"And this one, this is my personal favorite: One Wall Street analyst to another wrote, quote, 'Let's hope we are all wealthy and retired by the time this house of cards falters.'"—60 Minutes correspondent Scott Pelly, reading a 2006 e-mail to Treasury Secretary Hank Paulson
"This is another fine mess you've gotten us into."—Oliver Hardy to Stan Laurel
For a decade the business mantra has been that the American economy had finally evolved. From its "old line" way of performance, that being manufacturing and sales, we had transformed into a far more modern and prosperous service and financial society. For the financial pundits to prove their point, they needed to look no further than Detroit's continuing [old line] problems in making any profits whatsoever, regardless of its overall sales volumes. Meanwhile, the analysts claimed that the half-decade-long housing boom proved the new wealth of all Americans. No one caught the fact that housing construction was also an old-line industry.
The nation was told the old rules that once determined the health of the nation's economy had at last been overturned. As manufacturing shed nearly 4 million jobs and Detroit posted tens of billions of dollars in losses, the stock market soared. The nation's GDP followed, and Wall Street crowed that a new day was dawning for American wealth and financial power.
Only something was seriously amiss. And had anyone bothered to ask Detroit what its fundamental problems were, instead of dismissing General Motors (GM), Ford (F), and Chrysler as yesterday's news, much of what the nation is now going through in the seizing up of our credit markets could have been avoided.
Because many car buyers went subprime before homeowners did.
Long before the term "subprime mortgage" entered the American language, Detroit knew that as each decade passed more and more of its potential buyers' credit scores were starting to suffer. In 1975, if someone walked into a new car showroom with horrific credit, there was little any finance manager could do to secure him a new loan. By the late 1980s, lenders were more sympathetic to those who had fallen on hard times; with the proper down payment and a good story about their past financial woes, many with poor credit had a good chance of getting financing for their new car. And by the mid-'90s, an entire industry had sprung up to deal with car buyers with seriously challenged credit scores.
However, as the nation lost more of its manufacturing base—whose employees were buyers for Detroit's products—in this same decade household incomes remained stagnant for most, while personal expenses for food, energy, and gasoline rocketed skyward. Yet those controlling the financial news in this country had only to point at the massive increase in homeownership as proof the economy was in great shape; in fact, it was claimed to be magnificent. Of course, we know now that much of the decade's housing boom was nothing more than a mirage, powered by subprime mortgages and the potentially even more toxic Alt-A mortgages that are already starting to reset, causing even more damage to our financial system. (Note to Congress: Has anyone asked about that coming mortgage crisis?)
One thing is inevitable: Many who have stayed employed will soon be homeless, because when their interest-only, negative amortization, or interest-rollover mortgages are reset, their monthly house payment will be more than they can pay. And that will throw untold hundreds of thousands into the ranks of the nation's future subprime borrowers.
A Slump on Steroids
As the American family's income seemed frozen in time, the nation's savings rate fell into negative numbers; in many years new home equity loans were in the neighborhood of $800 million. In the "old line" way of thinking, the nation's bankers would have required their customers to pay down their outstanding debts in slow times; but in our "new service and financial society," it seemed as if the bankers were asking why the customer didn't want to borrow even more.
But had anyone really been looking for the truth about Main Street's economic squeeze, it was there in plain sight: The continuous suicidal incentives Detroit has offered have been a desperate roller-coaster attempt to lure financially strapped families into its dealers' showrooms, and that alone told the story. In the past, in healthier historical cycles of new car sales, the record-breaking years for the auto industry in 2000 and 2001 should have led to a natural increase in automotive replacement demand by 2005. But no such thing happened; instead, that summer GM had to offer Employee Discounts for Everyone plus rebates to move the market at all.
The same thing happened this summer, only on steroids. Suddenly, between the factory discounts and rebates, one could purchase a new $29,000 Dodge Ram pickup for around $17,000. Ford offered up to $8,100 cash back on certain models of its once-dominant F Series truck, and GM light trucks buyers found out that getting 35% off the list price was no longer something salespeople laughed at when you suggested it. Meanwhile, Toyota (TM) quickly announced it was shutting down production of its truck line at Princeton, Ind., and that its planned Mississippi plant would build the Prius hybrid instead of a crossover SUV.
While it is true the largest incentives went to prop up light trucks, large incentives or subvented interest rates or leases were also offered on many popular models, such as the Toyota Camry. Yet in spite of these moves, new vehicle sales have fallen dramatically.
Detroit's manufacturers believe they have the answer: Not only must they create "must-have" compact and extremely fuel-efficient automobiles, but the U.S. car buyer's perception of fair window-sticker prices for these new cars must be realigned. In a nutshell, buyers must start expecting to pay what Europeans do for compact cars.
Obviously, Japanese automakers would love to get even higher prices for their most basic econoboxes too, but the competitive nature of the U.S. car market might make this more of a fantasy than a possibility. Look at the test cases already in the market, say, for example, the Saturn/Opel Astra. The German-inspired Astra has a base price of $18,480, while the Honda Civic's is $15,402. The predictable result is that in August, Honda (HMC) sold 30,052 Civics, while the Saturn Astra managed a pitiful 1,994 sales.
Is This Another Bad Loan?
So, after publicly pleading poverty owing to the high costs of employee health care, then switching the blame for its downfall to its high costs of labor, suddenly Detroit foresees no problem repaying $25 billion worth of new co-signed debt, just as soon as Congress can get this new financial package moving. And with this money Detroit promises more fuel-efficient vehicles that (it hopes) can bring premium prices, thereby restoring its financial health.
Don't misunderstand me: I want Detroit to recover and succeed. In the same way, I want Honda to come up with exciting new designs, or for that matter any car company to do well: That creates real competition in the market and gives us real innovation, and the car-buying public is best served by having many choices when they go to buy new. But my goodwill and intentions don't alter the real underlying problem.
The average American family's income is virtually the same as it was eight years ago. But their indebtedness has grown, and their expenses for necessities like food, energy, and gas have in some cases doubled. Their net worth is falling with the housing problem, which isn't going away until the subprime mortgage issue is fully resolved—and until we are told the truth about what damage the Alt-A mortgage resets coming our way will cause. (Spoiler alert: Some believe the Alt-A crisis will be much larger than the subprime problem.)
America has had to pry the bad news out of Wall Street about the health of our financial system, and as of today that's still not fully disclosed. Maybe it's time for the automakers to come clean on what they know about the financial health of their buyers. That's what will really determine whether their plan of automotive conquest, using our $25 billion, has even a remote possibility of working.