The Chapter 11 solution

Today’s topic: Would we be better or worse off now if the government had let General Motors and Chrysler slip into bankruptcy?

Complete Dust-Up: | | Day 3

Chapter 11 for GM and Chrysler would make Lehman seem like a party
Point: Dean Baker

When Lehman Brothers went bankrupt last September, the financial world shook. A major money-market fund “broke the buck,” as it was no longer able to honor its deposits at 100 cents on the dollar. Banks stopped normal inter-bank lending, and investors everywhere bought Treasury debt as the one safe asset.

Many economists came away from the Lehman bankruptcy thinking that we could never let a bank fail again. Although this conclusion does not follow (we can and should let some banks go through an ordered bankruptcy), economists are right to be cautious about the effects of an uncontrolled bankruptcy of a major corporation.

Had General Motors and Chrysler been allowed to go into bankruptcy last fall, it would have quickly led to a chain of bankruptcies by a whole set of parts suppliers, all of whom are owed large amounts of money by these two companies. It is virtually certain that these companies and their suppliers would be forced to shut down, because no one would have stepped forward to provide credit to operate through bankruptcy without a government guarantee. Because Ford shares many of these suppliers with GM and Chrysler, the disruption to the supply chain almost certainly would have been enough to push Ford over the line as well.

This would have meant almost a complete shutdown of the auto industry in the states of Michigan, Indiana and Ohio. In these states, the auto industry and its suppliers account for close to 6% of total employment. Imagine if the country suddenly lost 8.4 million jobs (more than twice the actual job loss over the last five months). Such is the impact these three states would face were the Big Three to cascade into bankruptcy.

This sort of catastrophic job loss would have had huge ripple effects in the region, as laid-off autoworkers would be forced to cut back on all sorts of spending in the local economy. Many would face losing their homes. Already hard-pressed state and local governments in the region would be swamped with demands for services at the same time that their tax revenue would be plummeting. The area would soon be seeing suffering and poverty that matched what the country experienced during the Great Depression.

President Obama (like President Bush) was right in opting not to go this route. It is unfortunate that we are in a situation in which the government has to bail out the auto industry.

The fault lies first and foremost with the incredibly incompetent performance of the Federal Reserve board and other financial regulators. This economic collapse was entirely foreseeable and preventable. The Big Three and their employers, and the regions that are economically dependent on them, are the victims. They may deserve blame for many serious mistakes, but they are on life support right now not because of their own errors but because of Wall Street’s sins.

Dean Baker, co-director of the Center for Economic and Policy Research, writes on economic reporting at the American Prospect’s Beat the Press blog.

Bankruptcy isn’t corporate genocide
Counterpoint: Matt Welch

An interesting phrase, this “uncontrolled bankruptcy.” Sounds kind of like a Category 5 hurricane and Santa Ana inferno rolled into one -- only even more deadly, at least if you swallow the absurd-on-its-face notion that bankruptcy proceedings on three companies would immediately liquidate each and every one of the 8.4 million auto-related jobs in Michigan, Indiana and Ohio.

What actually happens in a bankruptcy? Typically, a judge sits down with a company, holds off many of its creditors, helps negotiate sales of various divisions, works with management on reforms, keeps productive factories churning out product and so on. In other words, it is the imposition, not absence, of “control,” usually by someone who -- unlike your garden-variety president -- actually has experience in the field.

If bankruptcy were merely corporate genocide, we wouldn’t be here arguing today. After all, the parent company of the L.A. Times is going through ... bankruptcy! No one but the most radical of media doomsayers is predicting that this august institution will cease to exist next month, next year or even next decade. The brand is too strong, the demand for news is still too great, and if things really get dire, Rupert Murdoch would buy the hollowed-out husk of Spring Street in a New York minute -- prompting, no doubt, howls of protest from the exact same Nation magazine crowd currently plumping for a massive bailout of newspaper companies. But I digress.

Big companies go bankrupt all the time. In 2001, WorldCom was No. 23 on the Forbes 500 list, with 85,000 employees. By 2002, in the wake of various scandals, it was the biggest bankruptcy in history. Did those employees all disappear? Did the domestic telecommunications industry collapse? Did Americans stop using high-speed Internet infrastructure? Nope. The company changed its name to MCI, restructured and was eventually bought up by Verizon. This is what happens to bankrupt companies with valuable assets and products. To the extent that the Big Three make valuable products in a way that different managers could extract profit from, their brands and showrooms would survive Chapter 11.

One begins to suspect that the word “uncontrolled” is less descriptive about a legal process than it is reflective of a generalized anxiety about capitalism. And that’s an understandable emotion: Companies and conditions in generally free markets change with a speed that’ll make your head spin. A&P was the dominant supermarket chain in the country back when GM still ruled the world, yet few now have even heard of it. Traumatic as that was for the company’s managers and employees, did Americans stop buying groceries or stop creating domestic retail giants that employ tens of thousands of people? No.

So yes, 6% of a three-state workforce is a big number. But how about two out of every five workers? That’s the ratio of Americans who were employed by the agricultural industry in 1900, compared with a measly one in 42 today. Does that mean we have 38% unemployment now? No. It means we’ve figured out how to farm more efficiently, allowing the rest of us to pursue more enriching, less backbreaking work.

Look, even though it’s not my cup of tea, I don’t mind if people are nostalgic for the Company Man 1950s (though I’ll take the “Bad News Bears” ’70s any day). But when they start using our tax dollars to preserve in amber the worst practitioners of a heavily technological industry, those companies are yanked even further away from their customers and more toward the temporal enthusiasms of politicians. And the reforms they require are kicked further down the road.

The federal government should be a referee, not a kingmaker, establishing clear and simple rules and procedures for industry and otherwise getting the hell out of the way. One of those procedures is the controlled force of bankruptcy. If GM can’t make a profit selling the beloved Cadillac, it’s long since time to find owners who can figure it out.

Matt Welch is editor in chief of Reason magazine.

Response from Dean Baker

Matt,

Fair is fair and you are entitled to last word, but I just want to be sure you understand that I was distinguishing between a bankruptcy in December 2008 and a bankruptcy in more normal times.

In more normal times, firms in bankruptcy arrange debtor-in-possession financing. This sort of financing almost certainly would not have been available in the financial environment that existed at the end of 2008 and probably not even now, unless the government was prepared to issue guarantees.

The repayment of DIP financing gets priority over almost all other forms of debt, but given the shortfalls that the industry was looking at on an operating basis, the repayment of DIP financing would hardly be a sure thing.

For this reason, coupled with the exaggerated fears in the credit market, I don’t think it is reasonable to assume that DIP financing would have been available to the Big Three back in December without a government guarantee.

Regards,
Dean