Whatever Happened to Bankruptcy?

Financial institutions (led by Citibank (C)) have hundreds of billions of taxpayer money (en route to trillions) to cover their many mistakes. Now the automakers continue to beg for $34 billion more of taxpayer money to bail out their failed business models, and the lame duck Congress seems intent on funding the bailout in exchange for micromanaging the firms and their management, floating lame ideas like merging the two sickest car companies in the world (to make a healthy one?)

The airlines fixed their problems with bankruptcy, but apparently very few people (especially in the ruling party) are giving this serious consideration. The president-elect has written off bankruptcy (perhaps because it would end union contracts?) and seems firmly in the micromanagement-bailout camp. And now pundit Tom Friedman — without the responsibility of ever having to run anything — has shifted his emphasis back to the micromanaging camp and away from accountability.

The willy-nilly trend towards bailouts is being decried by at least some who know something about running an economy. Oliver Hart and Luigi Zingales wrote last week:

This year will be remembered not just for one of the worst financial crises in American history, but also as the moment when economists abandoned their principles. There used to be a consensus that selective intervention in the economy was bad. In the last 12 months this belief has been shattered.

Practically every day the government launches a massively expensive new initiative to solve the problems that the last day's initiative did not. It is hard to discern any principles behind these actions. The lack of a coherent strategy has increased uncertainty and undermined the public's perception of the government's competence and trustworthiness.
…
We believe that the way forward is for the government to adopt two key principles. The first is that it should intervene only when there is a clearly identified market failure. The second is that government intervention should be carried out at minimum cost to taxpayers.
…
Our desire for a principled approach to this crisis does not arise from an academic need for intellectual coherence. Without principles, policy makers inevitably make mistakes and succumb to lobbying pressure. This is what happened with the Bush administration. The Obama administration can do better.

Absent any sense of principles (or restraint), the temptation for politicians to use Other People’s Money (ours) to intervene in the economy and bail out failed companies is continuing unabated.

In November, Jon Fine of Business Week jokingly proposed under this same logic that the government should bail out newspapers, since their business models are also failing. Apparently Connecticut politicians are now seriously proposing such a plan. (Fortunately, the parent of the Los Angeles Times and Chicago Tribune, the Tribune Co., (TXA) would require a multibillion dollar bailout and so instead will fix its own problems using bankruptcy.)

The Libertarians over at Reason.tv have taken this bailout fever to its natural conclusion, bringing back Sock Puppet to ask for his own bailout — using the same arguments to save Pets.com as every other failed company.

Comments

[1worldcurrency:]

Paulson, Bernanke and pals decided Bear Stearns could not go bankrupt or the whole house of cards would collapse. The rest follows.

2008 Dec 09 03:03 AM

[James Wilson:]

What would be worse the bail out or a few million people who lose everything in their 401k, 403's and other retirement funds ? This will create a huge underclass of poor elderly Americans.

2008 Dec 09 05:49 AM

[John Anders...:]

The damage done by operating without principles is eloquently captured by Mr. West in this blog. This is the kind of measured, mature commentary that everyone in Washington, D.C. should be forced to read. We shouldn't fool ourselves however. Our new President will be under tremendous pressure to go ad-hoc. Here's hoping his appointees have those above mentioned principles to hold the line at this desperate moment.

2008 Dec 09 07:46 AM

[scfranklin94:]

James - propping up failing businesses only puts off the inevitable. Not that I'm a big fan of his, but Krugman is already calling for the next decade to be like Japan in the 1990's - deflation and economic contraction. So we can either spend money to keep people in make-work jobs with zero economic growth for a decade, or we can either let the market run it's course and try to set ourselves up for the best chance for economic growth.

2008 Dec 09 08:26 AM

[ChuckL1962:]

A Chapter 11 bankruptcy is in fact government micro-managing of the highest order. A judge (a government bureaucrat) decides who gets paid and who does not. I believe what we are seeing with government intervention is consistent with the principles of a Chapter 11 re-org but with the addition that the government is a funder of last resort and has skin in the game in addition to playing the defacto role a judge in a Chapter 11 proceeding would play. Rick Wagnor will probably be gone due to prodding by the Congress; is that not accountability? I believe what we are seeing is a modified version of a Chapter 11 bankruptcy necessitated by the significant adverse consequences which would result if a traditional Chapter 11 were to take place.

