The Detroit automakers should be allowed to fail, and here's why. This obviously isn't going to be a very popular post for people tied to the industry, but in the interest of sanity and the common good, here's my perspective, with GM's case being imminent.
The government should should not provide General Motors (GM) with the financing it is seeking at this time since it would be akin to throwing money down a rat hole. Mark my words, Congress will pass this bailout, but they shouldn't. By next summer, GM will be back with their hands out for money again. This "bridge loan" is a bridge to another handout.
Bankruptcy is not the end
When people hear "bankruptcy", they assume this is the total demise of an industry. The company's products and employees will disappear into the void. Quite the contrary. We felt comfortable enough putting ourselves and our families on airlines in bankruptcy, right? Just this decade, US Air (LCC) entered bankruptcy twice and emerged successfully. United (UAUA) was in the same boat; the list is quite long. I just flew US Air. Here's how this could work for GM:
Debtor in Possession Status
Wikipedia: A debtor in possession, in United States bankruptcy law, is a person or corporation who has filed a bankruptcy petition, but remains in possession of property upon which a creditor has a lien or similar security interest. A corporation which continues to operate its business under Chapter 11 bankruptcy proceedings is a debtor in possession.
- What is going on now is that the government is being asked to hand over $15 Billion in what will turn out to be a band-aid loan. This will not ensure the long term viability of GM.
- There is also NO Downside Protection for taxpayers under this scenario.
- Debtor in possession would put the government at the front of the line with respect to other debtors and the taxpayers would be assured a higher level of protection via the automaker assets than what is being floated now.
- With the debtor in possession route after GM declares bankruptcy, the government would have oversight over the new entity, allowing for more leverage over unions, suppliers and other factors influencing the slow death of the domestic carmakers.
According to Professor Edward Altman, famous for his Altman z-score company solvency model, he has calculated that with the recent bailout proposal whereby GM was seeking $18 Billion, even with the temporary infusion of cash, GM will be bankrupt within a year unless they continued to receive new funding. This is not a sustainable model and we should not beguile ourselves into this illusion.
Arguments For Bailout:
#1) People will be hesitant to buy a car without assurances that the company is a going concern.
Well, wouldn't you be more comfortable buying a car from a company that you know is backed by the US government with skin in the game and a more sustainable model? Under the current proposal, we may very well have to eventually cut bait, and consumers know this. GM may never start selling cars at a sustainable rate again under the current proposal.
#2) We'll fire all those guys who got us into this mess and the "Car Czar" will do things the right way!
Right, someone from the government is going to come in and save the auto industry. Since when has a government entity run anything better than private industry? Under the current constraints, these automakers simply cannot be competitive, no matter who's running things. We are in the midst of an unprecedented global financial meltdown. People are not buying new cars, especially in the face of questionable future warranties and support from the supplier.
Weak companies failing and newer, more competitive and innovative companies prospering is what made this country great. When we start intervening in the natural business cycle, we just prolong the inevitable and hinder our competitiveness within our borders. We all know, next comes the airlines, retailers, hotels/casinos looking for their handout. Where does it end? Clearly, GM should be allowed to fail and reinvent itself under more advantageous conditions.
If you feel that the likes of GM and Ford (F) are viable and will survive this, incredible money can be made from their corporate bonds as highlighted here. Caveat emptor.
Sources:
Wikipedia
Bloomberg Radio
Professor Edward Altman
Disclosure: No position in GM or Ford equity or bonds
