Bankruptcy for GM
What would it mean to have GM go bankrupt? A change in ownership and a renegotiation of contracts.
The factories, computers, office space, intellectual property and so forth that are now owned by GM would not disappear; they would basically become the property of GM’s creditors. These creditors would sell the assets to the highest bidder. Assuming there is economic value to be created by continuing to operate the company as a business, private equity or strategic investors would buy the assets, shut down some plants, fire some union and exempt workers, and probably use the leverage of bankruptcy court to get a better deal from the unions. The current employees and creditors would be better off if you and I were forced by the federal government to pay money to the corporate entity named General Motors, to then be paid to these employees and creditors. Of course, you and I would be worse off in this situation. On balance, if you believe that markets are more efficient allocators of capital than Congress is, the population of the United States would, on the whole, be worse off.
Is this fair to the people who work at GM and will now have a deal changed after the fact? Well, when people sold parts to GM on credit, or employees (individually or via union negotiations) entered into labor contracts with GM, they undertook counterparty risk. That is, they were taking, in part, a bet about whether GM would actually be able to pay them what they are owed. This is also true for pension payments, which are simply deferred compensation, as much as it is for deferred payments on credit terms for parts. To act now as if they should be protected from this risk is to treat them as children.
Is this fair, given that you and I are being forced to cough up an immense amount of money to bailout bankers in New York who are far less sympathetic characters than assembly line workers or Assistant Market Research Managers in Warren, Michigan? We are bailing out bankers, not because we want to avoid employees losing jobs at AIG or shareholders losing money at Merrill Lynch – in fact, as I have argued form the beginning, it is essential that employees and investors not be protected as part of these bailouts – but because the economy as whole is at risk of devastation if we allow systemic collapse of the banking system. We are bailing out parts of the finance industry because it is good for us, not because it is good for the finance industry. This ultimate public backstop is why it is appropriate and prudent to regulate parts of the finance industry to avoid collapses that threaten the whole economy.
Isn’t it important that we maintain an industrial base as a matter of national security? Yes, but that is not the same thing as saying that the current management of GM needs to continue to have operational control of these assets, or that current employment levels are appropriate, or that current union contracts need to be maintained. There is a potential argument to be made on these grounds for some kinds of restrictions on foreign ownership.
A bailout of GM would be a pure exercise of political power to deliver taxpayer funds to one organized group of citizens at the expense of the country as a whole. It should be avoided.
This is the best analysis I have read.
— matoko_chan · Nov 13, 05:37 PM · #
Yes, yes and yes. Beyond that, it’s never been clear to me how having 5, 6 or 7 different car brands, who compete with one another to sell the same basic models, is a good business model for the auto industry.
How, on the other hand, do you take into account regional impact, assuming as I do that you don’t want to consign this region to the dustbin? I don’t think anyone really has an answer to that question. I do think it’s part of the motivation to bail out the Big 3 on the part of people who are sincere about such things.
— Chris Anderson · Nov 13, 05:55 PM · #
It seems like letting GM go bankrupt is the same functionally as letting it just dissappear. It would take a long time before it would be employing people and buying parts again, if ever. With the economy in it’s current state, the shock of losing the GM ecosystem—a big ecosystem—would further damage the economy. The questions I have is how much further damage would it cause; what would the long term consequences be to the areas of the contry that depend on the GM ecosystem; and what effects those consequences would have on the rest of the country. For instance how much would the rest of the country pay over time in safty net costs as compared to how much would we pay to bailout GM (assuming a bail-out would even work).
Also, is there anything that we can learn from the International Monetary Fund’s interventions in Argentina and other parts of the globe? As I remember they took similar a hardline in how they delievered rescue funds and a lot of people criticized their approach as causing more harm than was necessary. THis is something I only vaugly remember, so I could be way off.
Anyway, I have no idea what the right thing to do here is. I do think that this is a time to reject the comfort of familier ideology—I don’t know what part ideology plays in Jim’s recommendation—and really think through all the consequences.
— cw · Nov 13, 06:21 PM · #
Jim — My null hypothesis is also opposition to the bailout, but the real fear (at least in market circles), as you’re probably aware, is that unit demand disappears once GM files. (See here or here .) Having worked in distressed debt investing for 10 years, that fear is almost always a red herring, but a warrantied, $30,000 durable good with an active resale market? No one knows. If sales drop steeply, it could push GM into an outright liquidation, and if this business can’t be maintained as a more-or-less going concern, the dissipation of value (not just for creditors but for the economy as a whole) would be massive. The only winners would be the lawyers.
