Brookfield Basics

Something important happened a little over a week ago - something went bump in the night. It remains to be seen whether that bump will turn out to be a ghost coming out of the closet, or whether it was just a whimper of our imagination.

Daimler-Chrysler AG of Germany sold its Chrysler Division to an independent and private group of investors by the name of Cerberus. This is significant on many levels.

First and most obviously, it is a major deal – Cerberus is paying nearly eight billion dollars for what was once an icon of American industry. Chrysler Corporation, once one of the “Big Three” US car manufacturers, was purchased by Daimler-Benz nearly ten years ago. After a massively failed experiment, Daimler has unloaded it to this private group of investors.

The Daimler sale of Chrysler was highly criticized by two parties: an employee consortium which wanted to purchase the company, and Lee Iacocca, former Chrysler Chairman and longtime senior executive of Ford Motor Company. The employee group claimed they were “sold out” by Daimler and the UAW, and that they had the financial backing and the “right plan” to return the carmaker to profitable operations. How a successful plan would have come from the very group whose negotiated wage, benefit and retirement programs are the death sentence of this industry remains unclear. As for Mr. Iacocca, he offered the most blunt if not the most insightful commentary in Business Week. “Daimler screwed Chrysler royally. Chrysler was the lowest cost producer and the most profitable car company in the world until Daimler drove them off the cliff”, he wrote. Apparently he has never heard of Toyota and the Honda Motor Company, whose income statements and balance sheets have put the domestic manufacturers to shame for over twenty years.

Barring a miracle or a government bail out, the US automakers are on a one-way trip to bankruptcy. The question is not IF they will file Chapter Eleven, it’s WHEN. This is more than just a forecast; it’s an actuarial eventuality, as their sales simply cannot generate enough cash to cover their hopelessly bloated fixed cost structures. Each year the cash reserves of Ford and GM dwindle by a few more billion, as they have no recourse but to use these reserves to pay for costs that their earnings cannot cover.

What is the source of their fixed cost woes? Bloated health care costs and un-funded retirement plans. General Motors currently has five RETIRED employees on their payrolls for every ACTIVE employee, and each of those five are getting full health care coverage and pension payments. You can do the math.

So what is it that went bump? I don’t know the plans of the managers of Cerberus, but my guess is they did not buy Chrysler to lose money. It is my subsequent guess that they will begin to address these fixed costs, and that may bring some very interesting developments.

What’s the point of all this? If you are not a shareholder in Daimler-Chrysler or Cerberus, why should you care?

Domestic auto executives, having consciously and steadfastly refused for forty years to address this coming storm, are already bleating to Washington about the need for a massive Federal bail out. If that happens, we’ll all pick up the tab.

Secondly, government better think twice before they bail out Ford and GM because it has the very same problem. The collective liability of all public sector employers for these same areas of fixed cost is now measured in the TRILLIONS.

It’s all about health care costs, which in the public sector and the US auto industry run two to three times the cost of the average private sector plan. When discussing what to do about health care costs, there are essentially two choices. We can put nearly twenty percent of our entire economy into the hands of the Federal Government in the form of a national health insurance program, or we can let the market work in the form of consumer driven health care reform. I will write more about consumer driven plans over the summer.

I know which choice I prefer.

How about you?