Why a GM Bankruptcy Would Be a DisasterWilliam J. Holstein
President Obama is nearing the most important decision a President has made in modern times regarding the American economy. On or about June 1, he will push General Motors (GM), the nation's largest industrial company, into bankruptcy. The key trigger may be on May 26, when GM's offer to bondholders to accept 10¢ on the dollar fails to win acceptance from 90% of them, a criterion that Obama has set for continued loans to GM.
But there's a strong probability the decision to push GM into bankruptcy will be disastrous. The mere threat of bankruptcy caused GM's U.S. sales to fall by 50% in the first quarter from already depressed levels. If GM were to declare Chapter 11 bankruptcy, sales would decline even further.
The reality—which the investment bankers and bankruptcy lawyers guiding Obama don't seem to understand—is that the auto industry is unique in the way it is built on long-term confidence. Buying a vehicle is second only to home buying as the most important financial decision people make, and Americans want to know that the company making their vehicle will exist for at least five more years, that their dealer will continue in business, that their auto loan won't be summarily revoked, and that parts and servicing will be available. That is a fundamentally different psychology from when a consumer buys a ticket from a bankrupt airline or purchases electronics or clothing from a bankrupt retailer. In those instances, there is an expectation of onetime or short-term use.
Suppliers Hanging by Fingernails
Then there are the thousands of suppliers, organized in multiple tiers, that support GM. This system depends on a vast, delicately balanced series of contracts and long-term relationships. Many of these suppliers are already hanging by their fingernails. The longer the uncertainty of bankruptcy lasts, the more likely they are to delay making crucial parts and the more likely it is that some will simply go out of business. In cases where alternate suppliers are not available, GM's assembly lines could start experiencing difficulty or even be forced to shut down.
The risk of liquidation would then loom large because the financial losses would mount. The dislocation would cascade through the economy, not just the Midwest. GM, with its suppliers, represents a full 1% of the economy. It is the largest private-sector purchaser of information technology, so Silicon Valley will feel it; and Madison Avenue will feel the collapse of its advertising spend. Any hopes that the U.S. economy has stabilized would take a beating—there would be another sickening lurch downward. Obama isn't just ruling on the fate of a single company; he is about to pull the trigger on a wide swath of the same economy he is attempting to stabilize.
The Obama camp seems to believe that the Chrysler bankruptcy is a template for what it wants to achieve at GM, but that's a critical mistake. Chrysler was a shell of a company, having been stripped of engineering and design talent by Daimler (DAI) and then mismanaged by private equity owner Cerberus Capital Management. The arrangement is to give the United Auto Workers 55% of Chrysler's shares and to give management control to Italy's Fiat (FIA.MI) group. This may work in political terms, but it's not a real-world business arrangement. The supposedly rescued Chrysler is, in fact, a house of cards that almost certainly will come tumbling down.
GM, in contrast, has invested heavily in product development and new technologies, such as the lithium ion battery for the Chevrolet Volt. It was in the late stages of a transformation effort when the U.S. economy collapsed last fall. Obama should not force such a company into bankruptcy because it cannot be "surgical" or "controlled," as some in the Administration are stating. Bankruptcy lawyers are arguing that GM can emerge within 60 days, but that is highly suspect. Even a Section 363 bankruptcy, in which GM would be allowed to park bad assets like dealer franchise agreements and bonds in a "bad" GM that stays in bankruptcy, then reemerge as a "good" unencumbered GM is highly complex. The reasons are the sheer size of the company, its extensive global operations that account for more than half its sales, and the range of interest groups that will fight tenaciously for their piece of the pie.
Huge Fees for Bankruptcy Lobby
The real precedent in this situation is Delphi, GM's largest parts supplier, which went into bankruptcy in 2005 and now faces probable liquidation. The bankruptcy lobby does not want to acknowledge this failure—they are too busy anticipating the huge fees from the mother of all bankruptcies at GM.
Obama has arguably achieved a large measure of what any government would want in this situation—it has ousted Chief Executive Rick Wagoner and pressured successor Fritz Henderson into implementing the tough restructuring plan that the company's critics have long advocated. The United Auto Workers apparently has just accepted management's latest very tough restructuring plans. Obama should now bring the full weight of his Presidency on all the remaining stakeholders and create the best possible solution outside of bankruptcy court.
Then the government should get out of the way and let management execute on its plan, with continued loans for a period of months, not years. Obama should proclaim that, in view of the dramatic progress that management and the union have achieved, the threat of bankruptcy has been lifted and that it's time for Americans to at least consider buying GM cars in view of their dramatic improvements in quality, cost, and design. He should be helping to create confidence in the future of GM, not destroying it. If he sincerely wants GM to be in position to help him achieve the fuel-emission goals he has established, he must not allow GM to get bogged down in a protracted bankruptcy.
But if the decision to push GM into bankruptcy is inevitable, as it appears to be, Obama should take a deep breath and recognize that once he makes the decision, it will be too late to reverse course. History will regard his decision as an unambiguous indicator of whether Obama knew what he was doing or actually compounded the economic crisis he inherited.