GM: The Bailout vs Bankruptcy Meme

There’s a bailout vs bankruptcy meme going around with regard to GM — a choice which makes me want to tick "none of the above". I’ve seen it in dozens of places of late, but since it comes with the imprimatur of Paul Krugman, let’s look at the argument of Jonathan Cohn:

GM can’t build cars without parts, and it can’t get parts without credit. Chapter 11 companies typically get that sort of credit from something called Debtor-in-Possession (DIP) loans. But the same Wall Street meltdown that has dragged down the economy and GM sales has also dried up the DIP money GM would need to operate.

That’s why many analysts and scholars believe GM would likely end up in Chapter 7 bankruptcy, which would entail total liquidation… [cue visions of millions of newly-unemployed workers and hundreds of billions of dollars in losses]…

Those are among the reasons most analysts and economists, however reluctantly, have concluded that a better solution would be another government bailout.

At heart, this argument is simple. There’s no available DIP financing for an orderly Chapter 11 bankruptcy, and Chapter 7 liquidation would be disastrous, therefore we need a bailout which avoids any kind of bankruptcy at all.

But I don’t see why a government bailout must, ipso facto, avoid any kind of bankruptcy. GM alone has $35 billion in long-term debt, most of which is trading at about 20 cents on the dollar. That might only be a drop in the bucket compared to its total liabilities of $193 billion, but it’s a good place to start: if bondholders took an 80% writedown while the government pitched in $12 billion of preferred equity in the post-restructuring entity, that’s a $40 billion improvement to GM’s balance sheet right there. And of course bankruptcy would give GM the opportunity to renegotiate onerous contracts with its dealers, as well as other real and contingent liabilities.

This is what I’ve been referring to as a "bail-in", and it makes quite a lot of sense on its face. Let the government provide the necessary financing, but ensure that bondholders share some of the pain as well, especially since doing so would simply ratify the mark-to-market losses they’ve already taken.

Such a plan would involve working out the details of a bankruptcy in advance: there are large dangers involved when a company the size of GM enters bankruptcy without any clear conception of how it might exit. So there would need to be serious negotiations between all of GM’s stakeholders and the government — negotiations which, I’ll concede, would be all but impossible during this uncomfortable interregnum between the election and the inauguration. Even if GM can somehow muddle through until January, it can hardly expect such negotiations to be concluded in a matter of weeks. So there’s a timing problem here, given that the present administration has demonstrated zero inclination to help out Detroit.

But I still think that it would be useful to stop thinking of a bailout as an alternative to bankruptcy, and start thinking more imaginatively about the different mechanisms, including both government funds and bankruptcy, which could help put Detroit on a more sustainable footing.

Update: Ryan Avent seems to be thinking along similar lines, in a blog entry entitled "Chapter Something Else":

If Congress can pass a special, tailor-made rescue bill for the automakers, then certainly it can also pass a special, tailor-made bankruptcy bill for them.

I guess my only question is what’s wrong with Chapter 11. Why create a whole new class of automaker bankruptcies, if a pre-packaged Chapter 11 would work fine?

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