What they really should doing is negotiating a prepack with the unions that equitizes the general unsecured — you could Chapter 11 roundtrip in 6 months, before any substantial permanent loss of market share. But the hope of a bailout and Gettelfinger’s obstinance will likely keep GM from pursuing that option. Now, if the feds were to refuse a bailout but offer to back a $10BN DIP, conditional on a prepack, we might be onto something. That should send a clear message to the parties involved, force everyone to the table, and it would be a smaller and essentially pretty riskless investment for the government.
— Rover · Nov 13, 06:24 PM · #
cw:
I take your point, but one purpose of Chapter 11 is to prevent exactly this outcome. The company can continue normal operations while banruptcy proceedings are underway.
Our relatively easy bankruptcy laws are an advantage of the American economic system, and we ought to deploy them here.
— Jim Manzi · Nov 13, 07:18 PM · #
This is a really good writeup. Do note that the American people hold an equivalent short-CDS position in GM as we take over a chunk of their pension (via the PBGC) – I am an expert on how that works but there is a position for the USA taxpayer at the table.
Still though, those pensions. I can’t just think of them as accounts receivables for some tubing, lube and piping. Those are people’s life work there, and they are likely to vanish.
— rortybomb · Nov 13, 07:49 PM · #
err, NOT an expert. I would say there should be a preview for these comments, but there already is one.
— rortybomb · Nov 13, 07:51 PM · #
Why do we not make two conditions a part of the “bailout:” 1) All top management is fired. (Some dude at WSJ made the same suggestion.) 2) Break up GM. This latter option has the added benefit of creating jobs as the individual brands will require the re-creation of positions that were formerly redundant under the GM umbrella. If your business is “too big to fail,” your business is too big to be in the best interest of our economy.
— James F. Elliott · Nov 13, 08:07 PM · #
James:
How do you know that all the management is incompetent? How do you know that GM is too big, or if so, how it should be broken up?
Q: How would Congress answer these questions?
A: In the way that maximized their power and odds of re-election.
I would much rather have new owners with skin in the game figuring out the answers.
— Jim Manzi · Nov 13, 08:21 PM · #
Jim-
In response to question one, forgive me for taking a cop-out, but isn’t that blatantly obvious? The companies have lurched from crisis to crisis, near-collapse to near-collapse, despite changes in ownership (Cerberus, anyone?).
By funneling federal funds, in the form of a bailout, don’t our elected representatives — and more importantly the board/commission/overseer appointed to administer those funds — actually have “skin in the game?” In my experience, civil servants — I am one — feel a great deal of obligation to protect and wisely spend the tax dollars entrusted to us.
— James F. Elliott · Nov 13, 08:47 PM · #
Here’s another question perhaps of more salience, one that might address more problems than just Detroit’s: GM spends $10 billion per year on health care. What if we invested that $25 billion as part of the move towards universal health care? That would free up an immense amount of operating capital for all the automakers and benefit other industries besides.
— James F. Elliott · Nov 13, 08:54 PM · #
I’m a little confused. Protecting unions from taking pretty standard form of counterparty risk (i.e., a contract with a Fortune 50 company) would be treating them like children, but bailing out investment firms that took on so much counterparty risk as to make it systemic is preferable?
— CN · Nov 13, 08:55 PM · #
Jim — not to jump up and down demanding attention, but the key question to be reckoned with is whether, in fact, the “company can continue normal operations while banruptcy proceedings are underway.” It appears you’re assuming it away, and I’m not sure why. Do you think that market concerns about the unwillingness of consumers to buy cars from a prominently bankrupt OEM are excessive?
Otherwise GM is likely to be liquidated piecemeal, and the potential ramifications of that for the broader economy are significant enough that we should try to ensure an orderly, swift process.
— Rover · Nov 13, 09:07 PM · #
CN:
As per the post, the reason for the financial bailout is to avoid the collateral damage, not to protect those who took risks as employees or investors. Use of bailout funds should involve (at least very close to) wiping out equity investors in these firms (as with AIG, where you and I now own 80% of equity) and a condition of loans, investments or asset purchases should be eliminating the responsible executives.
