Wednesday, December 03, 2008
Why is a Detroit Three bankruptcy "not an option"?
I did not watch the hearings or read the presentations because I have a day job, but I note that lots of people -- or at least Nancy Pelosi and various gum-flappers on NPR this morning -- are now saying that it would be catastrophic if the Detroit Three reorganized under Chapter 11. This is obviously disappointing to those of us who believe that any taxpayer dollars thrown at these companies in advance of a reorganization will only postpone their inevitable failure. Chapter 11 at least allows the Detroit Three to reject executory contracts, whether with unions, retirees, or suppliers, that otherwise will crush their P&Ls and make it impossible for them to return to something vaguely resembling profitability.
So, apart from the corrupt political goal of not pissing off UAW retirees or the owners of failing Dodge dealerships all over the country, why is Chapter 11 "not an option"? Could somebody who knows something about this please explain it to the rest of us proles?
22 Comments:
By 
Christopher Chambers, at
Wed Dec 03, 02:50:00 PM:
Good question. Why is it not an option for these pinheaded bankers and greedy hedge fund tools? Better lobbyists? There doesn't appear to be a credible accounting of TARP $ so far in the financial sector, so what's the beef with Detroit?
By JPMcT, at
Wed Dec 03, 03:38:00 PM:
Is it just me...or does the vapidity of Pelosi's public comments not send a chill down your spine?
By Escort81, at
Wed Dec 03, 04:40:00 PM:
Pelosi might be confusing Ch. 7 (liquidation) with Ch. 11 (reorg, sometimes now done as a pre-pack). I have maintained for some time that Pelosi and the rest of the Congressional Dems would essentially provide DIP financing, presumably but not necessarily within the context of Ch. 11, provided that their union friends are made whole, and emerge with effective equity control post-reorg. Maybe they (the unions) can make a go of it -- they can't do much worse than current management -- or maybe it will be a case of the inmates running the asylum. Either way, as Seinfeld would say, "good luck with all that."
Christopher -- to your point, the financial lobby is probably a bit stronger. That said, Lehman and others did have their equity wiped out, and Lehman did file. I might agree that it was kind of hit or miss as to which firms were allowed to fail and which were bailed out (although the equity was effectively zeroed out anyway in both cases). Stipulating to Wall St. excesses over the past 25 years or so, and the intensity of the boom/bust cycles, it has still been, net-net, probably a significant engine of growth both here and abroad, lifting standards of living for many people (besides those that work there!). Detroit, on the other hand, has been unable to compete effectively with foreign car builders for most of the last 35 years, and what profits they have made have come from SUVs or their credit businesses. I guess the question is ultimately not which party deserves a bailout more, but rather what are the ripple effects of a particular corporate entity defaulting and liquidating -- a tsunami or a thunderstorm?
Exit question for Christopher: does George Soros fall under the category of "greedy hedge fund tools," or does he receive a special dispensation? Most Hungarians like receiving special dispensations, primarily because they have been shat on for most of the past half-millenium (Turks, Austrians, Germans, Russians) and some feel as though they merit aggrieved status. But the silver lining is, as TH has posted previously, Hungarian women are hot (although that all gets a bit weirdly Oedipal for me, since my mother was born in Budapest).
By TigerHawk, at
Wed Dec 03, 04:57:00 PM:
To me, the question of who "deserves" a bailout is immaterial. The question is whether a particular outcome is essential to the economy. The financial crisis was such that even banks that had not entered into foolish transactions -- Bank of America, JP Morgan, and Goldman -- were going under for liquidity reasons. They were not, in fact, badly managed firms, they were being taken down by a seizing up of the interbank lending system. That is why Paulson essential forced the healthiest banks to take TARP funds.
My problem is that I have not heard a good reason to keep Ford, GM, and Chrysler alive as corporations. It is not as though people will not be able to buy cars -- there are plenty of Toyotas, VWs, Nissans, Hyundais, etc. available to buy, most of which are made in America. The basic problem is that there is massive *overcapacity* in the automobile industry. Capacity must be destroyed. The only question is whether we allow the market to destroy the capacity in companies that are blatantly uncompetitive.
