White House tells GM boss to step down

[The Minsky Moment]

Legacy benefits add $1,500 to the cost of each GM car. 

And how did that come to be?  Companies that pay defined benefits are supposed to set aside annual reserves which are then invested.  The annual cost to the company is thus a function of the total benefit that needs to be paid, and the expected rate of return (ROR) on the benefit fund.

What happened is that the car companies decided to make unrealistic assumptions about the long-run rate of return.  GM for example assumed 10 percent.  During the bull market of the 90s, those assumptions held up and the company was even able to use high returns to cut back on contribution flows.   Even after the run ended, GM only cut back ROR to 9 percent.  This allowed the company to do things like gain paper profits on bizarre accounting tricks - for example, GM once borrowed over $10 billion on the bond market at 7.5% and then put the money in the pension fund.  It then immediately booked hundreds of millions in profit based on the expected 9 percent return on the pension fund! 

These accounting games are all fine and dandy, except that to no one's surprise, the GM pension fund has not in fact returned 9-10 percent over the last decade.  That shortfall has to be made up and making it up requires taking a hit on the income statement.  And there lies the source of much of the legacy cost overhang.

[Admiral Yi]

OK, but what does that have to do with Wagoner?

As an aside, do you know by any chance whether the retiree health plan (as opposed to pensions) is funded out of current revenue?

[The Minsky Moment]

If quote unquote mismanagement were the sole or primary reason for the loss then he would deserve to be sacked.  But it seems in this case mismanagement is being used as a synonym for bad outcome.

For example I caught a soundbyte on the news which made it sound like part of the White House bill of particulars against Wagoner was that he didn't "negotiate strenuously enough with labor unions and GM creditors."  Does that seem fair to you?  If the unions and lenders don't give up enough to restore GM to profitability is that Wagoner's fault?

I kind of agree that Wagoner got scapegoated but the plain truth is that GM and the others made big mistakes, and he bears some of the responsbility for that.  Let's say for the sake of argument (only) that we let him off the hook for the strategic blunder of putting all the company eggs in the SUV basket.  That still leaves the problem that the Big 3 (with GM in shaky lead) seriously overinvested in production capacity given the market base.  And when it became apparent that production levels were unsustainable, rather than take necessary steps to retrench, GM's response (and Ford and Chrysler) was to jam more product down with margin-busting price incentives, and "zero money down" sweetheart credit offers arranged through their financing arms.  That temporarily staved off the day of reckoning, but only by guranteeing that when that day came, it would be even more painful. 

Yes the unions bear blame, but this is not unique to the Big 3.  There are unions in Germany as well - plus they have those crazy co-determination rules where lathe operators get seats on the board, and there are enormous social contributions taxes to pay.  Renault has to deal with French labor conditions and social charges which aren't fun either.  Every company has to deal with their own set of challenges.  As it so happened, GM failed to overcome theirs.  And at some point, the guy in charge has to held accountable.

[DontSayBanana]

I'd say this is a muddy mix. Wagoner mismanaged things? Certainly. It should have been a quiet separation, though; UAW needs to be taking more fire from this- their workers earn up to TWICE that of comparable non-union personnel, and yet UAW refused to BUDGE on payroll. People need to remember this when plants start closing down and UAW members find the supply of jobs in their hiring halls drying up. The media blitz surrounding Wagoner is still diverting attention away from serious money pits in the auto industry.

[DGuller]

Legacy benefits add $1,500 to the cost of each GM car. 

And how did that come to be?  Companies that pay defined benefits are supposed to set aside annual reserves which are then invested.  The annual cost to the company is thus a function of the total benefit that needs to be paid, and the expected rate of return (ROR) on the benefit fund.

What happened is that the car companies decided to make unrealistic assumptions about the long-run rate of return.  GM for example assumed 10 percent.  During the bull market of the 90s, those assumptions held up and the company was even able to use high returns to cut back on contribution flows.   Even after the run ended, GM only cut back ROR to 9 percent.  This allowed the company to do things like gain paper profits on bizarre accounting tricks - for example, GM once borrowed over $10 billion on the bond market at 7.5% and then put the money in the pension fund.  It then immediately booked hundreds of millions in profit based on the expected 9 percent return on the pension fund! 

These accounting games are all fine and dandy, except that to no one's surprise, the GM pension fund has not in fact returned 9-10 percent over the last decade.  That shortfall has to be made up and making it up requires taking a hit on the income statement.  And there lies the source of much of the legacy cost overhang.

