The Chapter 11 argument has some appeal, because (a) that’s what everyone else has to do under these circumstances, so it’s not really fair to other struggling businesses to hand mountains of cash over to GM just because GM seems prepared to fail in a spectacular fashion; and (b) Chapter 11 is designed to allow companies to restructure, to shed burdensome liabilities, and to emerge hopefully as a leaner and more efficient operation — and this has actually worked in the past. However, a good point has been raised, namely, that for the business to continue operating in Chapter 11, someone has to be willing to supply what’s called “DIP financing” (DIP stands for debtor-in-possession, the technical term for a company that has filed Chapter 11 but is still in operation). And, this argument goes,
the same Wall Street meltdown that has dragged down the economy and GM sales has also dried up the DIP money GM would need to operate. That’s why many analysts and scholars believe GM would likely end up in Chapter 7 bankruptcy, which would entail total liquidation. The company would close its doors, immediately throwing more than 100,000 people out of work. And, according to experts, the damage would spread quickly.
Now, I absolutely agree that a Chapter 7 liquidation for GM is not an acceptable outcome. GM is, unfortunately, “too big to fail” on that kind of massive scale. So we either have to solve the DIP financing problem, or we have to hand cash to GM.
But isn’t there a sensible way to get around the credit freeze that otherwise might prevent GM from obtaining DIP financing? Why not allow GM to file Chapter 11, but with government-guaranteed DIP financing? If the loans are backed by the full faith and credit of the U.S., surely lenders would be more willing to participate, since then there’s no risk of losing their investment. One could even imagine the government as the last-resort DIP lender, if nothing else worked.
This approach does not resolve the “psychological” issues, namely, will anyone buy cars from a company that’s in Chapter 11? And those concerns are real. The question is whether they’re significant enough to warrant a radical government bailout (which, incidentally, at the moment seems to have little chance of making it throught the Senate before GM runs out of cash).
Finally, I ran across some interesting historical tidbits on the Chrysler bailout. It wasn’t just loan guarantees. It was, in fact, essentially a Chapter 11 filing by a different name. Here are some details (yes, it’s the Heritage Foundation, but the facts seem reliable).
In the past three years [1980-83], Chrysler has renegotiated its debts and restructured its organization in a way that greatly resembles a company going through Chapter 11 bankruptcy. Its creditors, like those of bankrupt firms, were forced to swallow sizeable losses.
This was the result of a clause in the Chrysler Corporation Loan Guarantee Act of 1979 that required creditors to make certain “concessions” to Chrysler. With this clause to exploit and with Treasury Department officials, including then-Secretary William Miller, pressuring its creditors, Chrysler was able to pay off more than $600 million in debts at just 30 cents on the dollar. In addition, the company was allowed to convert nearly $700 million in debts into a special class of preferred stock-paper relatively worthless in the financial markets because the shares earned no dividends and were to be unredeemable for several years. In early 1983, Chrysler reached a tentative agreement with its creditors to trade this preferred stock for Chrysler’s regularly traded common stock. However, the creditors still get the short end of the financial stick: the face value of the common stock to be received will almost certainly be less than the face value of the original debt.
Chrysler’s creditors are not alone in being socked by the company’s quasi-bankruptcy. The firm’s workers have paid an even greater price. Despite the fact that the loan guarantees were approved by Congress mainly to protect jobs at Chrysler, the company has sent home nearly half of its employees, cutting its white collar work force by 20,000 and laying off 42,600 of its hourly workers since the loan guarantees were signed into law.
Everyone should be clear on one thing: there is no guarantee that handing GM a big pile of cash is going to turn the company around. Doing so might just stave off the company’s inevitable collapse by — what, a few months? A couple of years, if we’re lucky? The problems at GM are profound and long-standing, and it’s not clear to me that tacking on a couple of “hey, why not build more hybrids” sorts of conditions onto a bailout is going to do the trick.