— Jim Manzi · Nov 13, 10:01 PM · #
Rover:
I think there are numerous possible soutions to this, all of which rest on the observations that: (1) this is, as you say, a transition issue that can be solved with escrowed money, (2) there is enormous economic value to be created by avoiding it, which translates to a profit opporutnity, (3) there is a lot of private equity, hedge fund and strategic money available to fund this opporutnity, and (4) Chapter 11 is designed to allow just such transition issues to be addressed in an orderly fashion.
Clever financiers can propose various much better solutions, but some obvious ones are: (1) GM should have $12BB+ of cash on hand at the end of the year, they could establish an escrow fund to support dealers and maintenance, and should be incented to use the funds for this purpose if the incremental value of avoiding this problem is so huge, (2) a consortium of private equity groups could set up such a vehicle, (3) a consortium of hedge funds could buy the GM dealer network and related IP, and capitalize it sufficiently to maintain consumer confidence, or (4) AutoNation or a similar company could establish a buying program for GM cars because the arbitrage opporutnity is so huge, since they could have some confidence that the transition issue would be worked out, and so on.
These are just ideas, and I suspect that there are legal, reglulatory or commercial problems with each of them. But msarter guys that I could come up with better ones I’m sure, and easing these regulatory barriers would sure be a simpler and better solution than a bailout. If it comes to it, your idea of government-backed DIP financing would be a lot better than a bailout. One way or another, this strikes me as an issue with a market solution.
— Jim Manzi · Nov 13, 10:11 PM · #
Jim — I appreciate the response. I work at one of those hedge funds you refer to, and I think you’re vastly underestimating the coordination problem. The only way I think you can get a deal done in an orderly fashion is with government in the lead. And even then I have my doubts. Realize that a prepack would have to review and renegotiate thousands of franchise agreements — half the lawyers in the country would end up involved. And if it doesn’t happen in an orderly fashion, I think GM ends up liquidating, which puts a giant divot in the economy.
But: we’ll see. The times are too exciting for me, of late.
— Rover · Nov 13, 10:52 PM · #
The reason for the financial bailout, we were told, was to protect the real economy from the impact of bank failures. We had to hold our noses and go along with it, because otherwise there would be massive disruptions to other industries. Just the sort of thing that’s happening in Detroit, right?
Now that the financial institutions have shown that they can wisely allocate capital about as well as GM can build popular cars, why should they enjoy a privileged position as locus of the bailout? Will feeding them capital actually keep the real economy afloat? Why not cut out the middleman, try to recapitalize the real economy in whatever awkward and unfair manner Congress chooses, and let the financiers wither on the vine?
I’m not trying to make the case for bailing out GM — just thinking through how flimsy the original argument for a bank bailout looks now. If someone else can take the pieces of GM and build better cars in the future, why not let innovators take the smoking fragments of the financial industry and build new and better ways of getting capital from those that have it to those that can make it grow?
— Matt Frost · Nov 14, 12:56 PM · #
If the automakers go into chap 11 they will drag their suppliers with them and the only source of DIP will be the government which will have to cough up $25-50 billion anyway. New hires at the UAW only make around $14 an hour and get a 401k rather than a defined benefit pension. As Wilbur Ross (somebody who actually knows something about BK) said BK is not an option and would results in the destruction of the U.S. auto industry.
I would also add that the weaker the brand the bigger an impact bankruptcy has on the company.
— bill · Nov 14, 02:23 PM · #
bill:
Wilbur Ross is an expert, but highly interested, party. One of his major holdings is International Automotive Components Group, i.e., a company that is a supplier to the automtive industry, and therefore would be stiffed in the event of a bankruptcy of one or more of his customers. Amusingly, a major part of IACG was the old Collins & Aikman, which Ross bought out of bankruptcy proceedings. Further, the point that I have seen him make about automotive bankruptcy is pretty narrow: he thinks it is problematic right now because of the weak economy, not that it is inherently undesirable.
Lots of other experts, including Jack Welch – who I believe continues to hold the record for adding the most absolute dollars of shareholder value in an industrial company in the last quarter-century – have argued publicy for bankruptcy to help fix the auto companies.
