Detroit's Woe, America's Worry

The biggest problem about the missteps plaguing GM and Ford: They're likely to cause an economic pileup clear across the country

By Amey Stone

These are tough times for Detroit, and they aren't likely to get better anytime soon. So motorists, consumers, and investors better all brace themselves: The effects of auto industry woes will likely rumble through the economy far beyond Motown's city line.

General Motors (GM ) shocked the financial world in mid-March when it warned of staggering losses in the first quarter of this year -- $1.1 billion in red ink when the number was announced on Apr. 19. Ford (F ) reported on Apr. 20 that it managed to post a profit of $1.2 billion in the period, but that was a punishing 38% drop from a year ago.

Both companies' stocks have fallen about 40% in the past year, and credit markets are reeling at the potential for credit-rating downgrades. "It's a very sad day here in Detroit," says Gerald Meyers, a professor at the University of Michigan Business School and former chairman of American Motors Corp. Even Chrysler, a division of Germany's DaimlerChrysler (DCX ) that's holding up far better than the other two members of Detroit's Big Three, is worried about what troubles at GM and Ford portend for the U.S. auto industry, says Meyers.


  Because of the domestic auto industry's size, its misfortunes have an amplified impact on the overall economy and on family budgets, say economists and industry experts. For example, financial turmoil sparked by a credit downgrade for the car companies could have a direct effect on many Americans' savings and retirement accounts. When debt falls in value, mutual funds and pension funds holding bonds issued by these carmakers fall, too. Rising gas prices only add to consumers' pocketbook misery.

Most shocking of all: Given the nature of this downturn, increases in car prices are likely to accelerate. "I don't think you'll see any diminution in the quality of cars or the choice, but I do expect to see higher prices," says David Cole, chairman of the nonprofit automotive think tank, Center for Automotive Research (CAR).

Auto makers are already reporting that incentives, like zero-percent financing programs, aren't stimulating buying the way they used to and are cutting them back, says Tom Webb, chief economist with Manheim Auctions in Atlanta. Used-car prices are also rising, which often presages higher stickers for new vehicles, he says.


  The industry's root problem is that it can't really squeeze any more savings out of suppliers or the manufacturing process, says Cole. Given the rising costs of producing cars, auto makers have little choice but to raise prices to return to profitability. "A car just got to be too good a deal, and that era is over with," he says.

U.S. cars won't be the only models that get pricier. Toyota's (TM ) chairman stunned the industry at an Apr. 25 news conference when he hinted that the Japanese giant would consider raising prices in the U.S. to help out American carmakers. Most analysts say Toyota would simply be using Detroit's problems as an excuse to boost its own profit margins. But such a move would also be prudent if Toyota is worried that a serious slump in the U.S. auto industry could spark a recession or lead to more protectionist policies domestically, says Cole.

The downturn in Detroit can't be chalked up merely to U.S. auto makers losing a popularity contest between gas-guzzling sport-utility vehicles and fuel-efficient new hybrid models. Instead, the industry's financial woes are due to far more intractable and long-term trends -- rising health-care and pension costs for workers, increased foreign competition from Asian manufacturers, and rising prices of commodities used to make cars.


  Even though auto industry employment is far lower than it used to be, CAR estimates that every job lost in an carmaking plant has the economic impact of losing 9.4 jobs elsewhere. GM alone still makes up 1% of the economy, says Cole.

Meyers worries that these trends aren't going away, no matter what the economy or gas prices do. "More and more people are going to be finding themselves idle when they would rather be at work," he predicts.

Most of the auto downturn's economic damage will hit states like Illinois, Ohio, and Indiana where carmaking is concentrated. "If you live in Flint, Mr. Moore is going [to have to] to make another movie," says Milton Ezrati, senior economist at Lord Abbett & Co, referring to the location of Michael Moore's 1989 documentary Roger & Me. "He will get rich, but they will remain poor."


  What most worries economists, however, is the potential for U.S. auto makers' debt ratings being downgraded. "Any threat of default or downgrade affects assets across the country," says Ezrati, who notes that GM and Ford paper is held in virtually every pension fund and money-market account in the country. "A lot of wealth has been destroyed already, but that's not to say it couldn't be worse," he says.

What could brighten this ugly outlook? Some innovative new designs might help. "Ironically, bad times in the auto industry often brings out the best in design," says Tim Yost, director of marketing at American Specialty Cars, which works with carmakers to create specialty vehicles. "It forces auto makers to stand out from the crowd all the more. It's ironic because in tough times most businesses hunker down, but in the car business, that's the last thing you want to do." Adds Yost: "A lot of people would say Chrysler is the healthiest auto maker in Detroit. Design had a big role in that."

But rather than waiting for trendy new models and bold, catchy new designs, consumers might want to buy a car now before prices start to rise, Cole advises. As the financials of GM and Ford show all too starkly, the U.S. auto industry can't solve it's problems by sales incentives alone, and more expensive sticker prices may just be one of several ways American families share their pain.

Stone is a senior writer for BusinessWeek Online

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