Just a few months ago, General Motors CEO Rick Wagoner insisted bankruptcy was "not an option." Suddenly, it's an option. And Wagoner is gone.
What changed? Plenty. GM's sales so far in 2009 are down nearly 50 percent, worse than the automaker expected. In addition to the $13.4 billion in government aid that GM has already received, the firm says it needs as much as $25 billion more. In response to that, the Obama administration has demanded radical restructuring and insisted that if it doesn't happen, a Chapter 11 filing may be GM's only option. To show he means it, President Obama set a deadline of late May for GM to show its hand of file for Chapter 11 protection. And he demanded that the bankruptcy-averse Wagoner resign.
A dire scenario. But if GM declared bankruptcy, it may not be as catastrophic as Wagoner and other GM defenders have insisted.
First of all, a bankruptcy filing doesn't mean GM would liquidate all its assets and shut down. A Chapter 11 filing gives a firm a chance to shed debt and reorganize, and more than two-thirds of firms that declare bankruptcy come out of the process as a healthier, standalone company, or as a viable part of some other company. The emerging plan seems to call for GM's strongest assets - such as the Chevrolet, GMC, and Cadillac divisions - to be split off, so that the healthy portion of the company can begin operating normally as soon as possible. The weakest parts - like Hummer, Saturn, and possibly Pontiac - would be wound down more slowly.
The catch these days is getting the financing needed to continue operating while in bankruptcy. With loans scarce, a lack of adequate financing is what doomed bankrupt companies like Linens 'N Things and Circuit City, forcing them to liquidate.
But Obama has said that if GM filed for Chapter 11 protection, the government would provide the financing. That could end up being a better deal for taxpayers than if the government simply loaned GM more money as part of an open-ended bailout. Here's why:
The bankruptcy courts are equipped to handle companies like GM. "Reorganization under Chapter 11 is a fairly efficient process, especially for large firms," according to a new book, Restoring Financial Stability, compiled by New York University's Stern School of Business. It hasn't been a useful option for troubled financial firms like Citigroup, AIG, and Bank of America, because the financial crisis erupted so quickly and a hasty Chapter 11 filing would have been devastating to thousands of other firms that had financing deals with the banks. But GM has already been restructuring for years, and third-party companies are fully aware of the automaker's problems.
Bankruptcy would help GM accomplish what it needs to do. In addition to building more popular cars, GM needs to renegotiate billions in debt, slash the number of dealers, and reduce costly healthcare benefits for workers and retirees. It's been trying to do that for years - but the glacial pace of negotiations has made it impossible to move fast enough. A Chapter 11 filing would give a bankruptcy judge and appointed stewards of the company the power to force concessions that otherwise might take years longer to achieve - or never happen at all.
The feds can still provide aid. Auto executives have long considered bankruptcy to be suicidal, since consumers would be loath to buy a car from a company at risk of going under. Obama answered that by pledging government backing for GM (and Chrysler) warranties if needed, along with financing and other support to help speed any Chapter 11 filings. Bankruptcy financing could even be arranged in advance of a filing. In Restoring Financial Stability, bankruptcy experts Edward Altman and Thomas Phillippon write that a "prepackaged" bankruptcy would be "far more reassuring than a Band-Aid bailout that will not materially reduce the public's uncertainty about a possible liquidation." They estimate that with proper financing, GM could emerge from bankruptcy in 18 to 24 months, and be much healthier than if it shambled along in bailout mode indefinitely.
[See how bailouts can butcher capitalism.]
It would reintroduce a heavy price for failure. One unsettling characteristic of Bailout Mania has been federal intervention that absolves wayward firms of the consequences of bad decisions. Citigroup, AIG, and many other troubled firms would already be bankrupt - thanks to horrible gambles made at the peak of the housing boom - if the feds weren't propping them up. That's a major break for investors, executives, and creditors who loaned these firms money without verifyng that it was a wise investment. Many analysts worry that by bailing out executives who made foolish mistakes, it will set a corrupt precedent and encourage more reckless behavior.
A GM bankrtupcy would completely wipe out existing shareholders. Bondholders would get less than 50 cents on the dollar. To some, it seems unfair for the feds to bail out big banks, while imposing bankruptcy on GM. But like it or not, banks are a special case, since they provide the liquidity that keeps the capitalist heart beating. Manufacturing firms do not.
It would help answer the question of what to do about Chrysler. Detroit's No. 3 automaker is in worse shape than GM, with a much smaller global footprint and a less compelling case for survival. And it may be the first of the Detroit 3 to founder. The government has determined that Chrysler can't make it as a standalone carmaker, and the firm will only get additional bailout money if it can pull off a risky shotgun marriage with Italian automaker Fiat. Failing that, Chrysler could be in bankruptcy court by May. Consigning both Chrysler and GM to a similar fate absolves the Obama administration of claims that it favored one over the other, and it also provides more standing to turn away Chrysler's well-heeled owners, the private-equity firm, Cerberus Capital Management.
[See how consumers are getting some relief from the auto bailout.]
It would begin to eradicate the specter of Lehman Brothers. When the notorious brokerage firm failed last September, it set off a panic among investors who feared that a cascade of failures would follow, causing vast losses. That nearly happened, and was pre-empted only by a confusing set of stutter-step government interventions that left federal coffers drained and nobody satisfied.
[See the cars that drove Detroit's customers away.]
Investors clearly worry that another large failure could send the markets into a tailspin all over again. But GM is different from Lehman Brothers. If GM declared bankruptcy, it need not be a chaotic, unpredictable mess; compared to Lehman's failure, it might seem downright orderly. Careful pre-planning could set GM up for success once it comes out. It would send a powerful message to other struggling firms hoping for a bailout: Solve your own problems. And it would bring some satisfaction to taxpayers tired of watching corporate titans exonerated for their mistakes. Finally.
Updated on 4/3/09: An earlier version of this story was published before the Obama administration fully outlined its auto-bailout plan.