advice from a fake consultant

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On Cutting Dealerships, Or, We Examine The Costs Of Selling Cars May 20, 2009

So there’s a lot of conversation out there about car dealerships being told they won’t be selling cars for Chrysler and GM any more.

The idea, we are told, is to save the auto manufacturers money by reducing the number of dealerships with whom they do business.

I don’t really know that much about the car business; and I really didn’t understand where these cost savings would come from, but I was able to have a conversation with the one person I do know who actually could offer some useful insight.

Follow along, Gentle Reader, and you’ll get a bit of an education at a time when we all need to know a bit more about these companies we suddenly seem to own…and about the closure of thousands of local businesses that will make the news about our bad job market worse.

We know, at the moment, that Chrysler wants to close more or less 800 of its 3181 dealerships, and that the list of dealerships was disclosed as part of the company’s bankruptcy filing. The dealer relationships with Chrysler are expected to end June 9.

We also know that GM intends to end relationships with at least 1100 dealers. That list has not been publicly disclosed, and the dealer relationships are not scheduled to end until after the end of the 2010 “model year”, in October of 2010.

It is anticipated that GM will eventually cut 2600 dealers from its current network in an effort to get down to about 3600 dealers; suggesting a second round of cuts is yet to come.

(It appears that Ford is seeking to cut sales costs by about $600,000,000 annually while not cutting the number of dealerships.)

In order to protect the innocent, I’m not going to name my source for this story, nor the dealer for whom he works. For our purposes, let’s refer to him as the “dealer rep”.

So the first thing the dealer rep told me is that many of the dealers affected are “midlevel” dealers who operate in a market with several other nearby dealers; closing these dealers will hopefully reduce costs without substantially reducing overall sales in those markets.

He reports that it costs GM about $250,000 a year to support each midlevel dealer.

The costs include providing unique tools to dealers, providing training to dealer personnel, and advertising and promotional expenses.

I’m told that these are “co-op” costs, with dealers also paying a portion of the same expenses…but GM’s share, multiplied by every 1,000 midlevel dealers removed from the rolls, equals a $250,000,000 annual savings for GM.

He also tells me that many of the dealers are located in rural markets and sell a relatively small number of cars. For these dealers, there is the additional cost of having to deliver vehicles on partially empty transport trucks (or as the dealer rep put it: they’re getting paid less for the delivery than it costs to actually make the delivery).

If we assume that GM spends only 30% of that $250,000 spent annually on midlevel dealer support for these dealers, each 1000 dealers cut saves about $85,000,000 per year; if they spend 60%, the savings is about $170,000,000.

Add it up, and the potential savings for GM might be in the range of $400-500,000,000. Chrysler might expect to save roughly a third of that amount…but that would assume the composition of dealers, and the money spent, is about the same as for the GM dealer group.

(Here’s a quick bit of gossip that I have not confirmed through a second source: the dealer rep told me that some GM dealers are being cut not for lack of sales, but as a result of “customer service” issues.)

There is another group of dealers who will be cut “through attrition”. These include Pontiac dealers, who already know there will be no more Pontiacs to sell, and Saab dealers, who know they won’t be part of the GM future. There are also dealers who are (and have been) closing because of the general economy.

Hummer and Saturn dealers currently face an unknown future.

Something else you should know: the dealer rep told me that Chrysler filed for bankruptcy before terminating the dealer relationships, which may give those dealers more rights in a bankruptcy proceeding than GM dealers that were notified before any bankruptcy filing.

He suggested such a filing might occur as soon as the second week in June…but that is also something I did not confirm through a second source.

He also points out that the successful outcome of all of this is that the two companies are able to make the same sales goals as before with fewer dealers…and he has no idea whether that will come to pass or not.

As for options: the dealer rep reports that the one manufacturer seeking dealers today is Hyundai; but even if they became Hyundai dealers, a lot of stores—particularly in rural areas—are not going to be as successful selling Hyundais as they were selling Chevy, GMC, or Dodge trucks…which might turn out to be good news for Ford and Toyota.

So what have we learned?

GM and Chrysler could save substantial amounts of money by reducing dealers; that process is underway…and for some number of dealers, it’s not about sales volume as much as it’s about sales practices.

GM and Chrysler hope that they can sell the same number of cars with fewer dealers, but as of today there is no way to be sure if that will come true or not.