2008 Dec 09 08:41 AM

[sumosama:]

Guess you never learned how bankruptcy actually works...a trustee is appointed...to the point of comment above, this is micromanagement of the highest order.

You article is long on passion, but short on facts. LOANS are what is being requested by the auto industry.

The Fed, FDIC, ... all played a role in the current banking crisis.

2008 Dec 09 09:59 AM

[SW Richmond:]

Isn't it obvious? The government IS acting on principles; it's own. The first principle of government is getting money from lobbyists. How does one do that? By stealing money from taxpayers, putting it in a really big and visible pile, and then hinting that it's available. All you have to do then is wait for the lobbyists to start streaming in your door with "campaign contributions" so that you can guarantee them their share of the pile.

Bankruptcy doesn't provide nearly the same opportunity for this, so it will be avoided.

Think of the lobbying that will occur around the Obama Stimulus. The Democrats aren't wasting any time making it clear that it's their turn: "We're the gatekeepers now, pay".

2008 Dec 09 10:16 AM

[Enough:]

Then they shouldn't have been so invested in equities. Stocks are not risk free investments.


On Dec 09 05:49 AM James Wilson wrote:

> What would be worse the bail out or a few million people who lose
> everything in their 401k, 403's and other retirement funds ? This
> will create a huge underclass of poor elderly Americans.

2008 Dec 09 11:11 AM

[mrpos:]

Yeah, but Mr. Bush wanted to have everyone put their hard earned money into "private pensions" because they could get better returns on the stock market...


On Dec 09 11:11 AM Enough wrote:

> Then they shouldn't have been so invested in equities. Stocks are
> not risk free investments.

2008 Dec 09 12:34 PM

[billddrummer:]

The proposed bailout plan is a Chapter 11 without the social stigma. The money provided by Congress is acting as DIP financing, the Oversight Board (or Czar) would serve as the bankruptcy trustee, and the recommendations by Congress (labor concessions, plant closures, management changes) function as arbitrarily as a bankruptcy judge would in determining who gets paid and who doesn't.

Let's not try to call this anything but a reorganization outside of bankruptcy, because that's what it is.

2008 Dec 09 02:53 PM

[RUFUS2008A:]

Do not knock bankruptcy as a legitimate way to survive a turnaround with impossible long term contract obligations that can never be serviced out of profits. What is missing with GMS is cash flow. They falsely claim that bankruptcy would prevent anyone from buying. That is patently spin. It is false. Any turnaround CEO knows that financial deals are always possible to SELL something. The automakers have millions of unsold autos in parking lots all over the country. These can be sold off for SOME price, generating cash flow, and creating new customers as well. Sales drives more sales. A public lottery of selling cars, backed by the government loaning money to the purchasers keeps jobs, keeps manufacturing, creates cash flow, and solves the cash crisis for now. Putting cash into a failing business, with no prospects of sales or priming the sales pump is foolishness that only a lawyer Congressman would fall for. There are union jobs that MUST go away to survive the economic crunch...no matter what congress of the UAW want to do to pressure the taxpayers to pay for their salaries. This just takes immediate and strong action to create money flows and reduce outflows immediately. The management team that run GMC have NO experience in a turnaround, and NO ONE that the politicians select as a so called car Czar will make any difference because they will be looking to provided uneducated oversite, not to force immediate action and reaction that are needed. This will not be pretty for anyone, and the Michigan folks, the UAW folks and especially congress need to get out of the way and let some professional turnaround managers take this thing until the crises can pass.

2008 Dec 09 05:05 PM

[RUFUS2008A:]

Bankruptcy is not a court micromanaging anything. A trustee is appointed for debtor in possession. Management still runs the company. It just requires a detailed workout plan, and then appropriate trustee approvals for transactions of money above determined amounts. I have turnaround businesses through Chapter 11 and if you have any chance at all in making a viable business out of a financial disaster like the auto makers have created with their huge obligations for future payments in benefits, it is the only way to get out of an impossible situation. Imagine the US government having to suddenly cash flow social security with no new tax money. Can't be done. The only possible solution is Ch. 11...as no one would purchase these businesses as they stand, and no investor would put a nickle into them. The government is like a really stupid guy with a lot of money that is being told by an unscrupulous broker to invest in something that everyone else recognized as a dead man walking. Difference is, the Congress is not investing their money, nor are they liable for their fraud or their malfieasance.