Here's another way to think about it: American financial institutions have been effective competitors against all comers, and are actually in better shape than their European counterparts. American automobile manufacturers have not only failed to compete in "neutral" markets, but they are losing their own market. Again, why do we need these clowns?
By Cardinalpark, at
Wed Dec 03, 05:03:00 PM:
The argument being made - with which I disagree, but it's not implausible - as to why a true bankruptcy exposes an auto company to excessive risk of outright dissolution is that customers would stop buying because warranties would in effect become worthless. That is not a silly argument. The reason a true bankruptcy works for most businesses is that customers don't generally change their behavior if the product isn't impaired by bankruptcy. With a car and its associated warranty, that's not so clear.
Having said that, you would think that one could organize a bankruptcy which tkes into consideration things of that nature, including dealer financing etc.
As to the quip CC made, nobody is bailing out any hedge funds, and they are going bust right and left. And the reason banks are being bailed out isn't for their shareholders, it's for their depositors and the overall health of the credit system. As a public policy matter, it really weould be terribly unhealthy to see a run on Citi or like institution.
By Mrs. Davis, at
Wed Dec 03, 05:12:00 PM:
Because Pelosi is the UAW's witch.
This isn't a bailout of auto companies.
By 
, at
Wed Dec 03, 06:18:00 PM:
There is no reasonable answer to Mrs. Pelosi's comments and others who say that Chapter 11 is not an option. There is only one bad answer and that is to preserve both the current UAW contracts as much as possible, while ensuring that the UAW retirees are also taken care of in a government funded bail out. In a Chapter 11 reorganization there is no way either of those stakeholders make out at all.
As for protecting the warranty's, this was a foundational point that Mitt Romney made in his OP-Ed in the NY Times "Let Detroit Die." The NY Times editors picked the title but the sentiment was anything but death to Detroit. It laid out a perfectly workable plan which included having the Federal Government back the warranty liability (which is very small by the way) prior to going into Chapter 11. His plan would actually give Detroit new life and give the big three a chance at survival.
I think Mrs. Davis was being nice to say that Rep Pelosi is the UAW's witch...the word I was thinking of sounds the same but begins with a "B."
By Escort81, at
Wed Dec 03, 06:44:00 PM:
Somewhat apropos to this discussion thread is Spengler's take on the last quarter century or so of the financial business in the U.S. (although the opinion piece has as its main target the quality of Obama's economic team). While there are points I disagree with, it is worth reading if for no other reason than the use of the phrase "Ivy League puppy mills." Woof woof!
Quaker Cat - "...both the current UAW contracts as much as possible, while ensuring that the UAW retirees are also taken care of in a government funded bail out. In a Chapter 11 reorganization there is no way either of those stakeholders make out at all." Sure there is, especially if you can control who the bankruptcy judge is and who the trustee is; and, since special legislation would be involved here, I dount many bankruptcy judges in whatever federal district Michigan is in would go against the wishes of Congress in saving the UAW by saving what's left of the Big 3.
By , at
Wed Dec 03, 06:52:00 PM:
Giving the UAW the equity for this bucket of bolts would just pour the money further down the rathole. Bankrupcy, chapter 11 is the only way to go on these junkers. They can get rid of the scrap and retool. The UAW would only run these companies like their personal piggy banks. Fire the management and dump ALL the contracts. Then start over.
They will have to burn the place down to save it, I'm sorry to say!
By , at
Wed Dec 03, 07:33:00 PM:
There appears to be a pervasive misconception that by declaring bankruptcy, a company can walk away from it's union contracts. It can't (without considerable legal maneuvering and no guarantee of success), and since union contracts are at the root of the big three's problems, a solution in which the government can dictate terms gives both the company and union leaderes cover to modify those contracts sufficiently to permit the survival of the company. The company can try to renegotiate in bankruptcy, but bear in mind that if a company's seniority list is sufficiently top heavy, it may be in a majority of the union members' interest to let the company liquidate vs accepting a reduction in pay/benefits, particularly if the pension plan is not currently insolvent.
