How Bankruptcy Would Benefit GM

The company would stay in business—and undergo real reform.

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Is the Midwest about to tumble into Lake Erie?

Sure sounds that way. With General Motors teetering at the edge of insolvency, the company's backers argue that a bankruptcy filing would basically wipe out the entire U.S. auto industry. All of GM's 125,000 employees would supposedly lose their jobs, along with many times that number at suppliers, dealerships, and other companies. A congressional analysis suggests that nearly 4.9 million jobs could be at stake. I guess we should start hoarding food and fuel, because the entire U.S. economy might implode.

At least that's the dreadful scenario that auto executives, union leaders, and the Michigan congressional delegation say justifies a government bailout that would start with $25 billion and surely go up from there—with dubious provisions meant to ensure that the sprawling automaker somehow gets religion and becomes a competitive car company.

But there's already a well-established process in place for helping troubled companies like GM deal with profound problems. It's called bankruptcy reorganization. For some reason, there's an impression that this is beneath Big Auto. But in fact, the process could serve GM well, as it has other big companies. Here's how:

GM would continue to operate. A bankruptcy filing doesn't mean GM would go out of business. Some bankrupt companies do, but many write off debt, shed costs, dissolve unprofitable divisions, and emerge as healthier companies. "You get an automatic stay on many of the obligations causing you problems," says bankruptcy expert Edward Altman of New York University's Stern School of Business.

Continental Airlines has declared bankruptcy twice and is now considered one of the healthiest airlines in the industry. Delta, United, and US Airways all emerged from bankruptcy far better off than they went in. Even at companies that end up dissolved, some divisions often stay in business, usually under new owners.

Workers would continue working. It's virtually certain that there will be fewer jobs at GM in three years than there are today. But that will happen regardless of whether GM declares bankruptcy. The U.S. auto industry has the capacity to build at least 5 million more cars each year than Americans want to buy right now, and much of that overage is at GM. If people aren't buying cars, jobs are going to go away no matter what. Unless, of course, Congress decides to pay GM workers even if they don't work, which, come to think of it, is something GM has been doing! Maybe that's not such a good idea.

The company would get a breather. With no intervention, GM is likely to run out of cash sometime early in 2009, which is why it can't raise financing in the ordinary debt markets—lenders are afraid they won't get their money back. Bankruptcy would give GM some relief it doesn't have right now with its creditors, unions, and dealerships. "GM is locked into a set of obligations that are unsustainable," says MIT lecturer Steven Spear, author of Chasing the Rabbit: How Market Leaders Outdistance the Competition . "Bankruptcy could give them the latitude to go to people where they've got obligations and say, 'We've been lying to each other.' " Debt would be reduced, union rules relaxed, and contractual obligations to dealers modified or canceled.

The price would be steep. In exchange for concessions, creditors and other GM counterparties would probably have a say in running the company and possibly get some kind of stake in the new GM to help them get some return on their money. They might seek to oust CEO Rick Wagoner and his management team—bad for Wagoner but not necessarily for GM, because outsiders might accomplish things that Wagoner hasn't been able to do.

Real reform would be possible. GM has been restructuring itself for at least four years, but water keeps pouring in faster than GM can bail. The company insists it needs seven of its eight divisions (it put Hummer up for sale this year), even though there's a ton of overlap between Chevrolet, Saturn, Pontiac, and Buick. Toyota, by contrast, has only three U.S. divisions, with virtually no overlap. And GM never shifted aggressively away from big trucks and SUVs until gas prices hit $4 per gallon this summer—which was too late.

A bankruptcy judge could appoint an outside turnaround team to take over GM. They'd have no hidebound ties to the GM bureaucracy and feel no nostalgia for age-old divisions like Buick or Pontiac and would retain only parts of the business that contributed to profitability. GM would end up smaller—which seems inevitable, under any scenario—but what's left would be able to support its own weight.

The feds could still offer help with less risk. Giving or lending GM taxpayer dollars now would delay its day of reckoning but do nothing to make the company more competitive. GM could end up at the brink of bankruptcy all over again in six or nine months. But if GM declared bankruptcy and succumbed to the usual workout procedures, that might be an ideal time for the government to extend a lifeline.

Here's why: Companies reorganizing under bankruptcy protection usually rely on a kind of funding called debtor-in-possession, or DIP, financing, which is often a lucrative business for lenders because they're guaranteed to get paid back first, under a judge's watchful eye. Right now, on account of the credit crunch, DIP financing is scarce. That's where the government could step in, by immediately guaranteeing any DIP loans the moment GM filed for Chapter 11 protection.

Altman of New York University points out that the feds have a few hole cards they could play in this game, especially with the banks that have taken part in the $700 billion financial bailout. "They could use some of the $700 billion to cajole banks to offer GM some DIP financing," he says. And he argues that the Federal Reserve, which exercises some oversight of the banks, could lower capital requirements or offer other favorable treatment to those willing to roll the dice on GM. By doing this after a bankruptcy filing, the government would be supporting a company being forced to restructure, instead of one merely pledging to. And taxpayer dollars would get top priority for repayment.

The government would stay out of the car business. Bailout plans being drafted by Congress call for the government to somehow work with GM to wave a magic wand and make the company "viable." Would you buy a car designed by the government? Under bankruptcy, people who know how to handle damaged companies would work on turning GM around. Government financing guarantees could play another key role, helping to forestall one of the worst possible outcomes of a Chapter 11 filing: People stop buying GM cars.

Surveys show that car buyers would flee an automaker in bankruptcy, since they want to know that service and spare parts will be available for the life of the car and don't want the resale value to plummet. And there are plenty of competitors that would be eager to take GM's business. So an aggressive confidence-building campaign, emphasizing the plan to emerge from bankruptcy healthier, would need to change some consumers' minds. This would be a gamble, but it might be more effective than current efforts to persuade customers to stick with GM as it begs for a bailout, slashes spending, dodges bankruptcy—and tries to go on with business as usual.