A Requiem: Restructuring the "Big 3"

The only remaining questions appear to be the process of their demise and how they will be restructured--and whether our public money is wisely spent in answering the pleas for life-support through this enormously wrenching and untidy process. Dying organizations, liking dying people, too often plea against reason for another day of life as they know it, and another dollar to make it happen. Regardless, of the answers there will be lots of pain to be shared by all. There is no soft landing to be had.

Under most circumstances, I would doubtless see no wisdom, no defensible short-term benefit, no accountability for long-term results attending any approach other than allowing the bankruptcy reorganization process to unfold and work its painful resolutions. Seldom does artificially supporting a noncompetitive, failing enterprise result in anything more than deferring the inevitable failure, and assuring that everyone suffers longer and loses more. And while Chapter 11 is still likely the best answer today, there are singularly unaccommodating aspects of the current financial and economic environment that could reasonably lead the taxpayers to assume the banker's role and provide "bridge financing" to the Big 3 as they work though this process--within or without the Chapter 11 process.

But if we are to consider this extraordinary venture outside the bankruptcy process, don't we have to require a financial stake in return, a planned restructuring process, oversight, and conditions that assure all other stake-holding parties--shareholders, employees, suppliers, creditors and dealers--share in the sacrifice necessary to produce an effective, competitive, restructured U.S. auto industry? And don't we have to accept that there may be only one or two companies resulting?

In a Newsweek article, "How to Bail Out General Motors," Robert Samuelson provides a balanced reflection on these issues and is almost persuasive that, all things considered, we may be better off holding our nose and providing "life-line" financing to the Big 3 outside the bankruptcy process. But first, on the off-chance that you haven't been paying close attention to these matters, allow me to share some personal reflections and conclusions about the Big 3, how they got to this place, and how dark their situation is.

Without Chapter 11 or government intervention, they will likely fail--GM soon, and one or the other soon after. The Big 3 have been in the slow process of leadership failure for at least a few decades. I once read a study that suggested that a principal factor in identifying great management and great leaders is how far and how insightfully they look into the future. And then, of course, it is just as critical how well they lead and manage to that future. The Big 3--and particularly GM--have failed on both counts, and they've been doing it for a long time. This is not a revelation; it is not news. As a professional and executive in large-corporation America for over 20 years, I can assure you that during that time this slow demise proceeded predictably and was discussed and written about with some regularity.

They have survived on yesterday's American market segments that foreign auto makers have largely left to them as the world has moved on. For during this time, more forward looking, more effectively managed and competitive automotive companies have evolved in Japan and Korea, and joined a few European auto makers to set the standards and claim world-wide leadership. Within 10-20 years, China will doubtless join or lead this group. And also during this time, new managers and older expatriates of the Big 3 have quietly shared their disappointments and frustrations with the myopic, sometimes dysfunctional, management cultures. The only question was, when and how they would fail?

The when, is now, and the how, is the question of the day. So let us just matter-of-factly pronounce the inevitable last rites and sing the requiem song over the dead men walking, and then move on to what a wise reorganization process of the American automobile industry might look like.

The Newsweek article by Samuelson makes clear the circumstances in which the Big 3, the congress, and we taxpayers find ourselves:

• "So it's come to this: General Motors, once the world's mightiest industrial enterprise, is now flirting with bankruptcy. Ford and Chrysler may not be far behind. Car and truck sales have collapsed. GM is rapidly exhausting its cash reserves and may soon be unable to pay its bills. Here's the dilemma: GM and other U.S. automakers ought to be rescued to minimize damage to the economy, but the rescue should require tough conditions that neither the Democratic Congress nor the incoming Obama administration seems willing to support."

• "In a booming economy, a GM bankruptcy might be tolerable and useful. It would remind everyone of the social costs of mediocre management and overpriced unionized labor. But far from booming, the economy is declining at an apparently accelerating rate."

• "No one knows what further havoc a GM bankruptcy might inflict. A study by the Center for Automotive Research (CAR) estimates that 2.5 million jobs would be lost in the first year. The logic: if any of the "Big Three" went bankrupt, many suppliers would also fail; because car companies share suppliers, all U.S.-based manufacturers would suffer crippling parts shortages. [But] this may be too pessimistic..."

• "In a Chapter 11 bankruptcy, GM would "reorganize." It would suspend many existing debt payments and continue normal operations. Perhaps. The snag is that even in "reorganization," GM would require new loans and these might not be available. "Historically, when companies go bankrupt, there's 'debtor in possession' financing—investors lend you money, but they get repaid first. That market has evaporated because of the credit crunch," says auto analyst Rod Lache of Deutsche Bank. No loans, no production.
  
  Another possible pitfall: worried about warranties and service, customers might shun a bankrupt GM's vehicles." [But I submit this would be a factor regardless of approach since the public has a ringside seat and clear sense of the Big 3's fragile condition and uncertain future.]

Based on those points, Mr. Samuelson then tacks toward avoiding bankruptcy through government loans, but with stronger conditions than have so-far been voiced by the congress. He follows this course despite his own expressed lack of confidence in the congress to require and enforce the necessary conditions, and in labor unions to agree to them.