By , at
Wed Dec 03, 07:33:00 PM:
Classic Democrat, purchasing votes. Bail the UAW out. Promise lower taxes to 95% of taxpayers, soak the other 5% that don't vote Dem. Affirmative action loans, there's the ticket.
So what's the tax plan going forward? The Reagan/Bush plan of course. Barack has also backed off the windfall profits tax on Big Oil!!!
Liberal voters have been fooled once again, but they still feel good about themselves. Next election, same promises, same result.
By TigerHawk, at
Wed Dec 03, 08:20:00 PM:
There appears to be a pervasive misconception that by declaring bankruptcy, a company can walk away from it's union contracts. It can't...
Really? I thought Continental Airlines did that twice in the 1980s. Did the bankruptcy law change to protect union contracts? I thought they were executory contracts like any other.
By , at
Wed Dec 03, 08:30:00 PM:
Rather than touching a comparative question of "why banks over autos," I'll provide and apply forward-looking market maxim: no single entity is to become large enough that its failure, or the failure of some small, select number, is substantially harmful to the economy. If it's too big, break it up, or regulate the bejeezus out of it such that the potential risk of taxpayer capital in bailout is hedged. This does run the risk of some countries not enforcing such a rule and AIG-equivalents incorporating in a random country like Bahrain, but with the major governments enforcing a systemic risk regulation with sanctions this problem can be avoided.
Step 1: let the failing, oversize auto industries restructure and break up.
By , at
Wed Dec 03, 08:49:00 PM:
Chapter 11 would relieve the auto maker of retiree pension and benefits, the union job banks (paying people for not working), leases on unused property, and unprofitable dealership agreements.
Chapter 11 is really the only option. The alternatives are really crappy nationalized companies or burning through $100 billion to delay their bankruptcy by a year or two.
The execs all want to avoid Chapter 11 because it would force them to make hard decisions and possibly expose them to being fired without their golden parachutes.
By , at
Wed Dec 03, 08:51:00 PM:
There appears to be a pervasive misconception that by declaring bankruptcy, a company can walk away from it's union contracts. It can't
It's not a matter of a company walking away from its union contracts; it's a matter of the court's powers in equity to set aside or re-write contracts.
By Escort81, at
Wed Dec 03, 10:08:00 PM:
TH - I think you are correct about union contracts in bankruptcy, although in fairness to the anonymous poster, he/she left themselves an out ("without considerable legal maneuvering and no guarantee of success"). That's why judges and trustees matter case by case in bankruptcy. So I think Dave Schuler above hits the nail on the head. But doublecheck with SportsProf, I think he still knows a thing or two about bankruptcy law. By the way, and I am not sure of this, but the changes to bankruptcy law of a few years ago had less to do with major changes to corporate restructurings and more to do with making it more difficult to walk away completely from your debts by filing personal bankruptcy. If memory serves, the final form of the bill was lobbied for by Delaware-based credit card company MBNA (later aquired by B of A)and supported in the Senate by none other than the Vice President-elect, who must have forgotten at that moment that he was Scranton Joe, champion of the little guy.
By , at
Wed Dec 03, 10:08:00 PM:
"Really? I thought Continental Airlines did that twice in the 1980s"
They did.
"Did the bankruptcy law change to protect union contracts?"
Yes it did: http://query.nytimes.com/gst/fullpage.html?res=950DEFDE113CF93BA15755C0A96F948260&sec=&spon=&pagewanted=all
"The Federal Bankruptcy Code was amended in 1984 so that the terms of union contracts are no longer automatically suspended after a filing for protection under Chapter 11"
That was a direct result of events at Continental. Didn't somebody mention conventional wisdom in the Southwest thread...
"it's a matter of the court's powers in equity to set aside or re-write contracts"
The auto industry is not subject to the RLA. Unions there have self help options that can be deployed faster than the courts can act.