— Jim Manzi · Nov 14, 04:36 PM · #
Matt:
The real economy impacts of contagion would be unpredictable, but almost certainly vastly worse than anything we have seen or could reasonably expect to see in the event of Big 3 automaker bankruptcy. To answer your question, that is why they enjoy a priveleged position for a bailout.
Also note that it matters what we mean by “bailout”. The indivudals currently running GM and the very highly-paid employees (versus what they would make if these specific companies were not able to hire them at wages which, at least under current management, can not be paid by a company that makes money) want to keep their jobs under more or less current arrangements. The shareholders of GM want to keep, and almost certainly radically increase, the value of their equity. A financial bailout can, and should, all but wipe out existing shareholders (this is pretty much what happened at AIG) and fire the senior executive teams, and fire / reduce comp for many, many employees, as long as the corporate vehicle that holds obligations to third parties makes good on its obligations. Saving the corporate vehicle – the legal entity and its existing obligations to third parties – is the point of the financial bailout. Killing off, or at least changing, the obligations of the corporate entity to third parties is the whole point of bankruptcy.
It’s unclear to me that the case for the financial bailout looks flimsier now than one month ago. Credit spreads have relaxed dramatically – the TED Spread is down by more than 50% – and we no longer get up each morning wondering what major financial institution is suddenly going under. Whether we are going into a recession or something worse, is of course, still an open question. One can’t answer the counter-factual of whether or not this waning of the current portion of the crisis would have happened in the absence of these measures, but it’s hard to see how dodging the immediate bullet would lower the odds a rational perosn would put on the finance bailout serving its intended purpose.
— Jim Manzi · Nov 14, 04:51 PM · #
Its amazing to me how you think its ok to be GOD and decide who lives and who dies. I say give the money to the companys who employe people to make things and let the banks go under. They are not loaning the money anyway some are just useing it to buy other banks. Besides why would other countrys around the world bailout there auto companys and the tax payers in the USA not do anything for ours. GOD BLESS THE UNITED STATES OF ASIA
— Dave · Nov 21, 03:34 AM · #
Who is going to buy an auto company in a recession? No customers, no dealers, years to get a new model out of the door? Where are they going to get the money to finance that, in current credit conditions? Perhaps the Federal Government. No, wait a minute …
— Steve Body · Nov 21, 05:25 PM · #
The following U.S. government policies, many of them having popular support, hurt the big three significantly relative to the foreign transplants:
1. Uneven union laws across states:
a. The 1935 U.S. government Wagner Act granted the right of workers in the private sector to organize labor unions and take place in strikes. What this effectively meant was the labor unions were allowed to seize the plant and prevent its use until they got what they wanted. This created the ridiculous result in the US that workers are paid in proportion to the pain they can inflict by shutting things down. Trains, docks, garbage collectors, police, … get high pay. People in low capital or less critical to safety related industries like restaurants and retail get paid low paid. The relationship of pay to skill, work ethic, hazards goes away. Soon after the Wagner act the UAW took over the auto industry; GM and Chrysler in 1937; Ford in 1941. With no foreign competition the UAW monopoly flourished for about 30 years.
b. The 1947 U.S. government Taft–Hartley Act tried to reign in the unions after a series of post-war strikes. While some provisions were national, the states were allowed to pass “right-to-work laws” that outlawed union shops. Such shops require workers to join the union and pay dues. Said state laws are serious impediments to union organization and viability because few people want to pay dues if not required.
c. The vast majority of foreign owned plants are in right-to-work states providing huge advantages in labor costs and productivity relative to the big three.
d. The big three would find it impossible to change the state laws where they are located due to union dominance of state governments. If they built in the South they have to accept the UAW because they would strike back in Michigan.
e. No other country has this crazy system to my knowledge.
2. Promoted defined benefit packages and kept them in the company name. Did you ever consider how totally stupid it is to pin an employee retirement package, meant to last about 50-60 years from first hire until death, to the viability of their company? The top 10 companies in 1950 were very different than in 2000, with the railroads taking a big dive since then. And in 2020 it will be totally different again. Defined benefit packages were a bad idea, promoted by the US government till this day, and the big three are paying the price. If a company is in decline, due to the other items mentioned here, their retiree pool grows relative to gross income and number of active workers. Costs rise and competitiveness goes down, sales decline in a vicious spiral. Note also that while someday the transplants will pay pensions here in the US, the bulk of their corporate salary people (engineers for instance) back home get pensions from the government. Again, a totally crazy concept promoted by the Feds with widespread public support. And again, affecting the big three orders of magnitude harder than the foreign auto companies.
