“Bailout won’t cure what ails Big Three”. USA Today. 13 Nov. 2008 – From the perspective of current and former employees worried about a job or pension, this is a no-brainer. If Washington is willing to rain money on Detroit, they’ll take it, and surely no one wants to harm hard-working people. But from the perspective of what will help ensure a vibrant domestic auto industry years from now, there might be a better place to look: bankruptcy court.
Bankruptcy need not mean that the company disappears. The Chapter 11 reorganization process has been used many times over the past several decades, notably in the steel and airline industries, to accomplish objectives such as those that the Big Three, GM in particular, need to do now. These steps include trimming labor costs, dropping product lines, eliminating dealerships and focusing on making popular, high-quality vehicles.
Many of these changes would be much easier in bankruptcy because a judge could simply approve what would otherwise entail tedious negotiations with dubious outcomes. To be sure, customers might be reluctant to buy from a company whose future is in doubt. But, by the same token, this would be an incentive for all parties involved to reassure consumers by completing the reorganization process quickly.
“Detroit Needs a Selloff, Not a Bailout”. Wall Street Journal. 27 Nov. 2008 – Bankruptcy has allowed some industries to turn themselves around. A decade ago more than 40% of the steel industry’s capacity was reorganized in bankruptcy. The result was the rationalization of capacity and new labor agreements that allowed three large players — U.S. Steel, Severstal and Mittal — to create a more efficient steel industry.
But this change occurred only after a dramatic restructuring of the industry in the face of fierce competition from new “minimills.” By the time the larger companies — Bethlehem, LTV, Weirton and others — collapsed into bankruptcy, they had already shed a vast amount of uneconomic capacity and ceded the production of certain types of products to the minimills.
Thus, the operations that Mittal, U.S. Steel and Severstal bought out of bankruptcy were the most efficient remnants and were devoted principally to making products used in motor vehicles, appliances and (to a lesser extent) construction. They did not have to build new blast or steel furnaces or revamp product lines. They simply had to rewrite labor agreements.
Similarly, the airline industry weathered a round of bankruptcies following 9/11. The problem then was overcapacity relative to what the changing market would bear. But economic recovery and lower labor costs negotiated in bankruptcy allowed most airlines to rebound because they did not have to face multiple carriers that offered better service and cheaper fares.
Detroit faces very different problems. It has had a persistent product-line problem that may be even more severe than its labor problems, and in any event will not be solved by getting UAW wage rates in line with those at the U.S. plants of Toyota, Honda, BMW and Nissan by 2010. The gaps between U.S. and foreign competitors simply have become too large to make up by reducing labor costs or rationalizing capacity. Even if the overall economy rebounds and gives Detroit auto makers some breathing room to emerge from bankruptcy, they will likely face similar — if not more severe — problems in the next recession.
“Editorial: Auto Bailout; The alternative is worse”. Philadelphia Inquirer. 23 Nov. 2008 – “Part of the problem is the Big Three don’t make enough cars that consumers want to buy. So will the bailout funds transform the companies or just put off the inevitable?
President-elect Barack Obama is said to be considering a so-called ‘prepackaged’ bankruptcy, which would allow the automakers to restructure more quickly than normal Chapter 11 proceedings under a judge’s supervision. Under this option, the companies would go into court with financing, a business plan, and concessions from unions and suppliers.
Included in any such deal should be replacement of executives and directors of the failed companies, renegotiated labor contracts, and trimmed pension obligations. The government could provide low-interest loans to allow the firms to keep operating during the restructuring. And Washington would control the automakers’ boards until the loans are repaid.”
The Big Three reject this solution, as does House Speaker Nancy E. Pelosi (D., Calif.), who said even a fast-track bankruptcy would be “digging a hole too deep” for the automakers. Pelosi wants the car companies to devise a restructuring plan as a condition of a bailout, but a modified bankruptcy would offer taxpayers more protection.
Mitt Romney. “Let Detroit Go Bankrupt”. New York Times. 18 Nov 2008 – The American auto industry is vital to our national interest as an employer and as a hub for manufacturing. A managed bankruptcy may be the only path to the fundamental restructuring the industry needs. It would permit the companies to shed excess labor, pension and real estate costs. The federal government should provide guarantees for post-bankruptcy financing and assure car buyers that their warranties are not at risk.
In a managed bankruptcy, the federal government would propel newly competitive and viable automakers, rather than seal their fate with a bailout check.
