The U.S. economy has sailed into a perfect storm—housing crisis, credit freeze and consumer collapse—possibly the worst financial crisis in 60 years. On January 20, 2009, Barack Obama takes our economic helm. How will he navigate the challenges ahead—stabilizing our credit markets, restructuring our largest industry and stimulating our economy? Will it be with good policy or bad politics?
Bailing out financial institutions was good policy
Financial institutions are fundamentally different from industrial corporations. The products of industry are goods and services, whereas the product of finance is money. We can live without most products for short periods. But we cannot live without money, not even for a day. So when our financial institutions came under such stress as to face collapse, the administration had to take immediate action that would ensure continuous money flow, even before the affected institutions could develop plans to ensure their viability.
Why bailout and not bankruptcy for financial institutions? To help answer this question, we have to go back to 2005. This is when Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act (BACPA), which was heavily promoted by landlords who couldn’t get released from bankrupt tenants. One of BACPA’s provisions was to remove certain leases and financial contracts from the “automatic stay,” the essential feature of bankruptcy that gives businesses time to reorganize. Unfortunately, the lawmakers didn’t consider that financial contracts form the very underpinnings of our credit markets. Had banks and insurance companies slipped into bankruptcy at the height of the credit crisis, commercial counterparties could have terminated financial contracts and potentially frozen credit markets with disastrous consequences.
The administration’s decision to allocate a portion of the $700 billion authorized by Congress under the Troubled Asset Recovery Plan (TARP) to bailout banks and insurance companies in the face of a credit freeze was good policy, as was its decision to leave much of the TARP funding unspent to give the new administration “dry powder” in the event of another credit, bank or financial institution crisis.
Bailing out the auto industry is bad politics
U.S. capitalism is the envy of the world largely due to our debtor-friendly bankruptcy laws. Bankruptcy provides the safety net that lets entrepreneurs and businesses take risks, fail and come back. Ask most venture capitalists and they’ll tell you their best CEOs have experienced failure, some more than once.
Bankruptcy laws were first enacted by Congress in 1789 and have been revised and reformed many times. Today, bankruptcy laws provide a consistent and transparent process that guides a company through reorganization. And if it becomes apparent that our bankruptcy laws come up short, they’ll be revised again.
So why do many of our leaders favor bailout over bankruptcy for automakers? Is this good policy or bad politics? The Big Three automakers employ 240,000 workers; provide benefits to more than 2 million retirees; and support more than 5 million dealers, suppliers and service providers. Yet they’re woefully approaching insolvency. Without new capital or protection from creditors, GM and Chrysler may not survive until year’s end—and Ford isn’t far behind.
Many in government believe the auto industry, and specifically GM, is too big to fail. A Midwestern economist was recently quoted “even if not providing a return on investment, [GM] is still providing a lot of good jobs.” But what if it—or any of the Big Three—were to fail? Their plants and equipment wouldn’t “vaporize.” They’d be sold and put to use under new owners. To paraphrase Jack Welch, former CEO of GE, it’s irresponsible to ask employees to come to work and develop skills for a business that isn’t viable. It’s not that GM and the other automakers are too big to fail. It’s that they’ve become too big and too bloated to continue without a complete overhaul.
Not surprisingly, Big Three executives are deathly opposed to bankruptcy. They argue that consumers won’t buy cars from a tainted manufacturer. But the taint of bankruptcy has long left the American lexicon. Every day, shoppers buy from retailers and travelers fly in airlines that are being reorganized under Chapter 11. GM management also argues it might not be able to secure new loans under Chapter 11, forcing a liquidity crisis that could destroy the company. This argument just doesn’t hold up. Loans to companies in Chapter 11 (called DIP loans) have “super-priority” over all other unsecured loans and attract sophisticated lenders who specialize in this area. In the worst case, the government could guarantee GM’s DIP loans at virtually no risk to taxpayers.
We also hear leaders in Congress insisting that any bailout package include a “viability plan.” In bankruptcy, this would be called a “plan of reorganization.” The difference between a viability plan and a plan of reorganization is transparency. In bankruptcy, every step of the reorganization process is fully visible to all stakeholders and the public. There are no such assurances under a bailout. To the point, Cerberus Capital, an unregulated and mostly secret private equity company, owns 80 percent of Chrysler and controls GMAC, GM’s financing arm. Without the transparency of bankruptcy, we may never know the interrelationships between Cerberus, Chrysler and GM.
Good policy or bad politics
Government is here for the people. Good policy is to aid auto workers and their communities, not the companies they work for. This might include extended unemployment benefits, pension plan support and job training. Good policy is to stimulate the economy with tax cuts and capital injections to create new employment. And it’s to let our excellent bankruptcy courts guide the reorganization of distressed companies—regardless of industry—and not let bad politics, with the potential of back-room dealing and political grandstanding, circumvent this time-honored and fully transparent process.
