Friday, November 14, 2008

What Might a GM Bankruptcy Look Like?

The Bush Administration has made clear that it will not sign off on a bailout of GM. GM's management has said that the company might have to file for bankruptcy by the end of this year. If so, the company will be in the tank before President Obama has a chance to put together a bailout bill. Let's take a look at what might happen in a GM bankruptcy.

Sales would probably fall off. A new car is a five or more year proposition for many buyers. They wouldn't want to buy a car from a bankrupt company that might not be around in a year or two to support the warranty and ensure a steady supply of replacement parts. GM would have to institute large, and perhaps massive, layoffs. Its suppliers would, in turn, have to make large, or even massive, layoffs. If the suppliers go into bankruptcy, their ability to supply not only GM, but also Ford and Chrysler, could be adversely affected. Ford and Chrysler, already seriously weakened, could begin circling the drain.

In order to reorganize and emerge from bankruptcy, GM would need "debtor-in-possession" financing, a special form of financing provided to bankrupt companies. But how many lenders are there, in these days of the credit crunch, who would fork over the billions needed by badly crippled GM for a reorganization? Maybe only a few. Very possibly none.

So GM might be unable to reorganize. In that case, its bankruptcy would be converted to a Chapter 7 liquidation. Some argue that this would be a good thing, that competitors would buy pieces of GM and get those pieces up and running again. But what competitors have the money to buy parts of GM? The financially strong ones, like Toyota and Honda. What might Toyota and Honda do if they bought some of GM's plants and facilities. Hint: it wouldn't be to operate them. The auto industry is plagued by serious overcapacity. Toyota and Honda could expand their share of the U.S. auto market by permanently closing any GM plants and facilities they bought in a Chapter 7 liquidation.

Would any leveraged buyout firms buy parts of GM? Not after Cerberus got clobbered for its investment in Chrysler. There don't appear to be any American investors who could come up with the money to establish a new company to take on Toyota and Honda. Any such transaction would require billions of dollars in bank credit lines, and what banks in the credit crunch era would finance such a business plan against such capable competitors? Today, banks only want to invest in U.S. Treasury securities. There wouldn't be a lot of them volunteering to finance a startup to compete against the likes of Toyota and Honda.

So GM's bankruptcy could end up with the U.S. auto industry seriously diminished. No nation remains great without a strong industrial base (compare the U.K. before and after World War II for proof of this proposition). Bailing out GM would be distasteful, since government bailouts are, as a matter of principle, not to be encouraged. But after the hundreds of billions of federal dollars that have flowed to Wall Street, it's hard to stand on principle because one ends up standing on hypocrisy.

One good thing about a Chapter 7 liquidation is that GM's current management would lose their jobs. That needs to happen anyway. After 8 years as GM's CEO, Rick Wagoner hasn't got the job done. He bet the company on a commodities play: that the price of oil would stay low and that the company could keep building high profit, low fuel economy trucks. He was wrong, and even though he is CEO, he like everyone else should pay for his mistakes. Is Rick Wagoner a bad man? No. Is he stupid? No. Did he try his best? No doubt he did. But he gets paid millions and should deliver performance commensurate with his pay. He hasn't. Besides, GM needs a new face in order to credibly promise better future performance. If GM goes into bankruptcy, its one real chance may be federal assistance in lieu of debtor-in-possession financing. A new face has a better chance of winning over skeptics with a believable promise of improved future performance.

Let's recall that the 1979 Chrysler bailout, along with management changes at that company, worked and provided U.S. taxpayers with a profit. GM can produce quality vehicles (check out the new Buicks). It has innovative engineers and perhaps the best styling among the U.S. auto companies (most of the time; the Cavalier was sad looking on its good days and the Lumina was hardly luminous). If we deviate from dour, rigid application of free market principles and provide some taxpayer support, we might end up a lot better off than we would without GM.

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