Andrew M. Grossman. “Automakers Need Bankruptcy, Not Bailout”. Heritage Foundation. 15 Nov. 2008 – Rather than throw even more money at the problem to little effect, Congress and the Administration should let the automakers take advantage of the same legal process to reorganize that thousands of other businesses use each year. The bankruptcy process is designed to address exactly the kind of challenge that the automakers now face: realizing the full value of assets and organizations that have been mismanaged and kept from reaching their potential. Conversely, outside of the bankruptcy process, the automakers will lack the legal ability, as well as the proper incentives, to confront their problems, restructure their operations, and return their assets and employees to productive service.
Andrew M. Grossman. “Automakers Need Bankruptcy, Not Bailout”. Heritage Foundation. 15 Nov. 2008 – The Bankruptcy Process
The bankruptcy process, as recognized by the Framers of our Constitution, is an essential piece of the nation’s commercial fabric. It is the means by which competing claims on assets by creditors are resolved and so is essential to the operation of credit markets.
Competing claims as a result of insolvency are the prototypical situation in which bankruptcy occurs. When individuals or entities reach the point where they are unable to pay bills as they become due or are, on an accounting basis, insolvent–that is, their debts exceed their assets–they may petition for bankruptcy. The federal Bankruptcy Code contains several “chapters” under which one may file. Under Chapter 7, the filer’s assets are sold to pay creditors’ claims. This is known as liquidation and, in the case of a business, results in its demise.
Chapter 11, however, is usually used to reorganize a business that, but for insolvency, is potentially profitable. It embodies the recognition that, in some cases, creditors fare better when a business continues as a going concern rather than being liquidated. These businesses are likely to be able to pay off more of their debts if they are reorganized to address their problems instead of being picked apart by creditors. What they need is breathing room from the threat of debt collection and broad power to rearrange their operations. The Big Three, though they could stand to shed some assets, surely fall into this category.
Though General Motors is probably not the largest in terms of assets (Lehman Brothers took that trophy when it entered Chapter 11 in September), its bankruptcy would probably be the most complex ever to hit the courts. To begin with, the company has over 250,000 employees, over 300,000 retirees and covered spouses, a dozen divisions, and operations around the globe. But with the sale of a majority stake in its financing arm, GMAC, in 2006, and with a 2007 deal to shift tens of billions in unfunded health benefits to a voluntary employees’ beneficiary association (VEBA) overseen by the United Auto Workers union, several of the thornier issues have already been removed from contention.
The chief complication will be the number of parties at the table in any automaker bankruptcy proceeding. In addition to secured and prioritized creditors, the unions, retirees, dealers, and even customers could seek to form committees to further their interests and block concessions that cost them money.
But the bankruptcy process is flexible enough even to accommodate these clashing interests. Especially in the districts were large bankruptcies are often brought, such as Delaware and the Southern District of New York, bankruptcy judges are generally adept at managing complex cases and wrangling parties.
There would also be several incentives for speed: All parties would be eager to see a reorganization plan in place quickly, and the corporation itself would have only an 18-month window of exclusivity in which to file a plan before the gates are flung open to others. While that deadline would be a major challenge, it would also inject some urgency into the proceedings and focus all of the factions on getting a plan approved and exiting bankruptcy. In any case, reaching discharge does not require complete consensus among creditors.
The Benefits of Bankruptcy
Bankruptcy is not, as some would have it, the end of the road; it is, rather, a new beginning. Under Chapter 11, it affords companies that have hit hard times a fresh start and a chance to reorganize to take better advantage of their assets.
For this reason, dire claims that bankruptcy is somehow equivalent to the end of a business–for example, some have stated that bankruptcy would imperil the employment of all of an automaker’s workers–are simply incorrect. Instead, the reorganization process provides unique flexibility to unlock the fundamentally sound productive capabilities of a faltering business by freeing it of many obstacles to success, such as unviable contracts, crushing debt, and poor management. Reorganization is the right tonic for businesses like the Big Three that need to adjust quickly to new economic realities but are, at their cores, sound, productive, and potentially profitable.
Breathing Room. The benefits of reorganization would begin immediately with the automatic stay obtained at the moment of filing. Once a company has filed for bankruptcy, it may suspend payment of all debts, giving it breathing room to take stock of its assets and situation.
For a company like General Motors, the stay would put to rest fears that the company would be unable to meet its current expenses as they arise. Thus, a filing might actually ease relations with suppliers who may now be wary of sending parts on credit–especially given that Ford and GM’s bond ratings entered junk territory in 2005 and haven’t looked back. Further, those who have contractual duties to the company are required to fulfill them; thus, an automaker’s suppliers and contractors could not cease dealing with it simply because it has filed bankruptcy and is undergoing reorganization.