In most western nations, if there is a defined benefit program, it is paid into a government fund and is divorced from the company. If the company fails, people don’t lose their pension. In the U.S., the Pension Benefit Guarantee Company, a quasi-government / private company (like Fanny-Mae) supposedly fills in when the company goes belly up. But it is really a welfare program, with maximum limits far lower than promised pensions for many salaried workers. The airline pilots at United Air Lines, the current poster child of how wonderful chapter 11 will be for the big three, got screwed out of a large percentage of their “guaranteed” pension. Apparently the courts have ruled bond holders have first dibs on people’s defined benefits supposedly “held in trust”. What a travesty; only in the worse run country in the western world.
3. No national healthcare. This is killing all US industry because we are competing with foreign companies with virtually no health care costs at home. Again, for transplants, the tens of thousands of such people at corporate headquarters are not in the U.S., but back home with free insurance. I’m basically a free market person but U.S. healthcare is so screwed up, and the employer based care creating such a competitive disadvantage, I give up – company paid healthcare must go and something needs to replace it. Watch for a future blog entry on that topic. Even though the transplants provide health care for their workers this is again an order of magnitude bigger problem for the big three because: 1) Corporate staff is back home with free health care, transplant workers are younger and therefore healthier, big three also pays health insurance for a million retirees.
4. Blunt instrument CAFÉ laws. The original purpose of CAFE was to reduce depletion of finite fossil fuel supplies and/or to reduce foreign imports. The Global Warming theory did not exist when CAFE was instituted but CAFÉ supports this as well. These same goals are achieved in almost all other Western counties via very high (on order of $3-$6 per gallon) federal gasoline taxes. That is the primary reason the cars are smaller in Europe and Japan. Our cowardly government did not want to be associated with taxes so instead wrote CAFE laws so the big three could do the taxing. I would argue that such laws fell, and continue to fall, disproportionately on the big three. The laws regulate an average fuel economy for a fleet produced by a given company. This forced the big three to abandon the cars they made money on, and build cars they don’t make money on, usually at a loss. The economics are simple: it takes as many overpaid UAW workers to put a door on a $14000 focus as a $30000 F150. So the bigger and more expensive the car the better the big three can compete. The above mentioned economic disadvantages of the big three are exaggerated on small, lower cost cars. And yes, people expect small cars to cost less. Screwed again by the feds! Ford, for instance, has trucks providing over 50% of sales. A rapidly increasing percentage of these trucks are used in the trades; try carrying a load of bricks or even a saddle in a Focus. Why does the Ford commercial truck have to go into a CAFÉ formula when a Mack Truck or Caterpillar dump truck does not? In the rest of the world, where gas taxes are used to reduce fossil fuel consumption, each company is allowed to compete in the part of the vehicle market where they do best. The customer takes the cost of gasoline with tax into consideration when he decides what size and features he needs, and then shops the brands that play in that market. With CAFÉ, the big three were forced at gunpoint to build and sell small cars at a loss just so they could meet the consumer demand for larger cars and trucks with their greater utility (carried more people for instance). The Japanese entered the market in the small car nitch where their low cost and experience from the sane countries with gas taxes gave them the greatest advantage. The Japanese became associated with small cars and better gas mileage, although for the same size car and performance there was no difference on average.
It it were one or two of these items the big three might have competed better, but between the four the cost disadvantage in thousands per car and the hill too hard to climb. People seem to think Americans are superman, blessed with privilege, and the big three should have been able to overcome these odds against our oriental upstarts. In my opinion the big three did an amazing job lasting this long, as they are only mere mortals; doing the best they can given the stacked deck against them.
I have only recently realized a new problem; seemingly insane self hate in America. I’ve travelled a bit and read a lot. I can’t imagine any other country where the citizens hate each other as much as we do. I don’t want to digress too much, but where else would the media stop covering a war when we started winning it? This self hate has come to a head with the big three. Owning a US made car has become downright un-cool. I watched the congressional testimony for three hours and thought it went pretty well for the CEOs. The congress people seemed to be swayed. But on all major networks all I heard was corporate jet and $1 a year salary. It made me truly sick.