"Chapter 11 would relieve the auto maker of retiree pension and benefits, the union job banks (paying people for not working), leases on unused property, and unprofitable dealership agreements"
The last two perhaps; the rest depend on how they're set up. If anyone is familiar with the specifics at the big 3, are retirees paid directly by the company, or are they paid by a currently solvent pension fund the company is obligated by a CBA to make deposits to?
By Escort81, at
Thu Dec 04, 01:10:00 AM:
Anon 10:08 - right, the full graf from that article reads:
"The Federal Bankruptcy Code was amended in 1984 so that the terms of union contracts are no longer automatically suspended after a filing for protection under Chapter 11. Thus Mr. Lorenzo must persuade the court to suspend the contracts before he can institute wage cuts and more stringent work rules."
So it can be done (not automatically as pointed out) -- there is no special protection afforded to the union contracts. It depends upon the court, meaning the judge, and possibly the trustee's actions as directed by the court.
But the point here with the Big 3 is that the unions will not be forced to give up much, because the naked political reality is that federal money will only be forthcoming once the pre-existing equity is wiped out, creditors work out new terms with some haircuts and management is streeted. Unions are a key part of the Democratic Party consituency, and it would be remarkable for a Democratic controlled House, Senate and White House to watch the UAW die becaus there are no jobs.
Well, come to think of it, I suppose the Big 3 could liquidate, and federal money could be allocated to pay UAW members not to make cars for the next generation, and also keep intact all of the legacy payments that the Big 3 are currently saddled with. I mean, if it's just about spoils for the unions, why bother actually having an operating business? Just pipeline the money right from the federal treasury directly to the UAW.
By , at
Thu Dec 04, 09:06:00 AM:
"So it can be done (not automatically as pointed out) -- there is no special protection afforded to the union contracts"
I'd argue that is special protection. Here's another article on the issue: fast.http://findarticles.com/p/articles/mi_m1153/is_/ai_3409838 . The process is neither simple nor fast. Do other contracts have this sort of protection in bankruptcy? (that's not rhetorical - I don't know)
By , at
Thu Dec 04, 10:11:00 AM:
I'd like to see someone examine Ford and GM's claim that they are selling cars at the "employee discount." I don't believe that because it would mean that a UAW member could be a company car at a dealer for the same price he would have been able to buy it through a company program. The marketing department would have taken a negotiated benefit away from the UAW members.
Why is this important? Because no matter what the companies and UAW say in public, there will be secret agreements and understandings. If our left wing Congress was really sincere, they'd ask questions about the "employee discount" claim. Auto execs would be devestated because they've never before had one of their claims questioned and would not be prepared.
By , at
Thu Dec 04, 07:20:00 PM:
Congress can pass bailout legislation that would give the autos the benefits they would hope to gain in bankruptcy, without putting the companies into a court process. My guess is that's what will happen.
Since this bailout idea was first raised, there have been about ten threads asking essentially the same question ("what about bankruptcy?!!!"), and there are answers to your question from several commenters buried in the archive. In summary, the answers have been: 1) the court in Detroit is a terrible court to begin with and would be overwhelmed by the industry arriving all at once, or even singly, 2) the Chapter 11 process would eviscerate whatever brand values are still there, by virtue of the length of time necessary to figure out a reorganization plan and the messiness quotient, 3) the idea of a pre-packaged process requires an activist creditor group willing and able to cram down everyone else, and we don't have that creditor group here, 4) there isn't new equity hanging around, just waiting for the baptism of bankruptcy to happen, 5) the downside of just-in-time manufacturing is that instant job losses would occur all over the mid-west if the autos ceased operations even briefly, and the resulting job losses would be inconvenient to the the Office of the President Elect. Etc. Etc.
By , at
Tue Dec 09, 12:39:00 AM:
In view of the fact that Chapter 11 was designed for exactly this situation, and the airlines go through it on a regular basis, the only reason I can think of that the executives keep saying bankruptcy is not an option is that their stock and stock options that make up the majority of their pay (or all of it if they agree to work for "$1 a year" which really means only for stock) would become valueless.
Cheers
John