Filing also makes it easier and cheaper for a company to finance its operations with debtor-in-possession (DIP) financing, which is given priority over other debts and so presents a low risk of default. Even in today’s relatively tight credit markets, DIP financing remains available, though rates have risen somewhat.
Nameplates and Dealer Networks. The filing company, however, does gain the flexibility to reconsider its own contractual obligations, and this may be the major benefit of reorganization for automakers. As described above, many of the Big Three’s legacy problems are manifest in contractual relations governed by unfavorable legal regimes. Among them are excessive and overbearing dealer networks that are nearly impossible to reform because of state franchise laws and unrealistic labor agreements struck under federal labor law. In bankruptcy, however, everything is on the table.
This power would allow an automaker to reorganize its dealer network without facing tens of billions of dollars in potential expenses. To begin with, this means terminating relationships with unprofitable and underperforming dealerships. According to Steve Girsky, a former General Motors consultant, the automaker could stand to drop about 60 percent of its more than 6,000 dealers. Perversely, this is one reason that there will be organized opposition to bankruptcy and reorganization, even though it is in the best interest of an automaker and its remaining dealers. But the fact of this opposition–that dealers believe that, given the option, an automaker would reduce its dealer network–simply proves the value of the bankruptcy process.
Further, an automaker could negotiate new contracts with remaining dealers to permit more flexibility, such as Internet sales, integrated inventory management, better customization programs, and other consumer-driven practices. These changes alone could dramatically cut expenses while improving focus and execution.
Cutting down on dealerships also opens the door to consolidation of nameplates. Out of General Motors’ bevy of brands, only two or three are needed to differentiate, according to Wall Street Journal Detroit Bureau Chief and industry observer Paul Ingrassia. A brand stable reduced to just Cadillac on the high end, Chevrolet in the middle and low end, and perhaps GMC for trucks would reduce expenses throughout the company and, again, provide more focus for management, especially regarding the composition of the company’s fleet.
Labor Contracts. The Bankruptcy Code contains special provisions for collective bargaining agreements to ensure that a company’s union employees are treated fairly and that the reorganizing company has the needed flexibility to operate as an ongoing, profitable business. For the Big Three, downsizing is inevitable as they adjust to take advantage of automated technologies, eliminate duplicative and unnecessary functions, and shrink operations to fit their current market shares, but labor law and agreements have made doing so impractical. Detroit is notorious, for example, for its automaker-funded “job bank” programs that pay unneeded employees not to work, reducing or eliminating the benefit of closing unprofitable operations. Without the flexibility to deploy its workforce efficiently, Detroit has no hope of survival.
Recognizing the great importance of labor relations, the Bankruptcy Code addresses it specifically. Unlike with other contracts, a business undergoing reorganization cannot simply reject a collective bargaining agreement. Instead, it must propose to the union modifications to the agreement that are necessary for it to achieve a successful reorganization and that “assure that all creditors, the [business] and all of the affected parties are treated fairly and equitably.” 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 rejected the modified agreement and “the balance of the equities clearly favors rejection of such agreement.”
Thus, the bankruptcy judge has significant discretion and power to push the parties toward an agreement that is mutually acceptable, conforms to the 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.
Debt Restructuring. One of bankruptcy’s chief functions is to free a potentially profitable business from crushing debts. This is the “fresh start” that reorganization promises: Pre-filing debts become unenforceable except to the extent that they are incorporated into the reorganization plan. A business that can be run on a positive-cash-flow basis, after all, has a greater chance of making debtors whole, or nearly so, than one that is unable to operate due to existing debt.
The automakers are awash in debt. General Motors, for example, has over $40 billion in long-term debt, while Ford has about $163 billion. Both rely on billions in short-term debt to finance ongoing operations and have faced soaring interest rates on short-term and long-term borrowing in recent months due to fear that they may default.
That fear would be realized in a bankruptcy proceeding, as some debtors would inevitably face a “cram-down”–that is, they would receive less than they are currently owed. It comes with the territory when making unsecured loans and is compensated by the risk premium. Much of the companies’ unsecured bond debt could be converted into equity during reorganization.
The reorganization plan, which is usually proposed by the business, must lay out all of the business’s assets and debts and state how each will be treated under the reorganization. It must be approved by a vote of at least one class of impaired creditors–those who would not be made whole under it. Finally, the bankruptcy judge must find that the plan is feasible, proposed in good faith, and in compliance with the Bankruptcy Code. These safeguards ensure that that the approved plan is the best possible in the situation with respect to creditors’ rights and has a high likelihood of actually succeeding.