The biggest winners in this process might be the surviving dealers, or the Ford and Toyota dealers with whom the closed dealers are no longer competing.

The employees of nearly 3000 dealers—and the cities in which they are located–are unlikely to end up winners in this process; however, some (such as mechanics) might eventually find work at the surviving dealerships.

Finally, I apologize for the fact that this wasn’t as inspiring a story as we like to present in this space…but now that we are basically the owners of two major auto manufacturers, it’s a set of facts and figures we better get to know.

WARNING—Self-promotion ahead: I am competing for a Netroots Nation scholarship, and I was not selected in the first round of voting. There are two more chances to be selected, and the voting has restarted from scratch…so even if you’ve done so before, I still have to ask you to stop by the Democracy for America site and click on the “Add your support” link to offer your support for me again. Thanks for your patience, and we now return you to your regular programming.


On A Way Forward, Or, Practical “Subprime Crisis” Solutions September 23, 2008

AUTHOR’S NOTE: This was originally published on February 14th of this year, but it seems to be exceptionally timely today.

We had a lively discussion last week regarding the causes and possible future of the “subprime crisis” that is on everyone’s lips these days.

Having examined the sources of the problem, and noting the lack of holistic thinking about how things might be resolved, I’ve taken it upon myself to come forward with an idea that can actually get at the root causes of today’s difficulties…and do it in a way that offers a potential “win-win-win” outcome for homeowners, investors—and the taxpayer.

Paying attention, Presidential candidates?

Good—because time is short, and we need to get to work.

For today’s solution to make sense, we, like Sherman and Peabody, need to make use of the “WABAC Machine”. We’ll set the time dial to the late 1980s, and we’ll set the location as the headquarters of the Resolution Trust Corporation.

What we’d find is a governmental organization established at the height of the “savings and loan crisis” of the 1980s. The savings and loan companies had made a series of bad real estate investments (much like today), and many had already entered or were in danger of bankruptcy.

Perhaps not surprisingly, many of the same names we recognize today from the world of politics were also to be found “doing bidness” at the time of the birth of the RTC…and if you look it up, you’ll find such luminaries as John McCain, Barney Frank, and even Neil Bush doing things that they today wish we would forget.

In fact, there were so many people doing things they wish we would forget that the RTC was needed to find buyers for all the bankrupt savings and loans that had piled up across the nation. The way this was accomplished was to use regulatory pressure to politely force the bankrupt to accept offers from the more solvent.

As a result, the Silverados of the world vanished, and Keating Five became part of the lexicon.

And with the history lesson complete, let’s scoot on back to the “WABAC” machine and return to the present day, shall we?

Those who participated in our bond insurance discussion (and many who didn’t) may recognize that the biggest problem currently affecting the American financial sector (and beyond) is an inability to accurately determine the exact value of various financial assets.

As you may recall, we noted that one form of these assets are “collateralized debt obligations” (CDOs), which are fundamentally income streams from loans backed by real estate collateral. The original debt was incurred in the form of mortgages or equity loans. The current owners of these assets are not the originating lenders; but instead investors scattered across the planet which have purchased bundles of these loans, a process known as “securitization”.

Because there is a disconnect between an investor in Singapore who purchased a CDO and the borrowers back in the USA who are supposed to be making the payments; it is at the moment impossible to determine with any accuracy the actual value of any particular CDO. In other words, if you invested in loans and you don’t know who might fail to pay, how can you know what your investment is worth?

Lenders, regulators, and investors prefer clarity above all else. In a perfect world, borrowers who might be in trouble would promptly contact lenders to initiate a “workout”. Then everybody would know the status of every individual CUSIP, and life would again return to a state of near normality. (CUSIP is a fancy technical term: each individual loan that makes up a CDO is known colloquially as a CUSIP, and has a CUSIP registration number. Other types of debt instruments, such as bonds, also use the CUSIP registration process.)

But how is that supposed to happen when neither the borrower nor the investor know each other?

That’s where this proposal comes in.

Imagine, if you will, a new Resolution Trust Company that would be chartered with the purpose of creating a “clearinghouse” where investors and borrowers could reach accommodation—and where the status of individual CUSIPs could be determined, registered, made known to participating investors, and, in a privacy protected form, to the public at large.