Thanks for touching upon this.  I myself am always a little confused when some Big Three diehard says that US carmakers are at a disadvantage because they have a lot of retired workers to support, while Japanese carmakers gain an unfair advantage by not having them in their own American plants.

I always thought that when a company has a pension fund, it funds it the moment a liability is incurred, and not when the worker retires and starts receiving payments.  Therefore in theory it doesn't matter if you have ten retired workers for every working one, or none at all, all those liabilities should've been taken care of long time ago.  However, I'm a property/casualty actuary, not a pension actuary, which means I'm pretty much a layman when it comes to nuts and bolts of this.

[The Minsky Moment]

As an aside, do you know by any chance whether the retiree health plan (as opposed to pensions) is funded out of current revenue?

What is supposed to happen is that regular contributions are supposed to be made to the benefit trusts, but if those contributions prove insufficient given the expected liability, there has to be additional amounts reserved, and that has to be taken out of operating revenue.

[derspiess]

GOVERNMENT WARRANTY

It is my hope that the steps I am announcing today will go a long way towards answering many of the questions people may have about the future of GM and Chrysler. But just in case there are still nagging doubts, let me say it as plainly as I can -- if you buy a car from Chrysler or General Motors, you will be able to get your car serviced and repaired, just like always. Your warrantee will be safe.

In fact, it will be safer than it's ever been. Because starting today, the United States government will stand behind your warrantee.

booyah. I'm pleased. I'm going to wrap my Challenger around a light pole now.

Yeah, have fun dealing with the government to get your warranty honored.  This won't be the same as cheese distribution.

[DGuller]

Yeah, have fun dealing with the government to get your warranty honored.  This won't be the same as cheese distribution.

What makes you think that?

[Vince]

Yeah, have fun dealing with the government to get your warranty honored.  This won't be the same as cheese distribution.

So it will be just like dealing with my car insurance company?   

[The Minsky Moment]

I always thought that when a company has a pension fund, it funds it the moment a liability is incurred, and not when the worker retires and starts receiving payments. 

That is what is supposed to happen.  And logically, because these obligations represent committments over decades of time, the company should just pick a realistic rate of return, and make regular contributions at a level rate per retiree given that ROR, with the understanding that some years you will outperform and some years you will underperform, given the nature of the markets.  But the Big 3 could not resist taking huge profits off of their pension fund outperformance in the 90s bull market.  GM took that extra money and used it to help pay out their dividend and do brilliant things like give Fiat a $2 billion put option for a JV it later abandoned.  When - predictably - the market turned, GM had to make up the losses.  For a few years, they put it off through various accounting gimmicks.  Now, their approach is to complain about "legacy costs" and burn through tens of billions of dollars in federal aid money.

[Admiral Yi]

What makes you think that?

If the company goes under you lose the dealer network that currently does the warranty work.  So at the very least you're going to have issues of third parter payers.

[DGuller]

What makes you think that?

If the company goes under you lose the dealer network that currently does the warranty work.  So at the very least you're going to have issues of third parter payers.

But don't the dealers get paid by the manufacturer for the warranty work?

[Ed Anger]

Yeah, have fun dealing with the government to get your warranty honored.  This won't be the same as cheese distribution.

Obamamessiah will send me a check personally.

And stop opening the wounds by reminding me of that delicious cheese.

[Admiral Yi]

But don't the dealers get paid by the manufacturer for the warranty work?

Sure, but I assume that the dealer relationship makes it easier to confirm that the work is covered by the warranty and for the manufacturer to confirm that the work they're paying for is actually being performed.  Maybe not.

[Sheilbh]

Well Wagoner leaves with a $20 million retirement cushion so I won't shed a tear over him getting canned.

I doubt there is anyone here shedding a tear over Wagoner's situation.  The issue with this story is what exactly canning him is supposed to accomplish.  "New leadership" is not a plan or a policy, it's a slogan.

He wasn't great from what I can tell.  I've read lots about how decent a guy he is but I don't know if that's really enough.  The new guy, I believe, helped turn around GM in Europe which is now one of their most profitable areas so he could be better.

I think the main thing (as with Obama suggesting bankruptcy's an option) is that this should scare the unions and bondholders into realising they've got to make some major concessions or the party's over.