Bankruptcy is Best to Save GM
JoShua Rauh and LuiGi ZinGaLES
ot long ago, Alitalia was one of the largest airline companies in the world. Today it is a shadow of its former self, having burned massive amounts of taxpayer money before finally entering bankruptcy with few assets remaining. The principal culprit of this debacle was the Italian government. Trying to avoid the political paina bankruptcy would have caused, the government continued providing subsidized financing to the money-losing airline, delaying the necessary restructuring. Not only was it a gigantic waste of taxpayers’ money, but it was a death sentence for the very company it wanted to save. Postponing the day of reckoning weakened Alitalia’s competitive
Joshua Rauh and Luigi Zingales are professors at theUniversity of Chicago Booth School of Business.
© The Berkeley Electronic Press
position, making it lose market share it will never regain as a reorganized company. General Motors is quickly going down the same path. It desperately needs a restructuring. According to its latest earnings report, GM’s operations burned $19.2 billion of cash during 2008. The company still has a total labor cost thatis substantially higher than U.S.-based Toyota and Honda plants, and it produces cars nobody wants even at prices that generate large economic losses. It is saddled with massive pension and healthcare obligations and is essentially insolvent: GM’s total liabilities are more than 50% greater than the book value of its assets, according to GM’s latest filing with the SEC. At the rate GM is losingmoney, the $17 billion in short-term loans from the U.S. government received in December, which were shared between GM and Chrysler, has not gotten GM --
much further. GM is now back at the trough, telling the federal government that it needs to increase its loan request to $30 billion. Little of this distress results from the current financial and economic crisis. The current crisis is simplythe proverbial straw that breaks the camel’s back. Without the crisis, the camel would not have lasted long anyway. If the government provides GM with more financing to continue operating under current conditions for another year or two, or even under its proposed recovery plan, money will simply be wasted and the problem postponed. GM will still be unable to survive in the long term. We aresympathetic towards the pain of the hundreds of thousands of workers whose jobs are at stake. It is precisely because we are concerned about their long term welfare that we oppose providing GM with federal loans to
The Economists’ Voice www.bepress.com/ev February, 2009
continue operating without a massive restructuring. Throwing money at a drug addict only enables the addict to continue abusingdrugs and ultimately shortens his life. Similarly, government money aimed at a company that needs restructuring enables it to avoid taking responsibility for its future, condemning it to a certain death. We therefore see four possible roads on which Congress and President Obama’s new automobile industry task-force could send GM. First, it could call its loans, stand back, and let GM file forbankruptcy. Second, it could arrange for GM to do a debt-for-equity swap, along the lines that one of us recommended for financial institutions in an earlier Economists’ Voice article. Third, Congress could provide GM with the requested loans in exchange for the recent round of restructuring promises by the company in its recovery plan. Fourth, the government itself could manage a Chapter 11 bankruptcyfor GM. As we explain below, we think the last of the options is by far the best. Under normal circumstance, the first option would be the natural one. A Chapter 11 bankruptcy would allow the company to be restructured into a new company that could
be managed in a way that creates value for its creditors and new owners. Management could be given renewed incentives to make value-enhancing...
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