I hope the readers now understand a little better what has been going on for the last 30 years. These stories just have not been reported. I have other insights and history from the inside of this industry that I’m sure people would find impressive. And I’m sure that the more you knew the more you would be impressed with the people in the big three. The management, engineering and yes even the bulk of the UAW. And no they don’t make $70 per hour. That figure includes a lot of indirect costs; the actual wage is in the high twentys; and for that you ruin your body. My relative who works in final assembly lives in a double-wide. With two incomes maybe you have a 1800 square foot house. I haven’t dug into the $70 number, but they just don’t see that.
An agenda for the feds:
1) Make the big three take whatever money they have left and maintain their pension funds at 100% for 2008. This is the law, but they are lobbying against it.
2) This may drive one or two of them into chapter 11.
3) During chapter 11, give pensioners priority over bond holders. This has been the PBGC position but they lost in courts.
4) Keep the pensions out of FPGC or it will go bankrupt. Getting a guaranteed accrued pension will help the UAW deal with other contract chages below. Further, getting the full earned pension will keeps 10s of thousands of salary retirees out of poverty ($25k per year).
5) Pass national health care immediately. We’re in a great depression, tens of millions are losing company health benefits. They will flood emergency rooms. What better time. Relief from this cost will help the big 3 and all US industry.
6) Implement federal laws to trump the state determined “right to work” laws. I don’t particularly care which way you go, just make them consistent. This will level the playing field between the big 3 and the foreigners.
— Mike Inmich · Nov 21, 10:54 PM · #
GM…PULL THE PLUG, Reset, PLUG BACK IN
Without the THREE U.S. automakers combining into one there is no rationality to bailing out GM. GM’s cash burn is triple the street estimate and has lost all control over its sales, its product development and its future. The executives and the unions have the company hostage to government capital infusion. Bankruptcy is a viable answer that can push off creditors and force unions and management to make concessions that are impossible unless a loaded gun is at their head. There is too much capacity, too many models, too many plants, too many employees producing products that are more easily produced by others. The VW bug was the first indication that the Big Three did not have a clue to the needs and long-term preferences of the U.S. consumer. And today we have a glut of SUV’s that will ultimately have to be sold at a first-ever half-price sale. GM has already built them, they have already paid for them and no one wants them. You need cash, blow them out the door ½ price or less and they are out of inventory and cash hits the balance sheet.
But to infuse GM with cash to keep it afloat without bankruptcy is no answer because next in line will be Ford and Chrysler. These three should be forced to combine and re-form to use their talents and capacity to building something we all need and that is energy independence.
There is one industry that has a payback that cannot be overlooked as a place to re-train and invest and that is in renewable energy. Train those people, insist that the manufacturing capacity of GM be converted to energy and produce, once and for all, a source of energy that once in place CAN NEVER GO UP IN PRICE. In World War II Ford built a massive number of B-24’s in their new Willow Run plant in Ypsilanti. That change in production and product proved that it can be done and Ford did a spectacular job producing that airplane to the considerable consternation to the Nazi war machine. Fast forward to 2008 and our enemy is our own waste and inefficiency; energy independence is crucial to our national safety and we can actually budget part of our national defense budget to this end.
I am not against giving money to GM…but I am against giving them money to build products that have no measurable or important upside to our economy long-term. I am against giving money to GM with Ford looking like that doggie in the window. Force them into solar, wind, wave and nuclear. Support them in their endeavor to re-tool and you got my money. Absent that, you will not get me to suggest giving them, their workers or their bloated retirees belly-aching about their co-pay when millions have no health care a single dime.
The side benefits are obvious: our defense structure is enhanced because we no longer have to depend on a cartel of Bedouins in the Middle-East to determine for us how much oil we are going to use and our environment actually can become healthy in L.A. vs. choking to death sitting in traffic on the five. We put a pin in our energy costs once in for all and bankrupt our dear friends in the middle east forcing them to drive Chevy Cobalts and trade in their Bentleys.
Here is what we said about the Chrysler/GM merger talk=
“Two drunks walking down the street
holding each other up…
until they hit the curb, then they both fall down”
— Axxel Knutson · Nov 26, 02:11 PM · #