Can Chrysler Be Cured?

By Justin Fox

On May 14, German automaker DaimlerChrysler announced that it would pay private-equity firm Cerberus Capital Management of New York City $675 million to take a bunch of old people's medical problems off its hands.

True, there was a carmaker thrown in as part of the deal, and Cerberus agreed to invest a few billion dollars to help get struggling Chrysler back on its feet. Just after the transaction was announced, DaimlerChrysler CEO Dieter Zetsche (he of the big mustache and the TV ads) bristled when a journalist suggested that he had paid Cerberus to cart Chrysler away: "It was clearly stated that Cerberus invests 7.4 billion U.S. dollars in this transaction, which is not any form of being paid," he snapped.

But there's no denying that Daimler, as the company will be known once Chrysler is driven off the lot, is forking over $675 million to make the deal happen--a remarkable repudiation of its $36 billion purchase of Chrysler nine years ago. And there's also no denying that the sums changing hands in the current transaction pale next to the $18 billion in health-care obligations that Chrysler owes its retirees.

Like the other members of what is now called the Detroit Three--the traditional Big Three moniker having been rendered obsolete last year when Toyota sold 2.5 million vehicles in the U.S. to Chrysler's 2.1 million-- Chrysler has long pledged to take care of virtually all its U.S. employees' medical expenses when they retire. Faced in recent years with stagnant sales and rising health-care costs, the automakers have been ratcheting down those benefits (mainly by requiring co-pays and contributions) for retirees without union contracts. Then, in 2005, General Motors and Ford persuaded the United Auto Workers (UAW) to break open an existing contract to cut health benefits for both current and retired workers. Chrysler couldn't get a similar break because at the time it appeared healthier than its Detroit brethren; plus it belonged to a big German company whose other businesses (Mercedes-Benz and Freightliner) were, and are, doing just fine.

Now, though, Chrysler is in the red (it lost $2 billion in the first quarter alone) and will soon be on its own, and the UAW's four-year contracts with the D3 expire in September. All eyes in Detroit are on how much Cerberus--a 15-year-old firm with a reputation for cost cutting--will be able to squeeze out of the UAW.

If it follows the usual private-equity script, Cerberus will try in a few years to take a slimmed-down, more competitive Chrysler public on the stock exchange or sell it to another automaker. More than any other single factor, it will be Cerberus' efforts to cut health-care spending on retirees that will determine whether it can do so at a big profit.

Discussions of the U.S. auto industry's woes often break down into something like those old Miller Lite tastes-great/less-filling debates: The cars aren't good enough! The pension and health-care costs are too high!

Really, it's both. Chrysler, like Ford and GM, has considerably narrowed the quality gap with foreign-car brands but perhaps not the perception gap. Critically, though, Chrysler hasn't designed enough vehicles that are attractive and fuel efficient, despite having the Mercedes crew to help.

Dig through the financial statements of the Detroit Three, however, and you can easily conclude that they are money-losing retirement and health-care organizations just masquerading as money-losing carmakers. Consider General Motors, which supports three living retirees for every worker now on the job (at Chrysler the ratio is 1.3 to 1). GM long ago lost its status as the nation's largest private employer, but it remains the biggest private purchaser of health care. Investors value GM's business at $18 billion; the fund it has set aside to pay for employee pensions is worth more than $100 billion.

The Detroit Three complain frequently about the cost that health care in particular adds to each car they produce in the U.S.--at GM it's $1,600, at Chrysler $1,500, at Ford $1,200. But the cost paid in management attention and focus may be even greater. The single greatest stroke of Rick Wagoner's seven-year tenure as GM CEO, for example, was probably his well-timed decision to use $18 billion in mostly borrowed money to shore up the pension fund in 2003 (yes, $18 billion does seem to be something of a magic number here). That move, coupled with the stock market's subsequent rise and the investment savvy of GM's pension managers, may well have averted bankruptcy. Can it be any surprise that the company's board would rather have a finance guy like Wagoner running the show than a full-time car nut?

Detroit got into this benefits predicament because of a not entirely conscious policy decision by Washington after World War II to encourage corporations to provide health care and pensions (most other affluent countries gave government a bigger role) in lieu of inflationary wage hikes. During the decades-long economic boom that followed, this system worked spectacularly well--especially for employees of Detroit's prodigiously profitable Big Three.

But as the country's manufacturers began to struggle with foreign competition in the 1970s, some retirees got shafted, and lawmakers and regulators responded with new rules that were intended to protect pensions and retiree health insurance but instead scared most companies away from even offering them. Pension plans have given way to 401(k)s, in which employees bear all the risk, and the Employee Benefit Research Institute says only 13% of U.S. private-sector employers now offer health benefits to retirees.

The Detroit Three, though, held out. When they ran into trouble in the early 1980s, the UAW gave some ground on benefits. But in the 1990s the automakers came roaring back to profitability--helped by falling gas prices (which boosted the pickup and SUV segments still dominated by Detroit), a booming stock market (which made pensions easier to finance) and a slowdown in medical-cost inflation.

Early in this decade, all three of those trends reversed, and Detroit was suddenly in big trouble again--bigger trouble, in fact, because the companies' ratio of retirees to active workers has only grown. Which has turned up the pressure on retiree benefits. In the case of pensions, GM, Ford and Chrysler now all have enough money set aside to meet their obligations. But none put much in the bank to cover future health-care costs.

Which brings us back to Chrysler, the UAW and what is shaping up to be a very hot summer of contract talks. The company's rank and file are less than thrilled about their employer's leaving the warm embrace of Germany and falling into the hands of New York financiers. "These private-equity firms are like modern-day robber barons," said a worker at the company's Warren truck plant outside Detroit. "People are feeling betrayed by the management."

UAW chief Ron Gettelfinger opposed the Chrysler sale. But after a quick trip to DaimlerChrysler headquarters in Stuttgart, where Zetsche said he would not be dissuaded from selling and Cerberus was the best of the potential buyers, Gettelfinger offered a tepid endorsement. "It's going to happen, and we're going to make it happen in the best interest of our membership," he said.

Gettelfinger has long argued that the best way to cut automakers' costs without shafting workers would be to move to government-run universal health care. Another possibility, pioneered last year by tiremaker Goodyear: paying the union a lump sum to take over retiree health care for good. But health-care reform won't come for a couple of years, if ever, and for automakers that lump sum would be staggering. So it's hard to see how Detroit can avoid a major showdown this summer. Road Race. The Fight for the U.S. Market [This article contains a complex diagram. Please see hardcopy of magazine.] Sources: Center for Automotive Research; Ward's Automotive Group; company reports

With reporting by With Reporting by Joe Szczesny / Detroit