could go on. Number fudging by GM occurred in its 2004 and 2003 reports, and five straight years of changing the way you do your financial reporting should be a big red flag to any auditor, especially since there were at least three major causes for the changes. There are numerous indicators of significant financial instability and poor management (a new CEO or CFO might be surprised by bad news, but when it keeps happening it’s a sign that the guy in the seat is a bad driver), and if GM had been an ordinary company, we’d have seen a government investigation long before now.

To be continued in parts 2 and 3

Sunday, November 30, 2008


4-hour Exam today, brain-dead. Post tomorrow.