Car Makers' profits warning highlight global shifts and the scale of the financial crisis

By David Bailey on Aug 3, 08 08:23 PM in Automotive

"History has rarely seen factors like this occur at the same time" BMW's financial director Michael Ganal told a news conference last week.

He spoke as BMW's first half pre-tax profits fell to €1.24 billion, down some 35% compared to the same period last year. Net profits also took a nose-dive, down 26%. They were not alone. GM and Nissan also announced dire results last Friday. GM's spectacular $15.5 billion second quarter loss is the third-worst in its 100-year history. Meanwhile, despite increasing market share in the US, Nissan's net income still fell by over 40%.

Ganal was in effect referring to a number of events that have come together at the same time. A 'perfect storm' might be another way of describing things for some major auto manufacturers.

With globalisation unfolding and China and India emerging as powerful economic players, the demand for oil and raw materials has increased in recent years, leading to hefty price rises and increases in costs for manufacturers.

Over the last year, the price of oil has been further inflated by speculation on the markets such that the current world price seems completely unconnected with fundamentals (indeed the $25 a barrel fall in oil prices over the last few weeks has come as speculators have unwound their positions).

That financial market deregulation was meant to open up opportunities for financing investment and trade, but has also brought us the sub-prime mortgage fiasco in the US where in the extreme case so-called 'ninja' (no income, no job or assets) mortgages were sold to people who didn't understand the complex financial products being pushed at them by commission hungry sales reps. These risky debts were then salami sliced into thousands of pieces and repackaged (or 'syndicated') with less risky debts and sold on around the world.

In so doing, US banks overextended themselves in a spree of reckless lending, assuming that the orgy of low interest rates, low inflation and a consumption binge were here to stay and that those salami-sliced syndicated debts would spread the risk around the world to the point where they needn't worry about defaults.

As I've noted in previous blogs, they were badly wrong. At some point the low-inflationary benefits of globalisation and cheap Chinese goods began to fade and high prices for oil and raw materials kicked in. When the Fed started to ratchet up interest rates to constrain inflation, the debt mountain in the US weighed most heavily on the weakest members of society. Defaults took off, house prices collapsed and the globalised financial sausage machine seized up...

The scale of the resulting house price crash and slowdown in the economy is now impacting badly on the bottom line for the major auto manufacturers. Sales are down in the US, and the value of second hand cars (including those given back at the end of leases) has fallen so much that BMW has had to make provisions of €695 million to cover financial risks, following a similar move by Ford. BMW spent another €100 million on cutting jobs.

Of course, the imbalances in the US economy were also reflected in the decline in consumer savings and the size of the US trade deficit that built up, as the country lived beyond its means. The correction now taking place sees the US dollar declining in value on world markets (the Euro is near a record high against the Dollar). Other things being equal, that in turn will make the US a more competitive place to manufacture in, as BMW itself has previously noted when it shifted some production from Europe to the US.

But the slowdown is now so intense that BMW can't sell all the cars it now makes in the US. As a result, it is cutting back production (hence the job cuts), and re-routing (i.e. exporting) some cars to Europe, and to emerging markets like the Middle East which is doing well. The latter is not surprising given the amount of oil money flowing into the region.

Quite where this leaves its European operations is an open question. European producers will also be affected soon by tough new emissions requirements that will see the premium end of the market in effect fined for high CO2 emissions across the range of cars it produces (this will also impact on Jaguar and Land Rover).

Globalisation has brought benefits in more choice for many consumers and cheaper goods from China. The flip side of negatives has included an excessive deregulation of financial markets which has caused a major crisis. The impacts of this are now playing through the real economy.

This cocktail of financial crisis, economic slowdown, higher oil and raw material prices and economic rebalancing has yet to play out fully, and there will be further job cuts and hits on the profits of BMW and other major auto manufacturers.