• "Why run these risks when the 6.5 percent unemployment rate seems headed toward 8 percent and almost a quarter of the 10 million jobless have been out of work for six months or longer? Just to satisfy a purist "free market" ideal? It doesn't make sense. But neither does it make sense simply to heave taxpayers' money at automakers. The objective is not to rescue the companies or workers; it is to shore up the economy and improve the U.S. industry's competitiveness. A bailout won't succeed unless other things also happen."

• "GM will need a $25 billion government loan to get through the recession and cover closing costs, says Lache. But GM already has $48 billion of debt. Unless the old debt is sharply written down, GM would be overburdened and its rendezvous with bankruptcy would merely be delayed. Already, shareholders are essentially wiped out."

• "Labor costs need to be cut. By Lache's estimates, GM's hourly compensation—wage plus fringe benefits—totaled $71 in 2007 compared with Toyota's $47. Health benefits for retirees (many in their 50s, having retired after 30 years) are expensive. These costs contributed to GM's massive cash drain, $31 billion since 2005. But the United Auto Workers opposes making concessions. Just the opposite. Government aid, says UAW president Ron Gettelfinger, is needed "so that auto companies can meet their health-care obligations to more than 780,000 retirees and dependents." The bailout should be more than union welfare."

• "In bankruptcy, a judge can modify a firm's labor contracts and debts. GM needs the benefits of bankruptcy without the uncertainties, but the political process—so far—resists that desirable bargain. The conditions that Democrats seem to be discussing are mostly rhetorical gestures against high executive compensation (already limited) and in favor of more fuel efficiency (already legislated)."

• "We are now seeing the first political side effects of the open-ended $700 billion rescue of financial institutions. With so much money going to so many recipients, boundaries and rationales need to be established. When is public intervention justified? Who deserves support and why? Otherwise, political firepower will increasingly rule. The reason for imposing tough conditions on the auto industry is not only to improve the odds of success, but also—by the sacrifices required—to make the process sufficiently unpleasant so that countless other companies and unions won't demand similar handouts. In 1979, when it rescued Chrysler from bankruptcy, the Carter administration insisted on concessions from management, investors and labor. We should do as much or more."

I think Samuelson has a made a strong case for the best course of action. It is just not the one he has proposed. They do need the benefits of a bankruptcy-like process to impose the requirements and necessary discipline on all parties to assure a viable restructuring of these companies--but only a Chapter 11 proceeding will provide it. Samuelson cannot just end his analysis with an unsupported conclusion based on the implied hope that somehow the congress, labor, and financial institutions will voluntarily do what they have expressed no willingness to do. And Chapter 11 is also the best way to avoid the slippery slope and impossible judgments of who among the lengthening line of supplicants also deserve to be "bailed out."

The one significant and justified reason for government "bridge loans" identified by Mr. Samuelson is the huge current problem with the lack of a normal banking and financing environment. And gaining the needed additional financing in this constricted and frightened market presents an abnormal and significant risk to the success of a normal bankruptcy restructuring process. Unless the $48 billion of existing debt is written down and subbordinated to "debtor in possession" loans from other financing sources, they are much less likely to emerge from bankruptcy optimally and successfully restructured. Unfortunately, it is quite possible there will not be adequate financing or reasonable terms from other sources in today's dysfunctional financial markets--except from the government.

The better alternative might be to allow GM and other members of the Big 3 to go into Ch. 11 bankruptcy proceedings, but with agreement that the government will be the banker of last resort providing financing up to what is economically justified--say, the requested $25B--but only if the banks holding the existing $48 billion of debt will subordinate it to the government loans. Then, let the Ch. 11 process legally force the unions to adjust to real market wages and benefits. Let the real forces of the world-wide marketplace exert their shaping influence on the restructuring, merging, split up, or outsourcing process. That will likely be the only way to bring the full force of market and economic reality to bear on the process--and on the timely resolution of the economies of scale and work force issues which allow all parties to get on with business, and get on with their lives. Tough, but likely right.

Yes, a lot of jobs will be lost, but they will be lost anyway, sooner or later. Job displacement, and all the unfortunate distress and suffering that goes with it, are a painful but constant fact of life in a healthy market economy. And there is usually no wisdom in subsidizing continuing failure or deferring the inevitable. We have or should have sufficient social support programs to bridge the displaced from lost jobs to new places and new jobs--and if existing programs are inadequate to the needs of this extraordinary time, then they should be legislatively strengthened and made adequate. That is also a necessary part of an effective market economy's healthy adjustment process.

To follow the course Samuelson proposes does not appear to follow from his facts or premises. It is unwise to merely hope the legislature will or can create the conditions, discipline, and accountability of a bankruptcy process outside of Chapter 11 proceedings. To harbor such hope is naive, at best. We can still be the banker of last resort in bankruptcy. But anything more appears mostly about politics. Maybe it's smart politics, but it is just politics.

[Thanks for the question, Adam.]