On the investor side, the process would begin with each investor voluntarily “registering” their CDOs with the new RTC. The registration process would determine exactly which CUSIPs are associated with every registered CDO, and this data would be maintained in a public database.

On the borrower side, an advertising campaign that might look like the ads you see for “credit counseling” services would be run by the RTC…something like: “Are you facing foreclosure? We can help to keep you in your home. Call 800 NO FORECLOSE today”.

The RTC would be empowered to act under a limited power of attorney on behalf of the registered investors and would have the authority to negotiate payment arrangements that might include extending the term of the loans at lower payments, some form of delay on “teaser rate” ARM adjustments, or converting the ARM to a fixed-rate loan—or any combination of the above, as warranted.

In extraordinary cases, the RTC could facilitate direct negotiations between homeowners and investors—and in cases where the home is “under water” (the amount owed is greater than the home’s value) such negotiations will be needed.

Every day, as more and more homeowners call in and the status of their loans is determined (“current—no issues”, “default”, “in processing”, “resolution unsuccessful”, “unknown”, and “resolved” are examples of categories to which the loans might be assigned) they can be matched to their registered CUSIP. As the database fills, this creates the clarity that allows more accurate valuation of the CDOs associated with the CUSIPs…which should be the necessary first step in resolving the valuation issue that’s currently choking up the financial markets.

By publicly posting the loan status and the CUSIP number-without other personally identifiable information-it would be possible, to some degree, to protect the homeowner’s personal credit information from public view, while still offering an “open and public” assessment by an independent third party of the CDO to which the CUSIPs are associated…which means private financing can return to the mortgage market with renewed confidence in what they’re buying…which should also have a positive affect on the stock prices of some of the most beaten down companies in today’s market.

At the same time, as the foreclosure rate declines (if this proposal were successful, that could happen rather quickly) less surplus real estate appears on the market…making investment in land and homebuilding once again a reasonable business proposition. Fewer foreclosures also means less decline in the value of affected neighborhoods, which means the neighbors benefit as well.

All of this could be funded by a registration fee per CUSIP (or based on the amount of the loan) charged to the investors that covers the cost of the RTC’s operations.

You might have noticed that I have not referenced what might be the most daunting problem a new RTC might face: the problem of large loans for large projects. How does the $30,000,000 loan to the Florida land developer who has a half-finished condo complex as collateral get worked out?

I have no idea, but it seems to me that the role of the RTC might be best served by doing the high-volume, “cookie-cutter”, single-family home resolutions (and similar duplex, triplex, and other “small unit” properties), leaving the most complex solutions to be negotiated directly between borrower and investor, with loan servicers and bond insurers charged with facilitating resolutions of these problems on their own.

If solutions can’t be found, the bond insurers are on the hook for the income stream, but if the bond insurers default the investors will get nothing (even when they do get paid the cross-ownership is so convoluted that as we move through the process some of the investors will potentially have to work out deals with themselves), so everyone involved should already-or soon will-have what R. Lee Ermey once famously referred to as “the proper motivation”.

So with all that said, what do we have?

We have a proposal that creates a new RTC for the purpose of “clearing” CUSIPs, which allows CDOs associated with those CUSIPs to be valuated, which creates the conditions for private investment to return to the mortgage market.

We do this with the only cost to the taxpayer being limited to incidental costs (registration fees not collectable, and the cost of enacting the legislation, for example) and the burden of bearing the upfront costs of establishing the RTC and launching the ad campaign—which presumably will be recovered as the process moves along to conclusion.

We also do this without changing the “risk profile” of the loan portfolios held by Fannie Mae and Freddie Mac—a potentially huge benefit to the taxpayer.

The investors, bond insurers and loan servicers win because it suddenly becomes possible to credibly and independently valuate the CDOs, communities win if foreclosures return to normal levels, and homeowners get to keep their homes and credit ratings…and the larger economy benefits as the CDO market, for the first time, feels the “cleansing effect of sunshine” brought on by greater disclosure.

And to top it all off, the “moral cost” of the bad choices made are borne by the involved parties, rather than the American taxpayer: homeowners who made bad loan choices still have to pay off the loans, even if it takes longer than they originally thought…investors will lose or have delayed some portion of their interest income…and the best part—investors and “predatory lenders” who foolishly participated in sketchy loans to currently “under water” borrowers will probably lose some or all of the value of those investments as the true state of their CDO portfolio becomes known to the market at large.