New Leadership. A bankruptcy filing is a signal that a business’s leadership has failed those whom it is meant to serve: the shareholders. Because shareholders lose their equity stake in most bankruptcy proceedings, the corporation’s new owners (its creditors) are able to revisit the question of board and executive leadership and frequently to make extensive changes.
For years, America’s automakers have been operated without vision by managers more focused on their ties to Washington than on their relationship with consumers. Reorganization would provide the opportunity for the automakers’ new owners to choose a different course and select more entrepreneurial board members from outside the Big Three establishment. In particular, the Ford family would stand to lose its controlling minority stake in Ford, which it has used in recent years to pursue objectives other than satisfying consumers and achieving sustainable profitability.
James L. Gattuso and Nicolas Loris. “The Detroit Bailout: Unsafe at Any Cost”. Heritage Foundation 16 Nov. 2008 – Should Washington bail out Detroit? That is the question facing Congress as it reconvenes this week for a special post-election session. Nearly everyone agrees that, with losses piling up, Detroit automakers need to change the way they operate and change soon. The real issue is how best to do that.
The Detroit-based automakers–General Motors, Ford, and Chrysler–argue that they need more money from U.S. taxpayers. That approach, however, is more likely to extend the status quo rather than lead to reform. A far better approach is to restructure the old-fashioned way, through a formal bankruptcy process if necessary. Bankruptcy–and the prospect of it–would provide both the incentive and means for making the hard and painful choices that Detroit needs to make. Lawmakers should turn down pleas for subsidies that would detour that process.
[…]The Bankruptcy Option
There is an alternative method of facilitating needed restructuring: bankruptcy. While often seen as a sign of failure, the bankruptcy process is often the best way for troubled enterprises to get back on their feet. Debts are reduced or cancelled and contracts terminated or renegotiated, allowing firms to get a fresh start. And if a firm still cannot be made viable, bankruptcy also provides for an orderly and clear process for getting assets–including plants and equipment–back into productive use by others.
There are, of course, losers under bankruptcy. Management is more likely to be replaced, but that might be deserved. Shareholders lose their investment, but stock values are plummeting already.
This is not to say that bankruptcy is necessary for every firm. Ford, for instance, is still expressing confidence that it make its way through without it. Chrysler, the smallest of the three Detroit firms, could possibly be merged with stronger partner, such as Nissan. But if other options fail, bankruptcy is a natural and practical choice.
Some argue that a declaration of bankruptcy would, in itself, drive auto customers away by raising concerns that crucial post-sale warranty service would not be available. But the auto firms have hardly kept their woes a secret. The word is already out. Rather than spawn concerns, a bankruptcy proceeding could actually reduce such worries by providing a path to recovery.
The most sweeping argument against bankruptcy is that the automakers are just too big to fail, citing the millions of people employed by the Big Three automakers and by firms dependent on them. But bankruptcy does not mean an end to operations: Firms routinely continue operations while in the bankruptcy process. Moreover, even the worst-case scenario–liquidation–does not mean vaporization. The assets of a firm do not vanish. Rather, they are resold to others more able to make productive use of them.
Of course, jobs will still be lost. But Detroit will almost certainly have to shrink under any viable restructuring plan. And in the longer run, addressing the hard questions and making the hard choices–rather than postponing them through taxpayers bailouts–will lead to more jobs and a better economy.
Daniel J. Ikenson. “Don’t Bail Out the Big Three”. The American. 21 Nov. 2008 – Bailing out Detroit is unnecessary. After all, this is why we have the bankruptcy process. If companies in Chapter 11 can be salvaged, a bankruptcy judge will help them find the way. In the case of the Big Three, a bankruptcy process would almost certainly require them to dissolve their current union contracts. Revamping their labor structures is the single most important change that GM, Ford, and Chrysler could make—and yet it is the one change that many pro-bailout Democrats wish to ignore.
The Big Three, the United Auto Workers (UAW), the Michigan Congressional delegation, Michigan Governor Jennifer Granholm, House Speaker Nancy Pelosi, and Senate Majority Leader Harry Reid all know that $25 billion is nowhere near enough money to fix the problems ailing Detroit. The politicians must know that bankruptcy is the better course for auto companies and their workers (indeed, it could save 100,000 jobs). But they also know who fills their political coffers, and the UAW leadership is opposed to Chapter 11 because its labor contracts would be deemed toxic and abrogated by a bankruptcy judge.
The U.S. auto industry needs a shakeout, not a bailout. What we are witnessing, unfortunately, is an attempted shakedown. Let’s hope it doesn’t succeed.