Last week, the chiefs of the Big Three automakers returned to Washington bearing "turnaround plans' that they say will, with the addition of $34 billion in government loan guarantees, return their firms to profitability. But in revealing the dire straights faced by General Motors and Chrysler (Ford, despite its request, says it really does not need taxpayer dollars), the plans provide further evidence that a taxpayer bailout will be insufficient to save the industry. Future bailouts, or eventual bankruptcy, would be sure to follow, say industry analysts and economists.[1]
Nonetheless, the automakers continue to maintain that allowing them to restructure under the protection of a bankruptcy court would not work, devoting pages of their plans to this point. The automakers' criticisms contain, at most, grains of truth, but they fail to demonstrate that bankruptcy would not work for their firms, as it has worked for so many others. Though a bailout may be better for the automakers' current executives and shareholders, restructuring in bankruptcy remains the best choice for the automakers' continued viability and future success. This paper considers, in turn, each of the automakers' arguments against allowing the normal operation of law--that is, bankruptcy--when a firm becomes insolvent.
Argument: Bankruptcy would lead to "failure' and millions of jobs lost.
Fact: Bankruptcy actually prevents failure, and liquidation makes sense only when a firm's business model is obsolete and its resources could be put to better use elsewhere in the economy--a circumstance that a bailout could not remedy.
Officials of the Detroit automakers claim that allowing any of the Big Three to "fail' would have a devastating effect on jobs and the economy. In particular, they frequently cite a report by their trade association that finds that a "major contraction' of the Big Three would cause 3 million job losses and billions in economic decline.[2]
That doomsday scenario, however, is impossible, for two reasons: First, bankruptcy and "failure' are not synonymous; indeed, bankruptcy protection actually prevents failure. Though a bankruptcy filing may imply that a business has "failed' at maintaining solvency as it is currently organized, it does not mean that the business and its assets will "fail'--that is, cease operations. Many companies, including the bulk of the airline industry following 9/11, have entered bankruptcy, reorganized under its protection, and then emerged as stronger, sustainable businesses.
Second, the auto industry's job-loss projections are premised on assumptions that actually ignore bankruptcy protection. Their chief assumption is that, without government aid, the industry would suffer a 100 percent contraction--that is, it would just stop. Under bankruptcy, however, that would not be possible. Once a company has filed for bankruptcy, it receives an automatic stay and may suspend payment of all debts, giving it breathing room to take stock of its assets and situation.
Argument: The automakers are too complex for bankruptcy.
Fact: The bankruptcy process is designed to confront and resolve complex problems and has successfully done so many times in the past.
The usual situation leading to bankruptcy is known as the "common pool' problem. This occurs when a business's assets and income are insufficient to meet its obligations--in other words, its creditors' claims exceed the common pool of assets available to pay them, meaning that some will not be paid in full or possibly at all. When a business's looming insolvency becomes apparent, then creditors rush to collect their debts, which may hobble an economically viable business and actually shrink the common pool available to all creditors. The immediate solution to this contentious situation is the protection of bankruptcy's automatic stay, which gives a business breathing room from its debtors' claims from the moment of filing.
The long-term solution is either reorganization or liquidation. Either would be impossible, of course, if any creditor or stakeholder could block the actions of the bankrupt firm, "holding out' for full payment or more favorable terms. This is why it is a universal feature of bankruptcy law that creditors and other stakeholders can be forced to accept concessions that are necessary to maximize the common pool. Thus some debtors may see their claims transformed into equity stakes so that a business, free of debt, can operate profitably and sustainably. Others may receive pennies on the dollar. Collective bargaining agreements may, as described further below, be modified to put costs in line with industry norms, and other contracts may be rejected.
In contrast, a bailout fails entirely to address the complexity of the automakers' problems. Unlike the finely honed tools of bankruptcy reorganization, a bailout fails to provide any mechanism (other than money) to restructure debt, repudiate contracts, or renegotiate labor agreements.
Argument: Renegotiating labor agreements in bankruptcy would be impossible. Fact: Chapter 11 provides a straightforward mechanism, unavailable outside of bankruptcy, to modify collective bargaining agreements to adapt to economic realities. Recognizing the great importance of labor relations, the Bankruptcy Code addresses it specifically. Unlike other contracts, a business undergoing reorganization cannot simply reject a collective bargaining agreement. Instead, it must propose modifications to the agreement that are necessary for it to achieve a successful reorganization and "assure that all creditors, the [business] and all of the affected parties are treated fairly and equitably.'[4] In addition, the business must provide the union with relevant financial information so that it is able to evaluate the modified agreement. The parties must then negotiate in good faith in an attempt to reach a satisfactory agreement. If that proves impossible, the bankruptcy court may hold a hearing and allow termination of a collective bargaining agreement if the union unreasonably rejects the modified agreement and "the balance of the equities clearly favors rejection of such agreement.'[5] Thus, the bankruptcy judge has significant discretion and power to push the parties toward an agreement that is mutually acceptable, conforms to economic realities, and ensures that the business is able to return to profitability. For a company in Chapter 11, and especially one whose unionized employees enjoy untenable pay and benefit packages, a reduction in labor expenses is the likely result.[6] A bailout, in contrast, would likely provide no new legal authority to achieve this result. Argument: Automakers' can easily shrink their dealership networks and consolidate nameplates outside of bankruptcy. Fact: Shedding excess dealerships and nameplates outside of bankruptcy would be protracted and expensive due to state franchise laws. According to industry analysts, General Motors needs to shed nearly 5,000 dealers from its network and eliminate five or six of its eight domestic brands. Without these changes, the company will be unable to compete with the likes of Toyota and Honda, which focus their energies on fewer brands and sell far more cars per dealer. Ford and Chrysler face the same problem. Making these changes outside of bankruptcy, however, would likely prove impossible. Argument: Restructuring in bankruptcy would be impossible because sufficient debtor-in-possession (DIP) financing is not available in the current economic climate. Fact: DIP financing is available to firms undergoing restructuring that have strong business plans and profitable cores, and if it proves necessary, the government could provide a "lender of last resort' facility without sacrificing the benefits of a restructuring under bankruptcy. Argument: Consumers would shun the vehicles of a company in bankruptcy, causing its sales to collapse. Fact: There is no evidence that consumers are shunning the Big Three today, despite their well-publicized economic woes, and automakers undergoing reorganization could boost consumer confidence with third-party warranties, insurance, and transparency. After two straight months of front-page stories on the Detroit automakers' woes, consumers are no doubt well aware that General Motors and Chrysler face insolvency and bankruptcy. And while auto sales fell sharply last month across the entire industry, General Motors' and Chrysler's declines were on par with those experienced by other automakers, given their fleets.
Argument: General Motors and Chrysler can be turned around outside of bankruptcy without putting taxpayer dollars at risk.
Fact: If these companies can be repaired, bankruptcy is the best (and possibly the only) way to do it.
Industry analysts and economists project that a bailout-style approach to turning around the automakers would cost in the neighborhood of $150 billion, far more than the $25-$34 billion that the automakers are now seeking from Congress.[10] And for all that money, there is no guarantee that a bailout would effectively return these companies to profitability or that taxpayers would not suffer losses if the companies file for bankruptcy down the road or Congress forgives the debt.
In contrast, bankruptcy pulls politics out of the equation and focuses on simple economic viability without putting any taxpayer dollars at risk. Reorganization in bankruptcy is designed to transform firms that are economically viable but have failed financially and can no longer meet their obligations.[11] Any deviation from this neutral standard reduces the chance that a business will successfully reorganize and remain viable over the long term.
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