2008 Dec 09 05:13 PM

[netskinner:]

Bankruptcy is better than management by Congress. No matter how dire, Congress management of the auto industry will be much worse. You want to buy a car with big earmarks all over it? Ugly! Expensive!

Bankruptcy is tough, yes. That is where they belong.

Congress does not have a better place to put them. The auto makers themselves spent like fools and have negative value.

Chysler? Wow, they are begging for $7 billion, which is 100% of their purchase price from the Germans for the Auto part (approx. $2.8 B and the Finance part (approx. $4.2 B). A bailout loan of 100% puts new meaning to zero risk investing. Why heck, anyone that knows how to beg can now be in the auto business.

2008 Dec 09 08:51 PM

[Jason Rines...:]

Since we will never know the outcome of no bailouts to anybody, I can only speculate. But here goes: Borrowing from the Fed to properly reinvest in upward mobility projects, government structured bankruptcies, nationalizing the banks would create tremendous additional chaos and a much harsher depression in the short term. What it would do is create the citizen backlash to root those out of Washinton and beginning elimination of the layers of corruption.

All we are doing now is stretching our the agonizing pain over a decade or more. Instead of having a massively booming market in a decade you have a lackluster one. Do you believe we will avoid another global conflict like what happened in WWI and WW2 which were spawned from global fiscal crisis? I don't. Malinvestment detracts from the necessary reorganization of our government and business community to be able to compete in the globalized economy. The events we see are the effects of too much power in the hands of too few and a sudden stripping away of the illusion of wealth from debt economy. In the debt economy, the VERY few prospered tremendously while the global citizen slowly but surely went bust. If we all enjoyed the party to some degree we should equally suffer the hangover and reorganization effort.


On Dec 09 05:49 AM James Wilson wrote:

> What would be worse the bail out or a few million people who lose
> everything in their 401k, 403's and other retirement funds ? This
> will create a huge underclass of poor elderly Americans.

2008 Dec 10 10:53 AM

[Jason Rines...:]

What you describe is the cause of voter revolutions. These have happened historically within a four year period of deep fiscal crisis. The citizenship finally gets off the couch and investigates whom should exit Washington. Roughly 1/3 is voted out of office in other voter revolutions. This one might be a bit more this time. Meanwhile the House will have it's way with the taxpayers.


On Dec 09 05:13 PM RUFUS2008A wrote:

> Bankruptcy is not a court micromanaging anything. A trustee is appointed
> for debtor in possession. Management still runs the company. It just
> requires a detailed workout plan, and then appropriate trustee approvals
> for transactions of money above determined amounts. I have turnaround
> businesses through Chapter 11 and if you have any chance at all in
> making a viable business out of a financial disaster like the auto
> makers have created with their huge obligations for future payments
> in benefits, it is the only way to get out of an impossible situation.
> Imagine the US government having to suddenly cash flow social security
> with no new tax money. Can't be done. The only possible solution
> is Ch. 11...as no one would purchase these businesses as they stand,
> and no investor would put a nickle into them. The government is like
> a really stupid guy with a lot of money that is being told by an
> unscrupulous broker to invest in something that everyone else recognized
> as a dead man walking. Difference is, the Congress is not investing
> their money, nor are they liable for their fraud or their malfieasance.

2008 Dec 10 11:09 AM

[BK GUY:]

This bailout is nothing like Bankruptcy. In Bankruptcy, all of the company's contracts (executory) can be accepted or rejected. In Bankruptcy, all payments to insiders (management) within the last year can be recovered. In Bankruptcy, the company is protected by an automatic stay. In Bankruptcy, a trustee can be appointed to investigate corruption and graft. Virtually none of these things will occur outside bankruptcy -- which is why this bailout is doomed to failure -- just like the others. This is a bailout for the UAW. Let's not kid ourselves.

2008 Dec 10 10:54 PM