Why Ford, GM and Chrysler Need A Bailout

Why not just let General Motors, and perhaps Ford and Chrysler, just go bankrupt? Even as auto industry executives and their political allies clamor for a bailout, the anti-bailout chorus is growing louder. The shrewd John Gapper makes the case in his Financial Times column, and hedge fund sharpie Bill Ackman seconds the motion. In the National Review, Jim Manzi makes the ideological case.

Of course they're all correct. Allowing the listing Big Three to keel over would be a triumph of free markets. It would punish failure and invite new managers and investors to enter the field. I'm a big fan of creative destruction and its wondrous benefits (I wrote a book about it). But I also think the no-bailout folks are being too cavalier.

Yes, GM's management has been dreadful. As the Israeli diplomat Abba Eban said about the Arabs, they never missed an opportunity to miss an opportunity. And it's difficult to make a case that Cerberus, the private equity firm that thought it was getting a steal when it bought Chrysler, should get any taxpayer assistance. But I'm having a difficult time jumping on the anti-bailout bandwagon. Perhaps it's because I grew up in mid-Michigan, and played little league baseball in the shadow of the Fisher Body plant. Or perhaps because, for a brief period long ago, I covered bankruptcy courts. In any case, what follows is less an argument for a bailout as it is an argument against those agitating for a rapid Chapter 11 filing.

If the Big Three don't get government checks, it's very likely that they'll run out of cash and be forced to file for Chapter 11 bankruptcy. GM, which is bleeding fastest, would be first to fall. Chapter 11 bankruptcy is an efficient process for conducting corporate triage. A retailer fails, and the creditors assume control. Some stores remain open, while other are liquidated. Trade and financial creditors accept partial payment of the debts they're owed. Leases and other pre-bankruptcy legal obligations are torn asunder. Mall owners around the country move swiftly to fill the vacant space. Several months later, the winners and losers having settled and moved on, a chastened, less-burdened company emerges from bankruptcy.

But General Motors wouldn't be a typical bankruptcy. GM's management argues that the very act of filing for bankruptcy eliminate the possibility of recovery, since people would be reluctant to purchase expensive, long-lived assets (cars and trucks) from a bankrupt entity. And because of its size and the place it occupies in the supply chain, the failure of GM would likely trigger the bankruptcy of hundreds of suppliers and other companies that rely upon GM.

More significantly, Chapter 11 proceedings for GM would be far more complicated than that of a retailer, or of Lehman Brothers. Recent experience shows that for auto companies, Chapter 11 is like the Hotel California. You can check in any time you like, but you can never be able to leave. Auto parts supplier Delphi filed for Chapter 11 in October 2005, and still languishes there. Getting out of Chapter 11 can be tough when (a) the bankrupt companies are capital-intensive manufacturers; and (b) creditors are reluctant to give up on their claims. Among those with the biggest claims on the automakers, and GM in particular, are the United Auto Workers. It's common, especially in the fever swamps of the right, to blame the UAW for the Big Three's high cost structure and legacy costs. (Never mind that management for generations willingly entered into the labor pacts, consciously trading salary increases for longer-term liabilities like guaranteeing health insurance for retirees. Such pacts allowed the Big Three to report higher profits in the short term, and pushed the hard choices to the future.). Last year, the UAW and the auto companies set up a health-care fund that, as the New York Times writes, would "shift a $100 billion burden off the companies' backs." Would the UAW simply give up on the health care benefits and tell hundreds of thousands of 40- and 50-something members to just go out and buy their own health insurance?

Another difference between this and other large bankruptcy cases is the potential collateral damage. New York will survive the failure of Lehman Brothers and Bear Stearns, although it will feel the pain of lower tax revenues  and retail sales. When a national retailer goes down, it hurts landlords all over the place, but rarely causes an entire mall to become vacant. But already-depressed Michigan, and several adjacent states, will have a much more difficult time dealing with the collapse of an automaker. This doomsday economic scenario, released by the Center for Automotive Research, says that up to 3 million jobs nationwide could be lost if the Big Three stop all production next year. That might not be in the offing. But the impact on Michigan's cities, towns, state government, housing values, and public institutions (including resources that the state has built that are national resources, such as its public university system) would suffer grievous harm.

There's a general consensus that in order to survive as going concerns, the Big Three need to shrink their capacity by 40 percent, recruit new managers and corporate boards, restructure labor relations in such a way that they can have lower-cost and more flexible workforces, and shuck many of the liabilities they willingly entered into, all while raising vast new sums of capital to invest in research, development, and factory modernization.

But is a Chapter 11 filing the best way to reach these goals? Answering yes presumes that the case would be resolved quickly, that the entities would be able to obtain ample debtor-in-possession financing, that parties with legitimate legal claims on the company's assets and cash flows would give them up willingly. But many of the questions surrounding the Big Three's future can't be resolved in law firm conference rooms or in the chambers of bankruptcy court, and won't center around legal questions. The failure of the American automotive industry – and let's be honest, it has basically failed – is a matter of public policy. If the Big Three can be saved, they can only be saved by government.

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